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Breaking the Law for Peanuts

It happens every day of the week. A borrower is told by their mortgage officer that the interest rate for their new mortgage will be higher than usual.

The reason? The borrower is seeking financing for an investment, or rental, property. The increase in rate seems significant so the borrower inquires about it. The loan officer explains that an investment property represents a higher degree of risk for a lender.

Then, what happens all too often, unscrupulous loan officers advise their clients to simply state that the home will be used as a second residence. Second homes typically carry the same rate of interest as a primary residence.

This is a very big mistake for two reasons.

The first reason is that this misrepresentation is a crime! Here is the exact wording that a borrower is asked to sign at the closing:

I have read and understand this Statement of Applicant. I understand that the making of false certifications or declarations is a crime under section 1014 of Title 18 of the United States Code.

You may not see this wording with your initial application but it will be there in the closing package. Most closings contain a form specifically addressing occupancy with the above wording directly below the statement.

Few people want to break the law. But adding the additional cost to words like "Oh, people do this all the time" from the loan officer, many people opt to mislead the lender. Of course the loan officer is also breaking the law by advising their client to do this, but very few ever get caught. But borrowers can get cauhght. Lenders check for occupancy on many of their loans. They check phone and tax records. It's actually pretty simple to catch these law breakers but because of the volume of loans that lenders provide, few people are ever convicted of this crime. And that is why so many people "take the chance".

But what is really puzzling about all this, is for how little people are willing to break the law. Fannie Mae and Freddie Mac are two government-sponsored agencies that purchase a large majority of the mortgages loaned in this country. The agencies have a set of rules. or "guidelines". If a loan falls within those guidelines, either entity will purchase the loan. The agencies take no issue with purchasing loans secured by investment properties other than they require a slightly higher fee, or interest rate.

How much higher?

That depends on how much is being borrowed. With a 10% down payment, there is an add-on of 2.5 points - each "point" represents 1% of the amount being borrowed. A $200,000 loan amount will cost a borrower $5,000 in order to get the very same rate they would get for a primary residence. A 20% down payment would have an add-on of 2 points and down payments of 25% or more would have an additional 1.5%. But these add-ons DO NOT have to be paid in upfront cash.

A borrower can elect to accept a higher interest rate rather than pay the extra fee. When paying points, borrowers are "buying down" the interest rate. The longer they have the mortgage, the more beneficial the rate "buy-down" becomes.

In a typically buy-down, one point (1% of the loan amount) will "buy down" the interest rate approximately 1/4 of 1%. If 1 point = 1/4%, then, 1/2 point = 1/8%. So a total of 2.5 points will be an approximate increase of 5/8% (0.625%). 2 points will be about 1/2% increase and 1.5 points will be around 3/8% (0.375%).

Going back to the above example of a $200,000 mortgage, at current interest rates, an increase of 5/8% adds $82 to the payment; a 1/2% increase is an additional $66 and 3/8% would add $49. Is it worth those kinds of numbers to break the law? I hope you feel like me and not even think twice.

Another part of this equation is that it becomes easier to qualify for an investment property because lenders will often use a portion of the projected rental income and add that to the borrowers regular income.

So follow Spike Lee's advice and "Do the right thing!"

Seed Newsvine

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