Mortgage Fraud (part I)

Mortgage Fraud and Predatory Lending Practices

As previously stated in this space, the FBI announced on September 17 that mortgage fraud is rampant, and that it is putting its considerable clout behind solving the problem. Oh dear, another of those boring corporate scandals that only accountants and The Wall Street Journal understands or cares about. Well, not exactly! In the first place, mortgage fraud is hardly boring. Organized crime is often involved, and even petty criminals pull off some pretty amazing coups. And while accountants and the business media have a vested interest, so do bank regulators, community groups, and secondary market investors.

And so should you! While financial institutions and the federal government are by far the biggest victims in terms of monitory loss, mortgage fraud is not just “their problem” Illegal activities aimed at your community bank or big nationwide lenders eventually and inevitably lead to higher loan costs and more restrictive lending practices. If widespread in one area, these scams can result in an epidemic of foreclosures and abandoned properties. A concentration of these can destroy neighborhood property values and damage the lifestyle of hardworking and responsible residents. Frauds that target federally guaranteed loan programs will – let’s all speak in unison here – lead to higher taxes.

Mortgage related fraud against financial institutions is a complex topic which we will discuss later. Some of these schemes are intricate and clever enough for a crime novel; consumers, especially gullible and/or greedy ones, are often caught up in them; and many are fascinating from the standpoint of how far the unscrupulous will go to make a dishonest buck and how often their victims seem eager to help them do it.But first we will take a look the victimization of individual consumers by fraudulent and predatory lending practices. At best, these practices are annoying to potential victims, but for the actual victims the end result is the loss of a home, financial devastation, and destruction of hard-won credit ratings.

Over the next few days and weeks we will describe some of the scams that target home buyers and those refinancing existing property. We will discuss some actual cases, alert you to warning signs and suggest some ways to protect yourself and where to go if it is too late for that.

Predatory Lending Practices

What is Predatory Lending? Predatory lending is the term used to characterize the usually fraudulent but always unfair and deceptive mortgage practices directed at consumers. Homeowners seeking to refinance are the most common targets, but home purchasers are not immune. At particular risk in the latter category are buyers who, because of credit problems or self-employment income, may not qualify for a conventional Fanny Mae/Freddie Mac mortgage and must rely on a sub-prime lender (one who, for a price, is willing to assume a higher risk than conventional lenders) to purchase or refinance. Also at risk, not surprisingly, are those seeking to buy in neighborhoods that have been red-lined (i.e. discriminated against) by conventional lenders. These are almost universally low income and usually minority neighborhoods, often in need of a substantial upgrade in housing stock. Buyers in these areas are, therefore, by default, placed at the mercy of sub-prime lenders.

But, beyond sub-prime lenders, there are a startling variety of people involved in fraudulent and predatory practices – big banks, the kind with their names on NASCAR billboards, loan servicing companies, small time con artists who once peddled aluminum siding and water filtration systems, loan originators working for otherwise legitimate firms, real estate attorneys, home builders, real estate agents. Predatory lending is profitable, and the opportunists have come out of the woodwork.

We present here our own list of predatory practices and the tactics that are used to promote them. We haven’t yet totaled up the number on our list, mainly because they keep popping up as fast as we can write them up. Nor have we tried to categorize them by target, method, or intent. But here are the first few of our top ten, or maybe twenty, in no particular order. Aggressive solicitation by lenders. Predatory lenders are pushy in their approach to borrowers. Their ability to telemarket has been curtailed by the Federal Communication Commission’s “No Call” rule, but they have the Internet, door-to-door salespeople, the U.S. Mail, flyers dropped on doorsteps or in mailboxes. The pitches are strikingly similar no matter who delivers them:
* We can lower your monthly mortgage payments * We will save you hundreds each month by consolidating your credit card and other payments * You can use your equity to buy that new (car, boat, kitchen, dream vacation - take your pick) * You can save your home from foreclosure; refinance your way out of bankruptcy.

And they don’t take no for an answer. If you don’t like one approach, they will try another. They insinuate themselves into your life, become a friend to the lonely, (making them particularly dangerous to the elderly who often have substantial equity in their homes.) One Internet lender sends me a minimum of three emails per day. When I “unsubscribe” they start up again, within the week, with a different email address.

