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Low Doc Loan Warning: The Fine Print Revealed

General Finance Articles > Article: Low Doc Loan Warning: The Fine Print Revealed

Low documentation or "low-doc" loans require less documented evidence of income, assets, and liabilities than a traditional loan product. Borrowers are still required to apply in writing and sign a loan agreement, but will not be required to produce paycheck stubs, tax returns, or any other form of proof of income. Because low-doc loans do not require income verification, these loans are an attractive financing option for borrowers who are self-employed, independently contracted, or work as investors.
Low documentation loans require applicants to go through a process of income verification called "self verification" in which the applicant simply states their income. Because the requirements are simple, low doc loans can benefit any borrower who would not qualify for a standard loan.

Low doc loans are popular options for borrowers who want to buy investment properties or refinance their existing mortgage, but lack the income verification to qualify. They are also popular among borrowers who have sufficient income but do not want to spend their time filling out a heavy load of paperwork or provide sufficient documentation for a traditional loan. However, applicants should be aware that because of the ease of approval, there are strings attached. Borrowers should understand the down side of low-doc loans before signing on the dotted line.

Borrowers might have to:

  • Pay a higher interest rate than those with standard loans because of the borrower's inability to produce sufficient financial documentation.
  • Pay additional, higher fees and charges. These charges usually include a 'risk fee' so that the lender has some security in loaning the money.
  • Offer the lender additional security, such as a lien against the borrower's car in case of default.
  • Pay a higher down payment toward the purchase price of the home
  • Sign a low doc loan for a short amount of time that will require refinancing when the loan term expires. Additional costs will be accrued at that time. Refinancing is costly.
  • Pay mortgage insurance (often required with a low-doc loan)

Some lenders, who specialize in low documentation loans, aggressively market this loan type. In some cases, the advertisements target people with poor credit histories and self-employed workers. The lenders know that these applicants find themselves in a weak position to negotiate because they are financially considered 'risky' or 'higher risk' than traditional applicants.

Borrowers that do not give their lenders an accurate description of their finances (attempting to beef up their income), might create problems for themselves. Repayment could be impossible. Lenders might base the approval of the borrower's loan on their own ability to recover costs by selling your home and any other property the borrower has placed on the line as security. Borrowers should be weary of lenders. The lenders might approve the borrower's loan, but that does not mean they are confident that the borrower will be able to make payments. To combat this, borrowers need to determine for themselves whether or not they will be able to afford the repayments. The lender should have no influence over this decision.

Low doc loans may seem to suit the needs of the borrower, but the borrower must weigh in extra costs accrued. In some situations, a borrower can receive a lower interest rate on their loan by taking the time to find more documentation of their financial history to provide to the lender. Lower interest rates are significant because the borrower will save more money over the lifetime of the loan.

Borrowers should also be aware that they would be required to pay for mortgage insurance. In the case of a low-doc loan, this insurance is designed to protect the lender, not the borrower. In the event that the borrower is forced to sell their home, they might face losing everything they invested in the property. Even worse, some borrowers might still owe money after the sale, if the sale price does not cover the amount borrowed.

Finally, borrowers should be aware that some low doc loan lenders will reduce the interest rate on a low doc loan after the borrower has proven they can make payments on time. Usually, the lender will require that the borrower pays their mortgage payments on time for a minimum of two years. This can help reduce the cost of interest on low doc financing over the lifetime of the loan.

Anyone attempting to apply for a low doc loan because they have not declared their full income to the Australian Taxation Office should never apply for a low-doc loan. These people are at risk of being caught and paying hefty penalties because of their claims.

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