Fraud Advisory Services

The “credit crunch” was named after the irresponsible lending practices by the banks and other financial institutions that were out of control when they reached their peak in around 2007. It had become possible for virtually anybody to approach a property developer and start buying properties without having any capital to invest. The driving force behind this was the ease with which the lenders would provide the money and the lack of control over who they would lend to. In the UK many property developers abused this credit glut and many even conspired with lawyers, surveyors and mortgage brokers to defraud the buyers and lenders of vast sums of money.

The USA has seen similar problems, with mortgage fraud again being one of the major contributors to the present downturn in the economy. In the late 80s and early 90s there was a similar crisis in the economy – albeit on a much smaller scale – with a collapse of confidence in the savings and loans system. The FBI geared up strongly following this in attempts to deal with the mortgage fraud and other financial crime that was firmly embedded within the crisis. A strike force based in 27 cities was staffed by more than a thousand FBI operators and forensic accountants, together with teams of federal lawyers to manage the resulting prosecutions. This thrust alone was responsible for over 600 successful convictions and confiscation orders amounting to $130,000,000.

Today’s financial downturn dwarfs its forerunner in the USA, as it does just about everywhere else in the world. In the USA the financial institutions have reduced their assets by an almost incomprehensible $1.2 trillion this time round. This is of course a massive reduction in value and one which crystallises the frauds and financial malpractices that were taking place almost unchecked. It compound problems in a crisis by, for example, causing investors to lose faith and requiring much higher returns from their investments – in this case the mortgage backed securities are the relevant investments that become expensive. The result is increasing interest rates and fees for bone fide borrowers who are chasing limited funds when compared to the previous glut.

What is mortgage fraud?

Mortgage fraud for profit is a planned attempt to remove equity from others for illegal profit. White collar criminals will purchase property using loans and then sell these properties on. If they inflate the value of the property borrowed, they can borrow more than the property is worth. Some times they will even borrow on fictitious property. This type of fraud usually operates in its various guises as a conspiracy to commit fraud between property developers, conveyance lawyers, mortgage brokers and property surveyors (property valuers). The victim can be either or both of the following:

1. The indevidual who buys an overpriced property using a mortgage and ends up with negative equity

2. The mortgage lender whose security does not meet the level of the amount loaned

Very often the mortgage lenders will pursue the individuals who owe them money even though they lent to them as a result of a fraud conspiracy or the sharp practice of the property developer. Many individuals can be bankrupted by this and in the end the mortgage companies also lose out.

Mortgage fraud can also be committed by a borrower, typically with the help of estate agents or property developers. In this way they are able to obtain a house that is perhaps more valuable than their situation would otherwise allow - they falsify their income in order to borrow more money. Although they do not qualify for a loan and are committing mortgage fraud, many of these types of borrowers happily service their loans and the mortgage lenders remain ignorant. It is only when the borrower is unable to repay a monthly installment or sell on to settle the loan that such fraud becomes apparent.

Trends in US Fraud

In the USA the FBI receives Suspicious Activity Reports as do the authorities in the UK – derived from the Department of Housing, the Urban Development Office and from the industry at large. However, a large part of the US mortgage industry does not have mandatory reporting and so the exact level of this type of fraud is unknown. The trends in those reports that are made do show an increase – for example during 2008, reported mortgage frauds were up 36% to 63,173 incidences.

It is a recognised fact that a financial crisis such as the current downturn will expose fraud schemes that had been thriving during the former boom years. As the financial markets deteriorate, fraud come to light – witness the number of Ponzi schemes (such as the Bernard Madoff scam) we are learning about seemingly daily!

The FBI investigated 566 major corporate frauds in 2006 – rising to some 2000 in 2008.  These frauds include mortgage frauds, accounting fraud and insider trading. The increases are apparently stretching the FBI’s white collar crime resources.

The mortgage frauds seen include scams such as equity skimming and property flipping, where the fraudsters use corporate shell companies and corporate identity theft to appear bone fide followed up by threats of bankruptcy proceedings and foreclosure on clients and individuals to trick householders and investors to release their assets.

The FBI is gearing its approach to detecting and prosecuting mortgage and other forms of financial fraud which are seen to be a currently emerging threat to the stability of the US economy. Specialist software has been developed to detect incidence of property flipping in some hard hit areas such as Baltimore and Washington – searching databases for companies and persons showing patterns of property flipping (i.e. back-to-back purchases and sales or successive sales with very different sales prices over a short time). Undercover operations and wire taps are being used to good effect also, thus allowing criminals to be caught “in the act”.

The problem with mortgage fraud is that, as in the UK, many US property developers simply took advantage of the ease with which credit could be obtained. Put this alongside human greed to make large sums of money very easily and many investors previously lost any caution when entering the property investment business. They would buy property unseen, to rent out or sell on, relying on the fact that the values of property were bound to increase – as history had shown property does increase but there are “blips” and cycles that need to be accounted for. There are commentators that are currently saying that property prices will not rise for another 10 years! The successful property speculator will plan for this, only paying market value or less and certainly not relaying on the hype that was circulated by many of the property development companies during the boom years.

Read these other articles on mortgage fraud:

Don’t Always Blame The Conveyance Process For Mortgage Fraud

Mortgage Fraud in the Buy to Let Market

This article is grateful for facts and information presented by Mr J Pistole of the FBI in a statement before the House Committee of the Judiciary on 1 April 2009.

If you’re planning to purchasing a house with a mortgage, you must ask yourself, “how much house can i afford?”. This is because how big and expensive a house you can afford depends on your home loan amount. Once you find a house that befits your affordability, shop around to obtain a suitable home loan. However, you must keep in mind that there are various fraudulent lenders who can scam you by not disclosing fees upfront and then charging you more in the long run. So, you must gather knowledge about the various mortgage frauds and the ways by which you can prevent them.

Different mortgage scams and ways to avoid them

Some of the common mortgage scams and ways by which you can prevent them are:

*Appraisal fraud: Some fraudulent lenders inflate the value of your home and compel you to obtain a larger loan amount. These lenders don’t care about your affordability and their motive is to make you pay more as monthly payments. So, when you’re finding an answer to “How much house can I afford?”, hire an independent appraiser to verify the value of your property and accordingly determine whether or not you can afford the loan amount required to purchase it. In this way, you can prevent getting scammed to obtain a mortgage that you cannot afford.

*Not mention certain fees: Some scammers will not mention fees like appraisal fees, credit check fees, etc., upfront and include them in the total cost in such a way that it becomes difficult for you to realize that you are being charged unreasonably. To prevent getting scammed, you must ask the lender to provide you with a detailed breakdown of all the costs associated with your home loan.

*Lock your rate when market rates are high: Generally, there is a lag between the time you submit an application for the loan and when the interest rates are locked. Fraudulent lenders will misguide you to lock the rates when market rates are high claiming that they will rise even further. But in reality, the market rates will fall soon. So, you must check the market rates yourself before locking the interest rate on your loan.

When you’re obtaining a mortgage from a particular lender, check the ratings given to it by the Better Business Bureau (BBB). Lenders with high BBB ratings are generally reliable and offer good quality service.

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!