When the U.S. Attorney's Office in late January announced a 101-count indictment in a mortgage fraud scheme, it closed a year-long investigation into a ring that involved 10 people and 43 houses in Indianapolis, Marion and Fairmount.
For the individuals involved, the indictments could bring prison time and hefty fines. But for the bank that loaned money on the houses, the scheme signaled the end of the road.
The lender, Louisville-based First Bank Inc., struggled during 2003 and 2004 to recoup several million dollars in losses on the loans made to straw buyers in the scheme. In December, unable to recover, First Bank announced its sale to Lexington, Ky.-based Central Bancshares.
No one knows how much money lenders lose each year to similar mortgage fraud schemes. Nationally, estimates vary from $200 million to $500 million, but those are little more than educated guesses.
"We generally tell people that any number they hear about the extent of By Tammy Lieber email@example.com
fraud is really unreliable," said Tim Doyle, a director in government affairs for the Washington, D.C.-based Mortgage Bankers Association. It's nearly impossible to put a dollar amount on such losses, he said. Mortgage companies aren't required to disclose such losses and most are reluctant to do so voluntarily.
Whatever the exact amount, some observers say a few extra steps by lenders could drastically reduce the problem, keeping more houses out of foreclosure and surrounding neighborhoods from deteriorating further.
As in many mortgage fraud cases, the Indianapolis and Marion-based group used a scheme called "flipping." Done legally, it follows a long-established method of making money in real estate-buying low, making improvements, then selling for a profit. It becomes fraud when buyers replace the second step with finding someone to make inflated appraisals after little or no money is spent on improvement, then "selling" to a straw buyer who borrows money to pay the home's inflated price.
Those involved in the scheme split the profit and the straw buyer defaults on the loan, leaving the lender with an overleveraged house often in need of significant work.
In the recent case, nearly everyone in the home-buying process except First Bank is accused of being involved-the original buyer, the brokers, the appraisers, the title company workers, the straw buyers. Other times, a few people in on the scheme may use stolen identities or forged paperwork to make the deal seem legitimate.
In all cases, the money comes out of lenders' pockets. The Indiana mortgage fraud task force behind the recent indictment has prosecuted cases in which lenders have lost at least $16 million, U.S. Attorney Susan Brooks said.
The task force was formed in 2002 by the U.S. Attorney's Office, the FBI, the Internal Revenue Service and the Postal Inspection Service to investigate a growing number of fraud complaints, many of them from people unwittingly involved in the scheme. Since its formation, the U.S. Attorney has prosecuted 43 people, 33 of whom have been sentenced for their crimes. Cases of the remaining 10 are still in progress, Brooks said.
Although lenders bear the brunt of financial losses, neighborhoods are "the true victims," Brooks said.
Most of the time, mortgage fraud schemes are perpetrated in inner-city neighborhoods where residents are already struggling with property values and crime. In the most recent indictment, three of the 28 Indianapolis properties involved were on the same block of the same Haughville street; many of the others were clustered on the near-east side.
A house involved in such a scheme may sit vacant for months or years until someone else buys it. In the meantime, it becomes a target for crime and devalues nearby homes, said Moira Carlstedt, executive director of the Indianapolis Neighborhood Housing Partnership.
"It isn't just the social implications. [Fraud] does have an economic implication to the individual households in the neighborhood," Carlstedt said. "People in these neighborhoods invest in homeownership for a safe, decent place to live, but they're hoping like everyone else that their house appreciates ... and they will have an opportunity to build some wealth."
To some observers outside the mortgage industry, a desire to generate as many mortgages as possible at the lowest cost has contributed to the rise in fraud.
"Mortgage companies are relying totally on mortgage brokers and appraisers," said David Bowman, director of special investigations for locally based Phenix Investigations Inc. Bowman, a former police officer, investigates fraud for corporations, including mortgage fraud cases.
In one case he investigated for a lender, one person had taken out 14 mortgages for different properties, defrauding lenders out of more than $2 million.
"It took me about 10 minutes to find out she had all these [past] foreclosures," Bowman said.
For instance, he said, if a borrower's application looks "too perfect," or if the same home has been sold within the last six months, it would take relatively little time and money to further investigate the deal.
Others say more focus on the appraisal could prevent many cases of fraud.
"Fraud schemes really rest on the fact that there's a false appraisal," Brooks said. "If there's not a false appraisal, you don't have a scheme."
There's no shortage of appraisers who will inflate estimates of a home's value, said Don R. "Randy" Scheidt, president of appraisal company Don R. Scheidt & Co. Inc. and a past president of the Indiana Commercial Board of Realtors.
Some appraisers inflate appraisals for aggressive mortgage brokers or legitimate buyers, such as those who want to take a home-equity loan for more than the true value of the equity in the house, he said. But whether an appraisal is inflated for a real or a fake buyer, lenders are hardly at the mercy of unscrupulous appraisers, Scheidt said.
"If lending institutions would use people they know are quality-oriented and competent, a lot of [fraud] could be avoided," he said. In nearly any case, a lending institution could find reputable appraisers in any major metropolitan area with a few phone calls, he said.
All mortgage lenders have methods of detecting fraudulent schemes. Several local banks, for instance, said they work only with appraisers from an approved list that is constantly monitored and updated. Others have computer software, backed up by human investigation, to flag suspicious-looking mortgages.
But as an industry, lenders are just beginning to work together and with law enforcement officials to combat mortgage fraud, which the FBI describes as "pervasive and growing."
Nationally, mortgage fraud is most prevalent in areas of the West and Southwest that are experiencing rapid appreciation in home values, such as Las Vegas and parts of California and Florida, Doyle said. But it's also on the rise in the Midwest, particularly in cities such as Indianapolis that have rapidly growing suburban areas and a high overall demand for mortgages.
Several factors have contributed to the rising number of mortgage fraud cases in recent years, Doyle said. Mortgage fraud is increasingly being used to launder money, a fairly recent phenomenon. But changes in the mortgage industry have played a part as well. In the past, home buyers typically went to their neighborhood savings and loan for a mortgage. Today, they are more likely to work with a mortgage broker to obtain a loan underwritten by a bank states away.
"It's a much more complex system today than we had 20 years ago," Doyle said. "For the consumer, it's good because it means lower rates and an efficient process and a true national real estate finance system. The downside is that there are more opportunities for those who understand the system to defraud the system."
The trade association is planning a national summit in Washington, D.C., in March to discuss mortgage fraud and ways to prevent it. Invitations to the summit are being issued to MBA members, brokers, consultants and law enforcement officials.
MBA's goal is to spotlight mortgage fraud and to work on solutions to combat the problem, Doyle said. The industry is also working on a proposal to improve data collection about mortgage fraud to assist the FBI and other law enforcement agencies, he said.