No Documentation Mortgage (No Doc)

What is No Documentation Mortgage (No Doc)?

No documentation mortgage (no doc) is a kind of loan that does not require the borrower to produce any proof of income or existing assets.

Generally, while giving out a loan, banks and financial institutions check the creditworthiness of the borrower by examining their bank statements, tax returns, and any other document which acts as a verification of income.

Creditworthiness is the ability of borrowers to repay their loans with interest. No Doc loans, on the other hand, are unregulated contracts that only require the borrowers to declare their ability to afford loan repayments.

What Kind of Debtors Opt for No Documentation Mortgage?

Applicants with volatile incomes such as self-employed individuals, and people who live off on commissions or tips, usually opt for the no doc method of securing loans.

Due to the high risk associated with no doc mortgages, lenders charge a higher rate of interest. Moreover, lenders only extend no doc mortgages to clients with very high credit scores and high liquidity in the form of cash balances.

These loans also require a higher downpayment to be made, mostly in the range of 30% to 50%, as opposed to 20% or lower in conventional mortgages.

No doc mortgages come under the Alternate-A or Alt-A category of loans, which have a relatively high-risk factor. According to the risk profile, Alt-A comes between prime (high credibility, low risk) subprime (low credibility, high risk) mortgages.

Besides no doc, alt-A includes low documentation mortgages, no income-no mortgages (extended to borrowers who need to verify only their employment status), and NINJA loans (for borrowers with no income, no job, and no assets).

No Documentation Mortgages and the 2008 Financial Crisis

No doc loans are a constituent of the class of mortgages termed “subprime,” and they are one of the many culprits behind the asset market collapse and subsequent Global Financial Crisis of 2008. The following table shows the increase in the share of Alt-A loans in the total value of mortgage loans between 2001 and 2006.

As the amount of no doc loans increased, their performance deteriorated. Default and delinquency rates rose sharply in 2006 and 2007. Some 3.5% of loans originating in 2003 were defaulted at the end of three years, whereas the share of loans lent out in 2006 and defaulted by the end of 2008 was 36.6%.

As more and more no doc mortgages were being given out, borrowers started taking out loans to purchase multiple properties. In fact, encouraged by the booming real estate sector in the early 2000s, investors started to make use of these mortgages to speculate on residential property prices.

The borrowers carried high credit scores, which is why they qualified for the loans. However, with their unstable income, holding and maintaining multiple properties was not possible, and they started to default on one or more of their mortgages.

In 2007, second-house mortgages demonstrated a higher default rate at 24%, two years after the date of origination and owner-occupied houses showed a default rate of 22.4%.

Not surprisingly, no doc loans posted a delinquency/default rate of 27%, more than double than that of conventional loans at 11.5%.

More Resources

CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• Loan Structure
• Credit Analysis Basics
• Asset-Based Loans
• Commercial Lending Training
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