What Are Mortgage Documentation Requirements?

5 October 2005, Reviewed February 2, 2011

Comment on February 2, 2011: This article is obsolete in the sense that the various documentation requirements described  are no longer available. In the post-crisis market, full documentation is the rule, see The Problem in 2010 Is Underwriting. Nonetheless, I decided to retain the article unedited because of its historical interest. Someday, a  happy medium may be found between the extreme rigidity of a full documentation requirement for everybody, which leaves many good loans unmade, and the excessive liberality involved in designing a documentation rule for every possible circumstance.

What Does Mortgage Documentation Consist Of?

A lender’s "documentation requirements" stipulate a) the information about income, assets and employment that must be provided; b) whether and how this information will be used by the lender; and c) whether and how the information provided will be verified by the lender.

Verification is of three general types. “Stated” means that there is no direct verification of the borrower’s claim. “Fully verified” means that the lender obtains written confirmation from the relevant third party, usually an employer or bank. In-between these extremes, lenders may accept evidence provided by the borrower, such as W2s and tax returns, or verbally by an employer or by the CPA of a self-employed borrower.

The Types of Documentation Requirements

The table below lists the major documentation categories, from the most restrictive to the least. Not every lender follows this pattern exactly, but most of them do.

 Type of Documentation  Type of Information
Income Assets Employment
Full  Fully verified by lender  Fully verified by lender  Fully verified by lender
Alternative  Lender accepts W2s, bank statements, verbal verification of employment
 Stated Income Stated  Fully verified  Verbal verification
 No Ratio  Not reported  Fully verified  Verbal verification
 Stated Income/Stated Assets Stated Stated  Verbal verification
 No Income/No Assets (NINA)  Not reported  Not reported  Verbal verification
 No Docs  Not reported  Not reported  Not reported

How Lenders Use Documentation Requirements

Because lenders view loans with weaker documentation as riskier, they often vary their documentation requirements with other features of a loan that affect risk, such as the loan type, down payment, loan purpose or credit score. For example, a lender might require full documentation on investment loans but allow more liberal documentation on loans to purchase the buyer’s primary residence.

Lenders also adjust prices for documentation. The table below, taken off a lender’s price sheet, is typical. It shows, e.g., that a NINA loan larger than 75% of value and used to secure the borrower’s primary residence will carry an interest rate .60% higher than the same loan with full documentation.

Interest Rate Adjustments For Less Than Full Documentation

   Loan-to-Value Ratio Less Than 75%  Loan-to-Value Ratio More Than 75%
Primary Home    
 Stated Income  .15  .40
 No Ratio  .20  .45
 NINA  .35  .60
Investment Property    
 Stated Income  .50  .75

How Borrowers Should View Documentation Requirements

In general, borrowers do better providing full or alternative documentation, if they can. It is because so many borrowers cannot that the other forms of documentation were developed. If they can’t document fully, they should seek the most restrictive form with which they can comply.

Full documentation:
Full documentation means not only that income and assets are disclosed and fully verified, but also that the income so disclosed and verified has come from a consistent source for 2 consecutive years. The borrower must have had the same employer for that period, or if self-employed, must have been in the same business. This rather than the difficulty of providing documentation is what trips up most of those who don’t qualify.

Alternative documentation: Sometimes called “Limited Doc” or “Fast Forward”, this is a modification of the verification requirements of full documentation. It is not priced higher, but borrowers may have to exceed some credit threshold to qualify. The intent is to save time. But the 2-year income rule applies to alt doc as well as to full doc.

Stated income: Under this rule, income is disclosed and the source of the income is verified, but the amount is not verified. It is the most widely used type of less-than-full documentation.

Self-employed borrowers often go stated income because their tax returns don’t reflect the actual cash flow they have available to pay their mortgage. Stated income may also be used by borrowers who can’t meet the two-year rule, perhaps because they have recently changed jobs or received a promotion.

Another possible stated income case involves couples with two incomes where only the income of one is used to qualify, perhaps because the other has poor credit or for some other reason. (See Should You Lie to Get a Better Rate?”). The income stated will include both incomes. However, this won’t work if that income is not consistent with incomes earned in the type of business or line of work in which the qualifying borrower is employed.

Under stated income documentation, assets must be verified and must meet an adequacy standard such as, for example, 6 months of stated income and 2 months of expected monthly housing expense. Self-employed borrowers usually have no trouble meeting the asset requirement.

No ratio: Under this rule, income is not disclosed, and therefore it is not used in qualifying the borrower. The standard rule that the borrower’s housing expense cannot exceed some specified percent of income, is ignored. However, assets and employment are disclosed and verified.

No ratio loans are for people who, for a variety of possible reasons, don’t want their mortgage-payment capacity judged by conventional housing expense ratios. The most important of these is the ratio of mortgage payment plus taxes, insurance and other debt payments, to income. While the application of these ratios has become much more flexible than it used to be, it remains a central cog in the underwriting process.

Borrowers electing the no-ratio option may be accustomed to living with very high ratios, perhaps because they have dependable sources of family support. Perhaps their other debt payments are unusually (but temporarily) high. Or their income may be largely from investments and they are disinclined to try and convince an underwriter that it is sufficiently dependable to be counted.

Couples with two incomes where only the income of one is used to qualify may also go no-ratio if stated income is not available. This would be the case if the qualifying borrower is not employed in a job or business that is consistent with a stated income that includes both incomes.

Stated income/stated assets: Under this rule, both income and assets are disclosed but not verified. However, the source of the borrower’s income is verified.

This rule is used by the same types of borrowers who go stated income when they can’t document their assets as well as their income. Some borrowers refinancing with cash out, who use this cash to meet their closing costs, use this form of documentation. Stated income borrowers who will be gifted the cash needed to close, can’t document their assets and may use the rule. It may also be used by real estate investors who purchase and finance multiple properties but hold very little cash for more than short periods.

No income/no assets (NINA): Under this rule, neither income nor assets are disclosed, but employment is verified. NINA is attractive to borrowers averse to disclosing anything about their finances, and it has the great virtue of simplicity. However, lenders will expect the borrower to have a job or a business.

No Docs: Under this rule, neither income, assets or employment are disclosed. This makes it the simplest of all to the borrower, and the riskiest of all to the lender. Ordinarily, it will only be offered to borrowers who have good credit.

Professionals moving their practice from one community to another may use no docs because they have no income, employment or business they can document. Borrowers with little income, no assets and poor credit but with a lot of equity may qualify for a sub-prime no doc loan.

While the documentation categories discussed above are fairly well established in the market, there are numerous differences between individual lenders in the details. For example, under a stated income program lenders may or may not require that applicants sign a form authorizing the lender to request the applicant’s tax returns from the IRS in the event the borrower defaults. Similarly, lenders verifying assets differ in the amount of assets they require.

Why Is There Such Complexity in Documentation Requirements?

Lenders have realized that many consumers with the potential for home ownership were shut out of the market by excessively rigid documentation requirements. It also dawned on lenders that documentation could be viewed as a risk factor that could be priced or offset by other risk factors.

Full documentation is the least risky to the lender, no docs is the most risky, and the others are in-between. If the documentation is riskier, lenders will charge more, require risk offsets, or both. The most important risk offsets are large down payments and high credit scores.

This change in lender attitudes toward documentation is similar to the change that occurred in connection with credit rating. At one time, lenders would only deal with what are today classified as "A credit" borrowers. Now, loans are available for "B", "C" and "D"-credit borrowers, but they are priced higher and may require offsets by other risk factors.

The change in attitudes toward both credit rating and documentation requirements has expanded the market.

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