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Wednesday, June 11, 2008

Buy and Bail

The WSJ has an article today about a troubling new phenomenon in which borrowers with extravagant mortgages buy smaller properties and then walk away from their current mortgage.

Next month, Michelle Augustine plans to walk away from her four-bedroom house in a Sacramento, Calif., subdivision and let the property fall into foreclosure. But before doing so, she hopes to lock in the purchase of another home nearby.

"I can find the same exact house as what I live in right now for half the price," says Ms. Augustine, 44 years old, who runs a child-care service out of her home. She says she soon will be unable to afford her monthly payments, which will jump to $4,000 from $3,300 in August, and she doesn't want to continue to own a home that is now worth $200,000 less than what she paid for it two years ago.

This sort of scheme is fraud plain and simple, and it is a troubling phenomenon. It works something like this. Borrowers with good or great credit own a home that has a mortgage significantly higher than the value. They can't sell, and the payments are becoming a problem. They use their good credit to try and buy another property. In buying another property, they claim that this one will be used as an investment property. They likely provide a lease but forged leases are a commonplace in the business. Then, once they purchase the new, lower priced property, they walk away from their current mortgage. What's unclear from the article is why any bank would believe a borrower would be moving into a property with a mortgage half the size of their current one. Since this defies all logic, any bank that allows such a loan frankly deserves the fraud that is then perpetrated on them.

Now, the article notes that Fannie Mae is taking steps to counteract this phenomenon.

Under revised Fannie Mae guidelines, which could take effect next week, loan applicants who claim they will rent out their first home will have to produce supporting evidence, including an executed lease agreement. Borrowers also will have to prove that they can pay the mortgage, property taxes and insurance for both residences. The guidelines will make an exception only for borrowers who have at least 30% equity in their current home.

Now, while this may in fact counter act this growing fraud, this policy also has unintended consequences. What this will do is make it that much more difficult for legitimate borrowers to buy property while maintaining another property for investment purposes. Remember, right now we are in a buyer's market. That means that everyone should be buying. In a perfect world, all buyers should hold onto any property they currently own. This new policy would restrict many buyer's ability to do just that.

Furthermore, the article says something else that is vital.

Homeowners are able to pull off this gambit -- which some lenders and real-estate agents call mortgage fraud -- by taking advantage of mortgage-lending practices that allow them to buy a new primary residence before their existing residence has been sold. And with the lending industry in disarray as it tries to restructure millions of mortgages, some boast they are able to pull off the strategy with ease.

In some cases, homeowners are coached through the buy-and-bail process by real-estate agents and brokers who see nothing wrong with it. Some blame the phenomenon in part on lenders' unwillingness to cut deals or restructure loans made when home prices were inflated. "It's just a business decision," says Linda Caoili, a Sacramento real-estate agent who is working with Ms. Augustine and others who are considering walking away from their mortgages. "If you're upside-down $250,000, why would you keep it? It just doesn't make sense."

In other words, unscrupulous borrowers team up with unscrupulous brokers and realtors to perpetrate fraud. This is of course counter to the narrative that the MSM, and some politicians, have been advancing. In their narrative, borrowers were simply duped into taking on loans they couldn't afford. In the case of borrowers perpetrating this scam at least, they simply manipulate the system to their advantage. It's hard to believe that any of these borrowers were ever duped into anything. These borrowers have a stunningly acute criminal mind.

Furthermore, it is amazing how little any of these borrowers concern themselves with their good credit rating. The only way to pull off this scam is with near perfect credit. Once they walk away from the property their perfect credit becomes terrible. These borrowers will struggle to get car loans, credit cards, and of course mortgages for many years to come. Of course, that's only after they trade down on their current mortgage for one significantly smaller.


Anonymous said...

I can't agree that this is criminal--it's "wrong" but specifically allowed by the law in all the states.

It's called "Purchase Money Loan" in my state, and it prevents deficiency judgments against mortgagees. This is explicit legal permission to do exactly what these people are doing.

mike volpe said...

It's absolutely criminal and it is fraud. Here is how. The borrower is claiming one of two things, and either is a lie. Either the borrower is claiming that the house they are buying is an owner occupied property, and in that case, they are forging leases on their current property, or they are claiming the house they are buying is an investment property when it really isn't. Either way, that is fraud.

It is minor fraud. The major fraud is the scheme that is perpetrated, and given that, I would prosecute the minor fraud to the fullest.