A low documentation loan is a type of home loan where the applicant does not need to provide very much information on the paperwork. There are a number of reasons why a borrower might pursue a low documentation loan, and it does come with a cost. Such loans typically charge much higher interest than conventional loans. Not all banks offer this service and those that do may not extend it to all borrowers.
In a basic low documentation loan known as a stated income loan, the borrower provides information about her income and the bank determines whether to offer the loan on the basis of the loan-to-value ratio, the amount the borrower needs as opposed to the value of the property. The bank can also look up the borrower's credit score to determine risk. Another variant, the no-ratio loan, allows borrowers with substantial personal assets to take out loans without providing personal information.
The low documentation loan may be an option for borrowers who want privacy. Some borrowers may have concerns about disclosing financial information, especially if they are engaging in activities like tax evasion and do not want to alert tax authorities to their true income. Other borrowers may seek a low documentation loan to push through the mortgage process and close a loan quickly. Since the bank has less paperwork to review, it can determine whether it wants to grant the loan faster.
This is a form of alternative financing. Borrowers need to consider a low documentation loan carefully, as the high interest rate may be a significant disadvantage. Taking some extra time to collect paperwork may make the loan process more sluggish, but will result in substantial savings over the long term, as more documentation usually means a lower interest rate. If the borrower plans to refinance to access lower interest, it can be advisable to talk about refinancing options with a broker to determine whether another lender will be willing to refinance the loan.
Some of the alternative names for this type of loan reference its poor reputation in the financial community; these loans are also sometimes known as “liar loans” because borrowers can state any amount they want for their income, for example. In the financial crisis of 2008 in the United States, these loans were fingered as one of the culprits behind the collapse of the mortgage industry, as many lenders issued them to high risk borrowers and paid the price when those home buyers defaulted.