Mortgage loan fraud, on the decline after the Great Recession due to more intense monitoring by lenders and regulators, is again on the rise. Title Insurer First American Financial Services estimates that fraud in mortgage loan applications increased nearly 10% between January 2018 and January 2019. Interest rates were low a decade ago, and refinance loans were dominant in the mortgage marketplace until rates gradually began increasing in 2016. As rates increased, the relative percentage of refinance loans—typically safer and better collateralized that purchase-money loans—began to decline.
Purchase-money loans generally have a higher potential for fraud to insert itself in the application and documentation process, largely because there are more commission-driven individuals in the loan supply chain. As a new kind of crisis has emerged—the affordability crisis—banks have been under pressure to loosen their credit and underwriting standards, which in turn has led to more fraudulent activity . . . and so the cycle begins again.
Everyone involved in real estate sales and closings is a potential subject of scrutiny. And prosecutions are not limited to actual mortgage and bank fraud. There are also related prosecutions for conspiracy, mail and wire fraud, identity theft, and money laundering. An example of the latter is the 2019 mortgage fraud conviction of Paul Manafort, who formed a shell company to buy an expensive Manhattan condominium for the purpose of laundering money on which income taxes had not been paid. Manafort later applied for a cash-out refinance loan and stated on his application that his daughter lived in the condo. This was false, since the truth was that he was renting the property on Airbnb. Manafort’s classic error? Greed, of course. Not satisfied with merely transforming untaxed income into legitimate loan proceeds, Manafort also wanted income from the property, running afoul of the old saying: “You can make money being a bull, and you can make money being a bear, but you can’t make money being a pig.”
Regulation and Enforcement
The Financial Institution Fraud Unit of the FBI investigates and prosecutes criminal loan fraud, particularly where mortgage industry professionals and insiders are involved, proceeding on the basis of suspicious activity reports (“SARs”). The FBI uses two categories: “fraud for housing,” which occurs when a single borrower misrepresents assets and/or liabilities in order to purchase a home, and “fraud for profit,” which occurs when mortgage professionals act collectively to defraud a lender to collect fees.
The 2007 Texas Residential Mortgage Fraud Act changed the legal landscape at the state level. The Act amended certain sections of the Finance Code, the Government Code, and the Penal Code to address mortgage fraud. It also created a Residential Mortgage Fraud Task Force under the direction of the attorney general, which includes a range of state officials—the consumer credit commissioner, the banking commissioner, the credit union commissioner, the commissioner of insurance, the savings and mortgage lending commissioner, the presiding officer of the Texas Real Estate Commission, and the presiding officer of the Texas Appraiser Licensing and Certification Board. Although the Task Force was abolished in 2017, the interlinked bureaucratic machinery remains, and these agencies continue to share information and resources.
Criminal prosecution is not the only risk. There is also the matter of civil liability. Lenders commonly file civil suits against perpetrators of mortgage fraud. In recent years, it has also become more common to see attorneys who assist in or facilitate the fraud sued as co-conspirators.
What does mortgage fraud look like?
Examples of fraudulent schemes include flipping based on false loan applications and inflated appraisals (this category does not include buying property at a bargain price and then selling it for fair market value for a profit, which is entirely legal); nominee loans using the name and credit of straw buyers; equity skimming in “subject to” transactions; phony second liens to contractors who never perform any work; “silent seconds” that involve concealing the loan of a down payment to a borrower, when the down payment was supposed to come from the borrower’s own funds; concealing other indebtedness of the borrower; the use of fictitious or stolen identities; and “stop foreclosure” schemes that mislead homeowners into paying fees and signing the property over to a crooked investor. Common to most of these schemes are inflated appraisals that create phantom equity, illegal kickbacks (payments not shown on the closing statement), and falsified loan applications.
One can be reasonably sure that loan fraud has occurred when it is clear that a lender would not have made a particular loan if it had known all the facts, and the lender was prevented from knowing the facts by means of misrepresentation and concealment. Putting it another way: inducing a lender to make a loan based on false pretenses is fraud.
Many transactions, while not plainly illegal, fall into a risky gray area. The popularity of no-money-down investment programs and guru seminars has added huge numbers of people to the investment game and resulted in intricate get-rich-quick strategies. The FBI attitude toward these schemes (and to real estate investors generally) is openly disdainful. One official was heard mocking real estate entrepreneurs as “entremanures.” So if the FBI comes calling, even legitimate investors should assume the FBI’s intent is hostile. Saying nothing and immediately contacting a white-collar crime defense attorney is probably the best course or action.
