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The Many Faces of Loan Fraud – How to Recognize Them and What You Should Do

By Janet B. Thoren, Deputy Legal Counsel

Loan fraud involves making false representations to a lender in order to obtain a loan of a larger amount or on more favorable terms than a borrower is otherwise qualified for under the lender’s guidelines.Loan fraud is a federal crime, punishable by up to 30 years in prison and $1 million in fines.In the past, most loan frauds consisted of a single transaction in which the purpose of the fraud was to get a particular buyer into a particular property that the buyer could not otherwise afford.Some examples of this single-transaction type of loan fraud include the following:

•False Gift Letter. A false gift letter is created so that it appears funds being provided to the borrower by another party are a gift, when in fact the funds are being offered as a loan and repayment is expected.

•Contract Kiting.Two contracts are created for the same transaction.One contract contains the actual terms of the agreement between the buyer and the seller.The second contract reflects a higher purchase price and is given to the lender and the appraiser in order to obtain a higher appraisal amount and permit the borrower to obtain a larger loan than he would otherwise be qualified to receive in the transaction.

•False down payment.The contract shows a large down payment made directly to the seller when in fact no down payment was made or the source of funds was not the borrower.

•Secret Second Mortgage.The buyer is not qualified to borrow the full amount needed so the seller consents to a “secret second” in which the seller or real estate agent loans additional funds to the borrower and receives a second mortgage on the property, which may or may not be recorded after closing but which is not disclosed to the lender.

•Secret Concessions or Undisclosed Rebates. The seller or broker offers concessions to the borrower for repairs, closing costs, or other items but fails to disclose these concessions to the lender or show them on the closing statement.

• False Statement of Owner Occupancy. The buyer represents to the lender that the property will be the buyer’s primary residence, when in fact the property is being purchased for rental or other investment purposes.

• False Qualifications of the Borrower. Information related to the buyer’s credit-worthiness, such as income or sources of cash, is misrepresented to the lender through false documentation or other means.

Within the last three years, the FBI’s mortgage fraud caseload in North Carolina has tripled, and real estate agents are being caught up in the newer and more sophisticated schemes.Loan fraud has advanced beyond the stage of a single transaction.Its purpose is no longer to put a single buyer in a particular home, but to intentionally steal loan funds directly from lenders.It has become a business through which a handful of individuals have made millions, but with recent arrests by federal and state authorities, those individuals are now beginning to pay the price.

In order for loan fraud to work on such a large scale, participants in the fraud typically include appraisers and mortgage loan brokers, and occasionally real estate agents and closing attorneys.The newer types of scams have different variations, but basically work like this:

•The scam organizer or promoter identifies himself or his company as a type of real estate developer or investor.The promoter selects a home, usually a new construction property, and negotiates a purchase price with the seller/builder – let’s say $200,000.This price is usually at market value, or it may be significantly lower if the home has been on the market for a while or if the promoter arranges to purchase multiple properties from the same seller/builder.Once the promoter has a property lined up, he recruits a buyer.These buyers are usually homeowners with relatively good credit, but typically don’t have enough income to purchase a second home in a legitimate transaction.

• The promoter offers the buyer the property at a greatly inflated price – for our scenario, let’s say $300,000.The written contract is usually between the seller/builder and the buyer, but reflects the $300,000 purchase price.The promoter convinces the buyer that he can purchase the home with no money down and, in most cases, even promises to give the buyer anywhere from $1,000 to $5,000 in cash outside closing if the transaction closes. The promoter promises the buyer that a tenant is ready to move into the property, and that the rent the tenant pays will be used to pay the mortgage payment.The promoter promises the buyer that the house will be sold within a relatively short period to the tenant for a huge profit, and that the promoter and buyer will then split the profits from the sale.

•Once the buyer is on board, the promoter directs the buyer to a particular mortgage broker and sometimes a closing attorney.Appraisers are used who greatly inflate the value of the property in order to substantiate the purchase price the buyer is to pay for the property.A mortgage broker creates false documents to show that the buyer intends to live in the property, to make sure the buyer appears to be qualified for the loan and to make the property appear to be worth more than the true market value.When the actual lender receives the paperwork, everything appears to be in order and the loan is approved.

•At closing, the promoterhas to make sure that he gets the profits from the loan, not the seller/builder.The seller/builder’s existing loan is paid off and he gets $200,000 for the property, less his closing costs.Closing costs may include a commission to a real estate agent that is based on the amount the seller agreed to receive, $200,000, rather than on the $300,000 purchase price shown on the HUD-1.The promoter receives the remaining funds from the loan, usually shown on the closing statement as a false second mortgage payoff or false assignment fee.Although the closing statement shows the buyer bringing funds to closing, in fact the promoter uses the funds from the loan to pay the buyer’s closing costs, and pay off the appraiser, mortgage broker, and buyer outside of closing.In the end, the promoter walks away with an average profit of $35,000 -$50,000 per transaction.

•The tenant, if there is one, pays rent to the promoter, who in many cases is running an unlicensed property management business.The promoter makes a few mortgage payments and then quits.In many cases, no tenant ever moves into the property and no mortgage payments are ever made.The buyer can’t afford to make two mortgage payments, and the property soon goes into foreclosure.The lenders can’t come close to recovering the full amount of their loans through foreclosure, and the buyer’s credit is ruined.

Banks and other lenders lose millions of dollars every year through mortgage loan fraud.Losses are often passed on to consumers through higher fees.Losses on government-insured loans end up being paid for by taxpayers.Individual consumers who dreamed of a business opportunity that seemed “too good to be true” learn the truth of the old adage the hard way when their credit is ruined and in many cases they are forced into bankruptcy.In addition, because promoters have targeted certain subdivisions repeatedly, false appraisals have caused property tax values in those subdivisions to soar, leaving the few existing legitimate home purchasers in houses that are overvalued for tax purposes and stigmatizing the neighborhoods with numerous foreclosures.

The FBI and SBI have been vigorously pursuing groups of promoters across the state.Some promoters, appraisers, and mortgage brokers have already been charged and other investigations are ongoing.The U.S. Attorney’s office has made a commitment to vigorously prosecute mortgage fraud at all levels, including individuals holding professional licenses who are seen as key factors in safeguarding the system.Such professionals include real estate agents.In addition, the Real Estate Commission has taken an active role in identifying real estate agents involved in these types of transactions and taking disciplinary action when appropriate, including the revocation of licenses and pursuing injunctive relief against unlicensed participants.

Loan fraud can be disguised in many ways.Whether it’s a single transaction loan fraud or a sophisticated scam, the Real Estate Commission expects its licensees to be the guardians of consumers and lenders alike.As such, it is your responsibility to further investigate any real estate transaction in which you are involved if it appears to include possible elements of loan fraud.You are required by law to make full disclosures to all parties, including the ultimate lender, if you suspect fraudulent behavior.Failure to do so may result in disciplinary action against your license, or criminal prosecution by federal and state authorities.

This article came from the May 2004-Vol35-1 edition of the bulletin.