Are No-Doc HELOCs as Good as They Seem?

We’ve talked a lot about home equity lines of credit (HELOCs) and home equity loans. These second mortgages are designed to let a deed holder reach a home’s locked-in value. A home equity loan will produce a lump sum; a HELOC is a revolving credit line. But have you heard about the no-doc versions?

Yes, no-doc loans are back — but with stricter approval standards than they had before the financial meltdown of ‘08. The Dodd-Frank Act responded to the mortgage crisis of the time with stricter approval standards, focused on examining the applicant’s ability to repay.

Lenders like these loans. There’s a market for them. Many deed holders are sitting on heaps of home equity, but have nontraditional earnings.

The no-doc loan does need documentation—but the lender will accept nontraditional proof of income. So, no-docs don’t demand the same documentation that traditional home equity loans or lines of credit do.

Say you need cash for making accessibility upgrades to your home, or installing an accessory dwelling unit, or simply getting a lot of high-interest debt out of your way. Is one of these second mortgages right for you?

Who Is No-Doc Borrowing Designed For?

You might have seen these advertised as options that don’t require the normal income verification and don’t ask for documents such as account statements and tax returns, bank statements and so on. And you might have wondered if this is the right kind of financing for you.

No-doc borrowers generally don’t fit the standard income and tax profile. For example, a no-doc customer could be an independent contractor. The no-doc application system tends to draw retired homeowners, entrepreneurs, real estate investors, freelancers, and so on.

As you probably know, perfectly capable deed holders who lack traditional W2s can be turned down for regular equity loans. To be approved for a no-doc HELOC or home equity loan, these applicants might want to demonstrate their assets or income by paperwork such as 1099 forms, business profit and loss statements, or bank statements. Some people turn to no-doc financing because they declare low income totals to the IRS, as they roll earnings into their business or take large deductions. 

For many of these loans, the applicant has to have at least a credit score in the mid-600s. The higher the applicant’s score, the better the interest rate will be.

And these borrowers tend to have a lot of equity built up. Lenders will look closely at the applicant’s debt-to-income ratio, so starting off with low mortgage debt is a major head start.

Debt-to-income ratio (also known as DTI ratio) means the sum of a person’s monthly loan payments as a percentage of total earnings and income. For standard loans, a borrower’s DTI ratio should be less than 43%.

In a Nutshell: Pros and Cons of No-Doc HELOCs or Home Equity Borrowing

The no-doc version of equity borrowing uses the same models as the regular ones. The no-doc HELOC enables you to use a line of credit if and when it’s needed. The no-doc home equity loan gets you a lump sum.

Getting the no-doc version is something of a mixed bag. First, the benefits:

• You don’t need an employer. No need to show pay stubs and W2 forms.

• Yes, the lender does verify credit, income, and assets. But the no-doc applicant needs to come up with fewer documents.

• The timeline to close the loan and get the funds is shorter. Moving through an online process, the timeline is generally a month to a month and a half. With regular home equity products, it would take two or three months.         

• Your income can be unconventional.

• If your earnings are strong enough, the lender can be somewhat flexible in how it sizes up your credit profile.  

Now, some potential downsides:

• With no-doc financing, owners can’t get as much cash out of home equity as they can get through standard equity financing.

• To qualify for no-doc financing, a hopeful borrower needs to show that the home has a lot of built-up equity. That means substantially more than the traditional 20% minimum expected for regular equity borrowing. If you hold at least 40% of your home’s value debt-free, you may be eligible. An approval will rely on whether you’re borrowing against a primary residence or not, and your credit score.

• A hopeful buyer needs a strong credit score. If you have a low credit score, you’ll need to show more equity built up in the home. See our credit repair tips here.

• Rates on no-doc loans or HELOCs run 1% or more over the regular versions. HELOCs have variable rates and home equity loans are fixed-rate.

Whereas regular home equity loans and HELOCs require full home appraisals, some no-doc applicants who have a lot of equity might not need one. This will depend on the amount requested, and the loan-to-value ratio you’d have once the loan is issued. If your LTV ratio is low and you have a high credit score, you may be able to skip the appraisal.

Home equity is the percentage of the value of a home you own, debt-free. Your loan-to-value or LTV ratio is your total home financing debt versus the property value.

What Are the Alternatives to No-Doc Home Equity Financing?  

There could be other options to compare and contrast:

• Some lenders specialize in bank statement HELOCs. These can be very helpful for entrepreneurs who don’t show a lot of income, for example, because they’re reinvesting into their company.   Your actual income has to be enough to enable you to handle the amount you’re borrowing.

So, the lender is looking for proof of your ability to repay the funds you borrow. To do this, the lender uses a nonstandard method of weighing income. The lender can check the actual deposits into your accounts. This form of financing could fetch the borrower a better rate.

• A cash-out refinance puts a bigger loan in the place of the borrower’s current mortgage. Taking on more debt this way frees up cash for the homeowner to use. While the interest rates on these loans do run higher than the rates on an original mortgage, they are generally lower than the rates for home equity financing.  

• And for the over-55s among us, there’s the good old reverse mortgage. Take a loan out against your home equity, and get paid (tax-free) by the lender. You need not repay this loan as long as you live. But your heirs will need to repay it. Remember that bumper sticker? “I’m out spending my children’s inheritance.”

If all else fails, the no-doc path is good to know about. It’s a simpler process from the applicant’s perspective. For those who have nonstandard income situations, it might just save the day. If so, the higher costs and the higher equity minimums might be worth dealing with.