Due to ever-increasing performance pressures on mortgage lenders, concerns in the credit markets and controversy over subprime lending, a growing number of mortgage brokers and predatory lenders are resorting to deceptive practices to increase the volume of loan production. These practices range from convincing borrowers to act against common sense to fraudulent or illegal mortgage scams.
These scams are usually focused on people who are attempting to refinance existing mortgages, although several scams are designed to prey on first-time borrowers and sellers. Although there are too many to address them all, outlining some of the more prevalent traps can help you identify practices to be aware of when dealing with the lending market. In addition to understanding these practices, there are several ways that borrowers and sellers can insulate themselves from predatory practices and mitigate the risk of being taken by one of these scams.
Financial institutions committing acts that are deemed unfair to borrowers is not new to the mortgage market. Various laws, such as the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Truth-in-Lending Act, the Real Estate Settlement Procedures Act, the Homeownership and Equity Protection Act and the Federal Trade Commission Act, to name several, were enacted to protect consumers. These acts allow consumers to make informed choices, promote competition among lenders and maximize the benefits of commerce.
Along with this regulation are the bodies that implement them, such as the Federal Trade Commission (FTC), which uncovers and enforces legislation that prohibits unfair or deceptive acts or practices in or affecting mortgage lending. The news has been filled with many high-profile cases of lenders who advertise non-amortizing loans as cheap, convince borrowers to use long-term home equity loans to pay off short-term debt, or fail to inform borrowers about the intricacies of adjustable-rate mortgages (ARMs) and other introductory pricing.
In a housing boom, predatory lenders use deception to gain a larger share of the mortgage pipeline. Conversely, in a credit crisis, dishonest practices are used to circumvent stricter underwriting guidelines. This allows lenders to earmarked as much capital for mortgages as possible, so that it doesn't produce unsatisfactory returns by remaining in cash.
But even as lenders may conduct practices deemed unfair, borrowers are not altogether blameless. Borrowers should be able to insulate themselves from these practices by investigating the structure of proposed loans and some of these underhanded tactics.
Scams Focused on Borrowers
A large portion of fraudulent activity is focused on people who have already built equity in their homes and have capital to access. This is especially true for people who find themselves in financial difficulty and are desperate to find a method to relieve their short-term debts, such as credit cards and lines of credit. The tricks focused on first-time borrowers usually revolve around presenting certain types of loans without divulging all the facts. In other cases, these tactics involve promises that are not actually kept. Some of the most common tricks played on these borrowers are:
Bait and Switch, Bait and Remember, and Loan Steering
Bait and switch, which is also common at retail stores, refers to when a mortgage company advertises a loan with terms that seem too good to be true and then, when a borrower attempts to get the loan, finds out that it is not available. Instead, the borrower is offered another loan with inferior terms.
Bait and remember refers to the lender deceptively forgetting loan fees or other significant loan terms until the borrower is too far along in the process to back out, and ends up with a costly or problem loan. Another tactic is to promise a fixed rate for a predetermined period but later fail to do provide it. Borrowers should also be wary of lenders that try to convince borrowers to float the rate and take interest rate risk while the loan is in production.
Loan steering refers to when a predatory lender or mortgage broker notifies a qualified borrower that he or she cannot qualify for a particular loan by reason of income, credit or a host of other causes (or that by doing so may violate fair lending laws) and at that time steer the borrower to other loans that are more profitable for the lender.
ARMs, Interest-Only Loans and Negative-Amortization Loans
Adjustable-rate mortgages are by no means illegal loans. However, when selling ARMs, lenders must inform borrowers about how much the loan rate can potentially adjust in the future. Borrowers must be aware of what they are potentially giving up in the future in order to get what can be considered a great introductory price today.
This is also true for interest-only loans, which are actually ARMs that do not require any principal payment during the introductory period of the loan. Although borrowers save during the initial period, they potentially owe the same amount as they did when they originally took out the loan.
Negative-amortization loans (sometimes referred to as "1% mortgages") are illegal in most states.These loans are usually advertised as allowing borrowers to borrow more than 100% of the value of their homes. This type of loan should not to be confused with a rehab loan (one in which proceeds are reinvested into the property), in which lenders allow for borrowing greater than the property value if the additional capital is used to enhance the property and increase its value. In a negative-amortization loan, the borrower is required to pay less than the amount due each month; the balance is tacked on to the principal, eventually becoming due as a "balloon payment." Predatory lenders still get away with selling these loans to uninformed borrowers with little risk of prosecution.
