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Occupancy fraud: Risks not worth the rewards

"Do you intend to occupy this property as your principal residence?"

The question, indicated by check boxes on most mortgage loan applications, might seem straightforward. But if you misrepresent your intention, it is a crime known in real estate lingo as "occupancy fraud."

Occupancy fraud occurs when a borrower says he or she plans to live in a home, all the while knowing the property will be rented out, according to Curt Novy, president of Corporate Mortgage Advisors, a mortgage fraud analysis firm in San Diego.

"Sometimes people change their mind and don't end up living in the property," Novy explains. "That's less serious than someone intentionally deceiving the lender by providing information indicating they are going to occupy, when they truly have no intention to."

Most lenders' loan documents define owner occupancy as a period of at least one year, but mortgage lenders have flexibility in their guidelines. If you intend to occupy a home, but move out within less than 12 months, you should notify the lender in writing and keep a copy of your letter, Novy suggests.

Why people do it

A misrepresentation of owner occupancy might seem like a small lie -- and one that could save you $100 to $200 or more in interest costs each month, making your investment more profitable. The exact savings depend on your loan amount and the interest rate differential between owner-occupied and nonowner-occupied financing, which is typically less than 1 percent.

"The financing package is much better for owner-occupied versus nonowner-occupied," Novy says. "Lenders perceive an owner-occupied transaction to be a safer credit risk than nonowner-occupied."

What happens if you get caught

Granted, one lie on a loan application isn't likely to trigger a full-blown fraud investigation, but that doesn't mean that occupancy fraud is a smart move, or that you'll be safe from negative consequences if you get caught.

Technically, the mortgage lender could call your loan due and payable, raise your interest rate and payment, or foreclose on your loan. However, Novy says those adverse outcomes are unlikely to occur if you're making your payments. Whatever does or doesn't happen will be solely at the lender's discretion.

The lender also could file a Suspicious Activity Report (SAR) into the federal government's Financial Crimes Enforcement Network (FinCEN), a centralized database that financial institutions use to report possible instances of fraud to law enforcement authorities.

SARs could become a problem if you make a misrepresentation on a loan application and later want to move to another home or refinance your mortgage, warns Tommy Duncan, president of Quality Mortgage Services, a mortgage compliance and quality control company in Brentwood, Tenn.

"They may initially get away with it, but they will be found out, and once they get found out, they get put into SARs," he explains. "When their name comes up hot in some of the fraud databases, it's going to be a lot harder for them to get a loan later in life."

Criminal prosecution

Novy says an investigation of one loan is "probably unlikely." But he adds that "if a person bought 10 different properties and put owner-occupied on all of them, submitting loans to different lenders, that falls into actual fraud. Individuals are and have been and will continue to be prosecuted for that."

The risk isn't nil, in part because lenders today hire experts to audit loan files, and they use that data to identify pockets of heightened fraud activity. For instance, a recent quarterly report by Interthinx, a loan risk analysis firm in Agoura Hills, Calif., identified four metros in south Florida, two in central California and one each in Ohio, Pennsylvania, Michigan and Louisiana as having the highest statistical risk of occupancy fraud in the U.S.

Mortgage fraud is a federal crime punishable by imprisonment and substantial financial penalties.

The bottom line for borrowers is that the relatively small financial reward of occupancy fraud isn't worth the risk of such bad outcomes.

"Is it really worth lying about [occupancy] over $150?" Duncan asks. "The money benefit is just not that great."

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