Chances are, you're offering incentives. But are they documented correctly on your mortgage applications? If your processes are wrong, you could be committing mortgage fraud.
Foot traffic is scarce, sales are slow, quarterly earnings are way down, and inventory is just sitting, sitting and sitting. You feel desperate to maintain or salvage your bottom line however you can. You result to sales gimmicks to help entice buyers to sign on the dotted lines so you can stop the company from metaphorically bleeding as you watch profits rinse down your spec home's Kohler drain.
The incentives you offer run the gamut from offering free upgrades to financing closing costs, reducing prices or even stocking a car in the garage. How far will you and your sales team go to close the deal? Perhaps you're not sure, but if you're not careful with what you offer or how you report it to the lender, you could end up committing mortgage fraud.
The FBI defines mortgage fraud as “any material misstatement, misrepresentation or omission relied upon by an underwriter or lender to fund, purchase or insure a loan.” It is estimated that about 10 to 15 percent of all loan applications contain misleading or false statements on the part of either the buyer or the seller, say experts. A large percentage of those committing fraud are unsuspecting individuals who are just anxious to close a deal. Fraud has become a tool of desperation that companies and individuals use to maintain lifestyles, livelihoods and bottom lines, says a recent fraud report.
Since the housing bubble has burst, the number of fraudulent loans issued during the first three months of 2008 skyrocketed 42 percent compared to the same period in 2007, according to the August report from the Mortgage Asset Research Institute (MARI).
Although it's true that unscrupulous individuals engaged in straw sales or foreclosure rescue scams have driven up the mortgage fraud rates, a fair amount of fraud is also committed by home builders and their agents, even if inadvertently.
If you offer a $15,000 landscaping allowance for a buyer to cash in after winter thaws but you don't properly document it on the loan application, you are committing fraud. The same goes if to close a deal you roll in the cost of a flat-screen TV, a car in the driveway, the furnishings from the model or other chattel without properly disclosing them to the lender — even if you raise a previously agreed upon sales price to give down payment assistance or fund the closing costs.
About 80 percent of builders today are offering some kind of incentive, compared with 72 percent last year, according to an annual survey by the NAHB. Most — 65 percent — are including optional items in the home such as a fireplace or granite countertops at no extra charge. The second most popular incentive, at 63 percent compared with 59 percent a year ago, is to offer a price reduction. Whereas 34 percent home builders finance points, 7 percent match future prices and a mere 2 percent offer a car.
“Seller incentives, if fully disclosed, are valid real-estate sales tools,” says John Mecham, a spokesperson for the Mortgage Bankers Association. “The trouble arises when the incentives are not well-disclosed, and thus a lender is deprived of important information when assessing the risks associated with making a specific loan.”
As many builders begin to feel the pressure to liquidate their inventories to meet the demands of their construction contracts and loan terms, some revert to deceptive practices and fraudulent measures.
Builder bailout schemes, as these fraudulent measures are known, are common to any distressed real-estate market, reports Freddie Mac in an “Emerging Fraud Trends” newsletter. “Markets, saturated by overbuilding plus an unfavorable housing climate, are generally more vulnerable. Builder bailouts can involve whole developments consisting of both completed and partially built homes, or occur when the bulk of inventory is sold but there are still unsold homes remaining,” it reports.
Fraud is more likely to happen on transactions where a builder uses its own appraiser and own lending company and partners with the same willing title company over and over again, particularly as it relates to lenders who were attempting to pressure appraisers to inflate a home's value, says Dallas-area certified real-estate appraiser Steve Nichols, who has been a whistle-blower on unscrupulous activities in his market.
Nichols, who is also running for governor of Texas for the 2010 election, says a few years ago many of the lenders, which were branches of the builders or in joint ventures with the builders, were looking to inflate the value of the properties so that they could roll in commissions or could allow buyers to fold in credit card debt or car loans into their mortgage.
The inflated appraisal would allow the seller to recoup the cost of any incentive he may have offered, from down payment assistance to upgrades to cash back at closing to help a buyer pay off credit card debt.
