Property Lending and Mortgage Fund Flashcards
In this chapter, we will be talking about mortgage fraud and predatory lending. There is a difference between the two. Mortgage fraud is when a borrower deceives a lender (for their own gain). Predatory lending is when a lender deceives or takes advantage of a borrower.
Mortgage Fraud
Let’s begin by talking about mortgage fraud. Almost anyone involved in a home-buying transaction could be involved in committing fraud: the agents, mortgage broker, appraiser, or title company.
The mortgage lenders are usually the targets of mortgage fraud. Mortgage fraud usually involves tricking a lender into loaning money for a property worth less than the loan amount, or that doesn’t exist at all.
The cost of this fraud eventually ends up being passed on to other borrowers — everybody loses!
All Types of Fraud
Here are some of the most common mortgage fraud scams:
Property flipping
Nominee loans/straw buyers
Fictitious/stolen identity
Inflated appraisals
Foreclosure schemes
Equity skimming
Air loans
Silent second
Chunking
Let’s take a look at what each of these entails.
Property Flipping
I already know what you’re thinking, but no, this has nothing to do with HGTV shows. Buying a distressed house, making truly valuable improvements, and reselling it for a fair price and profit is not fraud.
The type of flipping I want to tell you about is different, and it’s a type of mortgage fraud.
Fraud Involves a False Appraisal
When a property is purchased and then quickly resold at a value that is artificially inflated by false appraisals, loan fraud has taken place.
No significant repairs or improvements have been made to the property, so the higher resale price is not justified (note that we’re not talking about buying an underpriced property and reselling it without making upgrades, or turning over a property in a rapidly rising market — we’re talking about someone actively misrepresenting the appraised value of the property).
The Buyer Is in on the Scam
Usually, the first buyer is reselling the property to someone who is participating in the fraudulent activity (in other words, the buyer is in on the scam).
What makes this transaction illegal is that the appraisal information is fraudulent. The schemes typically involve one or more of the following: a fraudulent appraisal; doctored loan documentation; inflated buyer income; kickbacks to buyers, investors, property/loan brokers, appraisers, or title company employees.
EXAMPLE
If a buyer purchases a home for $400,000 (which is the actual value) and then resells it at $600,000 with help from a phony appraisal and a buyer who is in on the grift, they might each pocket $100,000. No payments are made on the $600,000 loan, and when the lender forecloses, they find the property is only worth $400,000. The lender has to absorb that loss.
Common Mortgage Fraud Schemes
Let’s keep going with these devious loan fraud cons. Next up: straw buyers.
Nominee Loans/Straw Buyers
The identity of the borrower is concealed through the use of a nominee or straw buyer. A straw buyer is someone who is in on the scam and allows the borrower to use the nominee’s name and good credit history to apply for a loan. In this scheme, there is the understanding that the straw buyer will not have to make any payments or be out any money.
Close-up of a number of straws.
Fictitious/Stolen Identity
A fictitious/stolen identity may be used on the loan application. The applicant may be involved in an identity theft scheme: The applicant’s name, personal identifying information, and credit history are used without the person’s knowledge.
Inflated Appraisals
An appraiser acts in collusion with a borrower and provides a misleading appraisal report to the lender. The report inaccurately states an inflated property value.
Foreclosure Schemes
The perpetrator identifies homeowners who are at risk of defaulting on loans or whose houses are already in foreclosure. Perpetrators mislead the homeowners into believing that they can save their homes in exchange for a transfer of the deed and up-front fees. The perpetrator profits from these schemes by remortgaging the property or pocketing fees paid by the homeowner.
Equity Skimming
An investor may use a straw buyer, false income documents, and false credit reports to obtain a mortgage loan in the straw buyer’s name. After closing, the straw buyer signs the property over to the investor in a quitclaim deed that relinquishes all rights to the property and provides no guarantee to title. The investor does not make any mortgage payments and rents the property until foreclosure takes place several months later.
Air Loans
This is a loan where the collateral property doesn’t actually exist. With an air loan, a scammer invents both a borrower and a property. Air loans are complicated to pull off. The perpetrator has to create a fake agent, buyer, seller, appraiser, credit history, and more. Usually it involves multiple fake phone numbers, P.O. boxes, and other fictitious architecture. Once the loan goes through, the scammer disappears with the cash, leaving the bank with no money and no home.
Silent Second
In this scheme, the buyer negotiates a second mortgage from the seller without either of them disclosing the loan to the lender. This leads the lender to believe the buyer has a larger down payment than they actually do.
