Awkward Question

[rusty]

My husband and I are filing chapter 7 bankruptcy and there is a potential problem that is causing me a lot of worry that I would like some advice on.

My husband owns his own business and for years we have filed tax returns showing a very low income from this business. A couple of years ago we bought a second house and had to provide documentation showing a much higher income than we have been declaring to the IRS. We also bought the house as a 'primary residence' even though we live in a different property.

The house is now in foreclosure and I am wondering if anything bad is going to come of the difference between the tax returns we have filed and the mortgage application which is for an amount ten times higher than our declared taxable income. Will this even come up in the bankruptcy? (Edit: the mortgage loan is 10x income - I didn't mean to imply that we claimed an income 10 times higher but it is several times higher than the income we declare on our tax return)

I am worried about this but my husband seems to think I'm being too cautious because he thinks everyone exaggerates income on mortgage applications. Could someone please explan any pitfalls in our chapter 7 proceedings that might come of this or perhaps put my mind at rest?

[BkinTX]

I don't know but that sounds BAD to me!

[mom2three09]

I'm no expert... and really have no idea if it will come up. I will tell you that I don't think 'most people lie about thier wages' when getting a mortgage -- we had to show documented proof of our income before we could get qualified for our mortgage. I guess it may be different when you own a business and are able to "show" your earnings to be whatever they need to be.

Honestly, I would be worried too if I were you. But then again I was worried about our 341 and didn't even have anything to hide

[backtoschool]

Any creditor that can prove fraud in a credit application can file to contest the bankruptcy, or at least discharge of their debt.

All creditors have a right to see everything on your bankruptcy petition. They can ask to see your tax returns. If the tax returns don't match the application then they can as for more info, etc....

There is no reason to assume that they will do this, you might "slip between the cracks", but they have the legal right to contest you including the house in the bankruptcy on grounds of fraud, if your mortgage application does not match your tax returns.

[want2save]

There is gross income and then net income after business expenses. The amount of profit on your schedule C would be your true income, but if the mortgage application asked for GROSS income and you showed that and have receipts to prove the income, you might be ok. The question would be how about the business expenses? Did the application ask about those? I would think the lender would have wanted the full tax return, including the Sch C. Or, perhaps you did a "stated income" loan and just picked a figure out of the air??

[rusty]

I don't know all the details about why our tax return is always so low which is why I am worried. I know my husband does claim a lot of business expenses and uses a tax specialist every year.

From the replies so far (thank you!) I am guessing that the area of concern is the mortgage company and not the IRS which would be the thing that would cause me to really lose sleep.

I have searched this forum and have seen other people saying that it is difficult for mortgage companies to come after you in a case like ours because the onus was on them originally to verify the loan properly. Hopefully this will work out for us.

[hereforinfo]

Let me guess. It was a stated income (no doc) loan?

You are right to be worried. What you did would be considered mortgage fraud. If the lender happens to research your application and closing docs, you will be in a very tough spot. The odds of that are probably low. But what if the trustee or any of the forms you fill out ask you if you misrepresented your income on any applications? You will have to be honest because if you lie under oath and then get caught, you are in even more trouble.

Most people do not lie on mortgage applications. Lenders usually verify the information you provide. However, a lot of people did "stated income" loans where you can put whatever you want on the application and the lender doesn't verify it. Those loans usually had a higher interest rate in exchange for the convenience. They were meant to make the application process easier for people who are self employed, not for people to lie and obtain mortgages for which they can't legitimately qualify or afford.

And people wonder why our housing market collapsed.

[hereforinfo]

I have searched this forum and have seen other people saying that it is difficult for mortgage companies to come after you in a case like ours because the onus was on them originally to verify the loan properly. Hopefully this will work out for us.

That's not correct. Read this link:

http://themortgageinsider.net/mortgage-answers/what-are-the-penalties-for-lying-on-a-mortgage-application.html

I don't want to scare you, because the odds of you getting caught are low and I doubt it would even be worth the lender's resources to pursue anything. However, what you did was illegal and is considered mortgage fraud.

[jadams]

What documentation did you provide to the mortgage company? Different tax returns? Bank statements? Invoices/Receipts? Or was it just a stated income?

Was the amount at all reasonable? For example is it in line with your receipts and you were just able to write off some extra things that year? Or did it include some projected future income that was reasonable and expected, but never materialized?

The biggest problem would be if you provided inaccurate tax returns to support the income.

You need to sit down with your husband and discuss the records and see if you do have a problem and how bad it is. You need to know and understand what's on those tax returns before you open your financial life to dissection by a trustee.

