In recent years, the number of mortgage brokers vying to make loans in the small residential property market has exploded. With this increased competition has come some advantages for the real estate investor: increased availability of fixed rate loans, more willingness on the part of brokers and lenders to work with marginal credit, 10% down investment property loans, and other decided improvements in the ease of borrowing money. Lately, though, in an attempt to increase profits in the face of ever harsher competition, some mortgage brokers have crossed the line between "creative" and "illegal" - and you may be subject to fines and jail time as a result.
In order to understand the nature of the problem, it's important to first understand the role of a mortgage broker in the lending process. A mortgage broker does not lend money. Instead, he works with several lenders who make mortgage loans, serving as a "go between" who finds, qualifies, and "sells" borrowers on a lender's products. The broker gets paid a fee - from 1% to 10% of the loan amount - for putting the transaction together and guiding it to a successful closing. No closing, no paycheck for the broker. Because many borrowers don't make the distinction between the mortgage broker and the lender, they are not at all alarmed when the broker suggests "doctoring" a deal in order to get 100% financing for the buyer. They assume that if the mortgage broker says it's OK, the lender must be in on it. The truth is, the lender is usually in the dark.
Here's the kicker: according to federal law, if you knowingly participate in one of these loan schemes by falsifying documents or signing a settlement statement that you know to be fraudulent, you could pay a fine of $1 million and spend the next 20 years at Club Fed. The loan schemes that you are most likely to run across as a real estate investor will take one of two general forms.
#1). Your lease/optionee wants to exercise his option to buy, but with his substandard credit, no lender will touch him with less than a 20% down payment. The mortgage broker suggests that you write up a land contract backdated at least one year, so that the loan can be treated as a refinance rather than a new purchase. The broker then gets an appraisal on the property for 20% more than the tenant/buyer's purchase price, gets the bank to loan 80% of the appraisal, and viola'! 100% financing.
The problems here are twofold: you have provided and signed a fake land contract, possibly dated before the tenant/buyer even moved in. The mortgage broker has procured an appraisal for significantly more than the property is worth. Thus, the lender has made a loan to a high-risk borrower on a property that now has no equity on your word that the nonexistent land contract account was faithfully paid. It’s important to note that some mortgage brokers actually do work with lenders who will refinance 1-day old land contracts. If this is the case, you won't be asked to falsify dates on your land contract. No fraud, no future problems for you.
#2). You want to buy the nice rental house up the street, but the owner wants $40,000 and you don't have the 20% down payment the bank wants. The owner suggests that you write a contract with a $50,000 price, and an owner-held second mortgage for $10,000. The bank will loan you 80% of the purchase price, or $40,000. After the closing, the seller will tear up the second mortgage, leaving you with a total purchase price of $40,000. Viola'! 100% financing.
This little scam has been going on for decades, and in most cases, no one is ever caught or punished. However, the practice has become so widespread that, in some states, the departments of commerce have formed investigative committees to look into these fraudulent transactions. More and more stories about Realtors, mortgage brokers, investors, and home buyers facing stiff fines and jail time are appearing in the paper. And beware the next economic downturn: these loans will go bad, they'll be investigated, and heads will roll. Think about this next time you’re tempted to sign a closing statement that doesn’t reflect what’s really happened. With all the ways to do deals creatively and legally, why put yourself at risk?
Vena Jones-Cox is a past president of the Real Estate Investor’s Association of Cincinnati, the Ohio Real Estate Investor’s Association, and the National Real Estate Investor’s Association. Vena has been featured in publications such as The Cincinnati Enquirer, Smart Money Magazine, Money Magazine and Reader’s Digest in articles about successful real estate entrepreneurs.
Vena Jones-Cox’s real estate business focuses on finding great deals on 1-3 family homes, and then lease/optioning them to homeowners or wholesaling them to investors and renovators. All told, she buys and sells about 50 properties per year.
Vena is a frequent guest lecturer at real estate investment groups throughout the country, and particularly enjoys working with new investors. Vena frequently authors articles on real estate investment and the regulatory environment for various newsletters and publications, including her own monthly newsletter. She has been a guest speaker at the Cato Institute in Washington, D.C., lecturing on the effects of lead-based paint regulation on small investors. And in her spare time, Vena Jones-Cox hosts a popular weekly call-in radio program on public radio.
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