Chunking
This is when a buyer makes multiple, fraudulent loan applications for the same property, closes them all on one day, and skips town with the cash.
More Loan Fraud Schemes
A buyer rebate sounds like something good, right? A little cash back to take to IKEA after you move into your new house. However, these buyer rebates are illegal, and a kind of mortgage fraud.
Anything during the transaction that causes money to go back to the buyer, either at or after closing, without the knowledge of the lender, is illegal. This is known as a buyer rebate.
Sometimes the money comes from the seller, sometimes from the real estate agent or a mortgage loan broker, and sometimes through a third party vendor.
Party Payment Disclosure
It is essential that the lender knows exactly how much money for the down payment and closing costs are being paid from the buyer’s funds. Anything being paid by any other party in the transaction must be disclosed in the contract and on the closing statement.
Most Common Rebate
One of the common forms of rebates happens when the contract calls for money to be paid to a certain vendor for future improvements to be done to the property after closing.A row of various colored construction helmets.
EXAMPLE
Here’s how a buyer rebate could work: A borrower tells the lender they will pay $20,000 to ABC Home Improvements after closing for future improvements, so the lender makes a loan for the price of the home plus $20,000. ABC Home Improvements is owned by a friend of the buyer and after closing the friend and the buyer split the $20,000. No improvements are made, no payments are made, and the lender has to foreclose and finds the property worth less than the loan amount.
Buyer Rebates
Here’s a list of things you and your client can look for to spot potential mortgage fraud:
Inflated price or appraisal
Real estate agent is asked to remove the property from MLS (a violation of MLS rules)
Agent asked to increase the price in MLS to a higher price to match the sales price
False financial statements by the buyer
Contract calling for payments at closing for future improvements
High fees to the mortgage broker, real estate broker, or both
No fee for a title policy on the closing statement
A title company you have never heard of before
Last-minute amendments to the contract, such as increasing the sales price
Some Red Flags
Next, let’s learn about predatory lending. But first I want to make an important disclaimer. Of course, the majority of lending professionals play by the rules and care about their customers.
Unfortunately, there are some bad actors out there who take advantage of people, and that’s why you need to learn about predatory lending. You can’t make your clients’ lending decisions for them, but you can attempt to bring their attention to potential issues with their loan.
What Is Predatory Lending?
Predatory lending includes the unfair, deceptive, or fraudulent practices of some lenders during the loan origination process. While there are no legal definitions in the United States for predatory lending, an audit report on predatory lending from the office of the inspector general of the FDIC broadly defines predatory lending as, “imposing unfair and abusive loan terms on borrowers.”
Predatory Lending
The Washington State Department of Financial Institutions explains predatory lending really well, so I’ll borrow some of their words here:
Lending and mortgage origination practices become “predatory” when the borrower is led into a transaction that is not what they expected. Predatory lending practices may involve lenders, mortgage brokers, real estate brokers, attorneys, and home improvement contractors. Their schemes often target people who have small incomes but substantial equities in their homes.
Products Aren’t Predatory
Products themselves are not predatory. For example, a loan with a variable interest rate can be a very good financial tool for many borrowers. However, if the borrower is sold a loan with a variable interest rate disguised as a mortgage loan with a fixed interest rate, the borrower is the victim of a bait and switch or predatory lending practice. In short, this type of conduct is nothing more than mortgage fraud practiced against consumers.
Aggressive Tactics
Consumers can be lured into dealing with predatory lenders by aggressive mail, phone, TV, and even door-to-door sales tactics. Their advertisements promise lower monthly payments as a way out of debt, but don’t tell potential borrowers that they will be paying more and longer. They may target minority communities by advertising in a specific language, or target neighborhoods with high numbers of elderly homeowners, or homeowners with little access to credit.
Disclosure Documents
Within three days of filling out a loan application, your mortgage broker or lender must provide you with a written document giving you most of the information you will need to know about the loan.
(This is a provision of TRID, but I’m sure you remembered that, Anthony.)
Let’s Hear from the Experts
Common Predatory Lending Practices
Common Predatory Lending Practices
Lenders have become creative in the way they structure subprime mortgages. One type of mortgage, which you’ve learned about already, is the adjustable-rate mortgage (ARM). This is generally a 30-year mortgage that charges a low rate for the first two or three years, then resets at a rate based on a current, prevailing benchmark rate like the London Interbank Offered Rate (LIBOR). Often, this reset rate will be higher than the initial rate.
Prepayment Penalties
A lot of the time, these ARMs are described with sets of numbers like “2/28” or “3/27”. So, if you see those, they might be subprime.
