Mortgage Fraud: The Forgotten Clue in the Minneapolis Duplex Market

 
If media headlines were our sole source of information, it would be easy to believe the entire reason for the mortgage crisis is evil loan officers who gave bad buyers loans for properties they couldn’t afford.
 
However, a story in Inman News today served as a reminder that nothing about this crisis is that easy. The real estate media outlet reported that a real estate agent and two former loan officers are among 17 people indicted by a federal grand jury for their alleged roles in a mortgage fraud scheme involving 25 residential properties in Missouri.

The Realtor and two former loan officers are accused of conspiring with property buyers to submit false information to lenders in order to purchase homes at inflated prices and pocket the extra proceeds.

Mortgage fraud hasn’t received a great deal of media coverage in the latter half of 2008. However, I believe that when the forensics of history are applied to this economic crisis years from now, we’ll discover it played a much bigger role than we imagined.

Were there people the last five years who over-extended themselves and bought properties they couldn’t afford? Yes.

But I’d be willing to argue there are just as many people suffering because of mortgage fraud; exactly like the kind in Missouri. It existed here too.

Last winter, I called a buyer who was in the “call me if you find a good deal” mode of looking. A 1950’s side by side duplex had just come on the market in a highly desirable area of the Lake Nokomis neighborhood. In fact, I had been through many of the comparable properties that had sold. All sold for at or near $310,000. The newly listed property was on the market in the low $200s.

Prior to meeting her, I gathered all the information pertinent to her making an informed decision on the property. I was surprised by the tax records. Just over a year before, the duplex  sold for a number in the low $400s. I was expecting it to be a terrific property. (Hey, sometimes I’m still a little naive.)

Well, it was trashed. There were broken tiles, worn hardwood floors, and absolutely nothing had been updated. And it was quickly apparent to both myself and my buyer that in all likelihood, this property had been purchased at an inflated price with the extra proceeds from the sale pocketed and the mortgage unpaid.

How did a transaction like the one that had clearly happened on this duplex contribute to the mess we’re in now?

Easy.

The majority of investors and home owners pay their mortgages on time. Many purchased property five to seven years ago with adjustable rate mortgages (ARMs) that were locked at a fixed rate for a set period of time (five or seven years). This wasn’t a “risky” loan, nor was it because the individual couldn’t afford the property. Simply put, they could get a lower interest rate with an ARM and thereby reduce their monthly payments. There’s nothing inherently evil in that.

The initial lock period for many of these loans has just or is about to expire. As a result, these good buyers would like to refinance their loans. They’ve got good credit scores and good jobs. But there’s a catch.

Remember that foreclosure down the street that was originally purchased fraudulently at an inflated price? Well, post foreclosure, it sold at a greatly reduced price.

For example, let’s say this Nokomis duplex sold for $219,000. The duplex owner across the street who purchased her property at $319,000 now wants to refinance. She can’t. Appraisals use recent sales figures and rental income from nearby properties to determine a value of the property the bank is considering lending on.

Let’s say the new value of our duplex owner’s property is now $279,000. If she put less than 10 percent down on her purchase, odds are she now owes more than her property is worth and can’t get a loan. And in her case, it isn’t that the other properties in the neighborhood have experienced a radical decline. Rather, that one case of fraud has pulled the rest of the neighborhood down with it.