Home improvement scams. This practice is a favorite topic of “gotcha” journalists, as well it should be. But, they expose it in 1998 then forget about it until 2004. In the interim, millions of people are victimized. The classic operation is a team thing. A homeowner needs a new roof or structural repairs, and approaches a contractor. Or maybe he has a long-held dream, a second bath or a new kitchen. Often he isn’t shopping, just dreaming. Then the doorbell rings. A contractor “working in the neighborhood” has equipment already on site and can offer a deal on any project. AND, his company can finance it (the paper will then be sold to a predatory lender) or he has a “friend” in the mortgage business who has a spiffy new home improvement program.
Snap goes the trap. The homeowner agrees, the papers are signed; the work begins immediately, often before the three day loan cancellation right ends. The work is overpriced, shoddy, and often done without proper permits that would require inspection by the local building inspector.

Of course, the double whammy comes with the loan. It will be a poster child for predatory lending, with a high interest rate, burdensome fees, and most likely a pre-payment penalty that locks the borrower in for an extended period of financial torture. Homeowners who have been impacted by these dreadful seasons of hurricanes, tornados, and forest fires should pay particular attention to these home improvement scams. The teams are probably in your neighborhoods, even as you read this. We have only just begun. This series will continue with information on other types of predatory loan practices, advice on how to protect your home and pocketbook from the scammers, and where to seek help if it is too late for that.

In this space, we recently initiated a series of articles on mortgage fraud, which the FBI says is now rampant. We began with a discussion of one aspect of this broad crime, predatory lending practices, by describing two of the more common predatory practices: aggressive solicitation by the lender, and home improvement scams. We continue today with a discussion of two more common techniques used by the predatory lender.

Just a note about sub-prime lenders, a term we will use a lot. These are companies or individuals who are willing to assume a greater risk than a bank, credit union, or thrift institution in return for a larger, often excessive, profit. The risk might relate to a buyer with a higher level of consumer debt, less than perfect credit, or hard to verify or inconsistent income (self employment or lots of overtime). It could be a risky property, one in need of rehab or in a neighborhood being (illegally) shunned by traditional lenders. It could be the loan itself that is risky. Many conventional lenders won’t touch a cash-out refinancing, certain types of construction or rehabilitation loans, or one with a very high loan to value (LTV).

Not all sub-prime lenders are bad. They can serve a useful purpose as long as a borrower is alert and informed. We are concerned here with the lending practices of the ethically challenged, those who often prey on vulnerable borrowers. Many sub-prime lenders flock to the industry in when home sales are skyrocketing and refinancing is the hot topic at every suburban cocktail party. Once the market cools, they crawl back under their rock. Now, more about predatory lending practices.

Pushing for refinancing a lower interest rate mortgage. An unethical mortgage lender, once he has sold the buyer on a new loan, will start pitching a refinance of the first mortgage rather than granting the second mortgage the borrower originally sought. The lender argues for the convenience of a single mortgage payment or promotes the potential savings. The lender may, for example, initially promote a second mortgage at 10% but reduce that to 8% if the borrower agrees to a total refinance of the first mortgage loan.

The borrower will probably save on his monthly payment. A second mortgage is usually for a term of 10 or 15 years, a first mortgage is typically amortized over 30 years. Wrapping both into a total refinance of a first mortgage that may have only 20 years left to run, and amortizing the total amount over 30 years will usually result in a substantially reduced monthly payment, even if at a higher interest rate. In the long run, however, the borrower will pay tens of thousands of dollars in additional interest (plus the initial loan fees, usually wrapped into the loan) over the life of the loan and will strip much of the equity out of his home.

The lender, of course, did not just fall off of the turnip truck. In addition to the immediate profit from a larger loan, his real goal is to gain a first mortgage position on the home. A second mortgagee is always behind the first in the case of a foreclosure or bankruptcy, and may have to pay off the first mortgage in order to recover on its loan. A borrower who develops financial problems can default on a second mortgage with little fear of foreclosure if there is a substantially larger first mortgage in place and he continues to make payments on it. The second mortgagee will get paid eventually, but might have to wait until the property is sold. Bait and switch. You know the term. It is most commonly used when a retailer advertises a great sale on a large screen television or new car. When the buyers flock to his store, that item is sold out or the ad was a mistake. However, the retailer has something “almost as good” that he will let go at a steal to make up for the confusion. Well this practice is rampant in lending as well. Here are two examples of mortgage bait and switch.

