Occupancy Fraud

Purposefully lying to a mortgage lender constitutes occupancy fraud. If you're not familiar with the term, we'll explain when, why, and how some home buyers commit occupancy fraud. We'll also tell you about the potential repercussions.

What is occupancy fraud?

When a person applies for a mortgage, they're asked a series of questions, including whether they're going to occupy the home as a primary residence, use it as a second home, or rent it to someone else. The question is asked because guidelines for mortgages differ, depending on how the funds will be used. For example, if a person requests a loan for a second home or investment property, they do not qualify for a government-backed loan like those offered through the FHA, VA, or USDA. Those loans are strictly intended for owner-occupants. Mortgage lenders need to know why they're lending people money in order to meet government guidelines.

Why would someone commit occupancy fraud?

There are many reasons someone might be tempted to commit occupancy fraud. They include:

• The borrower is buying a second home. As mentioned, anyone borrowing money to purchase a second home or investment property cannot take out a government-backed mortgage. That leaves them with a conventional mortgage. Typically, conventional mortgages have tougher credit requirements than government-backed loans, which may lead some people with less-than-perfect credit to lie about why they want to buy a property.
• The loan applicant is taking a mortgage out in their name, even though it's for someone else. Frequently, it's a family member or close friend who puts their name on the loan because the person moving into the house does not have a high enough credit score to qualify for a mortgage.
• A borrower wants to make the smallest possible down payment. While an owner-occupied home may require no down payment (or as little as 3.5%), second homes require a 10% down payment, and to purchase an investment property, a borrower must put a minimum of 20% down.
• The borrower realizes that the lowest interest rates are reserved for owner-occupants. If it's a second home or they're buying an investment property, they may lie to take advantage of the lower rate.

Why does it matter?

Lending guidelines are in place for a reason. If the Great Recession taught us anything, it's how easy it is for someone to get in over their head with a mortgage they can't afford. Let's say a young couple has poor credit and can't qualify for a mortgage. One set of parents takes out a mortgage in their name, knowing it's the couple who will live in the house. For their part, the couple promises to make the monthly payments, but old habits return and they fail to live up to their promise.

Legally, it's the parents who are responsible for repaying the entirety of the mortgage, no matter who lives there. And because they knowingly lied to the mortgage lender, the parents may face legal consequences.

Is occupancy fraud punishable?

It may feel like a little white lie to the person committing the fraud, but if caught, the act can lead to serious consequences. The person who took out the mortgage, knowing they were deceiving the mortgage company, could face significant charges and fines. If anyone else was involved in the scheme, including a real estate agent, attorney, or mortgage loan originator, they are also liable for committing occupancy fraud.

Occupancy fraud may not seem serious, but it is a form of mortgage fraud. And in the U.S., mortgage fraud is a Class C felony, punishable by up to 20 years in prison, followed by three years of supervised release, and up to $5 million in fines. In addition, the property can be confiscated.

For example, say a person intends to purchase a rental property but wants the low down payment available through an FHA loan. Normally, this person would need to take out a conventional loan and put 20% down to buy an investment property. They work the system by lying on the mortgage application, claiming they plan to be the owner-occupant. The day they sign closing papers, tenants move into the house.

The penalties can be serious

Fast forward five or 10 years. The same person applies for another mortgage. In the process of a routine credit check, the lender realizes they already own a home and it's not the address listed on the loan application. After a quick online background search, the lender sees that the loan applicant never lived in the property purchased with an FHA loan. In short, they're caught red-handed.

Because occupancy fraud is a federal crime, there's little chance the person will be given probation.

According to the United States Sentencing Commission guidelines, a person convicted of occupancy fraud would be given prison time. In 2021, the average federal sentence for mortgage fraud was 14 months behind bars, according to the United States Sentencing Commission.

Finally, the person would be required to repay any gains made while they owned the house. For example, if they paid a $2,000 per month mortgage but collected $2,500 in rent each month, they would have to repay the extra $500 they received each month they owned the home. If the homeowner sold the asset, they would have to repay any money earned through the sale.

Exceptions to the rule

The law accepts that life happens and circumstances change. Let's say the homeowner in this scenario took out an FHA loan with plans to live in the house for many years. In other words, they go into the purchase with owner occupancy in mind. Unfortunately, they become seriously ill a month after closing and must move in with a relative to be looked after as they recover. Because this person's mortgage payments are still due each month, they find tenants willing to live in the home and make the monthly payment. This does not constitute fraud. When the homeowner filled out the mortgage application, they had every intention of living in the house as their primary residence.

Illness is not the only exception to the rule. For example, if a homeowner lost their job and had to move to another state for new employment, they could move tenants into the home. The same is true if they had to move into a parent's house to care for them, or they met a new romantic partner and impulsively decided to explore the globe for a year or two.

In other words, intention matters. If someone has every intention of living in a home when they fill out a mortgage application, they never lied to the lender.

A common issue

Because intention matters, it can be incredibly difficult to prove that a homeowner intended to commit fraud. According to the legal site NOLO, it is estimated that about 10% of all mortgage applications contain either an intentional omission or mistake. It's impossible to know how many of those omissions and mistakes were meant to deceive the lender and how many were simple oversights.

While a person's odds of having a case of occupancy fraud discovered are relatively low, the potential penalties should be enough to convince home buyers that the risks associated with lying on a mortgage application are too great.