Homeowner fraud exacerbates mortgage crisis

Aug 31, 2008 (The Press-Enterprise - McClatchy-Tribune News Service via COMTEX) -- FNM | Quote | Chart | News | PowerRating -- Aug. 31--Some homeowners tempted to buy a more affordable house in a declining market have committed fraud to ditch the supersized mortgage they no longer want.

This month, Fannie Mae, the giant government-sponsored enterprise that buys and guarantee mortgages, began enforcing new guidelines that could help stop the practice, called "buy and bail."

Freddie Mac, another major government-sponsored market for home mortgages, and the Federal Housing Administration, which insures mortgages, are expected to follow suit.

The abusers are homeowners who could afford their mortgage payments but didn't want to keep a house whose value had dropped below what was owed on it.

If they just walked away, their shattered credit would prevent them from buying again. Instead they continued making timely payments on the first home. On the loan application, they led the lender to believe they intended to put a tenant in the first house so they could afford the two mortgages. But once escrow closed on the new house's purchase, they stopped making payments on the first house, letting it go into foreclosure.

"This adds an element of fraud to a market that is already out of control," said Inland economist John Husing.

Under the new Fannie Mae guidelines, in most cases, a borrower now must have at least 30 percent equity in his house to buy another. Otherwise, he cannot use the rent he says he will get to prove he can support two homes. The deterrence is that no one would want to walk away from a house in which he had a large amount of equity.

Also, the rental income the borrower claims now must be fully documented.

In another scam on lenders, homeowners have been lowering their mortgage payments by arranging fraudulent "short sales" at prices less than what they owe their lenders. The buyer whom the seller chooses, who may be a relative or friend or a "straw buyer" paid for his service, agrees to transfer ownership back to the seller, who winds up with a smaller mortgage on the same house and never has to move.

In such a short sale, the seller commits fraud by having a side arrangement with the buyer that he does not disclose to the lender. When lenders accept short sales, it is because they think the price is the best they can get. Mortgage industry officials say lenders would reject a sale in which there was a special relationship between seller and buyer on the grounds that the selling price most likely was not the best one available.

Michael Pfeifer, an Orange County lawyer who specializes in recovering losses from mortgage fraud for lenders, estimated that one-quarter of the "short sales" in this market would fail to meet the criteria of arm's-length transactions.

"Many of the brokers think it is OK, which is ridiculous. It is out and out fraud," Pfeifer said.

Although the seller quickly regains ownership of his house, the short sale destroys his credit. But real estate agents said within a few years, he may rebuild his credit enough so the mortgage on his house can be refinanced in his own name.

A borrower who takes part in one of these scams can be sued by the lender or criminally prosecuted. The real estate agent involved can be prosecuted and lose his or her license.

And a lender who discovers he has been bamboozled into approving a loan with phony information can require the agent or borrower to pay off the mortgage immediately.

However, neither the lending industry nor law enforcement has aggressively punished such offenders.

Larry Roberts, who leads the real estate fraud unit of the San Bernardino County district attorney's office, said lying on a mortgage application is a prosecutable crime, but it has low priority. He said the office is more eager to prosecute scammers who profit by deceiving consumers into believing they can help them avoid foreclosure than it is in catching consumers who defraud a lender with the intention of buying or keeping a home.

Wrongdoers are further insulated by California law, which greatly restricts a lender's ability to sue borrowers to collect the money they've lost in a foreclosure or short sale.

Pfeifer blamed the abuses on homeowners desperate to keep houses on which the mortgages have reset at higher interest rates and on "brokers who are out to get a commission and don't particularly care how."

But real estate agents and brokers can be held liable, said John Giardinelli, a lawyer who represents nine Southern California real estate associations.

"I am telling them, 'If you put your handprint on something deceptive or fraudulent, then you could lose your license or conceivably be brought up on criminal charges,' " he said.

Joe Cusamano, broker/owner of Pro-One Investments in Riverside and president-elect of the Inland Valley Association of Realtors, said he knows he has clients who have lied to lenders to "buy and bail" and done short sales between parents and children.

He said he tells them what the law requires but still works with them because he believes they are good people caught in a collapsing market who are not getting sufficient help from either lenders or the federal government.

Cusamano described one client as a young law enforcement officer and family man who was buying a bank-repossessed house next door to one he already owns in Moreno Valley.

The client could afford his current $1,900-a-month payment for his mortgage, taxes and insurance, but he saw "buy and bail" as a way to improve his family's lifestyle. He had bought his house in June 2005 with a $294,000 mortgage, and since then, its value had fallen to about $155,000.

He noticed that the bank-owned house next door was bigger and had more upgrades, and he put in a winning offer of $145,000.

The client's plan is to let his original house go to foreclosure, Cusamano said, and probably the only adverse consequence he will face is having bad credit for the next five years. Meanwhile, he will save $700 a month on his house payments.

Real estate experts blame the walk-away phenomenon on "nothing down" financing during the recent housing boom, which has given borrowers no incentive to ride out the real estate downturn.

Also they say more people now than in the past consider their house primarily as an investment rather than a home they cherish and for which they would sacrifice everything else.

And today's homebuyers seem less inclined than their parents or grandparents to value their promise to repay a lending institution, Cusamano said.

Peer pressure is partly to blame for today's profit-driven ethic, said Larry Calbers, director of the Center for Accounting Ethics at Loyola Marymount University.

"First you are a fool not to get in (the housing market), and then you are a fool not to get out," Calbers said.

Pfiefer said he believes many people who are duping lenders do not think it a crime as they would consider robbery to be.

"The classic characteristic of mortgage fraud is that people think of it as a game," he said.

Earlier this decade, the same scofflaw attitude in real estate transactions contributed to the current rash of foreclosures, Pfiefer said. People inflated their incomes on mortgage applications to buy homes they now find they can't afford.

"Lying is the reason we have the economic crisis to begin with," he said. "People thought it must be OK because they could get away with it."

A 55-year-old man said he let a house in southern Corona go to foreclosure and bought another in Lake Elsinore, lowering his monthly payments from $5,200 to $2,100. He wanted to remain anonymous because what he did "could be construed as fraud," he said.

He had seven money orders for $500 apiece made out to himself and asked a friend to sign a rental agreement so he could deceive the lender into believing he had rented out his first house and therefore could afford to buy a second one, he said.

His Christian beliefs told him lying was wrong, and his parents had taught him to pay his debts, he said.

"The only way I can justify it (lying to his lender) is that I think a lot of people made a lot of money selling bad mortgages to anyone who walked in the door," he said.

Sandra Gloshen said after her husband, an airline baggage screener, was transferred to Boise, Idaho, by his employer, they were unable to sell their house in Lake Elsinore, which was then worth less than they owed on it. But they had no trouble buying a home in Boise after they told the lender they would rent out the Lake Elsinore property, she said.

In actuality, she said, it would have been impossible to charge enough rent to cover the mortgage payment, which had ballooned when their interest-only loan reset. She said their original lender ultimately seized the Lake Elsinore home.

"Some of the people walking away may have their reasons that seem good to them. But I know if I was the mortgage holder, I wouldn't be happy about it," said Wil Herring, president of the California Association of Mortgage Brokers and broker/owner of Moreno Valley-based Mtg. Experts Inc.

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