These types of loans will also tend to have prepayment penalties. This means that if someone wants to pay this thing off early, they’re going to have to pay extra. Seems a little weird, right? The reasoning for this is that lenders want to be able to predict their incoming cash so they can make accurate business predictions for the future.
Interest Rate Caps and Adjustments
The borrower will also have to look out for subprime loans that don’t have interest rate caps. This means they can just go up and up and up with no limit, which is going to be hard for anyone to deal with.
Once a borrower’s payment adjusts out of their introductory rate, they’re often unable to afford the new higher rate and end up defaulting on the mortgage. As we talked about in the last chapter, this was one of the factors that lead to the subprime crisis in 2008.
Many people were given subprime loans which they could only afford as long as the market was strong. When the housing market started to go south, millions of these borrowers defaulted, and this touched off the financial crisis.
Subprime Loans to Watch Out for
defaults on the loan the lender can repossess the property, sell it or foreclose on it, and make their money back.
Lenders might be accused of tricking a borrower into believing that an interest rate is lower than it actually is, or that the borrower’s ability to pay is greater than it actually is. The lender, or others as agents of the lender, may even profit from the repossession or foreclosure upon the collateral.
Home Equity Loans
People that are in a large amount of debt might be tempted to take out a home equity loan to pay it off. Credit card interest rates are often north of 20%, while a home equity loan’s interest rate could be in the single digits.
This could be useful to a borrower if utilized correctly. In taking out the loan, the borrower would also be consolidating their debt to one payment. This is known as debt consolidation.
But, as you probably remember from a previous chapter, a home equity loan is a loan in which funds are borrowed using the homeowner’s equity for collateral. So, if the borrower finds themselves unable to repay the loan, they could lose their home. Borrowers should carefully consider their situation before taking out a home equity loan.
Home Equity Loans Are Not Inherently Predatory, Either
Home equity loans, like subprime loans, are not inherently predatory. In fact, for a lot of folks, they’re great. The world would have fewer backyard pools if home equity loans didn’t exist.
But just remember: predators like collateral.
Borrowers should examine the terms of a home equity loan very carefully. A predator might hit the borrower with a large balloon payment at the end, or a variable rate might put the borrower in a worse position than when they started.
Debt consolidation through a home equity loan can be a risky move, and borrowers should be aware of those risks.
Predators Like Collateral
We touched on this in an earlier chapter, but predatory lending does not affect all communities equally. Especially during the runup to the 2008 meltdown, predatory lenders specifically targeted Black and Latinx neighborhoods for their bad loan products.
Looking at the Data
The academic journal Housing Studies published an article, “The Social Structure of Mortgage Discrimination”, which examined the data about who is offered high-cost subprime loans and who is not. Here’s what they had to say:
In the decade leading up to the U.S. housing crisis, black and Latino borrowers disproportionately received high-cost, high-risk mortgages—a lending disparity well documented by prior quantitative studies.
Our analyses reveal specific mechanisms through which loan originators identified and gained the trust of black and Latino borrowers in order to place them into higher-cost, higher-risk loans than similarly situated white borrowers. Loan originators sought out lists of individuals already borrowing money to buy consumer goods in predominantly black and Latino neighborhoods to find potential borrowers, and exploited intermediaries within local social networks, such as community or religious leaders, to gain those borrowers’ trust.
You can see that this wasn’t just a case of a borrower misunderstanding their loan’s terms — it truly is predatory lending.
Predatory Inclusion
The practice of targeting minority neighborhoods for high-cost loans — called “predatory inclusion” or “reverse redlining” — had disastrous consequences for Black and Latinx homeowners during and after the crisis.
Lawsuits about this predatory lending, particularly against Wells Fargo Bank, are still being settled, but for many, the damage has irreparably been done.
It’s important to understand this context when thinking and talking about predatory lending in this country.
There’s a Pattern to Predatory Lending
Be a Super Agent!
Be a Super Agent!
Let’s talk about how you can spot predatory lending practices and stop these bad guys in their tracks. Look out for these warning signs:
Unbelievably Low Interest Rates 🚩
Is the lender marketing astonishingly low interest rates? Is it below market? That’s a red flag.
This might just be a trick to get a client to call them up, only to have them learn that the rate isn’t available. Even if the interest rate is low and your client still wants to go with that lender, they will probably try to make up for the difference with some sort of fees somewhere along the line.
Pressure to Act Fast 🚩
Is your client being pressured to act fast, to take advantage of the rate before it changes? That’s a red flag.
