Under ordinary circumstances, we think of lying as something that a few people do. But the nickname "liar's loan" is stunningly apt. The vast majority of the people who took these loans out exaggerated at least a little. Most lied a lot. And it's likely that most of the liar's loans—including those given to people with excellent credit histories—will go bad.
Think about that for a second. Imagine a city center where running red lights isn't something that the occasional drunken driver or road-rage victim does, but where everybody does it all the time. That's a lot like the mortgage market in big swaths of the country one or two years ago.
My wife and I bought our first house in 1993. We had to come up with a lot of paperwork and documentation to prove our income. We had to prove we had been employed at the same job for three years. Even back then they offered to extend a loan for twice of what we were requesting.
We bought a new house in 2001 and there was a little less paperwork. I thought it was because we had already been through the purchase of a home. When I thought that credit was at rock bottom, we re-financed. Each time we went for money, we were offered much more than we wanted. Each time we said no and took a conservative approach to borrowing. Each time we insisted on a fixed-rate mortgage.
Because my wife and I had various periods of unemployment through the years, we knew that borrowing based on what you are making today is not smart. You can be out of work next week. Then how will you make that house payment?
The lesson is: Just because you are eligible for a loan doesn't make it a smart thing to get.