What Are Low/No Documentation Loans?
A low/no documentation loan allows potential borrowers to apply for a mortgage while providing little or no information regarding their employment, income, or assets. Regulation of these loans has evolved significantly since 2008, but they remain an option for some borrowers in nontraditional financial situations.
How Do Low/No Documentation Loans Work?
Borrowers who seek out these products tend to have nontraditional income streams that may be more difficult to document through a traditional mortgage application. Examples might include alternative investments or self-employment arrangements where the borrower minimizes income reporting for tax purposes. Lenders considering these loans often focus on the applicant’s credit score, ability to make a larger-than-normal down payment, and nontraditional documentation such as bank statements. Interest rates on these loans tend to be higher than those of traditional mortgages.
The Origins of Low/No Documentation Loans
A low/no documentation loan may sound like a throwback to the pre-2008 days of liar loans and subprime lending, but it remains an option for some segments of the mortgage industry. Historically, the concept originated in the build-up to the real estate crash of 2008. In the early and mid-2000s, there was substantial pressure on lenders to issue loans with favorable terms. Consequently, documentation requirements were loosened to the point that low-documentation products, including NINJA (No Income, Job, or Asset Verification) loans, became commonplace.
Loans like NINJA were often extended to borrowers based solely on their credit scores, without any further validation of the individual’s ability to make payments. This broad loosening led directly to the 2008 financial crash. As the housing market slowed, many borrowers struggled to keep up with their mortgage payments. In response, regulatory measures such as the 2008 Federal Reserve rule under the Truth in Lending Act (TILA) mandated verification of borrowers’ ability to make payments, which was solidified by the 2010 Dodd-Frank Act and subsequent rules finalized by the Consumer Financial Protection Bureau (CFPB).
The Return of Low/No Documentation Loans
While the riskiest low/no documentation loan categories, such as NINJA loans, largely disappeared post-2008 crisis and Dodd-Frank enactment, the ability to repay rule allowed for some leeway on low-documentation loans, creating a category known as alternative documentation loans.
In 2018, portions of the Dodd-Frank Act were repealed, loosening standards for qualifying mortgage classifications. Despite not modifying the ability to repay rule, these changes effectively made it easier for certain loans to avoid being labeled as low-documentation. Many smaller banks advocated for these modifications, asserting that stringent regulations were punitive for smaller lenders and argued such loans could support local communities and real estate market recovery with more flexible, albeit higher-risk, lending practices.
Related Terms: alternative documentation, NINJA loan, ability to repay, Dodd-Frank Act, credit score.
References
- Consumer Financial Protection Bureau. “Ability-to-Repay/Qualified Mortgage Rule”.
- U.S. Government Publishing Office. “The Financial Crisis Inquiry Report”, Page 6.
- Federal Register. “Ability-to-Repay and Qualified Mortgage Standards Under the Truth in Lending Act (Regulation Z)”.
- U.S. Government Publishing Office. “The Financial Crisis Inquiry Report”, Pages 6-7.
- U.S. Congress. “S.2155 - Economic Growth, Regulatory Relief, and Consumer Protection Act”.
