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Occupancy Fraud and the Sub-Prime Melt Down

Alot of the media coverage of the subprime mortgage crisis has suggested that the "victims" have been poor and unsophisticated borrowers who did not understand the terms of loans that predatory lenders sold them. In truth, a large segment of these problem loans may have been made to more affluent, sophisticated (greedy?) borrowers.

When a borrower signs a loan application and closes on a mortgage loan, the borrower must swear that information provided to the lender has been truthful. To lie on a mortgage loan application in order to get a loan (or better terms on a loan) is FRAUD. It really doesn't matter what the loan officer tells the customer. It is dishonest and illegal.

One such fraud perpetrated on lender relates to occupancy. An investment loan almost always comes at a higher cost, with a higher interest rate, and requires a larger down payment than a loan for an owner-occupied residence.

These sorts of misrepresentations seem to occur most frequently with regard to speculative investments in new constructions condo projects. Would-be investors who hope to buy condo units at pre-construction prices and then sell for quick profits shortly after the units are completed and purchased from the developer. Alternatively, some may opt to hold the units as rental properties. In either event, these players want to keep their investment costs as low as possible and there is great temptation to "pretend" that they will live in the condo unit as their principal residence.

When prices are increasing, this is often a fairly easy/passive way to make money. On the other hand, as we are now witnessing, when the markets slow, it takes longer to sell these units and the prices do not increase sufficiently for these investors to make profits (let alone recoup expenses).

Sadly, over the last year, I have seen several clients sell these types of properties at a loss. In some instances, I have even seen clients walk away from their earnest money deposits rather than complete a purchase contract on a unit they know they cannot immediately resell.

Not surprisingly, it turns out that a fair number of people who have bought on these sort of speculations have also started defaulting on their mortgages.

The Wall Street Journal reports on a Fitch Ratings study that found such "Occupancy Fraud" in as many as two thirds of of the subprime loans that defaulted within 12 months of origination. Another research firm, BasePoint Analytics suggests that 20% of all mortgage fraud involved this type of deception.

Investors tend to be more likely than borrowers who live in the homes to walk away from their purchases when home prices fall.

Source: The Wall Street Journal, Ruth Simon and Michael Corkery (02/06/08)

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