Though the real estate system is set up with multiple checks meant to keep all the players in a transaction accountable, our industry has so much money floating around and so many different individuals involved in each transaction that full visibility is practically impossible. Every day scammers are thinking up new and creative ways to game the system, or falling back on old tricks to defraud new victims. At S2T we believe it is our responsibility as real estate professionals to educate ourselves about the different types of fraud so we can have an eye for them if we ever encounter them in the course of our dealings—and so we can close loopholes and create an industry culture more conducive to spotting scams and nipping them in the bud. Here is a list of six common types of real estate fraud to be used as a resource both for homebuyers and for real estate professionals.
FLIPPING
The term “flipping” has entered common parlance to mean buying a home, renovating it strategically, and selling it for an overall profit. That is a totally legal enterprise, and if you can pull it off—more power to you! Recently there was a bumper crop of reality TV shows featuring buyers renovating and flipping their homes. Maybe—if you play your cards right—you could be the next Kim Kardashian.
However, “flipping” can also refer to a type of real estate fraud in which a number of people collude to inflate a property’s value with the purpose of securing a hefty second mortgage. While there are always multiple players involved in illegal flipping, the appraiser and the closer are the scam’s cornerstone.
First, the buyer takes out a mortgage for the home’s actual cost. Shortly thereafter, perhaps after some perfunctory improvements, a fraudulent appraiser values the home for significantly more than it is worth. The original buyer sells the house to another person (the home is “flipped”), who takes out a large mortgage. The larger mortgage is used to pay off the original mortgage, the profits are split, and the larger mortgage defaults. Sometimes the buyers are in on the scam, sometimes they are not, but usually the lenders bear the brunt of the loss.
APPRAISAL FRAUD
Real estate agents work on a commission—the more the buyer pays for the property, the more money goes into the agent’s pockets. That’s why real estate agents are known to play hardball—they want a smooth, fast transaction, and every cent affects their salary.
However, some real estate agents take it a step further. With the help of a fraudulent appraiser who receives kickbacks for his or her services, they sell a house for more than it is worth with an eye to secure a large commission. Sometimes the homeowner is in on the scam, and splits a mortgage payment between the co-conspirators before allowing the home to immediately default. Other times, buyers are unaware of the fraud and have no idea they’ve been duped into overpaying for their home.
“STRAW BUYER”
The “straw man” is a logical fallacy in which a debater misrepresents his opponent’s argument in order to win the argument. The debater creates a “straw man” that is easier to knock down. For example, if I say, “S2T should go to the beach,” and you say, “No, S2T shouldn’t fritter away the whole day—we have errands to run,” you are creating a straw man argument. The S2T proposed beach trip might have taken four hours—but you are deceptively presenting my suggestion as a full-day trip, which makes your argument seem stronger than it really is. (And if you don’t want to go, you can just tell me.)
Just as a straw man argument is a deceptive misrepresentation, a “straw buyer” deceptively misrepresents his creditworthiness. By helping buyers distort their financial situation, the perpetrator helps them buy a home and secure a mortgage they wouldn’t otherwise have been creditworthy enough to qualify for.
Sometimes the perpetrator temporarily increases the buyer’s net worth by briefly lending the buyer some money. The buyer allows his financial situation to be misrepresented, because doing so allows him to get the home he wants. (“Besides,” he thinks—“I’ll be able to pay it off later.”) Other times, another buyer—one who is more creditworthy than the actual buyer—enters the equation and buys the home on the other person’s behalf.
While the latter form of “straw buying” isn’t necessarily illegal, duping banks into entering agreements with borrowers who are actually sub-prime is an unethical and costly practice.
DEFALCATION
Defalcation is probably one of the most basic types of real estate fraud. The attorney or agent in charge of the escrow funds absconds. Buyer and lender alike are left bewildered. As long as we have an escrow system in place, defalcation is possible. An individual who has fiduciary responsibility over funds can break the contract and leave without warning. Usually the lender is held liable for the loss.
FALSE FORECLOSURE RELIEF
When the subprime mortgage bubble popped, many homeowners found themselves defaulting on their mortgages and facing foreclosure. During this time of confusion and fear, a wave of unscrupulous individuals and groups presented themselves as a solution for homeowners facing the prospect of losing their home. Using aggressive telemarketing and advertisement campaigns, they promised that, for a fee, they could reduce the homeowner’s debt burden or even release the homeowner from debt obligations altogether. Sometimes the scammers would send official-looking documents, telling homeowners facing foreclosure that, for a fee, they can join a massive lawsuit against banks or other lenders.
Of course, the services promised are never rendered, and the scammers make off with the cash while the homeowners, worse off than before, face foreclosure.
REVERSE MORTGAGE SCAMS
Home equity conversion mortgages (HECMs), commonly known as reverse mortgages, are especially susceptible to fraudulent activities because these mortgages serve a vulnerable segment of the population. Reverse mortgages allow homeowners over the age of 62 to convert their home equity into a payment, which they can receive either in monthly chunks or in one lump sum. Borrowers don’t need to repay the loan until after they stop using the home as their primary residence (either due to death or moving, usually).
The number of reverse mortgages taken out by seniors has increase tenfold over the past decade, and fraud has increased as well. In addition to most of the types of fraud described above, perpetrators also prey on vulnerable seniors using more straightforward methods, like demanding bogus payments, withholding money that rightfully belongs to the buyer, or bullying the buyer into disadvantageous deals.
The risks associated with reverse mortgages have multiplied now that HUD has recently ended its program of subsidized, mandatory counseling for reverse mortgage applicants. While there are still certain avenues that applicants can take to receive counseling free of charge, this change makes the process more complicated, and reduces the likelihood of seniors educating themselves about the process.
WHAT CAN WE DO ABOUT IT?
S2T believes that education and accountability are the keys to reducing fraud. Buyers must be knowledgeable about what they are doing. Too often buyers feel that they are being presented with reams of papers to sign, and that they are pressured to sign them quickly and without careful consideration. The Internet is an excellent resource, and many consumer-facing guides exist to explain the concepts behind and steps involved in a real estate transaction. S2T further believes that we should take the time to keep buyers abreast of the transactions they are taking part in, and we should point them toward the resources they can use. By demystifying the real estate process, we could help make fraudulent activities seem more suspicious.
Also, we should remain vigilant of the warning signs that fraud is occurring, and we should be tougher on the perpetrators of these scams. If a property is quickly resold for a substantial mark-up, there should be a system of checks in place that throw up a red flag. If an attorney defalcates, punishment more severe than a simple disbarment must be enacted. California Attorney General Kamala Harris is on the right track: she recently initiated a lawsuit against a group who allegedly duped thousands of homeowners into paying money to join a nonexistent lawsuit against banks.
Together, we can reduce the incidences of mortgage and real estate fraud. As real estate professionals, it is our duty to educate ourselves and be vigilant against mortgage scams, which in the long run affect our whole economy.