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Suppose a borrower applied for, and got a mortgage from a bank, by reporting an income for several years of say, $100,000 a year. Suppose this borrower had zero legal income during this time, but had income from illegal sources of over $100,000 a year?

Could the borrower be found guilty of lying on the loan application about his income? Could the bank be found negligent for not verifying if the income was legal, even thought it was actually in excess of the reported $100,000 a year? Would the answers change if the illegal income was of a kind that can be reverted or "clawed back" because of conversion or other charges (such as drug dealing)?

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  • well, at minimum they could be charged with fraud if someone was persuing it criminally. Civilly, easily get a breach of contract, fraud. – Andrew Jul 6 '15 at 14:40
  • @Andrew: That is a very helpful comment. Why don't you turn it into an answer? – Libra Jul 6 '15 at 14:50
  • This seems like it could be an interesting question if the illegal "income" weren't subject to "clawback," in which case it's not exactly "income." Can you clarify why that clawback stipulation is in the question? Otherwise, one assumes, "illegal income" is still "income" by definition. – feetwet♦ Jul 6 '15 at 14:52
  • @TomAu because I have a few 'design around' memos to write today as well as some new claims for an office action. (Pretty busy Monday) – Andrew Jul 6 '15 at 15:10
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    As you pose it now what is the potential "lie" in question? If the applicant affirms that his income is legal then of course he's lying. If the applicant has to declare the source of his income, and he says "construction" when the real answer is "drug smuggling" then that's also a lie. But if he doesn't have to make a false statement, or affirm that his income was legal or reported to the IRS, then I don't see how there's a question of the applicant lying or doing anything wrong with respect to the application. – feetwet♦ Jul 7 '15 at 16:59
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The financial institution is only likely to run afoul of anti-money laundering laws.

The Bank Secrecy Act (1970) and the USA PATRIOT Act deal with anti-money laundering in the United States.

Now, this may not necessarily be the financial institution that funds the loan. However, a financial institution will verify the income as part of the lending process. For example, these are some of the ways a bank may verify your income (this isn't exhaustive):

  • 1040 Tax return (Federal or state).
  • Wages and tax statement (W-2 and/ or 1099, including 1099 MISC, 1099G, 1099R, 1099SSA, 1099DIV, 1099SS, 1099INT).
  • Pay stub.
  • Self-employment ledger documentation (can be a Schedule C, the most recent quarterly or year-to-date profit and loss statement, or a self-employment ledger).
  • Social Security Administration Statements (Social Security Benefits Letter).
  • Unemployment Benefits Letter.

Now, really, only the last two forms of verification would not be accepted by a financial institution. In the event that a financial institution completes its due diligence and verifies the income, the financial institution that funds the loan is unlikely to be found negligent.

However, if this income passes through any single financial institution, they may have obligations under the BSA to report the transactions, either through a Suspect Activity Report or a Currency Transaction Report. Failure to comply with these obligations can result in sanctions placed on the bank.

The borrower, on the other hand, is only likely to be subject to the laws that outlaw whatever criminal activity the funds were a proceed of, and/or perhaps money laundering laws.

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