Uncovering Mortgage Fraud

A federal judge in Atlanta sentenced Phillip Hill to 28 years in prison, The Atlanta Journal-Constitution reported Sept. 21. His crime? Running an elaborate mortgage fraud scheme that …

A federal judge in Atlanta sentenced Phillip Hill to 28 years in prison, The Atlanta Journal-Constitution reported Sept. 21. His crime? Running an elaborate mortgage fraud scheme that racked up $112 million in fraudulent loans.

The sentencing exemplifies how punishment of the most severe mortgage fraud is more serious than that of voluntary manslaughter, which carries a maximum sentence of 10 years in prison. Although dozens of victims of the same mortgage fraud scheme probably won’t lose their lives, they may lose their livelihoods. In lieu of an increase of fraud cases being discovered, prospective homeowners need to know how to protect themselves.

It appears that fraudulent activity has blossomed in recent years because of the increased activity of the mortgage lending industry and the corresponding spread of naïve consumerism. The incidence of mortgage fraud during the past two years has been substantial enough to spur the FBI into action.

The FBI signed a memorandum of agreement with the Mortgage Bankers Association in March to promote the FBI’s Mortgage Fraud Warning Notice, which states, “it is illegal to make any false statement regarding income, assets, debt or matters of identification, or to willfully inflate property value to influence the action of a financial institution.”

As an increasing number of complaints are investigated, more mortgage fraud is being discovered, Mark Leyes, director of communications for the California Department of Corporations, said.

“The sad fact is that mortgage fraud has increased over the past four or five years because the activity in the mortgage lending industry has increased so dramatically,” Leyes said. “It goes hand in hand; as that level of activity goes up, the opportunities for fraud [also increase] and unscrupulous people unfortunately take advantage of that.”

The increase in reports of alleged mortgage fraud can be partially attributed to the recent surge of defaults and foreclosures across the country, according to state and federal government experts.

“I think some fraudsters were betting on the fact that they would be able to sell the property at the inflated values and cover up their tracks before the loans ever went into foreclosure,” John Fleming, general counsel for the Texas Department of Savings and Lending, said. “[However], as the housing bubble has popped in hot markets [like Arizona, Nevada] and Florida, I think [significant fraud] has now come to the surface.”

BasePoint Analytics, a fraud analytics company, analyzed more than 3 million loans and found that between 30 and 70 percent of early payment defaults are linked to significant misrepresentations in the original loan applications.

Additionally, mortgage programs that did not require sufficient verification of the underlying facts, such as stated income programs, also opened doors for mortgage fraud.

“I really think that the lenders set themselves up to be defrauded,” Fleming said.

Prospective homeowners should also be aware of mortgage fraud and know how to identify suspicious activity to avoid becoming victims.

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The most serious type of mortgage fraud is referred to as “fraud-for-profit.” According to the FBI, fraud-for-profit involves multiple loans and elaborate schemes perpetrated to gain illicit proceeds from property sales. The most common type of fraud-for-profit is “illegal property flipping,” which usually requires two major ingredients: false appraisals and other fraudulent loan documents.

“Those two gimmicks unfortunately trapped a lot of people in loans that were [worth] more than the house was worth,” Leyes said.

Although the lender suffers the major monetary losses, consumers who were lured into the scheme are hit hard by foreclosure and ruined credit, Fleming said.

Fraud-for-profit schemes typically involve four or five persons committing illegal acts, including the consumer, Fleming said. The consumer, however, is usually naïve to his or her involvement and has no intention of committing a crime; rather than face prosecution, the consumer is often asked to testify against the persons who intended to make an illegal profit. Such fraud rings can include mortgage brokers, loan processors and escrow agents. They can also include “promoters” who lure consumers into fraudulent deals with promises to obtain approval for a loan and manage the property, Fleming said.

A hypothetical fraud scheme might involve a pushed or altogether false appraisal of $500,000 for a property originally selling for $300,000; the contract presented at closing would show a $200,000 payoff to a remodeling company that may or may not exist, but which has no intention of providing any remodeling services. Essentially, the promoter would lure a buyer into a loan for more than the house is worth. The promoter may promise huge returns on the investment, often in the form of a large percentage of the back end profits. The deal requires little to no cash or time on the investor’s part, who is only asked to sign for the house, wait, and sell the house for considerable profit when the construction is finished six to 12 months later.

“[What generally happens then is that] the fraudster makes off with the extra $200,000, [and] six months later the property is in foreclosure,” Fleming said. “The poor borrower is getting foreclosure notices from the lending company, and of course at this point the guys who got him in the deal are long gone,” Fleming said.

