I want to talk about a controversial practice in the mortgage world - the Form 4506 - Request for Copy of Transcript or Tax Form.
Basically, when a borrower signs this form, it allows the lender to obtain a copy of his tax returns from the IRS. Lenders contend that the form is used as a quality control method to discover and prevent mortgage fraud. Before a loan is closed, most lenders will require two years' tax returns from borrowers who are self-employed. After the loan closes, the 4506 form will enable the lender to obtain copies of the borrowers' returns from the IRS. The lender will then match these returns with the copies provided with the loan package. If the numbers are different - bingo - the borrowers may have provided fraudulent tax returns to the lender.
Believe it or not, this can happen. It happened to me. A few years ago, I brokered a loan to a national lender. The applicant owned a small business and provided computer-generated tax returns. They looked official - all the numbers calculated to the penny. Anyway, the loan was approved and the lender asked me to have the borrower sign the 4506 prior to closing. So I phone the borrower and tell him he needs to sign this document. I explain that it allows the lender to obtain a copy of your returns directly from the IRS. I fax the form to him and he has no trouble signing it and faxing it back to me. The loan closes and everyone is happy.
Two months later, I receive a phone call from the lender who tells me that the loan was randomly picked for a quality control audit. They use the 4506 form to obtain a copy of his tax returns and they discover that the numbers are completely different. As the mortgage broker, I was asked to sign a statement stating that I had not altered the tax forms that the borrower had provided to me.
I don't know what happened after that. The borrower's credit was excellent. Perhaps the lender was too busy to make an issue out of it. Anyway, that's what the 4506 is supposed to do - help discover mortgage fraud. And it seems to me that if the borrowers are applying for a "full documentation" loan that carries the lowest interest rate, they shouldn't have a problem signing the 4506.
Let's look at the other side of the coin. Many lenders require that a 4506 form be signed on "Stated Income" loan programs. A Stated Income program will sometimes carry a slightly higher rate, but does not require the actual verification of income that's disclosed on the application. Tax returns aren't required in the loan package.
Herein is where the problem arises. If a lender were offering a Stated Income program, why would it require the signed 4506? The answer is that a Stated Income loan is more valuable on the secondary market (where loans are bought and sold) if it contains a signed 4506. That's the bottom line. And I suppose lenders have every right to offer a mortgage program requiring no tax return information except the 4506. Whether this program should be called a "Stated Income" program is a subject for another column.
But what if the borrowers didn't know they had to sign the 4506 until the day of closing? What's up with that? Let me tell you another story. I recently brokered a refinance loan through a lender offering a Stated Income program. Great rate - great service - easy approval. The signing of a 4506 was not among the closing conditions faxed to my office. Only at settlement did we discover in the lender's loan papers that a 4506 was to be signed. Needless to say, my client refused to sign it and I arranged for that condition to be waived.
If a lender wants to offer a so-called "stated income" product that requires the signing of a 4506, that's fine with me. Just make sure the borrower and the mortgage broker are well aware of the fact. Don't try to sneak the form in at the last minute.