The Perils of Mortgage Fraud: Why Cities Should Care
Having the FBI spy on you is not a goal of most public officials. Yet there I sat in a meeting with self-described “real estate developers” while federal agents covertly watched our discussions through (if you didn’t know better) what looked like office furniture. This came about when I served for a number of years overseeing housing and economic development for the City of New Haven, Connecticut, but the lessons learned are clearly relevant today.
Our team was just starting to have success turning around a decade-old problem of vacant and blighted houses in the late 1990s when we came across a new threat. A zealous character on my building department staff, Jim Turcio, was known for his penchant for street level detective work in his effort to unwind arcane housing code enforcement mysteries. He became intrigued when he discovered that mortgages were being taken out for amounts three to five times what we knew the properties were worth.
Jim, the city’s attorneys, and I figured out this represented a very destructive form of fraud that is much more common than most cities know. Indeed, an FBI and U.S. attorney team we worked with later rounded up a crew in New York that engaged in fraud so large that it froze renewal efforts in Harlem for years.
Working clandestinely with the FBI, we invited some of these “real estate developers” in to explain why they were apparently paying such high prices for dilapidated structures but could not manage to pay their real estate taxes on time. Over the course of a year, we identified several teams engaged in mortgage fraud at the multi-million dollar level, some with apparent ties to organized crime.
Some of these teams made use of the U.S. Department of Housing and Urban Development’s so called 203(k) program, which provides guarantees to lenders to encourage renovations in low income neighborhoods. Unfortunately, we found fraudsters set up shell non-profit organizations to use this program to borrow even more money. This effort to exploit a federal program to get even more cash is what drew the interest of the FBI and inspectors for the Department of Housing and Urban Development, and would eventually lead to dozens of arrests around the country.
Mortgage fraud is likely to occur whenever urban neighborhoods see prices of real estate drop catastrophically in some neighborhoods while they remain much higher in places nearby. Fraudsters buy up properties at low cost, maybe throw on a coat of paint, and take some pictures. They then work with a disreputable appraiser to dramatically over-value the property based on comparables from wealthier neighborhoods elsewhere in the city.
Sometimes they sell the property a couple of times to different shell companies they own, each time artificially raising the price without making any improvements. They then use this increased price scam and fake appraisal to get a mortgage for much more than the property is worth. They can easily make a hundred thousand dollars or more per fraudulent transaction. With a couple of dozen properties cycling through such scams they can capture millions of dollars long before anyone catches on.
Mortgage lenders are often the victims of these scams, yet some are in on the deal as well. They are not usually your brand name mortgage companies, though my experience was that the Money Store, the company endorsed by famed New York Yankees shortstop Phil Rizzuto in a long-running ad campaign, was an apparently willing player in some of mortgage fraud schemes before it closed shop.
More often, though, fly-by-night mortgage companies know that they can quickly sell the mortgage to another bank or investor. Under current laws affecting mortgages, in most cases, all subsequent buyers need not investigate the value of the underlying property before they in turn sell it themselves. This creates the ease of mortgage transfers that allows your home mortgage to be owned by one lender one month and another the next, with no new inspection of your house.
The problem for cities is that the over-valued mortgages, which after a few months stop getting paid, remain on the properties as debts and liens. This means that no one can buy the property unless they first pay off the mortgage. I have seen properties that are realistically worth no more than $10,000 sit vacant for years because they have a $150,000 mortgage waiting to be paid off.
With the value of the property so low, even if an honest investor or mortgage company gets caught holding the mortgage, it may not make economic sense for them to foreclose on the mortgage and acquire the property. Doing so means they get stuck having to pay the taxes and other liens on the property. And, no one wants to own a property they can’t sell but which they have to keep clean and secure—often in neighborhoods where squatters can be a real problem. So these properties sit vacant for long periods, lowering property values for all the homeowners unlucky enough to share the block.
To fight this, cities need to do a number of things. First, they should consistently watch the real estate listings and their own land records. Are there low-dollar sales followed by high-dollar mortgages? Both have to show up on land records to be enforceable.
Second, keep a particular eye out for smaller out-of-state mortgage companies or new non-profits suddenly doing a lot of business in a small number of neighborhoods. Work with state regulators and the state appraisers’ association to let appraisers know that the city is watching and will pursue criminal sanctions against anyone they find faking appraisals.
Third, invite apparent fraudsters into City Hall to meet with housing officials and investigators or police to discuss exactly what it is that they are doing. We found this chased off several criminals before they could get a foothold.
Finally, cities need to have an aggressive property tax foreclosure program. Often cities don’t like to do this because of the villainous image associated with foreclosure. But cities can choose to target these foreclosures at properties which are vacant, or owned by absentee landlords while working out payment plans with moderate-income homeowners who have gotten caught up in the current mortgage crisis.
Tax foreclosure matters because it alone trumps mortgages and other liens sitting on blighted abandoned low value properties. When a city forecloses for unpaid taxes on such a property, the mortgages get wiped out, and the city usually then becomes the owner. The city can now renovate and sell the property to a new homeowner or sell it to a legitimate non-profit housing agency to do the same. (See the recent CAP piece by David Abramowitz describing how this can be one part of a federal strategy to address the sub-prime mortgage collapse).
Over the last two decades, as housing values in urban neighborhoods have climbed, fallen, climbed, and now are falling again, mortgage fraud has been a recurring and quite massive problem—one that has mostly gone unseen and unaddressed. It has delayed inner-city turnarounds and kept legitimate entrepreneurs from being able to purchase, renovate, and resell homes in neighborhoods most in need of private investment.
Now that urban neighborhoods are once again on the downside of the home value and mortgage roller coaster, cities should keep their eyes open and put the pieces in place so they can stop fraud in its tracks. If they do so, when property values start to climb again, they can enjoy the ride and not watch idly as their neighborhoods become blighted.
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