[albacore44]

it would be very difficult to prove. stated income loans were also pushed purposly by the banks during the boom eager to satisfy there grreed for a quick buck during the housing boom. my last 3 refis on my second were stated income. I had a good, honest broker, and he said it's part of the game. you pay a slightly higher rate to use stated income. not only that, what exactly is income ?? Is it just your salary, reported on your w-2 reported to the IRS ?? no. It can include other income. lets say you rent 2 rooms of your house out for $800 a month each. You have $1600 a month in additional income not reported on a W-2. so your stating money you have avaliable that they would no see under a normal application

[hereforinfo]

it would be very difficult to prove. stated income loans were also pushed purposly by the banks during the boom eager to satisfy there grreed for a quick buck during the housing boom. my last 3 refis on my second were stated income. I had a good, honest broker, and he said it's part of the game. you pay a slightly higher rate to use stated income. not only that, what exactly is income ?? Is it just your salary, reported on your w-2 reported to the IRS ?? no. It can include other income. lets say you rent 2 rooms of your house out for $800 a month each. You have $1600 a month in additional income not reported on a W-2. so your stating money you have avaliable that they would no see under a normal application

That rental income would have to be included on the income tax returns. You can't tell the lender you have that income and then hide it from the IRS. The lender usually has stated income borrowers sign an IRS 4506, and if they want to perform an audit all they have to do is pull that and verify the income you claimed on your taxes the previous 2 years, because basically that's the number they want when they ask for your income. Most loan applications have a space to include other/additional income, where you could list income sources that aren't on your tax returns (such as child support).

How long did you pay on the loan before defaulting?

[backtoschool]

it would be very difficult to prove. stated income loans were also pushed purposly by the banks during the boom eager to satisfy there grreed for a quick buck during the housing boom. my last 3 refis on my second were stated income. I had a good, honest broker, and he said it's part of the game. you pay a slightly higher rate to use stated income. not only that, what exactly is income ?? Is it just your salary, reported on your w-2 reported to the IRS ?? no. It can include other income. lets say you rent 2 rooms of your house out for $800 a month each. You have $1600 a month in additional income not reported on a W-2. so your stating money you have avaliable that they would no see under a normal application

W2's and rental income would both be included in the income tax return and on the mortgage application.

There are two issues the OP is having here. One is the inflated income numbers on the mortgage application, and two is the fact that they declared the house a primary residence, but don't live in it.

Yes, this type of mortgage application is common from the boom times, but lying on an application, even a "stated income" application will put the OP at risk of the mortgage company contesting the bankruptcy.

If the house is underwater, and the OP is going to go into foreclosure anyway the mortgage company will probably not dig too deeply.

But misrepresenting your financial situation on a credit application is considered fraud for bankruptcy purposes and could jeopardize the bankruptcy if found out.

Also, if there are any taxes that are back due or part of the bankruptcy at all, then of course the IRS will be very interested in the discrepancy between the stated income on the loan app and the tax return, although this is not fraud. It could result in a tax audit however if there are any taxes being put as items owed or expenses on any of the schedules in the bankruptcy petition.

[mike258]

How much unsecured debt do you have? Is it more than 100K? I only ask because if the UST gets involved, she may request copies of credit applications.

I had to provide the UST with all copies of all credit applications from 2006, 2007 and 2008 (along with 2000+ pages of other documents). They were specifically looking for misrepresentations in income.

My case was scrutinized by the UST because I have a large amount of unsecured debt, 185K+.

[music12]

i think it would depend on what kind of role the lender played in your overstating income. if the lender did play a role in it, encouraging it in any way, then they have "unclean hands" and should not be able to say anything to the bk court about it.

you should find out all the details from your hubby or from the person who helped with the taxes. i think not knowing at this point is not a very good idea.

[Trixie007]

Wow, lots of scary answers here! Yes, misrepresentation on the mortage application (primary vs. investment & income) is mortgage fraud - some in the industry refer to it as "soft" fraud or "white collar" fraud.

First on income - it is common practice to add back in deductions that you took on your taxes for the purpose of your income on the loan application. For instance, depreciation is a valid tax deduction, but you add that back on for income on a loan app - there are others as well. Chances are that you provided a P&L to your Loan Officer (even for a stated income loan, I always used to look at these) and your LO would have known what could be added back in. Also, for a stated income loan, you may have earned X in year 1, Y in year 2, but in year 3 (when you are applying for the loan) be on track to earn Z. In a stated income loan situation, you would "state" the Z income even if higher than X & Y. I would think you have several different ways to explain a discrepancy.

On the issue of primary residence - you've had the loan for a few years, good luck to the lender proving you never had the intent to live in the home as a primary residence. The IRS only cares about this if you mis-claimed mortgage interest on your taxes.

As for the trustee asking for lots of extra documentation, I would think the previous poster had an unusual situation that caused the trustee to look so closely. We were pushing 200k in unsecured, plus around 900k in mortgages in our BK, and so far we're doing ok in our filing. The UST asked a few questions in email form prior to our 341, and we haven't heard a peep since. The local trustee filed a report of no distribution on 7/23. Good luck to you!