The Subprime Lending and Mortgage Crisis effectively exposed one thing; mortgage fraud was rampant in the system. Since the end of the Great Recession and Global Financial Crisis, regulators began pursuing more seriously investigations and prosecutions of such crimes. In this article we look at the white collar crimes of mortgage fraud and equity skimming.
The federal government quickly discovered that mortgage fraud and equity skimming were a national phenomenon. Congress enacted the Secure and Fair Enforcement Mortgage Licensing Act. This created a national system of mortgage registration and licensing protocols.
It also enabled prosecutors to go hard after mortgage fraud. The FBI Director Robert Mueller declared that the number of cases of mortgage fraud rose by almost 63 percent between years 2008 and July 2009. To go more effectively after these “white collar” criminals, Treasury Secretary Tim Geithner announced his Treasury Department would begin collaborating more intensively with the Federal Trade Commission, Department of Justice, Financial Crimes Enforcement Network, and Housing and Urban Development in order to effectively tackle mortgage fraud around the country.
The feds believed that such a multi-organizational approach to hunting down mortgage fraudsters would permit the federal government to successfully boost its enforcement, all the while raising consumer awareness of fraudulent and abusive schemes in existence.
The government enacted severe penalties for such criminal behavior of mortgage fraud. The penalties can include large fines, seizure of business licenses, misdemeanor charges, and even criminal felony charges. With state and federal agencies working together to uncover and prosecute such criminals, the chances of people becoming caught has substantially increased.
The downside to this higher level of inter-agency communication lies in the higher odds for false accusations to arise. Attorneys with great experience in defending against such accusations of mortgage fraud come in handy for any business which feels that it is being improperly targeted for deceptive lending or fraudulent practices.
Loan originators are where the problem ironically originates. This is because they are compensated in part based on the volume of their loans instead of the soundness of them. There was also a higher dependence on what are called third party originators like conduit lenders and loan brokers. The sad truth is that investigators found bank loan officers who were easily seduced into committing fraud against their own institutions when the compensation packages rewarded them for carrying out these types of actions.
There are a range of deceptions involved with mortgage fraud and equity skimming. These include the following six categories:
Deceptive purchase agreements beg the question: Is a purchase actually real? Studies on the subject consistently report that appraisers will estimate values that prove to be the same as purchase prices from 96 to 97 percent of real cases. Fraudsters are all too well aware of this. They have elevated to an art form teaching No Money Down seminar practices of coming up with deceitful purchase contracts to aid both real estate agents and new real estate investors in practicing their flipping trades.
Appraisers have to contemplate that a purchase may not be a legitimate third party transaction, but rather a deceitful arrangement in which a property buyer is actually only buying the property he already possesses. This is where skimming enters the scene. Skimming occurs when a property owner obtains as great an income as humanly possibly by renting out a property and cutting back all services and costs in order to encourage the dissatisfied tenants to move away.
Net cash flow would then become negative and the fraudster would simply pocket all gains and walk away from the property loan. Thanks to the owners having deceived the lending institution into loaning out 100 percent of the loan to value ratio, the owner has no skin in the game to lose, plus he walks with all of the income realized during the scheme.
Income property appraisers must be well versed in proper accounting practices pertaining to properties so that they can recognize unlikely income and expense statements. More to the point, appraisers need to obtain independent accountant-prepared financial statements on properties. It would be better still if these were for three years— the year to date period as well as the prior two years.
Appraisers must take the extra step of verifying that tenants claimed to be occupying a property really are there in the assigned units and paying the contracted rent rates. This level of verification truly will require making investigative trips out to the property in order to observe and talk with the tenants who are there on site.
Many different unfavorable property conditions could exist on a property. These can be easily and variously misrepresented by owners of the properties in question. It helps if an appraiser keeps a handy checklist of these types of common conditions misrepresented to be ready to go through at a moment’s notice on a particular income rental property.
There are two that are especially prevalent in this business. Hidden encumbrances could be something like a special assessment. Environmental damage could be substantial and wide ranging. Both would dramatically and negatively impact the value of the property being appraised. Owners will not likely volunteer the information in either case.
There are two different categories of most common deceptions in this regard. Residential properties and developers will typically provide “pie in the sky” projections as to the sales rates and prices in order to positively influence their appraiser. This is why appraisers must verify from a third party and reliable source the sales rates and rents in a given market using objective data and sources.
With commercial properties, owners may attempt to underestimate their costs of relevant expenses. This would make it easier to overestimate their income levels and increases in commercial property projections.
The media portrays mortgage fraud in a certain specific light. It touts these fraudsters as flippers and rings of flipper organizations. Their modus operandi is to purchase low and then sell high, often employing straw buyers who would quickly default on their mortgages shortly after the loan is completed and issued. While this kind of glorified property and mortgage fraud clearly does exist, it is not the most common one.
The most typical forms of mortgage fraud involve deceiving lenders into over-loaning out more money than a property could realistically secure, based on a falsely high property value or overestimated income property cash flow. The purchaser may or may not have an honest intention to pay back the loan assuming that the scheme goes according to plan.
It becomes fraudulent when a property is secured with no or very little money put down on it. The idea for the fraudsters is to minimize their cash equity in the property. This permits the owner to gain an attractive return on the investment when the value increases, allowing him or her to easily repay the loan.
In cases where the property value declines though, the buyer had no skin in the game in the form of personal equity. This means that there is honestly no reason not to simply walk away from the property and then allow the loan to default. Believe it or not, “No Money Down” seminars around the U.S. continuously teach and actively recommend practicing such a strategy every day of the year. It amounts to gambling using other people’s cash, since the absence of sufficient equity in the property will greatly raise the ultimate risk of default on the loan.
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