5 misconceptions about low-doc loans
What do you know about low-doc loans? Low-document (low-doc) loans have a bad reputation thanks to layers of misconception in the past, but current data shows that many of the drawbacks cited are unfounded. Here’s a primer on low-doc loans for today’s property buyers.
What is a low-doc loan?
When you apply for a full document loan, in most circumstances, you need to supply multiple years’ tax returns, along with further paperwork, to have that loan approved. This can often include a deposit of 20 per cent of the property sale price; a deposit less than that will incur lenders mortgage insurance. Borrowers must also have consistent and stable employment and income and a healthy credit score.
A low-doc loan provides potential borrowers who do not meet those criteria with alternative access funding. These borrowers include self-employed people (freelancers, people who own their own business), contractors and investors who derive income from investments. Some of these businesses may have only been up and running for a short amount of time, so their income stream may be inconsistent. One year an IT contractor may make $40,000, but the year after, they may score a contract worth $300,000; therefore, their tax return across the two years will be extremely varied. On a low-doc loan, you’re judged on what your business is currently earning today. A low-doc loan declaration is co-signed by the borrower along with their accountant, who must be a registered tax agent, to determine that the income declared is true.
Low-doc loan myth busting
There are five major misconceptions about low-doc loans that you might have heard, and I want to set the record straight.
Myth 1: Low-doc loans come from shady lenders
Truth: Both banks and non-bank lenders provide low-doc loans; however, banks will only offer them for unregulated loans. Securitised lending is more regulated than banks. Banks are regulated by the Australian Prudential Regulation Authority; non-bank lenders are overseen by the Australian Securities and Investments Commission and the National Credit Code, which guides responsible lending practices. It’s not the source of the money that borrowers should worry about but whether the lender is lending responsibly.
Myth 2: Low-doc loans are always short term
Truth: Long-term low-doc loans are available; borrowers can receive a 30-year mortgage just as they could from every other lender in Australia. This also means that, like banks and other lenders, there are zero exit fees.
Myth 3: Risk fees apply to all low-doc loans
Truth: We need to stop equating low-doc borrowers with risk. If the lender believes they are risky, why are they lending to them? If they are viable clients, why punish them with additional fees? Some lenders apply risk fees, but they do not apply to all low-doc loans. Rate Money has never had them, and other lenders have now followed suit. It’s important to shop around and find a lender that is competitive and suited to your needs.
Myth 4: Low-doc borrowers frequently default
Truth: According to Rate Money data, low-doc borrowers do not default at a higher rate than full-doc borrowers. In fact, our full-doc borrowers are in arrears at more than twice the rate of our low-doc borrowers, and overall, only 0.05 per cent have completely defaulted on their loans — that’s just two out of 4,000 customers.
Myth 5: Self-employed people are unreliable borrowers
Truth: Actually, self-employed borrowers are among the most reliable clients. If the lender does its due diligence and the borrower has been in business for two years or more; has earnt a steady income in that time; and doesn’t have any defaults or bad credit, then that track record is more reliable than an employee who only needs to show a few months’ pay slips.
And think about it: if their business starts to fail, who are they going to let go first? The staff, of course — they won’t sack themselves. So, it stands to reason that self-employed people are more reliably employed.
More than 10 per cent of Australia’s workforce is self-employed — that’s a sizeable portion of the population that could be suited to a low-doc loan and may even find it’s the difference between them securing finance or having a loan application rejected. Those prospective buyers shouldn’t be penalised for having inconsistent but reliable income streams when applying for a home loan. Low-doc loans fill the gap in the market, allowing more Australians to enter the property market.
Ryan Gair is the chief executive and co-founder of Rate Money.