Cash-out Refinancing, Hard Money Lending, and Equity Stripping
These lending practices are aimed at people with equity in their homes, who are usually in financial trouble. Although a cash-out refinance might make sense in the most dire circumstances, in most cases it is advertised to people who have overextended themselves with short-term debt. Selling refinance options or equity lines that allow owners to access some of the equity in their homes by trading long-term debt to cover short-term credit. Borrowers can be easily fooled to take these loans because the new monthly costs are so much smaller than the monthly expense for all their credit cards, auto loans, retail credit and other short-term debt Many borrowers don't realize, notwithstanding the costs and fees to do the loan, that by extending out the payments (for up to 30 years) the actual cost of financing is much greater than their original debts.
Hard money lenders provide loans up to a marginal percentage of value (loan-to-value ratios up to 50%), because their intention is to foreclose on the property. They find any reason and are quick to foreclose, pocketing the borrower's equity as profit. Anyone in financial difficulty or seeking to finance a small portion of a home's value to access equity should be very selective in choosing a lender.
Equity stripping, or phantom help, occurs when a borrower who is having financial difficulty is offered unsolicited help, which then leads to significant costs and no help for services the borrower could have performed without the help. Here's how it works in the worst cases: Someone gains the borrower's confidence and has the borrower temporarily transfer title in the guise of helping the borrower qualify for a loan or sell the house cheaply and then rent it out in a lease buyback option. The problem is the conveyance back to the original owner - if it doesn't happen, the owner loses ownership of the home. In cases where the liability of the mortgage is fully transferred, the original owner can lose the home and still continue to owe on the original mortgage.
Scams Focused on Owners and Sellers
Several scams that are focused on homeowners range from convincing them to conduct unneeded or faulty repair on their homes to committing fraud.
Home Improvement Scams
In these scams, the unsuspecting individual requires some type of large home repair work or wants to do a large rehabilitation project. A "contractor" solicits and convinces the homeowner to let the contractor do the work and deliver financing. The financing, usually is done at unfavorable terms but in an amount equal to or greater than what the project requires, is completed and sold to a predatory lender. The often shoddy and expensive work is completed just before the standard three-day rescission period before the loan can be "put" back to the lender. The borrower does not realize the inferior work until it has been paid for and it is too late to do anything about the inferior loan.
Million Dollar Dump
In this scam, the con artist, using false identification, agrees to buy a home from a willing seller with agreement of a small favor. The buyer reveals that he or she needs a larger mortgage than he or she can be qualified for at the existing market price. So, believing that the buyer is planning to upgrade the property, the owner agrees to relist the home at some multiple of the original value so the buyer can get a larger mortgage.
The transaction is done, the seller paid at the original price, and con artist pockets the remainder. The house usually goes into foreclosure and the original owner is at risk of being convicted of fraud - and seller doesn't receive anything more than if he had sold the home to a legitimate prospect.
The list of these scams goes on and on. In all of them, the unwitting mark is given a promise of some extraordinary gain in terms of proceeds or in some cases, just in loan terms. As in most of these cases, if it seems too good to be true, it probably is.
Insulate Yourself From Mortgage Scams
The best way to mitigate the risk of being taken by any scam is to be knowledgeable of deceptive practices and to do research on anyone you expect to do business with. As for financing scams, the general rules to follow are:
- Never sign any contractual document without legal review
- Never make any transfer of ownership without also being released of any mortgage or financial liability.
Increased diligence is warranted when in financial difficulty or during the threat of foreclosure. Predatory lenders and swindlers have the ability to pinpoint those who are easily manipulated or vulnerable because of a dire situation. In addition to putting a suspicious eye on any promise or offer that seems too good, you must also be wary of anyone overeager or overaggressive in proposing solutions to credit or mortgage problems. Unsolicited offers or phone calls should be initially regarded with caution and anyone who does not accept an initial "no" answer to their proposal should be dismissed.
If you need rescuing, begin conversations with current lenders or creditors before considering any type of bailout scenario. Don't ever get involved with anyone who even hints at performing an illegal or improper act even if there is a proposed benefit. That benefit, even if it does materialize, will undoubtedly come with consequences and limitless risks.
SEE: Avoiding Foreclosure Scams