Short sale fraud plagues the housing market

July 14, 2011: 4:26 PM ET

NEW YORK (CNNMoney) -- Just as the housing market began to collapse near the end of 2007, a real estate agent in Bridgeport, Conn. asked Regions Bank if it would accept a $102,375 bid on a home that was underwater on its mortgage. Under the impression that this was the best offer on the home, Regions agreed to the short sale and released the mortgage it owned on the home.

Later that same day, the new owner -- an investment group owned by another real estate agent -- resold the home to a buyer who had been lined up before the short sale transaction went through. The final sale price: $132,500, netting the seller a cool $30,000 -- a profit that should have gone to Regions.

In this latest twist on short sale fraud, scammers have found a way to rip off mortgage lenders by tens of thousands of dollars -- sometimes in a matter of hours.

The scam artists, usually real estate agents, will secure a legitimate bid on a home, one where the borrower owes far more on the mortgage than the home is worth. Then they arrange for an accomplice investor to make a lower offer on the home.

Foreclosures for sale: Big supply, low prices

The agent then presents the lower bid to the lender and asks them to forgive any remaining balance owed -- without disclosing that there was a higher bid made on the home. Once the short sale is approved, the scammer then sells the home to the higher bidder, often on the same day.

"These same-day resales are on average nearly $50,000 greater than the lender agreed upon short-sale price," said Tim Grace, senior vice president of product management and analytics at CoreLogic (CLGX), a financial analytics company based in Santa Ana, Calif.

Such transactions are expected to cost lenders more than $375 million this year, up more than 20% from last year, according to CoreLogic

The anatomy of a scam

Most of the time, pulling off one of these scams involves a real estate agent and an investor acting as a "straw buyer." Sometimes, the owner of the home is involved as well, but not often, said Robert Hagberg, an investigator for the mortgage giant Freddie Mac (FMCC, Fortune 500).

"In most instances, the sellers are apathetic; they've, basically, already lost their homes," he said. With nothing to gain or lose, they allow agents to handle the entire deal.

To get the banks to approve low bids, appraisals or broker price opinions are manipulated. Home prices have plummeted in many housing markets and the house may be worth far less than what the seller paid.

Sometimes, said Hagberg, fraudsters bribe appraisers or brokers to get the prices they want but they can employ sneakier methods as well. One method: Misstating the home's location so it's compared with much cheaper places.

One case in California last year involved an expensive Malibu property that the agent said was in Riverside, Calif.

"It didn't cause any alarm bells to go off at the bank," said Grace. "The short sale went through at $200,000, which was a fifth of its value. It was turned around for $1 million."

Sometimes an agent will point out every defect in the home to get appraisers to reduce their values, according to Hagberg. In Wisconsin, an agent left the windows open during spring rains and flooded the basement. He told the appraiser the plumbing burst and would need expensive repairs. All it really needed was a pump.

"When the flippers say there's something wrong with the electricity, the plumbing or the roof, the appraiser can't tell whether they're being deceived or not," said Hagberg.

Fraud ultimately hurts homeowners

Five years ago, when the housing market was thriving, lenders rarely heard of a short sale fraud. But as the housing market crumbled and beleaguered homeowners increasingly turned to short sales to get out of their underwater mortgages, the frauds increased as well.

Now, 13% of all existing homes sales are short sales, according to the National Association of Realtors. And last year, frauds associated with short sales comprised half of all fraud investigations for mortgage companies like Freddie Mac (FMCC, Fortune 500), according to Hagberg.

The impact of short sale fraud goes well beyond the direct losses to banks. These frauds have become so common, it has become more difficult for legitimate short-sale transactions to go through.

That hurts sellers because it forces more of them into foreclosure. It hurts banks by adding to their costs and it can make all the parties more cautious.

The frauds "defeat why we do short sales in the first place," said Hagberg.

In the Bridgeport, Conn. scam, two real estate agents were arrested. It was just one of four similar frauds that were listed in their indictment, which netted them a total of more than $180,000. They pled guilty and are awaiting sentence.

They may be out of business but with home prices off about a third from their peak nationwide and down 50% or more in many post-bubble communities, there are opportunities for other short-sale fraud artists to take their place. To top of page


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