While basic understanding of the "book smarts" within the mortgage industry will help you understand specific terminology, loan programs, and features, there is so much more you will need to know in order to make an informed financial decision.
My approach to providing education strives to further your understanding beyond the "book smarts" of the mortgage industry, and learn the valuable "street smarts" that will help you achieve the best possible results, while avoiding the most common pitfalls that non-informed Borrowers and Real Estate Professionals have experienced.
The Mortgage Street Smarts of Mortgage Loan Fraud:
As a Real Estate or Mortgage Professional, do you ever find yourself asking "why are these Underwriters so paranoid?" If you answered "yes" to this question, the following explanation of Mortgage Loan Fraud might prove useful in helping you see the bigger picture (while helping you to properly prepare your Buyers/Borrowers for realistic expectations of the loan process).
Underwriters are employed by Banks/Lenders to help determine which Applicants are approved for their loan and which ones are declined. When the "Mortgage Meltdown" occurred, many Underwriters lost their jobs...some of these layoffs were justified, while others were not. The end result is that the surviving Underwriters became extremely paranoid that any given loan they approved might someday default and inevitably cost that particular Underwriter their job retro-actively.
One of the biggest concerns among Underwriters is Mortgage Loan Fraud. Below are examples of some of the most common types of Loan Fraud.
NOTE: This information is purely to educate you on the bigger picture of Underwriter paranoia...it is not meant to encourage any unethical or illegal behavior!
Flipping - purchasing a property and then selling it for a profit. By definition, flipping is both legal and recommended. Flipping becomes problematic however, when it is used to facilitate a fraudulent transaction.
Flipping has been used to create comparable sales to be used on appraisals of legitimate transactions.
Example: Let's assume a builder has a number of homes in the same subdivision. The builder's transactions are running into problems because the appraiser cannot reach the sales price. The comparable sales in the area do not justify the sales prices for the builder's properties. In order to create some comparable sales which will allow the appraiser to appraise the builder's homes for the targeted purchase prices, the builder "sells" several homes to relatives or other related entities and then shows the transactions as comparable sales. This is an example of flipping used to facilitate fraud.
Flipping has also been used with fraudulently documented loans or identity fraud to allow the seller to realize unrealistic gains on the sale of a property.
Example: an investor purchases a property for $60,000. He then finds a buyer who does not qualify for a loan. The investor convinces the buyer that he can qualify if he purchases the investor's property for $90,000. The investor commits fraud to qualify the borrower for a loan used to purchase the property for $90,000. The borrower is not concerned about the sales price as he could not get into a home any other way. The borrower closes on the deal and promptly gets into financial trouble, as he can not afford a loan of $90,000. The investor has already realized the $40,000 profit from the transaction.
The same type of transaction can occur but with a fictional borrower using a stolen or fraudulently obtained social security number. The main purpose of the transaction is to allow the investor to sell the property at an above-market price. Many fraudulent flips involve an inflated appraisal. Flipping has also been used in extensive schemes to defraud lenders out of substantial amounts of money. Many of the loan fraud cases now highlighted in the press involve sophisticated flipping schemes. These schemes typically involve multiple types of fraud and several participants.
Case Study Example:
Let's trace the steps common in many of the flipping cases which are attracting media attention. While our example is not based on any particular case, it is very representative of the types of cases which are being prosecuted.
1) Mischievous Mike purchases a property for $500,000. The property may be worth slightly more, but the initial purchase price is usually fairly representative of the actual value of the home.
2) Mischievous Mike may finance the initial purchase himself or he may convince an "investor" to finance the home. While loan fraud may occur with this financing, it is more likely to occur later on in the process.
3) Mischievous Mike then finds an "investor" (often the investor is a regular individual who is employed in a traditional job but is attracted to the potential profits involved in real estate investing. We'll call our investor Paul Profit
4) Mischievous Mike tells Paul Profit that if Paul will "purchase" the property, Paul will receive $30,000 at the time of closing and then a share of the profits once the property is sold.
5) Mischievous Mike sells the property to Paul Profit for $1,000,000. Mike arranges for 90% financing for Paul Profit. Mike structures the financing in a way that the 10% down payment is carried by the seller.
6) Let's do the math on this part of the transaction. Mike purchased the property for $500,000. He has now financed the property for $900,000. He owes Paul Profit $30,000 for his role, leaving Mike $370,000 from the transaction.
7) Mike keeps some of his "profit" to make the payments on the loan. He then finds another "investor" to purchase the property for $1,500,000 and does it all over again. Many of these deals have produced hundreds of thousands to millions of dollars of "profits" for the masterminds of the schemes from just one single property.
8) Eventually the property will go into foreclosure and the final lender will lose substantial amounts of money on the transaction.
This example illustrates:
- Problems for the investor
- Paul Profit became liable for a $900,000 mortgage. If the property sells and the mastermind of the deal makes the payments until the property sells, Paul will not have a problem. However, if the mastermind fails to make the payments or if the property does not sell, Paul Profit is liable for the loan until it is paid off. Many investors in these schemes have been left with huge mortgage payments on which they could not afford the payments. The properties have gone into foreclosure, ruining the investor's credit.
- Loan fraud
- Perhaps Paul Profit was able to legitimately qualify for the $900,000 mortgage. However, in most schemes the "borrower/investor" does not qualify for the requisite financing. The mastermind of the scheme arranges fraudulent financing. Perhaps a stated income program is used and the income for the borrower is over-stated. Income documentation may be fabricated or produced in order to allow the borrower to obtain financing. In many cases, the borrower/investor claims they will occupy the property as their primary residence in order to obtain more favorable financing terms. Rarely, does the investor intend to move into the property, making their occupancy statement fraudulent.