A borrower commits to a mortgage under a set of terms: a certain interest rate, a fixed or adjustable mortgage with a specified frequency and method of adjustment; length of loan; and so forth. Then, at the closing table, the borrower realizes that the loan documents specify a higher rate, more frequent adjustment, a five year note with a balloon or other terms to which he was sure he had not agreed. The loan originator does not answer his cell phone, the moving van is loaded, and the sellers are beginning to look real unhappy. Under such pressure, the borrower signs the documents while swearing to get the mess straightened out. But with a signed note and mortgage, it is now a legal issue that will take time and money and perhaps the courts to sort out.

Lest you think this could never happen to you, in a California study of 125 persons who borrowed from sub-prime lenders, 70% reported that a key element or elements of their loans changed negatively at closing. Let me illustrate a second form of bait and switch with a true story.

Pam, a single mother (and ironically a woman with considerable experience in the mortgage field) was struggling with credit card debt and an increasing number college loans. She had an adjustable rate mortgage that had tumbled as far as it could, to a remarkable 5.25%, but it was unlikely to stay there and she know her well-paying job would probably end in less than a year.
She had toyed with the idea of a home equity loan, so when a mortgage company called her at home, she was curious enough to give them her financial information and allow them to run her credit, which she knew was excellent. They were back the next evening with a proposal, a two-stage deal. Since this was a cash-out refinance of her existing mortgage, it could not be a conventional Fanny Mae or Freddie Mac product. Instead, she would be simultaneously approved for the cash out at 10.5% through a sub-prime lender and for a 6% conventional loan with a well known nationwide lender. She would close on the higher interest loan first and then on the conventional refinance after the first loan had “aged” for a few months. Both transactions would, of course, carry broker fees and closing costs, but the end result would be manageable payments that would allow Pam to keep her house even if she eventually had to take a lower paying job.

Pam agreed to the proposal. Her house appraised higher than she had anticipated (another predatory practice), high enough to allow her to also pay off her auto loan. The 10.5% loan closed in May, and, even with the higher interest rate, her payment was several hundred dollars less than she had been paying on the old mortgage and installment loans. In July she inquired when she could move on to phase two, the conventional loan, that would drop her payments another $600 per month. She was told that her current loan would have to age another four months, into late November. By then she had received a date certain for a corporate-wide layoff, and began an increasingly frantic series of calls to the mortgage broker. How soon could they close on the new loan? After a few frustrating conversations, the office manager even intimated that she was making things up, her calls were no longer taken or returned. Pam was laid off as scheduled; and, after weeks of searching, ended up with a commission-based job. Without verifiable income she could not qualify for a better loan. Within 18 months she had run through her modest savings and her 401K and lost her home to foreclosure. Oh, by the way, she never heard from the mortgage company again. We will continue with this series in the near future. In the meantime, if you have a story about mortgage fraud or predatory lending to share

Lending More Than a Borrower Can Afford.

You’ve seen the ads in your email box or on late night television: “Borrow 125% of your home’s value.” “Use your home to buy a new car (boat, a fabulous vacation, etc.) While these can be classified under Predatory Lending Practice #1, aggressive solicitation, they are also part of a more devastating practice, purposely granting and/or structuring a loan with monthly payments in excess of what the borrower can reasonably be expected to pay. Beyond loaning at an over-the-top LTV (loan to value), there are other ways to structure a loan guaranteed to get a borrower in trouble:
* Disregarding income and debt. Predatory lenders ignore conventional guidelines regarding the borrower’s ratio of debt to income, or the level of income itself. If a borrower is obligated to pay 55% of his monthly income to principal, interest, and property taxes and another 20% to installment loans, medical, or other expenses, he is nearly bound to fail. * Negative amortization. This is now illegal in many states and should be in all of them, but lenders can usually get away with selling “neg ams” to uninformed borrowers with little risk of prosecution. With a neg am, the borrower is required to pay less than the amount due each month, the balance being tacked on to the principal. Obviously, at some point, that swollen principal will come due. * Interest only loans. Zero amortization is only slightly less dangerous than “neg ams.” The borrower makes a minimum payment for a period of time, that amount covering the interest, but paying nothing toward principal. After five or ten years, payments are accelerated to cover both interest and principal. This is usually legal and some bank home equity loans are structured along these lines.

