Why a ‘liar loan’ is one easy option for self-employed homebuyers

Today I want to give you a flavor of the exotic mortgage world otherwise known as non-QM or non-qualified mortgages.

These are purchase and refinance loans for borrowers — be it owner-occupied, second homes or investment properties — who don’t fit the conventional mortgage box from the likes of Fannie Mae and Freddie Mac.

Let’s start with the simple profit-and-loss mortgage. Industry parlance calls these liar’s loans.

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I kid you not: All a borrower has to do is create a profit-and-loss statement, show proof of self-employment for at least the last two years, have a 700 or better FICO credit score, and show the most recent two months of business, or in some cases, personal bank statements. Those bank deposits must align and make sense with the profit-and-loss statement.

Industry sources told me these liar loans are show signs of performance issues such as late payments and the like. When the income is poorly vetted and verified, this is what can happen.

Some exotic lenders don’t offer liar loans because of the inherent risk. Others want a tax preparer to provide the profit-and-loss and sign it. One lender told me the tax preparer must be the same tax preparer who signs the borrower’s tax returns.

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In contrast, there is also a 12-month or 24-month bank statement program offered by every exotic lender I interviewed.

Essentially, the lender adds up all the bank deposits for the period, subtracting out transfers, dividing by the timeline and then taking an overhead haircut to come up with a monthly income.

For example, let’s say you are a home-based attorney. Over the previous 12 months you’ve deposited an average $15,000 monthly. Say your haircut (overhead) is $3,000 or 20% of your bank deposits. That lands you at a monthly income of $12,000 for mortgage qualifying purposes. Usually, the lender is going to want the tax preparer to attest to the amount of overhead.

In my experience ethical CPAs and Enrolled Agents will only sign off on accurate overhead assessments. It’s not worth risking their livelihood. There are also bad actors out there willing to write anything for a fee.

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Now, let’s say you own a restaurant with $50,000 in monthly deposits. The haircut is likely to be 50% or more. Nobody is going to believe you if you claim 20% overhead. The haircut needs to make sense.

Why would someone do a bank statement mortgage instead of just showing the tax returns? After all, a Fannie Mae mortgage is likely to land you a one-half point to a full point lower in interest rate.

There are lots of reasons. Sometimes the borrower doesn’t want to deal with the intrusive underwriters, especially when one has complicated tax returns or owns a lot of businesses or properties. In other instances, it’s because the borrower is underreporting his or her income or overreporting expenses to the IRS.

My all-time favorite loan is what I affectionately call the “fog the mirror mortgage.”

For this mortgage, a borrower must put at least 20% down. The income and job section of the mortgage application is left completely blank. The interest rate is very high, starting in the mid-8% range. It’s not a liar loan because there is no statement of income or job. The lender is relying on the down payment or equity in the property, excellent credit and plenty of cash reserves.

Another popular program is the Debt Service Coverage Ratio loan (DSCR) for those wanting to finance rental properties. It’s solely focused on the subject property.

Borrowers don’t need to be self-employed and other income and debts are not considered. The key here is realistic rents for that neighborhood. Some lenders want the rent to be at least $1 more than the total DSCR house payment. There is even a “no ratio” program. In other words, it doesn’t matter what the rents are compared with the monthly rental income generated.

“There’s a big difference between self-employed (providing) tax returns and listing income without verification,” said Guy Cecala, executive chairman at Inside Mortgage Finance. “… (12 months of) bank statements is a pretty good proxy for income.”

Is the exotic mortgage market growing?

“We estimate non-QM to have grown from about 1% of total originations at the time of the pandemic to about 5%” in 2025’s third quarter, wrote Andras Malatinszky, director of data sales at Inside Mortgage Finance. “Also, the increase in non-QM’s market share shows that it’s a product that is less sensitive to interest rates than conventional or government lending.”

To be very clear, all these loan programs require good credit, at least 10% down, if not a lot more, and a healthy amount of cash reserves.

I don’t believe this generation of exotic mortgages is similar to those that caused the 2008 mortgage meltdown. That generation of loans were given out to folks with bad credit, no down payment or skin in the game with catapulting rate adjustments after the prepayment penalty ended.

To be fair, we’ve also been lucky when it comes to non-QMs (except for the liar loan). We haven’t experienced a mortgage meltdown in at least 15 years. In the meantime, owners have seen a huge increase in property appreciation. This makes it easier for someone to sell, should they get into financial trouble because the home likely has equity.

If the economy were to turn badly, I wouldn’t want to be an exotic loan investor.

Freddie Mac rate news

The 30-year fixed rate averaged 6.09%, 2 basis points lower than last week. The 15-year fixed rate averaged 5.44%, 6 basis points lower than last week.

The Mortgage Bankers Association reported a .03% mortgage application decrease compared with one week ago.

Bottom line: Assuming a borrower gets an average 30-year fixed rate on a conforming $832,750 loan, last year’s payment was $427 more than this week’s payment of $5,041.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 5.25%, a 15-year conventional at 4.875%, a 30-year conventional at 5.5%, a 15-year conventional high balance at 5.375% ($832,751 to $1,249,125 in LA and OC and $832,751 to $1,104,000 in San Diego), a 30-year high balance conventional at 5.875% and a jumbo 30-year-fixed at 5.875%.

Eye-catcher loan program of the week: A 30-year mortgage, fixed for the first five years at 5.125% with 30% down payment and 1 point cost.

Jeff Lazerson, president of Mortgage Grader, can be reached at 949-322-8640 or jlazerson@mortgagegrader.com.