Comptroller Dugan Expresses Concern Over ‘Stated Income’ Subprime Loans

NEW YORK—Comptroller of the Currency John C. Dugan said today he is increasingly troubled by the growing use of unverified "stated income" in subprime lending, and said he believes the federal agencies should address the practice in pending guidance.

"Sound underwriting – and, for that matter, simple common sense – suggests that a mortgage lender would almost always want to verify the income of a riskier subprime borrower to make sure that he or she had the means to make the required monthly payments," Mr. Dugan said in a speech to Neighborhood Housing Services of New York.

"But the norm appears to be just the opposite: nearly 50 percent of all subprime loans last year accepted stated income," he said.

Mr. Dugan noted that in a market where house prices are rising, the risks of stated income loans are masked, since borrowers can refinance if they run into trouble.

"As a result, the rapidly rising housing market of 2003-2005 was the perfect Petri dish to incubate the widespread practice of stated income loans," he said. "At a very fundamental level, it was a bet that the increasing value of a borrower's collateral would offset any inadequacy of the borrower's income."

However, he added, we are now seeing the results of stated income loans in a market where house prices are falling or failing to increase, and the consequences have been rising delinquencies and foreclosures, with serious costs for families and communities.

While reliance on stated income is not the only cause of today's problems, Mr. Dugan said, "I do find it telling that, when faced with new housing market conditions, lenders have responded first by tightening standards on stated income." In addition, he said, one of the first things loan servicers do when trying to decide whether to restructure or foreclose on a mortgage is to seek verification of income.

"Apparently verified income is viewed as a critical factor in determining whether a loan can be saved, which of course begs the question: if loan verification is such an important predictor of the borrower's ability to repay in the current environment, why wasn't it equally important when the loan was first made?" Mr. Dugan asked.

The Comptroller said there are clearly some circumstances in which reliance on stated income is appropriate, such as a straight refinancing that doesn't involve a cash take-out and which is underwritten by the same lender. The lender not only has experience with the borrower, but knows that the new mortgage will be more affordable, and hence more secure, than the one it replaces.

But he said such uses of stated income lending should be the exception, rather than the rule, for three key reasons:

• Stated income is too great a temptation for misrepresentation and, in its most extreme form, outright fraud.
• The practice also undermines transparency: "How can lenders seriously talk about debt-to-income ratios, for example, if the denominator of 'income' is really an unknown variable that can be whatever the borrower says it is?" he asked.
• It is not a safe and sound underwriting practice to make mortgage loans that substitute future house price appreciation for borrower income as a key source of repayment, as appears to have been the case in many subprime loans underwritten in the last few years.

Mr. Dugan noted that the use of stated income has been addressed by the federal banking agencies in guidance on home equity lending and nontraditional mortgages.

"Now we must decide whether to address the practice even more strongly in the context of finalizing the guidance on subprime lending," he said. "For the reasons described above, I believe we should, although how we do so and the extent to which we do it are of course decisions that should only be made after careful consideration of the comments we have received."

Related Links

• Remarks before the Neighborhood Housing Services of New York
• Comptroller of the Currency John C. Dugan