Home Mortgage: Strict Loan Documentation Standards and Housing Bubble

The housing bubble and the result is what we are witnessing these days. The fabrication of income largely by borrowers and its encouragement by lenders has contributed to the housing bubble. Loan programs for stated income was very popular and lead to rise of uncertainty where second mortgages were concerned. The lenders were not sure if the billions of dollars that they had lent would be paid back and this largely contributed to the deflation of housing bubble. The investors had no way to ascertain the financial capability of the borrowers.

Thus secondary mortgage market lost all its credibility. State income programs were discouraged and were affected by the credit crunch faced by the country today. These initial casualties of housing market should be totally eliminated. There were no more funds and fraudulent dealings should have been used as reasons for stopping the continuation of these programs.

There is a usual argument that document preparation fees would be increased if the documents have to be prepared correctly and accurately. If the lenders and borrowers could be penalized for this misappropriation then certainly more importance, time and money would be spent on it. A little bit of increase in fees while availing a loan for hundreds and thousands of dollars is minimal inconvenience when compared to uncertainties that lenders face regarding the fate of his loan. Some additional expenses would allow both lender and borrower to reap benefits.

Laws should be passed to ensure document adequacy and authenticity. For example to establish work history of a borrower only one W 2 form is not enough, but there is also no need for two years worth forms. Salaried people are less problematic, to determine the financial capacity of a self employed person is more difficult. Theoretically self employed people have to give details of their income to the government as Schedule C reports or as corporate K-1s.

These documents do not show the complete income of self employed people. They are usually understated. The tax deductions are also availed by these self employed people. Thus they get both benefits. If tax returns papers are used as proof of income for the self employed during loan applications many discrepancies can be done away with. Businesses that have just begun or have completed only one year might not be able to meet the income standards necessary for long term loans and these can be separated from the real deserving ones.

The bursting of the housing bubble was a blow to lenders who were lax in their paperwork. Since the main burden of paperwork essentially falls on the lender the mistake is also theirs. Borrowers are also to blame since they have fabricated and misrepresented themselves. Lenders can go to the law against borrower. They can file a civil suit against the borrower for misrepresentation of documents. There are no criminal charges that can be levied. The civil suits are expensive, cumbersome and time consuming hence very few lenders opts for it.

Tightening of documentation rules and standards would be able to curb and avoid many fraudulent deals.