Reverse Occupancy Fraud: About This New Mortgage Scheme And What To Do Instead

Over the past few years, lenders have seen a noticeable uptick in reverse occupancy mortgage fraud cases. This relatively new practice is much different than traditional mortgage fraud schemes. With reverse occupancy fraud, buyers take out a loan on an investment property when they have no intention of renting it out.

So, what exactly is reverse occupancy mortgage fraud and why someone would do it? What are the risks associated and some legal alternatives that buyers should consider instead?

What Is a Reverse Occupancy Scheme?

Reverse occupancy fraud is a type of mortgage fraud that involves taking out an investment loan when the borrower actually plans to make the property their primary residence.

This may seem counterintuitive: Mortgages for investment properties typically come with higher interest rates and larger down payment requirements. However, investment properties have one main benefit not available to owner-occupants: using future rental income to help qualify for the loan.

Conventional lending guidelines allow borrowers to count 75% of future rent towards their qualifying income when applying for a loan. For some individuals, especially those with low income or high debt, this added income can help them meet the typical 43% debt-to-income ratio limit.

For Example:

A borrower wants to purchase a home for $500,000. They can comfortably put down 25%, the minimum required on an investment loan. The home has an estimated monthly rent of $2,500. Their regular monthly income is $6,000, and they have no current debt obligations.

*Calculated with a 7.5% interest rate. Available rates may vary.
Monthly payment is estimated with the MRC conventional loan calculator.

Without using any rental income, the borrower would not qualify for this loan. However, by claiming future rental income, their debt-to-income ratio falls within the allowable range.

In this case, the borrower would only meet DTI requirements by claiming rental income. The buyer commits reverse occupancy mortgage fraud by taking out an investment loan for a home they plan to live in full-time.

This type of fraud also happens (and is actually more common) when someone buys a duplex, triplex, or fourplex as a pure rental property, claims all rental income, then lives in one of the units.

Reverse Occupancy Fraud vs Traditional Occupancy Fraud

Reverse occupancy fraud is a relatively new type of mortgage fraud. The scheme was first discovered by fraud analysts within the past decade, and reported cases have risen dramatically over the past few years.

Traditionally, occupancy fraud has consisted of borrowers doing the opposite: taking on a primary residence loan on a home they intend to rent out. This allows them to take advantage of smaller down payments and interest rates lower than available for investment purchases.

This approach benefits borrowers with a high-income level but little in the way of assets for a down payment. But for those committing reverse occupancy fraud, the situation is flipped. These borrowers are generally sitting on a large liquid reserve but have little documented income.

Occupancy Fraud Red Flags for Lenders

According to research by the Federal Reserve, someone committing occupancy fraud is 75% more likely to default on their mortgage than a borrower who qualified legitimately. This poses a significant risk to lenders.

By assessing the recent increase in reverse occupancy mortgage schemes, fraud analysts have identified some red flags that can help alert loan originators to potentially fraudulent applications. These red flags may not indicate fraud on their own. Still, underwriters will look closer when numerous warning signs are present.

Reverse Occupancy Fraud Red Flags During Underwriting:

A few of the warning signs of fraud that underwriters look for during the origination process include:

• Borrowers are first-time homebuyers purchasing a multi-unit investment. Reverse occupancy fraud occurs with single-family homes but is more frequently seen with multi-unit properties.

• Borrowers have little to no established credit.

• Borrowers have little documented earnings but a large reserve of liquid assets and are willing to make a sizable down payment.

• Borrowers can only qualify for the loan if they apply future rental income.

• Borrowers currently live with family or in a similar rent-free situation with no housing expenses.

• Borrowers live within specific geographic areas with a greater likelihood of mortgage fraud. According to industry analysts, some states with the highest risk of fraud include New York, New Jersey, Florida, and California.

Reverse Occupancy Fraud Red Flags After Closing

Even after a deal has been funded, lenders have teams of fraud analysts who conduct quality control reviews on their loans. Some things that they’re watching out for after closing are:

• Borrowers filing for primary residence tax credits on an investment property.

• Rental property insurance policies changed to owner-occupant policies soon after closing.

• Borrowers contacting the loan servicer to change their billing address to that of the investment property.

• Occupancy verification services finding the borrower living on-site during post-closing inspections.

Consequences of Mortgage Fraud

Mortgage fraud is illegal under state and federal laws and can have serious consequences. It's not something to treat lightly. In some situations, it can even result in prison time and fines as high as $1 million.

Realistically, however, this is unlikely to be the situation for an individual buyer committing reverse occupancy mortgage fraud. Because of the limited scale of the crime, most cases are not prosecuted. But it is still a legal repercussion that should not be ignored.

When reverse occupancy fraud is discovered, the most likely action is that the lender will force the borrower to pay off the remainder of their loan. If the borrower cannot refinance the loan and is otherwise unable or unwilling to pay the balance, the lender can file for foreclosure.

This can lead to the borrower losing considerable equity, as multi-unit investment properties require at least 25% down. Plus, they'll have a much more difficult time obtaining a loan in the future.

Alternative Ways To Qualify for a Loan

No matter how you look at it, reverse occupancy mortgage fraud is a bad idea. There can be severe consequences, the least of which is losing out on a substantial down payment. Thankfully, there are a number of legal strategies that buyers can instead employ to qualify for a home loan.

Revisit Their Housing Options

Just like fish in the sea, there are plenty of other housing options out there. If a borrower's income level doesn't support the property they're eyeing, a lending professional can guide them toward a purchasing scenario that is within their budget.

And that doesn’t necessarily mean downsizing. The ideal solution may be finding a larger multi-unit property with rent levels that support the buyer making it their primary residence.

Take on a Co-Borrower

Not everybody has someone who can co-sign on a loan with them. But for borrowers with a friend or family member in the position to do so, taking on a well-qualified co-borrower can help boost income above the required level. Conventional lending guidelines are pretty lenient on non-occupant co-borrowers.

Purchase Mortgage Discount Points

Buyers with low income but substantial cash assets may want to consider purchasing mortgage discount points. The cost of a mortgage discount point is generally equivalent to 1% of the total loan. It can be paid to the lender in exchange for a 0.25% interest rate reduction.

Most lenders let borrowers purchase up to four points. In some cases, this interest rate reduction of up to 1% can drop the monthly payment enough for buyers with low qualifying income to obtain a mortgage.

Find a Fixer-Upper

There are plenty of loan programs - conventional, FHA, and VA loans – that let you finance a fixer-upper. This may sound like a roundabout means of affordability, but it’s rather straightforward. Find a home that’s offered at well below market price due to its condition. Rehab it, financing nearly all construction costs. The lower price point could mean that you qualify for the loan.

Apply for a HomeReady or Home Possible Loan

Lenders have several first-time homebuyer and low-income loan programs with benefits that can cut monthly costs. For this situation in particular, HomeReady and Home Possible mortgages.

These loan products are designed for lower-income borrowers who make up to 80% of their area's median income. They come with better interest rates and loan discounts, which can significantly bring down housing expenses for some borrowers. Plus, they allow for multi-unit purchases and rental income to be used for qualifying.

Reverse Occupancy Mortgage Fraud Is Never the Answer

While it’s easy to be tempted if you feel the path to homeownership is blocked, reverse occupancy mortgage fraud is never the answer. It's illegal and can have serious consequences, including prison time.

Instead, be upfront with your lending professional about your intentions and financial situation. It's in the best interest of these mortgage experts to find you a loan, and they'll use their in-depth knowledge to help you do so legitimately.