Detection and prevention of mortgage loan fraud

RMA Journal, The, Sept, 2004 by Vernon Martin

In situations like these, appraisers and lenders should throw away the comparable sales data and look at listings instead. An in-depth review of a builder refinance application in Provo, for instance, revealed 253 listings of similar new homes in the same zip code, listed at or below the appraised value.

Borrower-provided comparable sales data. On the residential side, borrower-provided comparable sales data is a favorite technique for property flippers and those who aid them. Appraisers do not typically need instruction in how to do their jobs, so insistent offers of free data should be viewed suspiciously as attempts to influence an appraisal assignment.

If an appraiser's comparable sales data search fails to provide other independent comparable sales, rigorous verification of the borrower's data is essential. Also, the parties in the comparable transaction need to be unrelated and the transaction closed with necessary cash equivalency adjustments to the sale price. Developers have fooled appraisers before with "pending sales" that turn out to be "offer" letters written by their relatives or friends.

False operating statements. The owner of a strip center/self-storage facility in Texas supplied deceptive operating statements that included "capital infusions" as actual income and double-counted (:AIM (common area maintenance) reimbursements in "base rents" and also as a separate line item of income. An unusually high percentage of revenues came from late fees, too, calling into question whether the fees were actually being collected. As a result of this deception, actual NOI had been inflated from $67,000 to $178,500. The center was in contract to be purchased by an illiterate immigrant for $1.7 million at a stated cap rate of 10.5%.

Client operating statements should not be taken at face value, but lie compared for reasonableness to operating data for similar properties. Various national publications summarize revenues and expenses by reporting members, including those published by IREM (Institute for Real Estate Management), BOMA (Building Owners and Managers Association), and ICSC (International Council of Shopping Centers). Nevertheless, tax returns (Schedule E for individuals) are the preferred method for verifying revenues and expenses (be sure to exclude interest and depreciation expenses).

Sometimes, tax returns can be forgeries. A Chicago motel owner, for instance, submitted Illinois motel tax returns that understated tax liabilities by 77%. Canceled checks are one way of verifying which tax payments were really made, and this loan applicant declined to provide them. Actual tax evasion, however, opens up the worse possibility of a tax lien on the property for the amount of all evaded taxes and associated penalties. As motel taxes are often greater than 10% of revenues, this can create substantial loss for both borrower and lender.

Straw tenants. Keep in mind that occupancy can be manipulated by special concessions, and this most often occurs in the multifamily sector. Recall the previous example of the Oklahoma apartment building that went from 50% to 97% occupancy by accepting new residents with poor credit, yet had to evict 55% of the new residents.