Alternative documentation loans are making a comeback through non-traditional lenders. These are the lenders that keep the loans they fund on their books rather than selling them on the secondary market. These lenders can make up their own requirements and not have to deal with the Qualified Mortgage guidelines. They still have to pay attention to the Ability-to-Repay Rule so that they are not giving borrowers loans that they cannot afford, but nonetheless, they can pretty much offer whatever they want without restriction on what they can charge. What does this mean for interest rates on loans that do not have full verification? In simple terms – the rates will be higher. But just how much higher is up for debate.
Making up for the Risk
Essentially, when an interest rate is higher it is because you pose some type of risk to the bank. This means that a person that qualifies for a conventional loan will likely have a much lower rate than someone that takes on an alternative documentation loan, such as a stated income or stated asset loan. This is because a person with a conventional loan has good credit, verifies their income with paystubs, W-2s, and/or tax returns, verifies their assets with bank statements, and puts down a nice sized down payment. A person with a non-traditional loan might be self-employed or have a job that relies heavily on commissions or bonuses and therefore does not have steady income. Their paystubs may show very little income right now, but they have large income coming in within a few months. This does not bode well for full verification loans, which is why borrowers turn to stated loans. With the ability to use bank statements in lieu of income documents or to state the amount of assets a person has on hand, the borrower can look more attractive to the lender.
The problem lies in the fact that the second borrower is much riskier than the conventional borrower so the lender needs to compensate for that risk. Generally, there are only a certain number of points they can put on the loan to make the money up front. In order to get the remaining money, they increase the interest rate. This means that they get more money over the life of the loan, assuming you do not default on the loan. The difference in interest rates could vary from .25 percent higher to 2 or more percentage points higher. It depends on the other factors that you bring for qualification purposes.
Bringing the Rate Down
The good news is that you do not always have to pay the 2 or more points on the loan if it is stated income or stated asset. If you have compensating factors that make you look like a strong borrower, the difference in the interest rate from a conventional loan might not be as severe. For instance, if you have good credit, a large down payment, or steady employment that can be verified even if the income cannot, you can make up for the risk your alternative documentation loans provide. Lenders are always looking for strengths in a borrower’s file, so whatever you can do to make yourself look financially responsible, the lower your rate will get. A credit score over 700; a down payment higher than 20 percent; and employment in the same industry or with the same employer for more than 2 years are great examples of compensating factors that can help bring your interest rate down.
In the end, yes, your interest rate will be higher on alternative documentation loans than fully verifiable loans, but they do not have to be unaffordable. There are many lenders today that offer a variety of products for you to choose from. The industry is slowly loosening up to make it possible for borrowers from all walks of life and financial backgrounds to get back into home ownership. Take the time to apply with various lenders to find the loan that is right for you!