This is a huge decision that could affect the rest of their lives. A client should take time and deliberation before deciding what they want to do. No one, especially a lender, should be pressuring a client to make a decision within a set amount of time. (By the way, in sales, this is called creating a sense of urgency.)
Unwanted Risk 🚩
Is your client being swindled into getting a more risky loan than they’d like? That’s a red flag.
Your client should know what they are getting and be willing to get a riskier mortgage, if that’s what they want. If not, there’s definitely something to be suspicious about. If your client who has a risky mortgage mentions anything about not getting the loan they originally wanted, it’s time to do some digging into their loan pre-approval and lender. 🕵️
High or Unpredictable Fees 🚩
How are the fees? Do they seem really high or do they change at closing? That’s a red flag.
Make sure the client compares the fee estimate with the final charges from the lender at closing. If there are large differences in the lender’s favor, there’s an issue. If fees are in the client’s favor, that’s usually okay. Work with your client and use your best judgment to decide what to do. If they feel like they need to cancel the loan, that’s a big step, but muuuch better than the consequences of not canceling a bad loan.
Lying on the Application 🚩
Did the lender ask your client to lie on the loan application? That’s a red flag. A huge, HUGE red flag. 😱
This is straight-up mortgage fraud. Tell your client to run far, far away. If you’re sure this was mortgage fraud, you or your client can gather up all the info necessary and report it to the FBI, the Federal Trade Commission, HUD, or if it’s a local lender, call the local law enforcement agency.
Predatory Lending Warning Signs
There are some laws in place that specifically combat predatory lending. The Home Ownership and Equity Protection Act (HOEPA) was created in 1994 as an amendment to the Truth in Lending Act (TILA).
HOEPA’s goal was to end abusive and predatory practices by lenders. The Act created a lot of restrictions for what it deemed to be “high-cost loans,” or loans with an annual percentage rate exceeding the average rate for similar transactions by more than 6.5%. The Act prohibits all sorts of predatory practices.
If you are interested in learning more, the Consumer Financial Protection Bureau has more information.
Usury Laws
In addition to federal law, most states have usury laws, which limit the maximum interest rate a lender can legally charge (usury is the illegal act of lending money at unreasonably high interest rates).
In Arizona, according to statute 44-1201, the highest rate of interest a lender can charge is 10% a year, unless the borrower agrees to a higher rate in writing.
Report It!
Hopefully this is something you never run into as an agent. If it is, make sure you report it. And even though it might be a big setback for a client to get to closing and need to back out, it’s way better to back out than be stuck in a risky situation and potentially being foreclosed upon in the future — which will ruin their financial standing as a future borrower. I’m sure that we’ve all heard the famous saying, “It’s better to walk away than to be stuck in a fraudulent mortgage.”
Anti-Predatory Lending Laws
Mortgage fraud and predatory lending are bad, bad news. Not only do they hurt borrowers and lenders, but they also taint our entire industry with a miasma of distrust. Odds are you will go your whole career without encountering either of these issues, but if you do, call it out! Make your buddy Ace proud.
Key Terms
Here are the key terms you learned in this chapter:
flipping
a mortgage fraud scheme that involves an inflated appraisal and a straw buyer
predatory lending
imposing unfair and abusive loan terms on borrowers
subprime mortgage
a mortgage with an interest rate higher than prime mortgages due to the higher risk associated with a less qualified borrower
usury
illegally lending money at unfair interest rates
Key Concepts & Principles
Here are the concepts and principles you’ll want to master from this chapter.
Common Mortgage Fraud Schemes
Here are some of the most common mortgage fraud scams:
Property flipping
Nominee loans/straw buyers
Fictitious/stolen identity
Inflated appraisals
Foreclosure schemes
Equity skimming
Air loans
Silent second
Chunking
Mortgage Fraud Prevention Measures
How to help prevent mortgage fraud:
A list of ways to prevent mortgage fraud.
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Subprime Loans
A subprime loan is a loan that has an interest rate greater than the prime rate. If the borrower has less-than-good credit, this is the option they’ll be given by the lender. Their assessment and qualification are based on a few factors, including, in this order:
Credit score
Size of down payment
Number of delinquencies on a borrower’s credit report
Types of delinquencies
Even if there is just one area in which the borrower is below standard, such as credit score, the lender will be less willing to give them a prime loan, even if their income and assets are to the lender’s liking. A low credit score is the most common reason for being disqualified from a prime loan.
Red Flags for Predatory Lending
Watch out for these red flags.
A list of red flags that may indicate predatory lending.
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Chapter Summary
