Fraud and Prevention

Mortgage Fraud: The Short Sale Scheme

By William Breeden
December 3, 2008

Some homeowners, faced with the prospect of losing their homes, are attempting to sell their properties prior to default. One method that is quickly growing in popularity as an alternative to foreclosure is the short sale.

In a short sale transaction, the amount owed on the property exceeds the property’s actual value, and in most cases, the homeowner is unable and/or unwilling to continue making the loan payments. In the current market, short sales have become more attractive to the lender due to decreasing property values.

As more and more financial institutions and their loan servicing partners consider alternatives to foreclosure, the sale of the property prior to completion of the foreclosure sale is a viable option towards mitigating losses. Unfortunately, as the real estate market looks for price clarity in down markets, there are some re-emerging schemes to defraud banks.

Short sale for profit is becoming increasingly easier to detect, but when the homeowner is looking to stay in the home or seeks help from an outside institution to help facilitate the fraud, it changes the scope of things.

Fidelity National Financial’s monthly newsletter Fraud Insights cites a recent example involving a property where the husband and wife held the title. They proceeded to deed the property to their trust and a relative, who also served as their attorney, signed the deed under a Power of Attorney. The title company handling the closing asked to see a copy of the trust and discovered it was a land trust. Land trusts were no longer valid in the seller’s state. Attached to the trust document was also an “Assignment of Beneficial Interest” that assigned beneficial interest of the property to the attorney’s firm.

This scenario sent up red flags for the title agent working on the transaction. The agent also received two settlement statements, which per the attorney’s company, were to be used in two separate closings; one for the amount agreed upon by the lender to the seller’s trust, and the other for an increased amount, which would be given to the actual buyer.

Unbeknownst to the lender, the property was being sold for a higher value than initially agreed upon with the borrower. The attorney’s company stood to make more than $13,000 in profit once both transactions were completed. In the end, the title company decided not to insure or participate in closing the deal.

While this case may seem easy to spot, not all companies are as diligent, and key documents often slip through the cracks. These types of cases are happening more often, and the fraudulent acts go undetected. When fraud is committed successfully, the industry as a whole is affected. Short sales are an effective way for lenders to mitigate losses and maximize payment on most of the debt owed on a defaulted mortgage. Communication between all parties involved in the transaction is the best method to ensure fraud schemes are caught in the early stages of the transaction.

When loan servicers enlist the services of an asset management company, they get the expertise that comes with the management company’s frequent exposure to REO sales. Asset management companies will play an important role in handling the increasing volume of short sale offers, often recognizing the signs of fraud, and when appropriate, declining closing when it appears the lender may be at risk.

The crash of the real estate market began with the so-called sub-prime distressed mortgage market that was all too often the result of fraud. Because of this, borrowers were able to obtain loans they could not afford with unreasonable terms that the market could not sustain. If we are to prevent a black eye on pre-foreclosure sale transactions, it is imperative the industry develop innovative ways to combat fraud on all mortgage-related transactions, including short sales. This, no doubt, will be a huge task that may only be accomplished through educating real estate constituents about the damage being done to our communities and prosecuting those parties who perpetrate fraud. That, of course, may be far from a reality, but it would be a start.

Given the increasing number of short sale transactions in many markets, preventing fraud is the next step on the road to price clarity and the return of liquidity in the credit markets. This will, in turn, lead to market recovery. As the market begins to recover, there will be a better understanding of the true damage done and the steps needed to move forward. One thing we do know for sure is that fraud will never cease to exist, but the more cases we prevent, the healthier our real estate markets and economy will be.

William Breeden is the senior vice president of ServiceLink default services and responsible for developing and managing collateral-based default services. For more information, visit http://www.servicelinkfnf.com.