Bad Loan Originators Are Coaching Borrowers and Agents to Commit Loan Fraud Everyday

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Secret Side Agreements For Repairs Is Mortgage Fraud!

Here’s how it happens…

Buyer contracts with Seller for a $200,000 home with the Seller paying all the closing costs which equates to 3% or $6,000….the current FNMA maximum. During the inspection, a faulty furnace is discovered. Let’s assume for this example it’s a working furnace, so it’s not noted on the appraisal report as a “require repair”. After all the appraiser is not an inspector. The inspector on the other hand did discoverer the problem and the buyer wants the furnace repaired. A reasonable request…and let’s say, this repair will cost $2,000.

Many agents will mistakenly believe they can simply write a “side agreement” which states the seller will cut a $2,000 check to the buyer at closing. They explain “this is done all the time” to get both the seller and buyer to go along…and the side agreement is never shared with the mortgage broker and ultimately with the wholesale lender.

Loan fraud was committed at that moment…a felony not only under Federal law, but also under most State law as well.

And all parties are equally punishable…the agent, the buyer, the seller and the title agent who disbursed the fraudulent payment…if in fact they even knew about the payment.

As a buyer or seller if you’ve been asked to enter into a secret side agreement, you’ve been duped into committing a crime. If you’re an agent who facilitated a transaction like this because your mortgage broker or banker told you too…you got duped as well.

In this example and in real life, agents have learned from bad mortgage originators that since the seller has reached the maximum in legitimate contributions to the deal…the 3% in closing costs..they can’t amend the contract to pass the additional repair cost of $2,000 from seller to buyer as closing costs.

So they go in search of another way. The next option most agents jump to is escrowing for repairs. This is where the lender allows for 1.5 times the repair cost to be escrowed by the title company for the buyer to make the repair after closing. This allows the transaction to close on time and it allows for the seller to fund the escrow account with sale proceeds, not out of his own pocket.

Sounds like a viable solution, right? Wrong!

Changes in recent years to the most popular loan programs now prohibit this practice. Fannie and Freddie conventional loan programs don’t allow “escrows for repairs” under any circumstances. FHA programs only allow it when weather won’t allow the repair prior to closing…like snow on a roof. If the repair is indoors, like our example, no escrow allowed.

So what now…what is the legitimate way to solve the problem?

1. Lower the price from $200,000 to $198,000 keeping all other terms unchanged. A contract amendment reducing the price informs everyone of the true nature of the transaction. It allows the deal to close on time and doesn’t require any money from the seller out of pocket. But for most agents asking the seller for a price reduction is tantamount to killing the deal…so they rarely take this option.

2. Have the seller make the repairs prior to close. Once again with a contract amendment, seller agrees to make repairs prior to closing. Buyer and Lender are given the right reinspection to see repairs were completed. You can see how all parties involved don’t like this option. Often the seller doesn’t have $2,000 to make the repairs. Or, waiting for the repairs is unacceptable to the buyer or seller or both.

So the originator and agent get together to decide what to do…..and Presto…an illegal, hidden, side agreement solves everyone’s problem!

Why is this particular scenario loan fraud?

Primarily because of the hidden nature of what’s really happening in the deal. It’s this withholding of information or the secret nature of the side agreement that makes this the crime of loan fraud.

The Michigan Association of Realtors put it best in a 2002 newsletter,

“But perhaps the most telling “red flag” of all is where the purchase agreement says one thing, and an addendum or side agreement says something else. REALTORS should keep in mind that fraud does not necessarily require the presentation of false information, but can also involve simply withholding relevant information. In fact, the United States Supreme Court has expressly upheld the conviction of a borrower who simply withheld a secret side agreement from its lender. US v Wells, 519 US 482; 117 S Ct 921; 137 LEd2d 107 (1997).

Often times, REALTORS will argue that the transaction cannot be fraudulent because it was structured at the direction of the lender or an employee of the lender. This is simply incorrect. REALTORS should be aware that federal courts have consistently held that a borrower is still guilty of a crime even if the fraud was committed with the knowledge and consent of one of the bank’s loan officers.”…and that would hold true for the Realtor and title agent as well in my opinion.

The Maine Creditor Update which is the newsletter for the Office of Consumer Credit Regulation said in an article from its September 2004 issue:

“Buyers and sellers of residential real estate will sometimes agree to “side deals” in which money changes hands to cover the cost of needed repairs or defects discovered on the property. However, if these adjustments are substantial enough to affect the value of the residences being used as security for loans to the buyers, and if the side deals are not reflected in the HUD-1 closing statement, then all parties to the transactions (including the settlement agents and the real estate agents) should carefully review their participation to determine whether legal or ethical principles are being violated.

In any FHA-insured loan, the buyer, seller and settlement agent each sign statements attesting to the accuracy of the figures being used. Knowledge of a substantial side agreement not reflected in the HUD-1 would almost certainly violate these representations. Maine law does not contain specific provisions prohibiting undocumented side agreements, such as the one enacted in Alabama which states that a real estate agent may lose his or her license for “misrepresenting or failing to disclose…the true terms of a sale of real estate” (Ala. Code, sec. 34-27-36(a)(21). However, parties to Maine transactions should not assume that the absence of a state law here means that such deals are permitted on mortgages headed for the secondary market, especially when the loans will be held or guaranteed by government or quasi-government entities.”

Know this: secret side agreements are always loan fraud….period. I’m here to keep you out of trouble whether you are buyer, seller or agent. I know most of you are doing these types of transactions on a daily basis and didn’t come up the idea all by yourselves. You got the idea from a bad loan officer.

That same bad loan officer could easily be sitting in Leavenworth Federal Penitentiary six months from now, and so could you.

Make sure you get sound advice from experienced mortgage professionals, not guys who just want to make a commission. With 15 years in the mortgage business, I’ve seen the likes of these hucksters originating anything and everything without regard for the law, ethics, or integrity. Safeguard yourself and your clients by only referring to experienced, ethical mortgage professionals.

By the way, the Federal penalties for fraud or misrepresentations committed by anyone involved in a loan transaction that is in any way funded or subsidized by any federally insured financial institution or government agency (such as the FHA, FNMA, etc.). According to 18 U.S.C. ‘ 1014:[w]whoever knowingly makes any false statement or report, or willfully overvalues any land, property or security, for the purpose of influencing in any way the action of [a federally-insured institution or agency] . . . upon any application, advance, discount, purchase, purchase agreement, repurchase agreement, commitment, or loan, or any change or extension of any of the same, by renewal, deferment of action, or otherwise, or the acceptance, release, or substitution of security therefore, shall be fined not more than one million dollars or imprisoned not more than thirty years, or both. (Emphasis added.)

My advice: Make the repairs before closing or lower the price. Put your choice in an amendment to the contract and submit it to the lender. Problem solved….legally.

Good Luck,
Rob K. Blake
The Mortgage Insider