One can nonetheless be sympathetic toward the FBI’s attitude, since the lender is not the only victim of mortgage loan fraud. It is easy to feel antipathy toward banks, but most home loans nowdays are either securitized or sold, meaning that others in the chain of ownership (including pension funds and the like) may be subject to loss. Also, many loans are sold to Fannie Mae, Freddie Mac, and Ginnie Mae, which are quasi-public entities. If there is a loss connected with these loans, it is the taxpayer who gets the bill. Finally, if loan fraud results in a foreclosure, then that has the potential to depress property values, so everyone in the neighborhood suffers. Mortgage loan fraud is definitely not a victimless crime.
Temptations of the Investment Business
A visit to the courthouse on foreclosure day is akin to watching sharks being fed at the aquarium. The problem, of course, is that it is impossible for all fledgling investors to become overnight millionaires. Real success involves hard work over time. Unfortunately, intense competition in the real estate investment business can lead impatient and unethical investors to look for profits in ways that cross the line.
Legitimate investors should avoid investment plans that sound too good to be true, either to the investor or homeowner. Programs that ask a homeowner to sign incomprehensible documents with weird names often involve fraud. If a deal is just too complicated for the average person to understand, it may well involve fraud. If it involves several people signing interests back and forth to one another and not recording anything, it is probably fraud. Payments made off the closing statement are almost certainly fraud.
Some perpetrators believe that giving their documents creative names will exempt them from the law. The problem for con artists who dream up these documents is that courts look to substance over form, and prisons are now offering long-term housing to these clever folks. Juries may not always understand the technicalities of mortgage finance but they intuitively understand fraud. Here are some other tip-offs that you may be dealing with a real estate con artist:
“This is a great investment! You’ll make great money with no effort.”
“There’s no need to talk to a lawyer. These are all standard forms.”
“Just sign this blank loan application here. We’ll do all the paperwork.”
“We put the property in your name. You’re totally secure.”
“We pay all the costs and you get half the profit! Easy money!”
“We’ll pay you a bonus at closing. You’ll have cash in your pocket and instant equity.”
“We’re going to manage and sell the property and then split all the profits with you.”
“God has sent us to give you abundant wealth.”
The Straw Buyer
The straw buyer scenario was more common before the bust, but it is becoming fashionable again. Here’s how it works:
1. A crooked investor generally looks for two categories of homes, those owned by distressed sellers who are behind on payments and new-home builders who have unsold inventory that is draining them because of the interest carry.
2. The perpetrator recruits straw purchasers/borrowers who are willing to allow their names and credit to be used in exchange for an up-front, off-the-closing statement kickback (often $10,000 or more) and then buys the property in their names. The note, deed of trust, and other loan documents, including an affidavit of intent to occupy, are all signed by the straw purchasers at a title company closing that appears legitimate.
3. A real estate broker accomplice may be involved to make this easier and eventually collect a commission from a “client” the broker never met, never obtained a buyer’s representation agreement from, and never gave an IABS to.
4. A mortgage broker accomplice submits a fraudulent loan application and supporting documents that show the straw buyer as having significantly higher income than is actually the case.
5. An appraiser accomplice inflates the value of the property, often by $100,000 or more.
6. The amount of the loan applied for exceeds the true market value of the house.
7. A title company may be complicit in this process in order to facilitate a smooth closing with no questions.
8. All the various accomplices and co-conspirators get paid large fees at closing, either on the closing statement for vague and unspecified charges, or off the closing statement altogether.
9. The house is placed on the market but does not sell because its value is grossly inflated.
10. The lender forecloses, taking a loss (part of which is passed on to HUD or a mortgage insurer) and ruining the credit of the straw purchaser. By then, the con artists have left with profits in hand.
Looking closely, it is clear that the whole transaction has been concocted so that the co-conspirators can generate large up-front fees for themselves, something that should always set off alarm bells.
Interestingly, straw buyers often allege that they were wronged. They even file lawsuits. It is difficult to feel sorry for them, however, since they willingly signed blank documents and gladly received an under-the-table payoff at closing. They cooperated in the fraud and benefited from it.
In the past sub-prime lenders were complicit in this process. Eager to make loans and collect fees, many did not supervise the underwriting process as thoroughly as they should.
In addition to the usual civil statutes that may be violated (statutory fraud, deceptive trade practices, etc.), numerous federal criminal statutes may be involved: