Fraud Advisory Services

The incidence of mortgage fraud appears to be increasing. Much of it has been coming to light as a result of the down turn in the property market that accompanied the current general economic down turn or “credit crunch”. When property values reduce to below the level of the mortgage that has been advanced on it the lenders begin to sit up and take note.

One of the pivotal areas within the whole property business is the conveyance process. This is where two firms of solicitors will represent the seller and the buyer respectively and ensure that money is transferred properly in return for the title to the property.

Most people look to pay as little as possible for the speediest conveyance possible. 99 times out of a 100 this probably works well enough. However, property law is complex and when things go wrong they are usually the unusual issues that many swift sale transactions would overlook. This is why for larger more expensive properties, even though the process is essentially the same, the conveyance fee is higher because of the higher risk of losing more money.

The buyer’s solicitor will take receipt of mortgage funds and documents that the sale process relies upon, such as valuations and certificates of building regulation compliance. The solicitor manages the whole process and is uniquely positioned to be able to vet the process for fraud. Indeed, all solicitors have an obligation to “know your client” for the purposes of anti money laundering regulations 2007 and to report any suspicious financial activity they come across.

A typical mortgage fraud will involve a property company either selling in its own right or acting as agents for property holding companies. They will inflate the property prices based upon the rental incomes that they say can be obtained from the properties. There is no law to stop them doing this. If a glossy brochure says that a three bedroom student flat costs £250,000 and allege that each room can earn £90 per week – then this indicates a return on investment of 5.6%. This would be an acceptable return in the property business (there is no standard as it varies from region to region, property to property). However, it does rely on the landlord letting all three rooms out for 52 weeks of the year and achieving the required £90 rent.

If the property was sold as bricks and mortar at an auction it might sell for £150,000. However, the valuation provided by the surveyor to the mortgage company will be based on the rental income and possibly on similar properties that the same development company has been selling nearby. When property prices were increasing this practice can be overlooked. When prices are plumetting and people try to realise their assets the overvaluation is discovered.

The conveyance process should spot this practice. The valuation used for the mortgage, arranged by the property company, should not be relied upon and any solicitor worth his or her salt will say that an independant valuation should be carried out. Any savvy potential investor will want to get a feel for property values in the area that they are buying anyway.

Where a problem arises is when the property sales take place in London with a lot of glossy marketing hype and the properties being sold are, for example, in the North of England. During the early 2000s there was a surprising amount of spare capital and credit available (as everybody has now come to realise) and individuals were mopping up buy to lets on 100% mortgages without even visiting them first. It is hard to believe but everybody was riding the wave of success and were blind to the possibility of a property crash.

In some cases solicitors were being appointed by the property developers on behalf of the buyers. They were happy to take the business, 100s of transactions a year at £600 per time. The trouble is that they were not looking for overvaluations, turning a blind eye to the gifted deposits (thus facilitating 100% mortgages). In short, a few conveyance firms were a party to the mortgage fraud. Developers, solicitors and surveyors conspired in what was much more than sharp business practice to ensure that by the time that the property values crashed in about 2007/08, many buyers lost their investments and went deeply into negative equity. The mortgage companies that were involved in the property company that I investigated lost on average £63,000 on each and every property where they advanced loans (there were several 100s of properties in this one case) thus they felt the impact of a very large multi million £ mortgage fraud!

Firms were shutting down in 2009 ahead of their October PII renewal (the Law Gazette)

Many conveyance firms have felt the pinch as a result of the greed of a few. All firms must have professional indemnity insurance in place that covers them for fraud amongst other things. Such is the increased incidence in mortgage fraud that these firms have faced severe hikes in their PII cover. For example one firm reported an increase of 550% to £110,000, some 25% of turnover! Some firms have been shutting their doors to conveying business and some have even gone into administration to avoid paying the bill when due.

In recent years the relaxation of lending criteria for those persons wishing to become property landlords has meant that the number of people buying houses purely to rent out to students and professionals alike has increased enormously.  No longer was there any  requirement for such mortgages to be limited to multiples of the borrowers earning capacity.  These loans were freely given on the simple basis that the anticipated rental income would cover the interest repayments by at least a specified margin.

Further protection for the lenders was supposedly obtained by the formal valuation of the property, and a willingness to lend only a proportion of this value to the prospective landlord.  The latter was therefore forced to stump up typically 15% of the purchase price as a deposit thus providing a margin of safety for the lender should there be a need for the loan to be called.

How did the situation arise then, where a taxi driver from Glasgow, of little means but who had previously never owed a penny to anybody, was made bankrupt as a result of buying four properties between 2002 and 2007?  Her properties turned out to be worth substantially less than her mortgages and the rental income was insufficient to meet interest payments.  What is more, she had run up £100,000 in debt in the form of loans taken out to try and meet the mortgage bills.

By “gifting” the deposit to the customer, the property developers were discounting their prices but are able to sell houses to people without incomes and without cash deposits purely on the basis that the rental income potential would cover the interest payments on what was effectively a 100% loan being taken out.

Indeed in 2008 I met one lucky customer whose day job earned him £30,000 per annum and who was persuaded by another property company to purchase 20 properties over a period of 6 months.

Lucky?  All he had to do was wait 10 years and the property prices would have doubled making his portfolio worth around £10 million.  Then he could sell the lot and pay off the £5 million he held in mortgages, the rental income servicing the loans in the intervening years.

You can imagine his horror when he eventually discovered that his properties were only worth £3 million and the rental income on the poor quality student lets fell far short of the glossy promises he had been given.  He too is looking towards bankruptcy after struggling for 18 months or so trying to keep his head above water and hopefully obtain some redress from the developers.

These are extreme examples, but there are thousands of other hopeful landlords in similar situations around the UK.  How can this have been allowed to happen?  The starting point is the glitzy brochures offering the opportunity to become property millionaires.  They told how it was possible to use borrowings to gear up investments and take advantage of a rising property market.  This was common knowledge to the person with a shred of common sense.

However, the developers then packaged their properties, whether refurbished units, new build or even off plan investments, making the purchase extremely easy for the customer, who only has to sign the back of a mortgage application form.  The mortgages were arranged in-house and the services of a friendly solicitor were used to convey the transactions on behalf of the customer.  Thus for example a customer obtains a six bedroom property for £300,000.  Although the customer will have paid perhaps a £2,000 reservation fee, the £45,000 deposit was gifted to him.  He is left with a mortgage of £255,000 and the company has promised to manage the rental of the six bedrooms to local students.  More than that, the developers have guaranteed the rental income from the property for one year.

Where does it all go wrong?  The luckier customer will have 12 months of rental income flowing in.  The unlucky one will have to fight for the regular payments and supplement the “guaranteed” income themselves while waiting for the developers to stump up the promised revenue.  But even for the luckier ones, when the 12 months is over and the realisation of having to service a massive mortgage sets in, they begin to take an interest in the investment.  The property is visited, often for the first time, to be found empty, devoid of tennants and in a poor state of repair.  The customer will generally wonder what he has spent £300,000 on and will have his property valued by an independent surveyor.  Now he will see that his property will be worth say between £150,000 and £200,000.  He can’t sell it to cover the mortgage and he can’t keep it because the rental income is insufficient.

The developer has valued the property as a “business” estimating rental income of £65 per room per week and assigning a rate of return of say 6.5%.  The rate of return is too low perhaps but who is to say what should be used.  The room rate is high for a property in poor state situated too far from the university, but is a rate that some students will be paying elsewhere therefore seemed “feasible” at the time.  One of the bedrooms in the property is a box room that can fit a single bed and nothing else.  As a consequence it is impossible to let, but was one of the 6 bedrooms used to initially value the property none the less.  In fact, the bricks and mortar valuation taken subsequently usually reflects the letting potential of the property much more accurately in practice.

So how can such a large mortgage be obtained?  The mortgage lenders rely on the valuation being realistic and presume that the customer has shown his commitment by paying the 15% deposit.  The mortgage form simply shows that £45,000 has been provided “from the applicant’s own funds”.  Therefore in not disclosing the gifted deposit, the customer has committed a fraud on the lender.

But surely the customer’s solicitor would point this out?  After all, they handle the deposit and lenders principal on behalf of the customer for payment to the developer.  Not at all, the solicitor is hardly independent, receiving hundreds of similar instructions each year referred to them by the developer.  Indeed, they even take receipt of the gifted deposit from the developer, returning it to them with the balance of the transaction received from the lender, ostensibly to give the impression that the customer did own the deposit funds.  The solicitor will say that they are receiving the deposit funds from the developer “who was holding them on behalf of the customer”, but in reality the customer is obtaining property that is overvalued even after being discounted by the deposit sum by obtaining a 100% mortgage from an apparently unsuspecting lender.

The response of the lenders is to sue the surveyors and solicitors for professional negligence and to repossess the undervalued properties from the defaulting customers.  The particular property developer that I was investigating meanwhile is investing its substantial profits from buy-to let into prime “business to business” city centre developments and presenting a respectable veneer to the outside world.  Many of these property developers come in similar guises or variants of the theme, and then they go leaving bankrupted individuals in their wake.  Some are closed down by the Department of Trade and Industry (now the Department for Business Innovation and Skills – and some, like the developer in the example above, even peak the interest of the Serious Fraud Office.  However what is needed is tighter control over the ease with which individuals were able to obtain massive amounts of credit, a reflection perhaps of today’s society.  This has come too late for many with the squeeze of the “credit crunch”.  Now a tangible deposit is required for such investment, with closer scrutiny by the lenders – sometimes as much as 45% or more!