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from Local Attorney, Michael H. Wasserman

Wednesday, February 6, 2008

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)

More on HELOCS

Never mind that the lender might send a letter telling you that the size of your line of credit is going to be lowered, if you are even remotely considering a sale of your home and purchase of another, NOW might be the time that WANT/NEED to get that HELOC anyway.

With a slow market, there is just no guaranty that you are going to be able to sell your home in time to buy the next one. You might be able to offer to buy the next house contingent on the sale of yours, but there is no guaranty that the seller will agree, or that you will find a buyer who can fulfill the contract to buy yours. Mortgage markets are tightening for everyone.

You may need to tap into that built-up equity in your current home before you sell it, in order to buy the new one.

THE PROBLEM: Most mortgage lenders will not want to remortgage your house for you once you have listing on the MLS. As suggested by Dan Green at Mobium Mortgage, "If there's even a remote chance that you'll need your home's equity for a downpayment on your next home, it's just good defense to get that equity out today -- before you list your home for sale".

A Warning to those with Home Equity Lines of Credit

A new warning to anyone who has mortgaged property with a Home Equity Line of Credit.

Borrowers with Home Equity Lines of Credit (HELOC) loan on their property pay interest to their lender based on the average daily loan balance outstanding at an interest rate that varies from month to month, typically tied in some fashion to prime lending rates. Typically, all that is required in the way of minimum payment is the interest only. As interest rates rise, so do the monthly interest payments. We are all sensitive to the effects of interest rate changes on our monthly payments as we get billing statements every month and can see the changes every four weeks.

With property values declining in many locations nationwide (including some parts of Chicagland), a stealthier, and perhaps scarier problem is looming:

STANDARD HELOC loan agreements allow lenders to DECREASE the lines of credit available to homeowners if the value of the property declines. Borrowers do not get a say in the lender's decisions. This appears to be a unilateral right.

The risk here is pretty obvious:

Home buyers who financed a part of their orignial home equity line of credit (HELOC) loan, "piggy-backing" on top of a first (conventional) mortgage or who have used HELOCs for home improvements or other non-housing expenditures may receive "margin calls" from the bank demanding repayment of any principal in excess of the diminished line of credit, or face a risk of mortgage default. Its a pretty safe bet that most of those who could be effected are using HELOCs precisely because they did not have other readily available cash on hand to cover those expenses they borrowed money to pay.

For others who maintain zero balance lines of credit as an emergency / rainy day fund, the safety they have relied on may also be decreasing.

Fortunately for most of us in the Chicago area, home values have not dropped sharply, so for now, this is merely a precautionary alert. Keep your eye on the neighborhood property values and stay alert to changes. The house you save may be your own.