Richard's Real Estate Thoughts: Liar loans back? Forbes headline says maybe so

Forbes has run an article proclaiming that Liar Loans are making a quiet comeback. The headlines may cause concern, but the actual article does not. There needs to be room in mortgage lending for low and alternative documentation lending.

First of all, liar loan is a phrase that was quickly applied to all alternative documentation loans, unjustly in my opinion. It is especially handy for politicians who love neat catch phrases that suit their soundbite campaigns. Another catchy phrase that has caught on is "skin in the game."

I have always thought the phrase "liar loan" to be misleading and misapplied in its common useage. The low documentation lending grew to unmanageable numbers and began to ignore any standard of underwriting and risk balance - with stated fixed income, stated W2 income, weak credit standards including credit depth as well as credit quality, high LTV, even high LTV investment and cashout loans, and other examples of underwriting neglect.

But the reaction evidenced by lumping all forms of alternative documentation lending under the name "Liar Loans," has added to the loss of the pool of qualified buyers which is creating the growing inventory of unsold homes.

Not all alternative documentation loans should be lumped under the name "liar loan". There are other underwriting criteria that might be used to qualify a mortgage - equity, liquid assets, future earnings, credit. There is a good market in strong borrowers who would qualify for mortgage loans with reduced or alternative documentation. We do not need to ignore this market because of the mistakes caused by a total lack of underwriting responsibility.

Secondly, the loans described in the article are not loans with low underwriting standards. The loans have very high underwriting standards. The standards just may not include income and debt ration, but there are strong balances to the lack of income documentation.

The Financial Reform Act includes strong incentive to offer only mortgages underwritten to traditional guidelines. The incentive is that a healthy amount of risk retention is required for loans that do not meet the standards in the legistation that define "qualified mortgage." This however omits a significant market of strong borrowers. It comes to my mind that a US Representative might not meet the standard guideline that income must be expected to continue for 3 years?

Anyway, not all alternative documentation loans were accurately described as liar loans. The media and Congress have attempted to paint with one brush, and I think have colored the housing market  red using that one brush. I hope that the Financial Reform legislation does not make that red brighter and deeper.