A lender usually does this to virtually insure that the borrower will fall into default. When this happens, the lender is the first to know and can approach its customer to offer bailout refinancing, with more fees and probably yet a higher rate attached.
Under any of these scenarios, a borrower might refinance two or three times before ultimately losing the house to foreclosure or being forced to sell and, with the equity stripped from his home, walk away virtually empty handed.

Some lenders, usually called “hard money lenders”, grant a loan with the sole purpose of foreclosing. These guys usually lend no more than 50% of the value of the home (the 50% equity will ultimately be their profit) and tend to prey on the elderly who have owned their home for many years, or on formerly credit worthy homeowners suffering financial distress. We will talk about how these hard money lenders (and many other only slightly more reputable folks) get away with keeping all of a home’s equity when we discuss predatory loan servicing practices.

Loan Steering

This happens when a bank or mortgage company notifies a qualified borrower (we will call him Tom) that he is not, by reason of income, credit, or a host of other causes, some of which may, on their own, violate fair credit laws, qualified for a loan from that institution. This may be done as a routine practice by a predatory institution, or an honest bank may be the totally innocent instrument of a renegade employee. In the latter situation, the rejection is conveyed by a trusted loan officer (Bill) acting totally on his own. AND, it just so happens, Bill has a friend, “Joe” who might be able to help Tom with a loan. Of course, the loan that Joe is able to arrange is quite different from what Tom imagined when he started the process. The interest rate is higher, usually much higher, than the rate offered by mainstream lenders, and the fees are a shock. But rejection by the bank has shaken him. Bill told Tom that, not only would his bank not lend to him, but neither would any bank or thrift, so Tom, who really wants to buy a house or desperately needs to consolidate his debts, is reluctant to approach and be embarrassed by yet another institution. While Tom is still thinking about it, Joe calls again, and promises to make it easy.

Then a host of the other predatory practices we have talked about come into play. * Joe is aggressive, calling Tom every night to push the benefits of his product.* The fees are to be wrapped into the loan amount, driving monthly payments up even further, perhaps beyond what Tom can reasonably afford. * Tom has already been victim of one form of “bait and switch,” when he was handed off to Joe, but now Joe does it again, promising that “after a period of time” paying on the high interest loan, Tom will be refinanced into a better deal. Of course you realize that Bill, the bank’s loan officer, and Joe are partners. Joe gave a kickback to Bill from the proceeds of Tom’s loan and, maybe even promises another down the line when Tom can no longer keep up the payments and must refinance with Joe, or loses his home to Joe’s “company.” The bank was probably as much a victim as Tom, losing his business and probably his good will.

Real life story. In the early 1990’s the Federal Deposit Insurance Corporation closed a $500 million dollar bank in Boston. In those days $500 million in assets did not indicate a huge bank, but it was a respectable size. It was, however, not a respectable bank. The local papers had long referred to it as “the mob’s favorite bank” and, indeed, it did have some interesting customers on its Christmas card list. But the real story centered on a member of its Board of Directors. This gentleman, a building contractor by trade, ran a loan sharking operation out of one of the bank’s branches. He had access to all of the bank’s files (technically he shouldn’t have, but the employees were scared to death of him.) When he found an application that had been rejected by The Board of Directors (do you sense a pattern here – this guy did not need a partner) he contacted the borrower and, giving his title and claiming to represent a subsidiary of the bank, offered a loan at twice the going interest rate. When all of the paperwork was done, the director actually kicked the branch’s manager out of his office and used the office as a place to close the loan. The director even had his own collections department although, by the time the bank was closed by the Feds, Frankie was serving life without parole for murder.
Let’s hope it wasn’t a hapless borrower.