The inherent complexity of real estate transactions, particularly those involving investors, offers ample opportunity to commit fraud. Sophisticated real estate investors understand the “ins and outs” of transactions, and may have plenty of tools in their arsenal to defraud banks. Fraudulent appraisals, corrupt mortgage brokers and straw buyers all play a role in real estate fraud. Bankers need to be on their toes to prevent bad real estate loans.
Here’s an overview of the types of schemes that crooked borrowers might use to defraud financial institutions:
To qualify for a loan, an investor, or his or her co-conspirators, may forge key documents to paint a rosier financial picture. This could include altering bank statements and earnings-related documents, such as W-2s. An investor might also misrepresent their employment status and the loan’s purpose, or fail to disclose assets and liabilities.
Because inflating a real estate asset’s value increases the chances the loan application will receive approval, real estate investors might seek out incompetent appraisers. Alternatively, an investor might offer the appraiser a kickback to inflate the appraised value. Or instead of paying a bribe, a real estate investor could provide the appraiser with altered or overly optimistic information, such as unrealistic vacancy rates, rental rates and expenses.
In a skimming scheme, an investor purchases a home using a loan that covers 80% to 90% of the purchase price. The investor pays a 10% down payment and rents the properties, but fails to make mortgage payments. While this scheme unfolds, the buyer recovers the initial deposit via rental payments. He or she also receives tax benefits from holding the real estate. Even if a bank forecloses and pursues the investor for a deficiency (the balance remaining after the bank foreclosed and sold the property), it may be difficult to track down the investor.
Flipping fraud happens when an investor purchases a property and then quickly resells it at an artificially inflated price to a co-conspirator or straw buyer who has no intention of living in the home or paying the mortgage. The original buyer pays off the first loan, while they split the proceeds of the second loan with the straw buyer. The straw buyer makes no mortgage payments. The bank eventually forecloses on the loan, which now far outstrips the actual value of the property.
An investor uses a straw buyer to purchase a property. That buyer then defaults. Just before the bank forecloses, the investor steps in to purchase the property as a short sale (an amount less than the mortgage balance, with the bank forgiving the shortfall). Thanks to the straw buyer’s default, the investor purchases the property at well below market value.
In these cases, a real estate investor submits multiple HELOC applications on the same property simultaneously. Due to delays in lien filing, multiple bankers approve the borrower. While each banker believes they are “first in line,” in reality, the borrower draws down the HELOC and disappears — leaving the bank with a loss.
While red flags vary by fraud scheme, be on the lookout for borrowers who produce photocopied documents that appear altered; or who appear unable to recall accurate numbers from their bank statements or W-2s when questioned. Also, pay attention to differences between a borrower’s education and ability to communicate, and their employment history and compensation. If a borrower appears unconcerned about the purchase price, the terms of the mortgage, or the location and condition of the property, consider conducting additional scrutiny of the application. If the property size and location seem inconsistent with the buyer’s socioeconomic status, proceed with caution.
In addition, when an unknown or inexperienced appraiser values a property, spend additional time and effort analyzing their work. Test the assumptions the appraiser relied upon — especially if they favor the borrower. Pay close attention to how an appraiser responds to analysis of the appraisal work, particularly if he or she is unable or unwilling to answer routine questions.
Real estate fraud happens often, but it doesn’t have to happen to your bank. Fraudsters come in all shapes and forms, and while most loan applicants don’t intend to defraud your bank, be aware that, as long as your bank lends money, it will attract the attention of real estate fraudsters.
The success of real estate fraud relies on the applicant’s ability to manipulate the loan application process. Some warning signs associated with fraudulent loan applications include the borrower’s:
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