While sometimes cynically referred to as "liars' loans," stated income mortgages aren't supposed to be used by those on mobile home budgets to buy mansions. The recent wave of stated income borrowers in default on their mortgages has prompted lenders to make these loans much harder to get. And pie-in-the-sky income claims will no longer fly.

Why Not Just Document Your Income?

Stated income loans were not invented so pathological liars could buy bigger houses. They were created because traditional underwriting guidelines can be quite strict 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 income is and be qualified for a mortgage based on that amount.

For instance some self-employed borrowers have very weird business cycles -- a developer may have huge expenses in the initial stages of building but make lots of money two years later -- and traditional underwriting may discount most of that income. Other hard-to-prove income can include child support, especially if it comes in sporadically. Stated income loans can be an alternative for self-employed borrowers who make more than their most recent tax returns show, or for multiple borrowers in situations where one borrower has bad credit and can't be included on the loan application.

Saying It Doesn't Make It So

However, "stated income" doesn't mean applicants pull numbers out of the air and lenders just believe them. Lenders look at the entire picture and determine if the income stated is realistic. Here are some things that can derail a stated income loan application:

• Your assets don't support your income. Generally, lenders use liquid assets to estimate the applicants' income, and having six months' worth of income in the bank is a typical requirement. If you're really making $8,000 a month then saving $48,000 shouldn't be that tough.
• You claim a ridiculous income for your occupation or claim full-time income for a part time job. Very few cosmetic salespeople achieve "pink Cadillac" status! In fact a Canadian study determined that 73% of home-based businesses contribute less than 5% of the monthly family income. So a six-figure income claimed for a home-based babysitting service will be scrutinized.
• The income would be easy to prove. Most lenders today will not allow a borrower who receives all income from W-2 sources to get a stated income loan. If the income claimed is legitimate, a W-2 borrower should be able to supply proof. Period.

Passing the "Laugh Test"

So if you can't submit your application with a straight face then just don't. Someone who claims to freelance in pizza delivery making $100,000 a year -- but paying only $800 a month for rent and with only $3,000 in the bank -- will probably be politely declined.

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Stated Home Loans Face New Scrutiny