The term “liar loan” has become synonymous with the American real estate boom and the subsequent fall of the market in the early to mid 2000s. And while we may like to think that such loans never did and certainly don’t know exist in the Canadian financial system, they in fact do. So what exactly is a liar loan? How does it affect the Canadian economy? And why would anyone actually want a liar loan? Keep reading as we unpack this financial issue.
Interested in more information on the economic crisis of the mid 2000s? Check out our article on near prime loans.
What is a Liar Loan?
The easiest explanation of a liar loan is when someone (either the borrower, the loan broker or the lender) lies about a potential borrower’s income. Simply put, it’s a liar loan because someone lied. There are certain types of mortgage that do not require as much information as you’d think, these types of mortgages are called low documentation and no documentation mortgages. The approval process relies heavily on the applicant’s credit score and repayment history for previous loans and mortgages. Because these mortgages require little to no documentation people are able to take advantage of them by lying.
Potential borrowers lie about how much money they actually make as well as the assets they posses in order to get approved for larger mortgages so they can purchase larger homes they wouldn’t otherwise be able to afford. On top of that brokers and other loan officers have been known to ignore discrepancies or look the other way in order to get their commissions.
Stated Income Mortgage Loan
It’s important to note that not all stated income mortgage loans (and low-documentation or no-documentation mortgage loans) are liar loans. It’s simply that these types of loans can often, but not all the time, lead to liar loans being approved.
The documentation associated with a stated income mortgage loan only requires that a loan applicant state their income, there is typically no verification. This of course leaves room for applicants who wish to obtain larger mortgages to lie about their incomes.
Low-Documentation or No-Documentation Mortgages
As stated above, not all low-documentation or no-documentation mortgage loans are liar loans. The documentation associated with these types of loans is even more minimal, sometimes disclosure of income and assets is not required at all.
Reasons Why a Borrower Would Want a Liar Loan
At this point you might be thinking why would anyone want a liar loan? In theory everyone has their own reasons and often it can be boiled down to the fact that houses are very expensive but also something that everyone wants and to a certain degree needs. There are of course a few specific reasons that we can pin point:
- A potential borrower does not make enough money to actually get approved for either, a mortgage of any value, or one that’s big enough to buy the house they want.
- A potential borrower is trying to hide their real income, from a spouse or the government.
- It is in the best interest of the potential borrower to lie about their income so that the terms and conditions of their mortgage loan are more favourable.
Long Term Affects
Obviously there are countless reasons why liar loans are a bad idea, but it’s probably the long term affects and the unknowable issues that can cause serious problems. When someone lies about their income on their loan application in order to get approved for a loan that they cannot actually afford, they’re betting on the future, a future that they cannot predict.
- Job lose, injury or health issues and emergencies are all unpredictable but they are also all reasons why someone may become unable to make their loan payments. Now factor in the fact that they couldn’t actually afford their mortgage in the first place.
- People are often given the advice that refinancing their mortgages in the future is a great idea. But what happens when these people make serious financial decisions hinged on the fact that they will be able to refinance their mortgage in the future and use that equity to pay off other debt? Then when the future arrives, the housing market is in a nose-dive and their houses aren’t even worth what they paid for them.
The long term affects are of course a housing market that’s in disarray, millions of people defaulting on their mortgages and even more people with too many loans and too much debt and no means whatsoever to pay any of it back.
In 2015 the Bank of Canada and the majority of financial experts made it abundantly clear that one of the biggest, if not the biggest risk to the Canadian economy is the ever rising amount of household debt, this of course includes mortgage debt (Take a look at our article “2015: The Year of Debt”). If there is one thing that we can be certain about, it is that the future is relativity unpredictable, especially for those who are currently relying too heavily on credit.
Take a look at our infographic on the rise of Canadian household debt.