Some years ago, a Northern California newspaper recently ran a story about a police officer who had been charged with felony mortgage fraud. According to the article, the officer took out two loans on two different residential homes at approximately the same time. That’s certainly not a crime. But the officer has been charged with applying for each loan as an “owner-occupied” loan. What’s more, the officer was apparently charged with substantially overstating his income on his loan applications. The police officer denied any wrongdoing.
If true, these charges would amount to lender fraud. Lenders want to know the economic status of the borrowers they deal with. That’s the reason lenders require Borrowers to fill out loan applications. A good credit score isn’t enough. The lender wants a true snapshot of the borrower’s financial condition. The lender wants assurance that the Borrower has the financial resources to repay the loan – with interest. And the lender wants further assurance that the Borrower will be motivated to repay the loan.
Borrowers who use a loan to buy their principal residence may be more motivated to repay a loan than borrowers who are purchasing investment property. If a borrower runs into financial trouble, that borrower may be more likely to default on an investment loan than on a loan on the home where they live. Thus, an “owner-occupied” loan may have less risk than a loan on an investment property. The simple reality is that a borrower’s home is often the last, and possibly most important, asset that most borrowers will ever have. Lenders can gain some assurance from knowing that a borrower is accepting a loan for a home where they plan to live.
Borrowers receiving an “owner-occupied” loan can often can get a loan on better terms than they could on a loan for purchasing investment property. There can be a substantial economic incentive for borrowers to claim that they intend to live in the property when they actually don’t intend to. If borrowers falsely represent they intend to live in the home they are buying, then the borrowers commit a fraud on the lender when they make such a representation.
The officer in the story referred to above apparently overstated his income by a significant amount. This can be a problem because a lender relies on income information in determining whether or not a borrower can repay the loan. Without sufficient income, the borrower may not qualify for the loan There can be a significant incentive for borrowers to overstate their income in order to qualify for a loan. Again, such a practice constitutes lender fraud.
In the story above, the officer reportedly refinanced both loans within a few months of receiving initial loans. He reportedly pulled cash out of the properties through refinance loans, and he then allegedly defaulted on the loans. The defaults probably spurred the investigation that resulted in his being charged with felony lender fraud. If loans are fully paid as agreed, then lenders may not have any incentive to confirm whether or not any misrepresentations were made on the loan application. But once loans go into default, and especially if a lender will suffer a loss, then a lender has an economic incentive to carefully review the borrower’s application to determine whether or not all of the representations were truthful.
What a terrible risk to take. When borrowers take out loans on investment property in a hot real estate market, misrepresentations on a loan application can seem to be a minor thing. But when the lender loans hundreds of thousands of dollars on those representations, and if the market turns downward so that there’s a foreclosure, then a borrower who is less than honest can end up facing criminal charges. Nobody expects this when they fill out a loan application – but it’s a real possibility. The end result? Honesty truly is the best policy – even when it’s more expensive.