Liar Loans: Fanning the Flames of the Financial Crisis

Buying a new home can be very exciting and offers a number of advantages, both from a tax and monetary standpoint, but also from a psychological one. Since most people who want to buy a home do not have the funds to purchase the home outright, they use a mortgage.

A mortgage is basically a loan that uses the home and land as collateral. There has been much controversy in the housing and mortgage industry over the last few months, but the roots of this controversy go much deeper than only a year. Instead, a number of less scrupulous mortgage brokers and home buyers helped fuel the problems that we face today, with Liar Loans being one of the fans of this fire.

In many cases when you first speak with your lender, they may simply take you at your word when you report your annual earnings, current debt load, and assets. It is very important to always be completely honest with your lender during this initial stage, because traditionally mortgage lenders have required physical proof of this information before they finalize the loan. As a result, artificially inflating your salary does not benefit the lender or the borrower.

For example, you might report your salary as $100,000 and the mortgage broker will print you up a letter saying you would qualify for a $300,000 mortgage. You can show this letter to prospective home sellers, which will help to show them that you are a serious buyer. However, when it comes time to apply for the mortgage, the lender will manually review your pay stubs and personal finances. If they determine the numbers you initially provided are not correct they might offer you a lower valued mortgage loan or even choose not to offer you a mortgage at all due to the breach of trust.

Traditionally, this has been the standard way that a mortgage is offered, but recently, more aggressive lending practices gave way to what are referred to as Liar Loans in the mortgage industry.

Liar Loans are not exactly new, but became very popular a few years ago and are in part to blame for our current financial situation.

A Liar Loan is basically an unverified loan where the mortgage lender does not verify the income, assets, or debt obligations of the borrower, instead taking them at their word. In the end, these types of loans not only hurt the lending institutions, but also the borrower who received a home loan that quickly became unaffordable.

One of the reasons Liar Loans became acceptable was due to the belief that a homes value would only increase and the housing market would continually grow. This was fueled by rapid home value increases during the 1990's in which a homes value would sometimes increase over 20% every year. This led investors to be much more relaxed about offering mortgages, because even if the person were to go into foreclosure, the belief was that the home could be quickly sold for a profit.

Liar loans were also brought about by how mortgages were packaged and sold to investors. A group of investors would pool their money and offer a number of home mortgages, packaging all of these mortgages together into a single fund. They would then sell this fund to other investors overseas, who were lulled by a false sense of confidence in the US housing market and promises of a very large return from their investment

From an investors standpoint these funds looked very solid and like a great deal. Over the course of a thirty year mortgage, the borrower usually pays several times the cost of the home, so a fund consisting of mortgages has the potential to pay off big

As a result of the way mortgages were packaged together and sold, the initial person that offered the mortgage might only hold it for a few months before they sold it to other investors. This meant that the people offering the initial mortgage had very little incentive to ensure that the individual was qualified for the loan. They would only be holding the mortgages for a relatively short period of time, so there was little risk that the borrower would foreclose while they were holding the loan. Instead, they would quickly sell the mortgage off and make a nice profit, leaving it as someone else's problem.

Many mortgage brokers quickly began offering mortgages to people who were completely unqualified and would have been rejected by the traditional mortgage approval process. As soon as they had enough mortgages packaged together, the investors would sell the mortgages as a single unit, which promised a big return for other investors looking to take advantage of the rapidly growing US Housing Market. Often, these mortgage bundles would be sold to overseas investors, which is why the financial crisis not only affects those in the US, but also people all over the World.

While Liar Loans are not the only cause of the current problems in our housing and financial market, they do share a large portion of the blame. However, it is important to note that it is not fair to only blame the people who were not honest about their financial situation or those who were offering the loans, because there are a number of factors which led to this being possible.