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A '95 Window We Could Do Without
Almost every day, some new miracle of the computer age enables us to do something we had never been able to do (model the atmosphere, Nintendo) or couldn't do without a prohibitive cost in time (decipher the human genome, balance a checkbook).
Every once in a while, a miracle allows us to do something we shouldn't. The worst of the shouldn'ts involve individual privacy.
In normal practice, for salaried borrowers, mortgage underwriting is intrusive and suspicious. Applicants have an affirmative burden to prove their financial situation; and throughout, their own word is unacceptable. All information must be verified by third parties. Guilty until proven innocent. There is little common sense, and no individual credit given for character, professional reputation, or standing in community.
For decades, self-employed applicants have had a tougher time: they have had to produce their tax returns in order to be approved for loans on good terms. The mortgage definition of "self-employed" goes well beyond ownership of a business, and includes any applicant whose income is 20% or more "contingency": bonus, commission, stock option, or dividend. Mere ownership of a rental property begets a demand for tax returns.
It's about to get worse. The mortgage business has arrived eleven years later than George Orwell's target date, but it's "1984", now.
Beginning in the late '80's, lenders began to suspect that certain inventive borrowers had given their lenders a set of tax returns different from the ones sent to the IRS. Naturally, the invented ones tend to report higher income than the originals.
Most loan underwriting is an effort to close various barn doors after herd, hay, and manure are long gone. The first effort at barn security was to require IRS form 4506 to be signed at closing by any borrower who had furnished income tax returns.
Charming 4506 allows lenders to pull the original returns from the IRS, and underwriters hoped that the threat of a post-closing audit would discourage creativity by borrowers. There is a very real club enforcing the threat: if fraud is discovered after a closing, mortgage documents give the lender the right to foreclose on the loan, payments on time or not.
Unfortunately, technology intervened in the creativity vs. audit threat stalemate; first to help the inventors, then the enforcers.
Hand-written or sloppy returns were more likely get 4506 treatment than formal ones. However, in the last few years, tax preparation software has made it possible to produce picture perfect "alternative" tax returns.
The lenders' Orwellian countermove has been made possible by easy electronic access to IRS records. In effect at some lenders now (and proposed for all), the 4506 investigation will take place at the time of application; and not as an audit of suspicious files, but for every applicant required to furnish tax returns. One test program in California recommends that any evidence of creativity be reported to the Justice Department for prosecution.
The many pay for the sins of the few; that's why there are speed traps, says the underwriter.
Wrong.
Find another way. Any banker who can't tell honest from not doesn't belong in the money business. A wholesale lender too anxious for business to screen its retail sources deserves exactly the loan quality it gets. Besides, getting snookered occasionally is a cost of doing business; mortgage lenders are not the only businesses forced to write off the occasional receivable.
The IRS is there to collect revenue, not to act as a credit bureau -- let alone on this sort of dragnet basis. Lenders are supposed to make loans, not twist arms for the IRS. Some lenders will claim: "But the borrower authorized the release of information!" Sure: no sign, no loan.
Breach of privacy aside, I have little confidence in detail work at the IRS. Comparison of two sets of tax returns can magnify an honest error into a declined loan or an accusation of fraud.
I've contacted our Congresspersons, and suggest you do the same. If this verification process becomes mandatory, I promise that most lenders will feel worse about doing this to you than you will feel about having it done.
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