debt to income ratio mortgage

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					                                                                               Daryl Hill
                                                   Head of Distribution – Group Executive
MEDIA RELEASE                                                           FEBURARY 2004

Low Doc History – A Briefing Paper
Most house buyers work for a steady paycheck and are willing to divulge details of their finances in
exchange for the best available mortgage loan; typically nowadays referred to as “prime borrowers”.

But a lot of house buyers don’t draw a steady paycheck from their boss:

       •      Some, live on a Contract by Contract basis (IT personnel, cleaners, etc…) and have
              difficulty substantiating historical wage history or their taxation returns reflect deductions
              which result in tax driven returns not adequately reflecting their true capacity to repay a

       •      Others notwithstanding the GST, still get their income in cash;

       •      Still others, live on investments – or an inheritance; and

       •      Some own businesses, and wish to expand their business but are constrained by Bank
              global credit limitations on security type, region or security location.

Limited-documentation mortgages are available and a practical solution for such borrowers. In the
market such loans are now called “low-doc” and “no-doc” mortgages due to the reduced amount of
documentation they require. The terminology isn’t however always accurate. Some low-doc mortgages
require the borrowers to give up lots of paperwork, such as tax returns and profit-and-loss statements,
trading or bank account statement history. Even a ‘No-Doc’ mortgages usually requires at least a credit
report and a property appraisal however several major Australian Banks are not requiring valuations in an
effort to compete and in one notable case allowing borrowers to borrow up to 95% without independent
valuation or independent credit check of the borrower being undertaken

The type of borrower a low doc loan appeals to are those consumers who pay for the flexibility and
privacy of these types of mortgages. They normally carry higher interest rates than conventional
(“prime” or “conforming” two other terms used) mortgages. As a general rule lenders will want these
borrowers to have substantial equity in the property offered as security (low doc loan-to-valuation ratio’s
are historically below 80%) and to have excellent unblemished credit history when checked.

Types of Low Doc/No-Doc Mortgages

There are four (4) main types of low-doc/no-doc mortgages.

       •      Stated-income mortgages: tend to be for people who work, but don’t draw regular wages
              or a salary from an employer. That includes self-employed people or those who make a
              living off commissions or tips. As verification of capacity to repay in this type of mortgage
              the borrower certifies they can afford to repay the loan amount sought thus the description
              “stated income” and no further checks or independent substantiation is required by the
La Trobe Financial                                    -2-

        •       No-ratio loans: Is often the right call for wealthy people with complex financial lives,
                retirees who live off investments, and people whose lives are in flux because of divorce,
                recent death of a spouse or career change. In the Australian market, such loans are better
                known as an “asset lend” as the testing of income to repayment ratio is not normally
                compiled by the lender in their assessment of the credit worthiness of the loan.

        •       No-doc or NINA (No Income No Asset verification) mortgages: are for creditworthy
                people who want maximum privacy and can afford to pay for it. Here there is no loan
                application form requiring the borrower applicant to disclose their income or asset and
                liabilities (generally referred to as a borrower’s statement of position). These loans are
                uncommon in Australia.

        •       Lite Doc loans: are a more disciplined variation of a ‘stated income loan’ and are more
                inclined to be used by conservative lenders who would prefer to see some form of
                independent verification of the borrower applicants income, and assets. This is achieved by
                a personal written attestation by the borrowers taxation accountant – that is some one
                independent from the benefits flowing from the ultimate borrowing - as to “in the
                accountants opinion their client can afford to make the monthly loan repayments of $x, on
                the loan amount of $Y at the current rate of interest proposed”. In all other respects the
                borrower completes a full loan application form, including a statement of their assets and
                liabilities, a full independent valuation of the proposed security is required, and a complete
                credit history check is conducted on the borrower

Regular people would get regular, conventional mortgages supported by lots of documentation –
typically, three (3) months of paycheck stubs, three (3) months of bank statements, letter of income and
employment from employer and complete income tax returns from the past two (2) years or their most
recent Group Certificate lodged with the Australian Taxation Office (“ATO”).

State-Income Mortgages

Someone who gets a stated-income mortgage must disclose annual earnings, usually for the last two (2)
years and sometimes more. Instead of backing up the income statement with pay stubs and letters of
income and employment, the borrower might have to show tax returns, bank statements and even profit-
and-loss statement.

The borrower must list assets and debts. That’s why the term “low documentation” for stated-income
mortgages isn’t always accurate. Stated-income mortgages are for people who make the money they say
they make, but that amount doesn’t show up on the bottom line of their income taxes.

They work for cash; they might be cleaning people or people who work in restaurants. It is also good for
self-employed borrowers who actually make gross sufficient amounts of income, but they write off on
their taxes. They have the capacity to pay the loan back.

