What is a Low Doc Loan?
General Finance Articles > Article: What is a Low Doc Loan?Low documentation or "low-doc" loans are often confused with non-conforming loans. Although low doc and non-conforming loans have some similar qualities, there are substantial differences between the two loan products. Low doc loans earned their name because borrowers are not required to provide the same level of documentary evidence to be approved for a traditional loan product. Low-doc loans do not require borrowers to submit income verification, making these loans an attractive financing option for borrowers who are self-employed or who earn their living as an independent contractor or investor.
This type of credit approval is also known as "self verification." Low doc loans are also popular among borrowers who have suitable income but who do not want to spend their time completing the paperwork and documentation required for a traditional loan. Although low doc loans do not have income verification requirements, borrowers will still have to submit other documentation required to apply for a traditional home loan.
Low doc loans are popular options for borrowers who want to buy investment properties or refinance an existing mortgage, but lack the income verification necessary to qualify. Low doc loans used to be provided primarily by lenders outside the banking industry; however, low doc loans have become more popular among mainstream lenders and bankers. In fact, low-doc loans now account for approximately 5 per cent of home loans in Australia.
The Downside of Low Doc Loans
Like non-conforming loans, low doc loans often carry higher interest rates as a tradeoff for the borrower's self verification of income. Lenders alleviate the increased risk associated with not verifying borrower's income through increased interest rates. The interest rate on low doc loans can be up to three times higher than traditional loan products, and low doc loans typically include higher fees and charges as well. Low doc loans can also have collateral requirements, and lenders may require the applicant to put down a larger deposit. Unlike non-conforming loans, which do not require insurance, low doc borrowers will have to obtain mortgage insurance to protect the lender's interests.
In some cases, lenders will reduce the interest rate on a low doc loan after the borrower has made two years of on-time payments. This can help reduce the cost of interest on low doc financing over the life of the loan.
Who Qualifies for Low Doc Loans?
Low doc loans are suitable for individuals who are self employed, working as an independent contractor, or investors - in other words, for individuals with nontraditional means of income. Although low doc loans are available for borrowers with less than perfect credit, a default or other serious negative mark on your credit file may make you ineligible for a low doc loan.
Low doc loans fall into three main categories: no ratio loans, no doc loans, and stated-income (low doc) loans.
No Ratio Loans
A no ratio loan is idea for borrowers who do not want to declare their income. When the borrower does not declare their income, the lender cannot calculate the borrower's debt to income ratio. Because the lender is increasing their risk by allowing the borrower to not verify any income or reveal other debts, the loan limit will generally be much lower than the value of the collateral.
No Doc Loans
A no-doc loan, on the other hand, requires a minimum number of documents. The borrower goes through the application process without submitting any financial documents, giving them maximum privacy. Again, because the lender is increasing their risk by allowing the borrower to avoid verifying their income, the loan limit will be lower than the value of the collateral.Stated Income Loans
A stated-income or low doc loan is ideal for borrowers whose income fluctuates frequently. To receive a stated income low doc loan, the borrower must submit proof of earnings for two years, tax returns, and bank statements. These low doc loans still require less documentation and verification than traditional loan products.Low document loans are ideal for borrowers who do not have the required financial documents, who have privacy concerns about their financial statements, or who are self-employed or earn their income through nontraditional means. Because lenders take on added risk by allowing borrowers to apply 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. Despite these disadvantages, low doc loans can be a suitable alternative for borrowers looking to obtain financing.
