Should You Fear Low Doc Mortgages?

The media does a great job at putting fear into their readers and listeners. After all who would not be afraid of such headlines:

” The low doc loan that brought down a family” …or  ” RBA exposes low doc loans risk”…

We are programmed to fear that which we do not understand. So what is the risk and fear that we are told we should have with respect to low doc loans? Lets look at what these loan products offer and where the risks may be for the borrower.

What are low doc loans?

Low doc loans are secured loans offered against the security of motor vehicles or property where the borrowers is not required to provide traditional proof of income as part of the loan application. While some proof of income may still be required it can be of an alternative format such as Business Activity Statements instead of tax returns or a letter from an accountant.

Given that the lender is not able to confirm borrower income fully. these loans are higher risk for the lenders and therefore tend to be somewhat more expensive than full doc loans.

Similarly low doc loans tend to require the borrower to offer a higher deposit than would be necessary if theirs was a full doc application.

Who are these loans designed for?

Low doc loans were always designed for the self employed borrower who did not have up to date tax returns required for their loan application but who was able to use other ways to substantiate their income.

What can go wrong with a low doc loan?

Where borrowers got into trouble with a low doc loan in the past was where the loan was not used the way t was designed. In pre-GFC years there was little regulation of the low doc lending. In that environment numerous brokers lenders and borrowers would close their eyes to the true financial situation of the borrower. As long as the borrower signed a statement claiming that they earned $200,000, they would qualify for a low doc loan which required this level of income.

Some years later when they were no longer able to maintain loan repayments, borrowers would claim that they did not understand the documents they were asked to sign and therefore were given a loan which they in reality could not afford.

There was a lot of finger pointing as to who was actually to blame for providing loans to borrowers who could not afford these.

However any borrower who tells the truth about their actual business income and borrows only on the basis of the truth should have nothing to worry about.

What can the borrower do to protect themselves?

The truth will set you free. If you only tell the truth in making a low doc loan application, and then confirm that your truth is correctly reflected on the application to which you are asked to sign, there should be no more risk that with any other loan.

As a borrower, irrespective of whether the application is low doc or full doc, you need to have an idea as to what level of repayments you will be able to make on your current income. Providing you do not commit yourself to a loan that you can clearly see that you are unable to afford, there is no risk.

If you are not quite sure that you are able to understand the loan documents you are asked to sign, seek legal advise before signing.

About the author

Oliver Revilo