Occupancy Fraud
It is usually harmless
When the price of a house goes up after you buy it, the lender has nothing to worry about. No matter how many lies you told on your mortgage application, the lender is likely to be able to recover the value of the loan. If you bought the house for $250,000 and it is now worth $275,000, then you have a strong incentive to keep paying the mortgage—otherwise, you could be throwing away $25,000 in capital gains. And if you do hand the keys back to the lender, the lender has a decent chance of not losing any money.1
The most serious form of mortgage fraud is appraisal fraud. Suppose that you can get an appraiser to sign a form saying that the house is worth $250,000, even though the house is only worth $100,000, or maybe there is no house at all. You get a mortgage loan for $200,000. Do that a bunch of times, and then abscond with all the money. Pulling off that scam is nearly impossible, but it is a risk that mortgage lenders need to protect against.
Other types of fraud are technical violations that have only a minimal impact on the lender’s risk. Overstate your income? Hide some of your non-mortgage debts? Claim that you intend to use a home as your primary residence when your plan is actually to rent it out (occupancy fraud)? These lies can help you get a mortgage at a lower rate than would be the case otherwise, or even get a loan that you would have been turned down for if you told the truth.
But these are relatively minor offenses. As long as the value of the property holds up, the lender will do fine.
In the years leading up to the financial crisis of 2008, occupancy fraud became widespread. That is because house prices had been appreciating, drawing in speculators. Beyond occupancy fraud, lending standards had become very loose, for a variety of reasons. That looseness was embedded in the phrase “NINJA” loans, in which the lender required no proof of income, job, or assets.
In spite of NINJA loans and occupancy fraud, mortgage defaults were low in the early 2000’s, because house prices kept going up. But when the appreciation stalled out in 2006 - 2008, the bad loans resulted in widespread foreclosures and significant losses. Mortgage securities that had been treated by Wall Street as solid collateral for short-term loans were no longer accepted for so-called repurchase agreements. This caused a major panic among investment bankers and banking regulators. For reasons that I still do not fully comprehend, this “financial crisis” spilled over into public policy and the economy at large.
Occupancy fraud has been in the news recently because that is the grounds for which President Trump claims that Federal Reserve Governor Lisa Cook should be fired. If you think she should be punished for occupancy fraud, I will not argue with you. Fraud is fraud, even if many people engage in it and even if it causes problems only in unusual circumstances (e.g., 2006-2008). But most of you have done worse things in your life than commit occupancy fraud.
The administrative costs of dealing with the foreclosure are likely to exceed $25,000. Also note that if the lender is able to sell the house for $275,000, the lender is only entitled to $250,000. The lender is not allowed to profit from foreclosure.
While I don't disagree with your claim that other people have done worse things than occupancy fraud (although I am not entirely certain I think it is true), government officials need to be held to a much higher standard. It isn't ok for police officers to speed without punishment even though lots of people do it; not only because it creates a two tier justice system but because those who enforce the law need to be trusted to do so.
If we don't care to punish people for doing something, fine, stop making it illegal. If it is going to be illegal, people should be punished for it, especially those in positions to enforce the rules on others.
Not to mention the fact that if someone is caught committing fraud blatantly and in a fashion they know is committing fraud (if a Fed governor doesn't know that, she shouldn't be a Fed governor) what are the chances that what was uncovered is the only fraudulent activity she knowingly engaged in? If you are committing fraud to save some money on buying a few different properties, are you not going to break the law when larger amounts of money are on the line? For instance, in your capacity as a Federal Reserve Governor?
Occupancy fraud is theft.
Because most mortgages are non-recourse in the US, lenders and MBS pool investors view primary residences as being better risks than investor properties. An investor will walk away from an underwater property more easily than a resident will- the resident needs a place to live.
Hence, investors pay higher interest rates or have to put more money down.
If someone tells me I am buying t-bills and pays me a t-bill rate but really what I own is an A rated corporate note - that is fraud. If I wanted to take the risk of an A rated corporate note I would get paid more for that.
The fact that house prices usually go up or that A rated notes almost always get paid off at maturity is irrelevant. In capital markets there are different prices for different assets and lying about the nature of the asset is theft and fraud.