When Sheila Stoner got a second mortgage and home equity line of credit a year and a half ago, she thought it was the answer to her prayers. The loan let her buy desperately needed amenities for her terminally ill parents--her mother has Alzheimer's, and her father, cancer. She bought a van for $30,000 to drive them to doctors and embarked on a $60,000 renovation to make their house more accessible. Only when Stoner fell behind on her monthly payments earlier this year did she ask herself why she was paying such staggering interest: 23% on the mortgage and 19% on the credit line.
Normally, only borrowers with bad credit get stuck with rates like that--and that's not Stoner, a New Haven social worker who earns a salary in the mid-five figures and had scant debt at the time of the loan. Frantic for money, she had jumped at the first offer--and was taken. "All I know is that this particular lender kept calling me and telling me this was the lowest rate I could get on a second mortgage. He said I had to act right away or I'd lose it," says Stoner. Crystal Clark, a credit adviser at Consumer Credit Counseling Service of Southern New England, who recently helped her refinance all of her loans at a lower rate, says: "There was no reason for Sheila to be paying such high rates."
Stoner's case highlights the underside of the sizzling housing and mortgage market. With interest rates at their lowest in four decades, consumers--many of them financially unsophisticated--are rushing to get in on the mortgage-money bonanza. "There's a `get in now or you'll lose out forever on these low rates' kind of fevered pitch," says Gary Gordon, a consumer-finance analyst at UBS Warburg.
The rich pickings have brought out hordes of unscrupulous and fraudulent operators. Scams range from what Stoner experienced--a sleazy mortgage broker persuading a creditworthy borrower to accept an outrageous rate--to shockingly high fees slapped on at closing to rings of developers, appraisers, and mortgage brokers who collude to push shoddy, overpriced homes on unsuspecting consumers. Another variant: house-flipping, where "investors" buy rundown houses dirt cheap, make cosmetic improvements, then sell at vastly inflated prices.
Mortgage- and housing-related swindles have risen over 25% in the past year, says the FBI. Borrowers who fall victim to aggressive lenders alone pay $9 billion more than they should for loans, says Kurt Eggert, a law professor at Chapman University in Orange, Calif. Adds James Croft, director of the Mortgage Asset Research Institute Inc. (MARI) in Reston, Va.: "People have figured out that robbing banks is too hard. The real money these days is in real estate."
A great facilitator in all this has been the Internet. Mortgage lenders embraced online applications and automated credit analysis to speed the loan process and extend their geographic reach without having to hire more salespeople. But the disappearance of face-to-face and even much phone contact has made life easier for fraudsters. Today, at least a quarter of fraud cases involve phony mortgage applications, according to MARI. Bankers say many borrowers take advantage of the new automated lending processes to pull the wool over their eyes. "Business volumes are stretching our systems to the max, and that's why you're seeing a rise in fraud," says Douglas G. Duncan, chief economist at the Mortgage Bankers Assn.
The mortgage process, in which each player has a financial stake in making sure the deal goes through, encourages deceit. To keep the wheels moving, the realtor recommends a pliant mortgage broker to a buyer. The realtor or broker may also recommend an appraiser who will value a house often at a higher price. "It's all one big game of collusion," says Richard DiMaggio, a lawyer who is writing a book on mortgage fraud. "If one of these professionals doesn't deliver--say, the mortgage broker can't get a loan through, or an appraiser comes in with a lower appraisal than anticipated--they don't get used again by that realtor."
Identifying and prosecuting the culprits has proven difficult because most real estate operators run independent, local businesses. It's so frustrating that lawyers for victims of small, unscrupulous lenders are targeting large companies that buy and consolidate mortgages. In 2000, a Pennsylvania Banking Dept. examination of GMAC-Residential Funding Corp.'s practices concluded that it had bought loans from 16 unlicensed mortgage brokers who tacked on illegal fees. GMAC-RFC, which faces at least one class action based on these charges, didn't respond by press time, but a source close to the case says GMAC-RFC denied wrongdoing in its response. "It used to be the street-corner loan shark who did this," says Thomas J. Methvin, a Montgomery (Ala.) lawyer who represents mortgage-fraud victims. "Now, it's the subsidiaries or agents of the banks located in the tall buildings on Wall Street."