- Appraisal fraud
- You may be asking during our example how a home which was purchased for $500,000 is later appraised for $1,000,000. While our example is not based on any single case, the numbers are extremely representative of actual cases. The answer to the question is typically "appraisal fraud." An Appraiser is part of the scheme, or in criminal terms, a "co-conspirator." The Appraiser may create comparable sales, misrepresent the subject property, or otherwise misrepresent the truth in order to produce an appraisal to justify the increased sales price. These flipping schemes often concentrate on particular geographic areas or neighborhoods. One of the reasons for this focus is the appraisal. Once the fraudsters "sell" our subject property for $1,000,000 and then again for $1,500,000, they have comparable sales they may use on other properties, making subsequent appraisals easier. The masterminds of these schemes have also been known to report the inflated sales on local multiple listing services (MLS). This distorts the market information heavily relied upon by industry participants, calling into question the integrity of the reported market data. Sales prices are also used to assess properties for the purpose of property taxes. Extensive flipping cases have increased the tax assessed values of an area, thereby increasing the property taxes owed by all local homeowners.
- Community problems
- This scheme will eventually fail and the property will eventually be foreclosed upon. Because the schemes are often concentrated on certain neighborhoods, this often means many homes in a particular area will be foreclosed upon and vacant, making it difficult for the traditional homeowners to sell their properties or maintain their neighborhoods.
You should be able to recognize all of the individuals that participated in our example. The mastermind and the investor played substantial roles. However, others were most likely involved including the Loan Officer, Appraiser, Real Estate Agent, and Title Officer. All of these participants are potentially guilty of fraud.
Silent Seconds involve a 2nd mortgage which is not disclosed to the lender. The borrower represents their down payment as personal funds, when the funds are actually borrowed. The 2nd mortgage is not recorded until after closing, or it is not recorded at all. The lender makes their decision based upon the borrower's representation that they have a down payment. The lender's risk is assessed based on the borrower's ability to pay a down payment. In reality the borrower has no down payment.
Straw Buyers are typically used when the true borrower and purchaser of the property are unable to qualify for financing. A borrower is found who is able to qualify for financing who poses as the purchaser of the property. This new borrower has no intention of retaining ownership or living in the property. It bears noting that all Federal Housing Administration (FHA) loans require the Borrower to live in the property (FHA only allows owner-occupied financing). Among the biggest causes of paranoia among FHA Underwriters is the possibility of a Straw Buyer. Be prepared for additional scrutiny for your Borrowers/Buyers in terms of fulfilling occupancy requirements when pursuing an FHA loan!
Fictitious / Stolen Identity (Identity Theft)
This type of fraud is fairly self-explanatory. Someone's credit report and social security number is used without their knowledge or consent to qualify for a loan used to purchase a property. No payments are ever made on the loan and the loan eventually goes into default.
Again, this type of fraud is fairly self-explanatory. Many fraudulent schemes involve an inflated appraisal in some form. The Appraiser could misrepresent the description of the subject property. For example, the Appraiser could state in the appraisal that the subject property is larger than it really is.
Take a look at the example contained in an FBI report we will discuss later. A loan was actually issued on the property pictured below. Obviously, the back of the property was not accurately represented in the appraisal used to approve the loan.
The Appraiser may also misrepresent the descriptions of the comparable sales. For example, the appraiser could use a property with a higher sales price, and alter the description to make it appear that the property is comparable to the subject property. The Appraiser could also use comparable properties, but misrepresent the sales prices for the comparable sales. The Appraiser is not always the guilty party when it comes to inflated appraisals. Loan Officers, Real Estate Agents, and other industry participants have been caught altering appraisals once they are received from the Appraiser.
As most appraisals are now submitted electronically, this has become easier with current technology. The traditional "white-out" is no longer a necessary tool for fraudsters.
Foreclosure Schemes involve the fraudster contacting homeowners who are close to losing their homes in a foreclosure proceeding. The fraudster offers the homeowner a way to save their home by deeding the property to a fraudster. The homeowner often pays up-front fees in addition to deeding the property to the fraudster.
The fraudster then re-mortgages the property, removes the equity from the property, pockets the up-front fees, and only postpones foreclosure rather than preventing it.
Equity Skimming can involve a combination of other schemes, such as identity theft and straw buying. The straw buyer purchases the property and immediately deeds the property to an investor. The investor then rents the property but never makes a mortgage payment. The investor simply pockets the rental income until the property is foreclosed upon.
Air Loans are loans which are secured by non-existent properties. The property itself is completely fabricated. Often, the borrowers, the borrowers' employers, and the borrowers' assets are completely fabricated as well. When the loan goes into default, the lender discovers that the property which secured the loan simply does not exist. The lender has only air for collateral.
Mortgage Fraud requires a Suspicious Activity Report (SAR) to be filed to the FBI. It goes without saying that no commission check is worth compromising your integrity and/or assuming the civil/criminal penalties for being part of Mortgage Fraud.
For more information on topics like this, please feel free to visit www.MortgageStreetSmarts.com (an educational resource for Borrowers, Real Estate Agents, and Financial Professionals)
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For more information on topics like this, please feel free to visit www.GordonMortgage.com (an educational resource for Borrowers, Real Estate Agents, and Financial Professionals). Educational content provided by:
Jason E. Gordon
Branch Manager | Sr. Mortgage Loan Officer
CMPS, CDLP, CDRE, RCS-D, CDPE, CMHS, CMC, NMLS 259027
11440 W. Bernardo Court, Ste. 300, San Diego, CA 92127
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