The borrower has to list debts because the lender wants to determine the debt-to-income ratio. That’s the
percentage of gross income that is used to pay off debt. Lenders look at two ratios: the percentage of
income that goes toward the mortgage payment, and the percentage that goes for all debt, including
mortgage, credit cards, car loans and other loans.

A rule of thumb states that the interest rate on a stated-income mortgage should be about 0.50% p.a.
above the comparable rate for a conventional mortgage. Like all rules of thumb, that’s sometimes
accurate and often isn’t.

A borrower’s interest rate depends on a lot of things: income stability, debt-to-income ratio, size of the
equity (loan-to-valuation ratio) and value of the property. Depending on those variables, A borrower with
a stated-income mortgage could expect to pay anywhere from 0.25 above the conventional rate to more
than 1 percent above.

This might be the right mortgage for someone who earns commissions by selling things or for the cash-
earning employees.
La Trobe Financial                                  -3-

No-Ratio Mortgages

With these mortgages, the borrower doesn’t declare income. No pay stubs, letters of income, no tax
returns. Think of it as the “don’t ask, don’t tell” mortgage: The lender doesn’t ask how much the
borrower earns, and the borrower doesn’t tell.

These are called no-ratio mortgages because the lender doesn’t compute the debt-to-income ratio. The
lender can’t compute it because the lender doesn’t know the borrower’s income. Sometimes the borrower
doesn’t supply a list of debts, either.

But the borrower does list assets – money in the bank, shares and bonds, real estate, ownership stakes in
businesses – statement of assets and liabilities.

The purpose of the no-ratio program is to provide expedited processing for creditworthy borrowers; it’s
not intended as a means to qualify marginal borrowers.

Someone who owns ten (10) car dealerships might apply for a no-ratio mortgage because a conventional
loan could require submitting personal and corporate tax returns and a year-to-date profit-and-loss
statement for all dealerships. It might cost him more to assemble that from his accountant than it would
cost in rate.

This type of loan also can be for someone going through a big change, such as a divorce, death of a
spouse, a career switch or retirement.

There are those who basically retire, say, cashed out of my business and got $3 million and I invested it
and I’m going to make 10 percent. That can’t be documented. That’s a person which might get a no-doc
loan until they get a track record of making money.

These also are for people who say, “I don’t want to tell my whole life story to someone, so I want to pay a
premium rate not to do that”.

The rate for a no-ratio mortgage would start out at about a 0.50% above the rate for a conventional
mortgage and might be up to 3 percent higher, depending mostly on the property Valuation.

This type of mortgage might be just right for those who own a business and are going through lots of
changes; death of their father, a career change and so forth.

No-Income/No-Asset Verification Mortgages (NINA/ No DOC mortgages)

These loans, sometimes known as “NINA” or No DOC Loans need the least documentation. In some
cases the borrower provides his or her name, Medicare or Drivers Licence number, the amount of the
equity LVR and the address of the property being bought. That’s it. The lender gets a credit report and a
property valuation.

The lines get fuzzy between no-ratio and NINA mortgages. A lot depends upon the borrower’s credit
with the credit check. The better the score, the less documentation the lender will demand. In many
cases, the lender will want to know what the buyer does for a living and for how long. Lenders feel more
comfortable with a borrower who has been doing the same job for at least two (2) years.

In any case, an excellent credit check score is required. These mortgages are for people who never, ever
fail to pay bills on time. Actually they’re for people who employ assistants to pay the bills on time.

They’re meant for people who zealously guard their privacy.

The less documentation, the higher the rate. Some getting a no-documentation mortgage might pay up to
0.75 percent higher than the going rate for fully documented conventional mortgages.

It’s always a layered risk situation. The size of the equity involved is one layer – the bigger the equity,
the lower the risk and the lower the rate. The same goes for willingness to show ownership of assets, and
the degree of openness about what the borrower does for a living.

La Trobe Financial                                   -4-

Lite® Doc – La Trobe

First introduced by La Trobe as a ‘pilot scheme’ in October 1990, we now have the longest track record
in Australia as to “low doc” loans and how they perform over time in a portfolio of mortgages. It is
important to note La Trobe’s Lite Doc® mortgage is not a ‘derogatory credit’ mortgage that is we have
always required our Lite Doc Borrowers to have an excellent Credit record. This is borne out by our ten
year historical loss severity ratio up to 2002 for such low doc loans – (i.e. their arrears ratio is 4 times
higher than a conventional prime loan but the loss ratio is exactly similar at less than 1% overall). The La
Trobe Lite Doc loan is merely a “prime mortgage security” with less paperwork vis-à-vis income
verification to a non-conforming borrower (someone who cannot substantiate loan repayment capacity
through conventional documentation methods). La Trobe lends on occasion to non-conforming
borrowers, but we always secure our loan against conforming Prime property types.

