Should You Take Out a Low Doc Loan?
General Finance Articles > Article: Should You Take Out a Low Doc Loan ?Low documentation or "low doc" loans are increasing in popularity across Australia. Low doc loans are loan products that require less documented evidence of the borrower's income, assets, and liabilities than a traditional loan. Borrowers applying for a low doc loan are still required to apply for the loan in writing and sign a loan agreement although they do not have to produce paycheck stubs, tax returns, or any proof of income.
Many borrowers of low doc loans are self-employed, independent contractors, and investors. These professionals choose low doc loans because they have more difficulty producing the necessary documents for a standard (full documentation) loan. Other borrowers that choose low doc loans are interested in refinancing their existing mortgage or want to purchase property as an investment. Finally, some borrowers choose the low doc loans because the application process is simple. These borrowers could produce the documentation necessary for a traditional loan but do not want to spend the time filing the paperwork.
Low doc loans fall into three main categories:
- No Ratio Loans
No ratio loans are for borrowers who do not want to report their income. Borrowers are not required to verify any income; the lender cannot calculate the borrower's debt to income ratio. The loan limit will be lower than the value of the collateral because the lender is increasing their risk by allowing the borrower to avoid verifying their income or revealing any other debts.
- No Doc Loans
A no doc loan allows the borrower to go through the application process without submitting financial documents, giving the borrower privacy. Because the lender is increasing their risk by allowing the borrower to avoid income verification, the loan limit will be lower than the value of the collateral.
- Stated Income Loans
A stated income loan is ideal for borrowers that have a fluctuating income. Borrowers are required to submit proof of earnings the two years prior to applying. They must also supply tax returns and bank statements to the lender. Although this loan is similar to the traditional loan in that it requires income verification, a stated income loan still requires less documentation than a traditional loan product.
Borrowers of low documentation loans should be aware that the ease of the application process does not continue after the loan is approved. Borrowers who are approved for a low doc loan will be required to pay higher interest rates than borrowers who have traditional loans. Lenders know that low doc loan borrowers are unable to negotiate lower rates because they are considered ‘risky' applicants (due to their inability to produce income verification).
Borrowers will also be charged additional fees so the lender has some security in the loan. Some lenders will require additional items of value as security against the loan. Borrowers could be asked to sign over rights to their car (or other personal property) in the event that they are unable to make monthly payments and default on their loan. Borrowers could be required to make a significant down payment toward the home in the contract. Everyone approved for a low doc loan will be required to pay mortgage insurance. Despite the disadvantages involved in a low doc loan, a low doc loan can be used as a suitable alternative for borrowers looking to obtain financing.
Lenders who market low doc loans usually target people with past credit blunders and the self-employed. Again, the lenders know that these people are unable to negotiate due to their credit rating or because they cannot document their income.
Am I Eligible for a Low Doc Loan?
Individuals who have non-traditional means of income are great candidates for a low doc loan (i.e. self-employed, investors, and independent contractors). Low doc loans are also available to borrowers who have blemished their credit rating, although a default or serious negative mark on their credit file could make them ineligible for a low doc loan.
Low document loans are best for borrowers who:
- Do not have the required financial documents
- Have privacy concerns about their financial statements
- Earn income through nontraditional means or are self-employed
Because lenders take on the added risk by allowing borrowers to apply for a loan without verifying their income, the interest rates on low doc loans are generally higher than the rates on traditional loan products. Low doc loans also tend to carry higher fees and charges.
