In a previous post, we introduced the topic of mortgage fraud and some of its players.  In this second article of the seven part series, we’ll introduce the first of several scenarios in which fraudulent transactions manifest.

The “Flip.” While not illegal on their face, “flip” closings have been blamed for a number of mortgage fraud transactions in which the title company was allegedly complicit, resulting in fines in the millions of dollars against various title companies throughout the United States, levied both by the Department of Housing and Urban Development and the respective States’ Department of Insurance.

In a “flip” transaction, there is usually a straw man established in the middle of the transaction.  For instance, in a typical “A to B to C transaction,” B would be a mere nominee (straw company) who is buying at a low price from a legitimate seller, but selling it at a much higher price to a buyer. The appraisal reflects property value much higher than its real sales price (on the sale from A), and a loan application to a lender is for far more than what the property is worth.

There are two transactions here. In a legitimate “flip,” B is obligated to buy from A, finds a buyer C while the contract is pending, then has two closings. B can, and is capable of, buying the tract regardless of C’s ability to perform. The problem in the fraudulent transactions is that the sale from B to C has to close before the sale from A to B so that funds are available to pay A.  For instance, assume a $400,000 initial sales price, and a $600,000 conveyance from B to C, the lender has to fund on the $600,000 in order to get the $400,000 to pay A.  The straw man (B) nets the $200,000.  Under most computer programs used in closings, the transaction is caught because you can’t close the second transaction until the first transaction is closed (B is not in title yet. What if A, the seller, backed out at the last second?).  In an effort to appease the greed, however, the escrow officer may override the program or use no program at all (filling out the closing documents by hand).  For the title company, it’s difficult to defend if a lender discovers the fraud.  The escrow officer has to step out of standard office procedure in order to complete the transactions.  If the A to B transaction closes at one title company, and the B to C transaction closes at another, it may be easier to juggle the timing, but the “conspiracy” net grows to include the other title company, who must help coordinate the closings.

Who is “C”? C can vary. He or she could be foreign born, relatively uneducated, and a recent attendee at “B”’s investment seminar on how to get rich in real estate. He could be a first time homebuyer lured by easy, sub-prime financing arranged by B. C could be completely fictitious. B finds a good credit application, changes the names, pays John Smith $200 to show up at closing and sign mortgage papers. In setting up a flip, the number of alternatives becomes exponential, therefore harder to catch unless your “red flag” traps are systematic.

In the next article of this section, we’ll discuss another scenario dubbed, “The Old Switch.”  Until next time.