Predatory practices, in which people are bullied into inappropriate loans or loans with terms they don’t understand, have been another commonly reported type of fraud during the past few years, but such cases are difficult to prove, Leyes said.

“[Consumers] might be unhappy with the terms of their mortgage loan, but it may not have been fraudulent if it was all done within the context of the law,” Leyes said. “The contents were disclosed, the instruments were legal, the contract is binding—it’s just that the market took a turn for the worst in the last 12 months or so and they’re in a bad position now.”

Foreclosure fraud has also come to the forefront. “Recent statistics suggest that escalating foreclosures provide criminals with the opportunity to exploit and defraud vulnerable homeowners seeking financial guidance,” according to the FBI’s 2006 mortgage fraud report.

Scammers who promise to rescue property owners from foreclosure siphon off equity through a series of sales and refinanced loans, then transfer the property through a legitimate sale or walk away with the spoils and let the lender foreclose and evict the original owner, Manuel Duran, an attorney who has served as prosecutor in foreclosure scam cases, said in an article published last month in The Los Angeles Times.

There are a number of steps that prospective homeowners can take to avoid becoming victims of mortgage fraud. Prospective buyers in the FBI’s top ten mortgage fraud areas for 2006—California, Florida, Georgia, Illinois, Indiana, Michigan, New York, Ohio, Texas and Utah—should be especially careful.

Taking time to research a property and watching out for red flags are two key ways that consumers can protect themselves, Fleming said.

Any money offered at closing, for instance, should be treated with caution. In the case of the fraud-for-profit scenario mentioned earlier, investors should be suspicious of any large lump sum of money that goes to a supposed company at closing.

Money for renovations that take place after closing should be kept in escrow and paid out in stages until the complete balance is used; rehabilitation or construction loans are available in order to do this legitimately. Banks generally require this type of an arrangement; scam artists, in contrast, will keep payments to a purported construction company hidden so that they fly under the radar of financial institutions.

Investors should research properties by obtaining a listing history from the Multiple Listing Service, Fleming said. Investors can review the listing history in addition to standard CMAs and appraisals to determine whether they are purchasing property above market price and potentially getting scammed.

There are some cases in which an individual might knowingly purchase property at an above-market price, because of an agreement with a promoter to have the money sent to a construction company or other business at closing.

Investors should never agree to this type of arrangement, which has a high risk of being fraudulent. If the agreement does turn out to be a scam, the victimized investor will have lost all the money that was intended for construction work that a promoter had falsely promised, and will also probably lose money upon reselling the property. The promoter and fellow fraud ring members, on the other hand, make off with the illicitly gained funds.

In addition, investors should personally examine property in person to verify its legitimacy; there could be false claims about a property, such as a property advertised as remodeled when in reality no improvements have been made.

Small investors who find themselves solicited for a purchase should only consider real estate in their vicinity in order to keep close track of the property and be actively involved in its management, Fleming said. Otherwise, “you’re opening yourself up to be taken advantage of.”

Investors should also be suspicious of extravagant promises made by real estate professionals or other property solicitors. Fraudulent persons, like many legitimate companies, can offer bundled services of finding property, obtaining approval for a loan and performing management duties. There are resources available for obtaining background information on real estate companies, including reference checks and possible enforcement actions taken against them.

The National Association of Securities Dealers (NASD) BrokerCheck is one such resource; it is  an online search tool for looking up license and contact information on real estate companies and brokers, such as where they are licensed, how long they have been licensed and whether they are active.

The California Department of Corporations website also features links for viewing enforcement actions against mortgage companies registered in California, Leyes said. Although such features may not be available for all states, investors should be able to obtain similar information by calling their state branch.

Persons who suspect they are a victim of fraud by a broker or lender should contact their state or county Department of Consumer Affairs or file a complaint with their local Office of the Attorney General.

Fraud hurts honest investors, costing them money and time. It increases risk for lenders and lenders, in turn, increase loan rates; in addition, fraud also causes investors to deal with extra paperwork and verification hassles.

Hope that lending conditions will improve largely rests in the hands of state and federal authorities, who are working to bring individuals who commit fraud to justice. Last month a case of mortgage fraud involving a ring of eight individuals, 20 victimized properties and more than $5 million in illegal profits went before a jury in Texas, Kaylynn Williford, Assistant District Attorney of the Harris County, said. Fleming, who investigates approximately 180 cases of fraud per year, had testified in the case.

“[Six] had pled guilty, including the mortgage broker and the loan processor, and two went to trial,” Fleming said. “They just finished the first trial on the promoter, and he got [a sentence of] 25 years.”

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