Liar LoanPriyanshu Ahuja
During the 2001-06 housing boom in the United States, they became extremely popular. The mortgages which were issued to borrowers who cannot disclose their earnings properly helped to drive a dramatic surge of defaults, and consequently disadvantaged themselves during the housing crisis.
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What is Liar Loan?
A liar loan is a category of mortgage where a lender does not verify the borrower’s income that can happen due to low documentation or no documentation. Some of the liar loans manifest in the form of NINJA loans, an acronym in which the borrower does not have “no revenue, no employment, no assets.” They referred to mortgages that allow borrowers to misrepresent data on the lending application, in order to induce dealers to strike deals with a greater incentive than screen applicants. This falsehood is mainly present in low or no-documentation loans, where most of the information reported is self-reported without stringent verification. As the real estate market has continued to rise, lenders become more lenient when it came to carrying out checks on individuals who borrow money.
How does it work?
At first, these types of loans were designed to support borrowers who have undocumented incomes. Liar loans mostly benefited borrowers with large down payments that did not want their income to be verified. It gave individuals with non-traditional sources of income to become homeowners. For example, an applicant such as a contractor would have to state he was paid in cash. The client of the contractor would have to conform to the lender that the contractor was paid in cash. Without having seen any paperwork, verifying the applicant’s income, the borrower would then be given a mortgage loan. Financial advisors, by encouraging such mortgages, believed they would enter a subordinate part of the real estate market – borrowers with strong credit but who could spontaneously disclose income or self-employment.
How it let to the financial crisis 2008:
According to Bennie D. Waller, Professor of Finance and Real Estate at Longwood University, liar loans were readily available but led to problems. Such loans were a significant contributor to the housing crisis of 2008. In the financial crisis of 2007-2008, the main cause behind as house prices began to fall slowly but nobody noticed that. Banks were giving loans to many people without properly verifying the documents, source of income i.e. liar loans.
These loans are considered liar loans because they unlocked the gates to fraud when borrowers, mortgage brokers, or loan officers exaggerate income and/or properties in order to be eligible as borrowers for a bigger loan amount. In order to obtain low or no documents, they misrepresented stats to facilitate the selling of a property that would not otherwise be approved.
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Following the sub-prime mortgage crisis, financial regulations tightened, resulting in the existing rarity of the liar loans. Fortunately, they are now a thing of the past. The Dodd-Frank Act bans any kind of loan based on the inherently ‘quality of loans. The Act bans liar loans. Additionally, Dodd-Frank established a gateway for all mortgages that comply with government guidelines. The stated income loans can no longer be offered by the lenders. The earnings of all borrowers should always be evaluated in the underwriting process.
Author – Priyanshu Ahuja
About the author – I’m a first-year student from City Premier College, Nagpur, pursuing BBA. My interest includes financial markets and investment domain.