31 May Liar Loan Discharged in Bankruptcy – Lender Must Vet Applicant or Take Loss
A bankruptcy judge stunned the mortgage industry this week by discharging a stated income HELOC mortgage deficiency, even though the borrowers lied about their income on the loan application.
A false loan application is fraud and usually grounds to deny a bankruptcy discharge, but this lender did not verify the income and did not rely on false application, according to an Oakland, CA, judge which called the case "a poster child for some of the practices that have led to the current crisis in our housing market."
As reported in the Wall Street Journal, the judge blames the lender for failing to vet the loan applicant’s ability to pay the loan and for relying only on an appraisal of the property, which turned out to be false.
“If you make a "liar loan," the Judge is saying here, then you cannot claim you were harmed by relying on lies. And if you rely on an inflated appraisal, that’s your lookout, not the borrower’s, ” said Tanta in her post on the Calculated RISK Finance and Economics blog.
What is a liar loan?
“Stated income loans are also called “liars loans”, because in some cases, the rules virtually invite the borrower to lie,” according to Jack M. Guttentag, Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania, and founder of GHR Systems, Inc., a mortgage technology company.
A stated income loan qualifies a borrower using the income the borrower states on the application form – as opposed to the income the borrower can document. With a stated income loan, the lender agrees not to attempt to verify the income the borrower states on the application.
In re Hill (National City Bank v. Hill), United States Bankruptcy Court, Northern District of California, Case No. A.P. 07-4106 (Filed May 23, 2008)
"While the Court finds and concludes that the debtors made a material false representation concerning their financial condition to the Bank in October 2006, with knowledge of its falsity and the intent to deceive the Bank, the Court finds and concludes that the Bank’s nondischargeability claim under § 523(a)(2)(B) must fail. The Bank failed to prove that it reasonably relied on the Debtors’ false representation concerning their income, as set forth in the October Loan Application. As a result, the Bank’s claim has been discharged. Judgment will be ordered accordingly." In re Hill (National City Bank v. Hill), United States Bankruptcy Court, Northern District of California, Case No. A.P. 07-4106 (Filed May 23, 2008)
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