Easy money is attracting a frightening new element. Last year, Richard Wood, a 53-year-old mortgage broker and real estate seminar instructor, was fatally shot in his front yard in Las Vegas. Police suspect a revenge killing. Wood had swayed seminar participants to invest in bogus property deals, defrauding them of as much as $6 million, according to his own bankruptcy court filings. "There is now a hard-core criminal element involved," says investigator Connie Wilson of App-Intell, a mortgage-fraud investigative agency. "You've got money-laundering operations in Miami involving real estate and rings of thugs in California doing house-flipping scams. That's come about in the past two years or so."
Rogue elements from the securities industry--many of them refugees of the tech-stock bubble's collapse--are plying a new trade as mortgage brokers. On Aug. 29, Jeffrey L. Greene, a 32-year-old Greenville (S.C.) mortgage broker, whom an Assistant U.S. Attorney for the District of South Carolina describes as "clean-cut, very professional-looking," pled guilty in Spartanburg (S.C.) Federal Court to falsifying hundreds of loan applications from unqualified people who wanted to buy mobile homes. As a stockbroker in the mid-1990s, Greene accepted a permanent ban from the industry by the National Association of Securities Dealers and settled allegations, without admitting or denying guilt, that he stole at least $10,000 of investors' money.
Consumer advocates and mortgage experts say the real drivers of fraud are industry pros. One of the fastest-growing scams, for example, is filing loan applications using identities of dead people from obituaries and genealogy Web sites. A misguided consumer fudging a poor credit history is unlikely to go to such lengths. "Borrowers don't have the savvy to know which documents to falsify. They're often coached by loan officers or brokers," says Robert Simpson, president of Imarc, a Newport Beach (Calif.) mortgage-fraud investigator.
Banks are starting to realize that this puts them at risk. "Banks used to say that a certain amount of fraud is the cost of doing business. Not anymore. It's costing them a lot of money, and they're finally going after it," says Simpson.
Easier said than done. The explosion of cyberfraud is leaving regulators and their patchwork of jurisdictions in the dust. The Housing & Urban Development Dept., Federal Trade Commission, and Federal Reserve Board all regulate mortgage lending. But lending rules vary by state, as do licensing rules for brokers, appraisers, and title companies. And most enforcement is carried out at state level. "There are at least 10 different laws that govern the mortgage industry, and three main groups discussing reform with consumer advocates," says Joseph L. Falk, former president of the National Association of Mortgage Brokers. One major nationwide reform in the works is a HUD-proposed rule that would make lenders disclose fees and guarantee loan prices up front.
Mortgage brokers have become a far bigger cog in the system. A decade ago, most folks headed to their local bank to meet with a mortgage specialist--and prayed they'd pass muster. Now, more than half of borrowers use mortgage brokers, up from 11% 15 years ago. The broker often helps fill out paperwork--sometimes padding it with numbers he knows are acceptable to a lender. Increasingly, brokers make loans themselves--which they sell to banks that, in turn, package and sell them as mortgage-backed securities. "You have a lot of room for fraud," says Natt Carey, a former mortgage banker who is now a special agent with the FBI in Memphis. "[These lenders] aren't federally funded institutions--they just sell their package and they're out of the loop."
Consumer advocates say mortgage brokers commit a range of abuses, but AppIntell's Wilson blames "20% of the brokers for 80% of the problems." The most common are last-minute fees, says Jack Guttentag, professor of finance emeritus at the University of Pennsylvania's Wharton School. "Some mortgage brokers and lenders will fail to mention certain fees until the borrower is in too deep to bail out." Guttentag, who runs a Web site offering mortgage advice, www.mtgprofessor.com, is so incensed about this and other practices that he has started a professional organization, Upfront Mortgage Brokers, for brokers who agree to do business ethically.
Such efforts won't have much impact unless they include other links in the chain, such as appraisers. Steve Nichols, a Frisco (Tex.) appraiser, says that because appraisers rely on a few lenders or brokers for referrals, coming up with the "wrong" number is career suicide: "It's just impossible for a small appraiser to survive without being creative."
In some cases, the trail of corruption leads all the way to homebuilders who lure buyers with instant financing. In hindsight, says Maxine Wilson, a law firm administrator, the seamless loan process should have tipped her off that the house she bought in a New York City suburb in 1997 had problems: "It was way too easy. When the loan manager walks into a builder's office, takes your application, and guarantees that you're going to be approved, something is wrong."