“You're not legally supposed to have equity in something you don't own yet,” says Nichols. “If the builder is giving cash incentives of any kind, they are giving you equity in something you don't own yet. If simultaneously as you are closing you are given a gift — a house of furniture, the media room is finished-out top-notch — if you are getting something in that purchase price that isn't real-estate — that constitutes fraud,” he says. However, if the items are reported separately in an addendum, valued and taxed and noted not to be part of the sales price, then you should be safe from fraud.
“Almost every top builder in this market area in north Texas were participating because they found a legal loop hole,” Nichols says in regard to down payment assistance programs via companies such as the Nehemiah Program.
Through Nehemiah or Ameridream and other such services, a seller could donate the amount of assistance it wanted to give the buyer, and the buyer in turn would receive a grant in that amount to use toward the down payment or for paying off other debt.
The passage of H.R. 3221, The Housing and Economic Recovery Act of 2008, put a ban on the down payment assistance programs for FHA-backed loans initiated after Oct. 1, 2008. The ban became law when President Bush signed H.R. 3221 on July 30.
“It was fraud if the info was hidden,” says Nichols, “if they are not disclosing it to the appraiser or the appraiser is not disclosing it to the lender.”
“One house that sold three times included a car in the mortgage. It becomes almost like racketeering because everybody went along with it, even the small builders,” says Janet Ahmad, president of Homeowners For Better Building, based in the San Antonio, Texas, area. Ahmad has reported fraud she learned about to HUD.
“I have seen the advertising. 'For the next three months, you will get $20,000 on a credit card... $20,000 worth of upgrades for the home, and you would be first qualified on the sales price,' and that would not be included in it,” she said.
Ahmad says she thinks the fraud is becoming more apparent in new construction neighborhoods where a high percentage of homes are now going into foreclosure and owners are learning that they owe more than their homes are worth.
Builder bailout fraud is second only to large flip scams in terms of damage, as it can involve whole developments, according to a report from WestStar Mortgage, in Woodbridge, Va.
Florida tops the list for the states with the most reported fraud (see sidebar, next page), but some builders there are so good at crossing their Ts and dotting their Is that they never have a problem with fraud. Builders' only problem instead is getting buyers to leave their own homes to come see what the builders have to offer.
“Price reductions alone have been a rather ineffective means of getting buyers through the door,” says George Schulmeyer, Tampa division president for K. Hovnanian Homes. He adds that getting buyers to sign on the dotted line takes a few more incentives than the company was offering two and three years ago, and that it even takes promotional giveaways such as iPods just to get them to attend showings.
“Now what is working is paying as much in closing costs as we are allowed because people are trying to buy homes with as minimal cash as they can,” he says. Now that down payment assistance has been eliminated for FHA-backed homes, many builders have been paying up to the maximum of 6 percent to cover the closing costs, fees and pre-paid items the lender might charge.
“We've been doing the 6 percent for five to six months now. That will cover a lot of the customers' other requirements,” Schulmeyer says, adding that the builder also has to throw in about $10,000 to $15,000 worth of free upgrades on homes selling for $250,000 as way to seal the deal.
Builders offer incentives in the hopes of moving inventory, but the effectiveness is not all that great, says Dave Seiders, NAHB's outgoing chief economist. "For price reduction, about half say it doesn't seem to be effective. It is sort of disappointing. It shows the perspective home buyer psychology at the moment."
He says in all of his years of working, which included stints at Pulte Homes and Beazer Homes since 1995, he personally has never encountered any problems of fraud arising because paperwork was not filled out accurately. “Any incentive that the builder gives should be documented in the beginning in the lender paperwork and shown on the HUD,” he advises.
Two or three years ago, offering a buyer chattel — those items they could take with them sold, such as a free TV, a car or a Caribbean vacation — was more popular. Sure, it's in part because buyers today prefer to negotiate the price down or they want free upgrades for the kitchen or a better interest rate. But the main reason it is less popular is because the banks aren't allowing it, says Tom Daddario, a sales manager with Standard Pacific Homes in Jacksonville, Fla.
