Until the recent mortgage crisis, it wasn't all that important to document your income for lenders if everything else was in order--good credit, assets, and a demonstrated capacity to handle large amounts of debt successfully. Stated income loans had a purpose, and it wasn't to allow pathological liars to buy bigger houses. They were created because traditional underwriting guidelines can be quite restrictive in determining what income gets counted when qualifying applicants for home loans. This means many sources of income that would be available to make a mortgage payment aren't used in calculating how much home a borrower can afford. Stated income loan programs allow borrowers to indicate what their available income is and be qualified for a mortgage based on that amount.
With a stated income loan, the lender extrapolates (calculates based on available information) the applicant's income from things like liquid assets. For example, it's not hard to believe that someone makes $10,000 a month if she's got a 401(k) with $200,000 in it. Second, stated income borrowers usually put more money down than traditional borrowers--this means they have more to lose if they overstate their income, can't make the payments, and lose their home. Finally, if someone runs up $25,000 on his Amex each month and pays it off each month, it's a pretty good indication that the income is there.
So why don't stated income borrowers just prove their income like everyone else? They could if the rules were a little different, but right now it's hard for many people with less traditional sources of income. For example, some self-employed borrowers have unusual accounting and business cycles -- a developer may have immense expenses and little inflow in the initial stages of building but make lots of money two years later -- and traditional underwriting may discount most of that income because it requires the underwriters take the lower of the last two years' tax return income. Other hard-to-use income can include child support (you have to provide 12 months of canceled checks and it's not always easy to go hat-in-hand to an ex-spouse and get these). If your support comes in sporadically or you get it in cash, underwriters probably won't allow you to use it. Stated income loans can be an alternative for self-employed borrowers who make more than their most recent tax returns show, for those making a lot of money but are doing it with a new business or sales job (2 year history required by traditional underwriting), or for multiple borrowers in situations where one borrower has bad credit and can't be included on the loan application.
The problem with stated income loans was that lenders eventually went too far--making loans to people with no assets, no down payments, and bad credit. Would you do that if it was your money? That mistake (called layering of risk) is what took a very good and useful product pretty much off the market. But the need is still here. And it will be back
