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"...lenders often times will receive insufficient return on their capital and are over-exposed on risk losses..."

In about 20% of mortgage fraud cases, the answer to the "Who's there?" question is – not the owner of the property, even though they indicated on their loan application that they intended to live in the property. The FBI doesn't typically investigate or prosecute cases of occupancy fraud. In fact, most law enforcement agencies would not consider prosecuting somebody for committing occupancy fraud at the top of their list of priorities.

Even though borrowers are not typically held accountable, lenders and investment banks often bear a significant risk when occupancy fraud happens. If undetected, the borrowers are able to obtain a lower interest rate and better financing terms on a loan. Because lenders typically charge a higher interest rate for non-owner occupied properties due to historically higher delinquency rates, the lenders often times will receive insufficient return on their capital and are over-exposed on risk losses relative to what they would have expected for an owner occupied property.

The motivation for occupancy fraud is typically better and less onerous terms

The motivation for a borrower to lie about their intent to occupy a property can be due to several reasons but in the end, borrowers would be motivated to misstate their intent to occupy because they can reduce their monthly payments, put less money down on the property and provide less documentation to a lender during the underwriting process. The primary reasons for occupancy fraud are:

1. More favorable loan to value ratios – Since owner occupied properties are less risky to a lender, they are often willing to let borrowers put less money down on the property.
2. Lower Documentation Requirements – Lenders often require significantly more documentation on investment properties.
3. Lower Reserve Requirements – Owner occupied properties typically require the borrower to have less money in their savings accounts than investment properties.
4. Better Terms – Borrowers can get significantly better terms from lenders on owner occupied property loans. A typical owner occupied property interest rate in today's market can be about .4% lower than a loan on an investment property.
5. Straw Buyers – In cases where borrowers are concerned about obtaining loan approval, they might have other people represent that they will live in the property when they are in fact acting as a front for the person who intends to live in the property.

Red Flags and Tell-Tale Signs

Occupancy fraud can be extremely difficult for a lender to detect prior to funding. Since the borrower is merely stating his intent to occupy a property, it can be difficult to reasonably predict that they will not follow through. There are, however, several tell-tale signs that can be identified and addressed during the underwriting process.

1. Payment Shock over 200%: Borrowers experiencing payment shock over 200% are more likely to be purchasing an investment property.
2. Appraisal discrepancies: Appraisals contain an indication of whether a property is tenant or owner occupied. BasePoint investigators examined loans that contained occupancy fraud and found many examples of appraisals that indicated the property was tenant occupied at the time when the borrower claimed it was owner occupied.
3. Address discrepancies on VOE or 1040s and documentation: In some cases, borrowers' misrepresentation of occupancy can be determined by examining if any discrepancies exist on the loan documentation.
4. Credit report discrepancies: The credit report can hold a world of insight on the borrower's intentions. In the case of straw buyers, unusually “thin” credit files compared to the borrower's stated assets or incomes are usually a tell-tale sign.
5. Lifestyle discrepancies: If borrowers own multiple properties, they will typically choose to live in the most expensive property and rent the less expensive properties. If borrowers are claiming to be purchasing and moving into a less expensive property than their current property this can be a red-flag for occupancy fraud.

Author

Frank McKenna is Co-founder and Chief Fraud Strategist for BasePoint Analytics based in Carlsbad, CA. He may be reached at (760) 602-4971 x104 or via email at FMcKenna@BasePointAnalytics.com

Frank McKenna, Co-founder and Chief Fraud Strategist of BasePoint Analytics

Frank helped develop and introduce advanced predictive technology to detect mortgage fraud. Frank's vast experience in fraud management has enabled him to identify unique and effective tools to manage lender risk through pattern analysis and evaluating other parties in the transaction, such as mortgage brokers.

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