Loans built on lies

Borrowers routinely exaggerated their incomes to obtain thousands of Sonoma County home loans during the housing boom, a major reason foreclosures are now spiraling to unprecedented highs.

In their eagerness to buy a home, many borrowers inflated earnings by 50 percent or more to qualify for loans they could not otherwise afford, according to a Press Democrat analysis of loans made in 2005 and 2006.

When home prices peaked in 2005, the typical home buyer in Sonoma County claimed to earn $120,000 a year on loan documents, according to federal home loan data. But they actually earned about $80,700, according to Census data. The spread grew in 2006, when the typical buyer claimed to earn $132,000; their actual income was about $79,000.

They were enabled by a mortgage industry that was so eager to hand out money -- and rake in lucrative commissions -- that it issued many loans without requiring borrowers to document earnings.

These stated-income loans -- the most popular of low-doc or no-doc loans, loan applications requiring little or no documentation -- had a different name within the industry: liar loans.

"The entire real estate debacle is the fault of everybody that was involved. And it was all about greed and speed," said Rachel Dollar, a Santa Rosa attorney who represents lenders in fraud and other cases. "The brokers wanted their commission. The lenders wanted their premiums. The borrowers wanted their homes."

The widespread use of such financing helps explain how so many people could appear to afford to buy homes at the peak of Sonoma County's housing boom. Just as they helped push home prices to record heights, these loans are now partly responsible for the market's implosion.

Once available only to the self-employed and commission-based workers with sporadic earnings, stated-income loans started to become popular in 2002 as they were expanded to wage earners. This allowed more borrowers to buy more expensive homes without providing documentation, such as pay stubs or W-2 tax forms, to prove their incomes.

'Liar loans'

More than half of all loans made to purchase Sonoma County homes in 2005 and 2006 -- about 7,000 -- were stated-income loans, according to First American CoreLogic LoanPerformance, a real estate research firm.

Lenders and borrowers bet home prices would continue rising, providing equity to refinance out of these high-priced, often-risky loans.

"The idea was that appreciation would be the white paint that concealed the faulty underwriting that was used. And as soon as the home values dropped off, the problems began to emerge," said Allen Fishbein, housing and credit policy director for the Consumer Federation of America.

The gamble isn't paying off for a growing number of Sonoma County homeowners. Home values have tumbled nearly 25 percent since their peak in 2005 and sales have dropped to a 12-year low. At the same time, mortgage payments are rising for many who used adjustable-rate mortgages to buy during the market's peak.

Every week, lenders seize an average of 23 homes from Sonoma County borrowers who can no longer afford their mortgage payments and cannot pay off their loans by selling their houses.

Lenders and investors who bought mortgage-backed securities have racked up billions in losses, contributing to disarray in the nation's financial markets and putting the U.S. economy on the brink of recession.

It is illegal for borrowers to lie on a mortgage application. But federal and state authorities said they are more likely to go after systematic fraud by the professionals who were hired by banks for various services connected with a loan.

Lenders blamed

Consumer advocates and even some mortgage professionals largely blame brokers and lenders for the problem.

"We can argue over how much the borrower should have known. Lenders have the responsibility to use sound underwriting to put people into loans based on their ability to repay the loan. And clearly that wasn't done here," Fishbein said.

During the housing boom, borrowers and their mortgage agents faced many pressures to overstate incomes in order to obtain a loan. Home prices tripled in just nine years, hitting a record $619,000 median in August 2005.

"When you've got a person who really wants to buy that house, they don't want to hear that they can't, especially when you have the great home appreciation. You feel like you're missing out. Stated-income loans made buying that home obtainable, but not affordable," said Steven Krystofiak, president of the Mortgage Brokers Association for Responsible Lending, an industry group pushing for the abolition of stated-income loans.

New math

Most banks refuse to issue mortgages to borrowers who must spend more than 38 percent to 40 percent of their monthly income on housing costs -- a number that includes the loan's principal and interest payments, property taxes and homeowners insurance.