La Trobe’s Lite Doc loan provides a very flexible range of products serving the self-employed, contract
workers, recent immigrants, older borrowers, and those unusual deposit sources. All La Trobe products
are Uniform Consumer Credit Code (“Code”) compliant, whether the borrower falls within “Code”

Hypothesis: Why Interest Only Loans Dominate the Low Doc Sector

Consumers, not lenders, have apparently lost interest in amortizing their home mortgages – tied in with
the current trend in western societies for individuals to hold higher lifestyle aspirations – “spend now and
enjoy life” thus the huge explosion in the demand for line of credit ‘equity’ loans where borrowers have
really a giant credit card mortgage on their home that they can draw upon at any time. The overseas
experience of these ‘equity line of credit loans’ as an aside is that only around 3% of borrowers actually
pay them off like a conventional loan and the rest just live on debt.

Borrowers are also are holding onto their mortgages for a shorter and short periods. People are
refinancing everywhere from every 1 year to 4 years, whether for relocation purposes or because they
simply wish to refinance, and this is likely to increase as brokers become the dominate preference of
Banks as the means for retail distribution of Bank mortgages and other products. Therefore a loan term
amortizing loan lasting 30 or more years, where in the first five you are only repaying predominately
interest only anyway, is to the short term thinking individual somewhat redundant to their future personal
financial planning.

However it is Brokers, above all else, who in our view are driving the demand for ‘Low Doc’ product as
it is they, more than the borrowers, who want to create the shortest possible paper trail when applying for
finance for the applicant – quick approvals and settlement means the broker receives their income earlier
than a conventional loan. I think its safe to say that from a borrowers perspective they are not nearly as
interested in the speed of approval, nor in owning their home outright as their parents had in the past for
their retirement, as in their view they are only acquiring a quality piece of property that will build equity
for them in the future through appreciation and equity that they can utilize in ways previous generations
would scoff at.

That’s a major selling point for the interest-only loan, especially in high-ticket housing markets. On a 30-
year amortizing loan of $500,000.00 at 6.5 percent fixed. The initial monthly payment would be
$3,160.00, with $2,708.00 going to interest and $452.00 toward principal. With an interest-only loan, the
fixed monthly payment would be $2,708.00 (14.3% lower in repayment dollar terms).

La Trobe Financial                                                                 -5-

Australian Mortgage Market segmentation

Only five years ago if you had approach someone in retail banking and asked if they did low doc/ sub-
prime lending you would have got a “please explain?” from the banker. Once explained to the banker
they would have politely stated such ‘loans’ would not meet the Banks higher standards for mortgage
lending and borrower qualification. Similar responses would have been received from any one of the four
independent loan mortgage insurers in Australia at that time (i.e. “no that type of business is below us”).

Well from 2001 to 2006 is a long time, and their now appears to be many new coverts (x-critics) to the
new ‘low doc’ religion. This has been a positive to the market enabling a better understanding by those
operating in the market and a deeper analysis of the underlying credit risk of different borrower
categories. The Australian mortgage market can now intelligently be segmented from the risk perspective.

Below is a basic illustration of the segmentation in the current Australian mortgage market bound by the
Prime lenders at the one end, and the Hard-Money or “D” lenders at the other. In between are various
segments, loosely termed non-conforming.

                                                     AUSTRALIAN MORTGAGE MARKET SEGMENTS
     C                                                                               NO BAD CREDIT
     F          PRIME
                Code Compliant                            Rates = 6.3-6.8%
     O                                                    Investment/owner-occupied
     R                                                    Often mortgage insured, particularly at higher LVRs
     M                                                    Long Term 300+ month Principle and Interest repayments

                LO DOC                                    Rates = 6.3-7.5%
                Non-Code/Code                             Nearly always non-code due to serviceability uncertainty
                                                          Usually mortgage insured > 80% LVR, usually shorter term 1-5 years
                                                          No material credit impairment
                                                          Some Long Term 25 year mortgages
     N                                                    Self-employed (code/non-code) – no financials
     O                                                    Available for start-up businesses.
                                                                             Impaired CREDIT HISTORY
     N          “SUB-PRIME”                               Rates – 7.54-12.19% - Loans to $1M per security
     F          NON CONFORMING                            Credit impaired (no limit on number or size of default) BAD CREDIT MORTGAGES
     O          Code Compliance                           Investment/owner occupied $3M max per borrower
     R                                                    Long Term (notional) 25 years
     M                                                    LVR Low doc 95%
     G          ASSET/EQUITY                              Rates – 6.5-14%
                LENDING                                   Usually lower LVR than normal 66% average.
                Non-Code                                  Nearly always non-code due to serviceability uncertainty, BAD CREDIT

                HARD MONEY LENDING                        Rates = 14-29%
                Non-Code                                  Sometimes called ‘payday’ or “D” lending
                                                          Often shorter terms, high rates, terms 90-180 days
                                                          Often (but not always) non –code
                                                          LVR < 66-70%

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