Now, Wilson says her home is sinking. The foundation is cracked, and she has mildew in her attic--where the bathroom vents. Wilson bought the house for $140,000 from father-and-son builders Isaac and Robert Toussie. Two years later, it was appraised for $15,000 less in one of the hottest U.S. housing markets. Wilson and 200 others filed a suit in federal court against the Toussies, but it was thrown out on Sept. 20 after failing to qualify as a class action. In May, 2001, Issac Toussie pleaded guilty to fraud in federal court on Long Island for illegally obtaining federal housing loans. On Sept. 25, Robert Toussie's lawyer, Richard C. Hamburger of Hamburger, Maxson & Yaffe LLP in Melville, N.Y., said his client is so confident of the quality of his houses that he will offer to buy back those of Wilson and the two other lead plaintiffs and pay their moving expenses and $5,000. Hamburger said a letter will go out to the plaintiffs on Sept. 26.
Aggressive mortgage practices could haunt banks as the economy weakens. In their eagerness to lend, banks have pushed too many people to take on too much debt. These borrowers are extremely vulnerable to higher interest rates and rising unemployment. That raises the prospect of a flood of defaults. And a wave of distressed properties would have major implications for the housing market--one of the few areas of the economy that is thriving. Fannie Mae and Freddie Mac, government-sponsored mortgage guarantors, which purchase about half of all mortgages, are likely to exercise their right to force banks to buy back bad loans.
Already, the number of home buyers struggling to make monthly payments is ratcheting up. Loan delinquencies have steadily risen in the past 24 months, to the point where nearly 1 in 20 home loans is delinquent--one of the highest rates in the past decade. A record number of loans are in foreclosure--and that's not even counting "subprime" loans to people with bad credit, according to the Mortgage Bankers Assn.
Banks' lax practices bear a heavy share of the blame for creating this anything-goes climate. They promote "125% mortgages" that let people borrow the full price of their house plus extra cash to "pay for a vacation, college tuition, whatever you need it for!", in the words of one ad. Then there's the proliferation of "lo doc" and "no doc" loans requiring little or no documentation of income or employment status and often carry high rates.
The process has become so automated that a borrower can get preapproval in "five minutes or less" on some Web sites. Borrowers can apply for a loan through eloan.com, a portal backed by legitimate banks such as Wells Fargo & Co. (WFC) that abide by fair lending practices. But there are plenty of Web sites that pitch preapprovals to people with bad credit. Many, say experts, are backed by unscrupulous mortgage brokers or lenders.
Securitization, in which banks package mortgages and sell them to insurers and pension funds, has played a big role in the industry's sagging standards. As risk has shifted from their balance sheets, the nation's biggest blue-chip banks have become wholehearted participants in the subprime lending market--a market they avoided in the past and one that has become notorious for abusive practices. Citigroup (C) recently agreed to pay $215 million, the largest consumer mortgage settlement in the history of the FTC. Associates First Capital Corp., which Citigroup bought in 1998, allegedly required thousands of customers to buy unnecessary credit insurance on high-interest-rate mortgages. Citi didn't admit or deny guilt, saying the charges predate the acquisition.
Citi isn't the only one facing such complaints. When a Household Finance Corp. salesman came knocking on the door of one couple's modest Natchez (Miss.) house last year, they invited him in. Within minutes, the salesman had persuaded them to take out a second mortgage and pay off their credit cards. The pitch sounded good: He could consolidate all their bills and reduce their monthly payment. Allegedly, there was one other little thing: They would have to purchase $15,000 in credit insurance. "He told them: `It's the only way you can get the loan,"' says Methvin, their lawyer. But it turns out credit insurance wasn't required. And the refinancing will cost them twice as much in the long run than if they had simply paid down their credit-card bills, according to their lawyer. They, along with 16 others, are suing Household Finance. Megan Hayden, a Household Finance spokeswoman, says: "The credit insurance these customers purchased was optional and clearly disclosed as such and reinforced through our loan-closing video and satisfaction survey."
Many of the problems, say experts, could be remedied if current laws were enforced--by one regulatory body. The fact is, fraud costs plenty. Who pays for it? "It winds up back in the consumer's pocket in the form of higher fees and rates," says the Mortgage Bankers Assn.'s Duncan. And that's perhaps the biggest scam of all.
Corrections and Clarifications
"The housing boom's dark side" (Finance, Oct. 7) incorrectly reported that Citigroup bought Associates First Capital Corp. in 1998. The purchase occurred in 2000.
By Marcia Vickers and Heather Timmons in New York