But many borrowers did not earn enough money to buy a typical home in Sonoma County while staying within those loan guidelines.

In 2005, for instance, typical Sonoma County homebuyers would have needed to spend 58 percent of their $80,700 annual income if they bought a $619,000 house with a conventional 30-year loan, even after paying cash for 10 percent of the purchase price.

To qualify, buyers could have inflated their income to $120,000 -- the typical amount stated on loans that year. That way, they could claim housing costs would absorb just 39 percent of income.

To lower monthly housing costs even more, many borrowers took out interest-only or payment-option loans. Payment-option loans feature minimum monthly mortgage payments that don't cover the full interest due on a loan. Even when combined with taxes and insurance, the borrower would spend 24 percent of his or her monthly income on housing.

"It made stated-income loans commonplace," Krystofiak said.

Maia Lomax, president of the Redwood Empire Mortgage Lenders Association, said a minority of mortgage brokers and lenders' agents engaged in such practices because overstating incomes is fraud and a violation of federal law. Some did, however, she acknowledged. Lomax and others in the business know of buyers they turned away who later purchased homes with such risky loans.

"There's a lot of people who do this for the right reasons who are really good at it," she said. "But a lot of people got into the business that saw money to be made. I think people were greedy."

No checks on balances

Some borrowers may have inflated their incomes without any direction from the lender. But brokers said most borrowers aren't savvy enough to know how to game the home financing system or fully understand how they could lose homes if values fell and payments rose.

"An hourly wage earner should never have been allowed to do a stated-income loan. But no one ever explained it to these folks," said Marty McCormick, owner of McCormick and Co., a Santa Rosa mortgage broker.

Powerful forces were at work to undermine the lending system's checks and balances.

As home sales accelerated, lenders battled for business by expanding loan choices and accelerating the borrowing process. Loans that once took two to three months to receive were issued in two to three weeks.

Lenders review a borrower's income, credit history, debts and ability to repay a loan. Technology helped speed up the process with automated underwriting systems used by the national mortgage companies, Freddie Mac and Fannie Mae, and some large banks and other lenders.

"It took underwriters out of looking at loans from a common-sense manner. It really became an automated, check-the-box process," Dollar said.

An underwriter, for instance, might pull a borrower's tax returns to verify income or send out an appraiser to double-check a home's value.

"The thing morphed over time because of the greed of Wall Street pushing the envelope of qualifying people," McCormick said.

Mortgage lenders and investment banks bundle home loans into securities and sell them to investors, who gobbled them up when housing was strong and the returns were solid. High-risk mortgage products, including stated-income loans, offered some of the highest yields.

Underwriting standards were eased so more stated-income loans could be made, even to subprime borrowers, who have poor credit and can pose the greatest risk for defaulting on loans, Fishbein said.

"You'd think that would have required documentation of income, not reliance on writing a number down," he said. "There have been a lot of indications that this was promoted by those interested in pumping up volume. They thought they could sell these loans, as soon as they made them, to investors who were willing to invest in these high interest rate loans."

No gain means pain

Borrowers likewise had a rosy outlook on home values rising and their ability to refinance out of stated-income and other risky loans.

"Home buyers were speculating in this market. They weren't buying because they had a home and could afford the payments," Dollar said.

Stated-income loans contributed to the escalation in sales and prices, delaying the market's eventual correction -- and making it more painful.

"These type of loans were one of the major causes of home prices becoming out of whack compared to incomes," Krystofiak said.

Buyers who couldn't afford the true cost of homes are now feeding the wave of foreclos-ures.

"Unfortunately most of the pain is being felt by homeowners, most of them of modest means, who may not be able to buy another home for many years," Fishbein said.

Housing's deepening downturn adds to the nation's and the county's economic woes.

"Now everybody is paying the price for that," Lomax said.

News Researcher Teresa Meikle contributed to this story. You can reach Staff Writer Michael Coit at 521-5470 or mike.coit@pressdemocrat.com.