One easy way to go to prison is by defrauding a lender or conspiring to defraud a lender.
This is otherwise known as mortgage fraud.
Of course, there are many types of mortgage fraud. But one scheme, in particular, is more prevalent among real estate investors. Let’s take a look at what to be aware of and what to avoid!
Let me tell you a story . . .
Sammy Seller posts a wholesale deal on MyHouseDeals with the following numbers:
Asking Price: $100,000
Cost of Repairs: $20,000
After receiving a few calls, Sammy Seller decides to flip the house to Bobby Buyer. They agree on a sales price of $100,000. Sammy Seller is excited because that price is $10,000 more than anyone else offered.
Seems innocent so far, right? Then, Bobby Buyer states that there are three conditions to the purchase.
Sammy Seller must:
- Write down $150,000 as the sales price on the contract.
- Give Bobby Buyer $50,000 “off the record” after the closing.
- Write down Cathy Credit as the buyer’s name. (Cathy Credit is Bobby Buyer’s associate.)
Sammy Seller agrees because the net result is the same for him and figures that whatever Bobby Buyer does is his own business.
Sammy Seller reasons that he will still get his $100,000 from Bobby Buyer. He just gets it in a different way . . . By collecting $150,000 at closing and then giving Bobby Buyer $50,000 after closing.
Bobby Buyer wants to structure the transaction this way because he can get a significant amount of “tax free” money from the lending company when he buys the property.
Do you know how much you should pay for investment properties? Go here to find out.
It’s Time to Get a loan
Bobby Buyer decides to get the loan through a friend named Billy Broker. Billy Broker is a mortgage broker who works with a few different lenders (Bank of America, Chase, etc.).
But the loan won’t be in Bobby Buyer’s name. Bobby Buyer’s associate, Cathy Credit, will be the borrower. After all, Bobby Buyer doesn’t like to put his own credit at risk.
Bobby Buyer and Cathy Credit have a side agreement that Bobby Buyer will give her a $3,000 “thank you gift” for using her credit after closing. She’ll be a “credit partner”—also known as a “straw buyer”—in this case.
Billy Broker knows that to get this deal done and collect his processing fees, he must get a high appraisal . . . An appraisal for $150,000, even though the property is worth $130,000 or less in its current condition.
So Billy Broker calls up his buddy Andy Appraiser to do the appraisal. He says, “Hey Andy. Go appraise this property. I need it to come back at $150,000. Make it happen.” And Andy, says, “Sure thing!” because he doesn’t want to disappoint Billy Broker and cut himself off from future business.
The appraisal comes back at $150,000 as expected. Bobby Buyer catches wind of the appraisal and sees green in his future.
Now It’s Closing Time
The loan is for 90% of the purchase price on the sales agreement. Based on a purchase price of $150,000, that’s a $135,000 loan. Bobby Buyer brings the extra $15,000 of his own cash to complete the purchase. It is funneled through Cathy Credit’s account, since she’s the buyer on the paperwork.
Bobby Buyer then gets $50,000 from Sammy Seller after closing. So, Bobby Buyer walks away from the deal with a loan balance of $135,000 (in Cathy Credit’s name) and $35,000 in cash. ($50,000 minus the $15,000 that he put down.)
Then Bobby Buyer gives Cathy Credit a $3,000 thank you gift for getting the loan in her name. And Bobby Buyer promises to Cathy Credit, “I’ll never miss a mortgage payment to keep your credit okay.” Bobby Buyer has now “profited” $32,000 ($35,000 minus $3,000).
Bobby Buyer can use this $32,000 to do the repairs and make the mortgage payments. But he doesn’t. Instead, he keeps the $32,000 and doesn’t make any repairs or payments.
Fast Forward a Few Months . . .
The house gets foreclosed on. This hurts Cathy Credit’s credit, not Bobby Buyer’s. Bobby has since spent the money on a new Lexus. Bobby Buyer’s friends may think he is cool, but they have no idea that he’s a criminal/scumbag who steals from mortgage companies and ruins the credit of unsuspecting victims like Cathy Credit.
By this time, Cathy Credit has done several “deals” with Bobby Buyer. So her credit starts getting pounded with negative items from several loans. Bobby Buyer doesn’t return her calls.
In the meantime, all of these defaulted mortgages under Cathy Credit’s name throw up red flags at the mortgage company. And more red flags go up when the mortgage company sends a realtor or appraiser by her (Bobby’s) properties to assess their values. And the values come back much lower than the appraisals from a few months ago.
Things Get Fraudulent
The mortgage company decides that there was a conspiracy to defraud the mortgage company. They don’t have time to deal with it so they hand the investigation over to their attorneys.
The attorneys come after Cathy Credit, and the Attorney General gets involved. Cathy Credit eagerly points to Bobby Buyer. Then a simple title check shows that Sammy Seller was involved as the seller. Now he’s in this mess. And before you know it, the appraiser and mortgage broker get thrown into the mix too.
By the time all is said and done; the seller, the buyer, the credit partner, the mortgage broker, and the appraiser lose money and tarnish their reputation. And it’s all because they got greedy and ignored broker law.
Here’s Why Everyone Is in Trouble
Bobby Buyer had full knowledge of and actually coordinated the “off the record” transactions of $3,000 to Cathy Credit and $50,000 to himself. He was the mastermind of the whole scheme.
Cathy Credit purchased the property with the sole intention of getting $3,000, handing over control of the property to Bobby Buyer, and never making payments. She also had knowledge of and actually received one of the “off the record” payments.
Sammy Seller gave money to Bobby Buyer outside of closing. This was money that was not on the paperwork at the title company. So he knowingly hid information from the mortgage company and thus helped to defraud them.
Billy Broker had knowledge of Bobby Buyer’s actions and conspired with the appraiser to get an inflated appraisal.
Andy Appraiser knowingly appraised a property too high which led the lender to believe they were making a secure loan when, in fact, they were not. Conspiracy to defraud the lender!
I won’t go into the details of the punishments for these crimes. All you really need to know is to stay clean and operate within the law. And don’t shuffle money pertaining to the sale between parties outside of closing.