“The banking industry, because of all of the problems it has, is making it very difficult to give those types of things away. They are saying you can't do that — just knock it off the price,” he says. “The bank says 'How much am I really lending you? Am I financing your car? Is it built in to the price?' So they say, 'You know what? We are not taking these risks like we used to. It has to be all above board and on the HUD.'” As a result, Daddario says, most of the builders are really going the extra mile to fully disclose everything to everybody and so it has just become easier to knock something off the price.
The deals are still out there, but whether or not seller incentives constitute fraud is a very gray area that comes down to how things are reported to the lender, or the one underwriting the loan. Forgetting to add the appropriate addendum could turn any of the following situations into fraud.
R. Randy Lee, Pres-CEO of Leewood Real Estate Group, a builder-developer of low-rise residential homes in the greater New York and New Jersey markets, began advertising a car giveaway on Oct. 1. “Two or three years ago the market was stronger; there were a lot more buyers and we might have only had to throw in a washer or dryer,” he said. The tightening of the market has made it that he has to up his ante with bigger giveaways, and kitchen upgrades with granite countertops are now standard.
“Right now one of our projects we have is called a 'double-green program.' We are giving away Honda Civic Hybrid cars. We are also planting a thousand trees in a national forest for everyone who buys a house and giving them a lifetime supply of environmentally safe light bulbs — the low-electrical use light bulbs. The double green program is putting green in the pocket of the buyers,” he said.
Once the home closes, “We turn the people over to the dealer, they pick out the color; when the car comes we send the check for the car. The people pay the tax, delivery and prep charges and the New York sales tax. We pay the big money for the car. That car runs about $24,000.”
In Maple Grove, Minn., some builders just this October are offering 4.99 percent financing if buyers use their own lender, while others are offering $15,000 landscaping credit if you close before the end of November. When this reporter toured a Lennar sales office, a sales rep named Alan said that if the builder couldn't complete the landscaping before the ground became too hard from the cold, they'd escrow the $15,000 for the homeowner to have the work done with a landscaper of the owner's choice once Spring arrived. The discounts — and paperwork — are everywhere.
Whether or not landscaping credit or a new car would constitute fraud all depends on how the deal is structured and reported, says Dave Muti, an attorney, a mortgage planner and author of “Mortgages: What You Need to Know.” “They are OK as long as it is disclosed up front that [the free giveaway] is not part of the purchase price. If it is structured as they are going to give away free upgrades, they are just cutting their profit margin.
“An example where it would be fraud is if I buy a house from you and it's a $300,000 house and we agree upon that deal. If you then say, 'Nevermind let me make it $310,000' and you then give me a $10,000 seller credit, now that is mortgage fraud because it is inflating the value.”
Muti echoed Nichols' concerns that mortgage fraud is more likely when you have too many professionals working on the same side of the coin: The builder's company, builder's appraiser and builder's mortgage company. “That's when it started to happen.”
The flip side can happen too, where builders offer special deals only if you use their affiliates. This isn't necessarily fraud, but it can violate RESPA laws, say some experts, and it can look suspicious.
Suspicious Activity Reports (SARs) related to mortgage fraud that are reported to the FBI have risen from more than 3,515 in fiscal year 2000 to more than 46,700 in fiscal year 2007, a 139 percent increase that represents approximately $1 billion in losses.
According to the FBI's “2007 Mortgage Fraud Report,“ “the downward trend in the housing market provides an ideal climate for mortgage fraud perpetrators to employ a myriad of schemes suitable to a down market.” In other words, mortgage fraud is not disappearing. In fact, it is expected to rise, evolve and penetrate new areas within the industry.
Given a fraud investigation is not completed until a year or two after the loan was originated, we're likely to see fraud rates continue to increase. To keep your head out of trouble, simply report everything and falsify nothing.