Every boom has a dark side. The merger mania of the 1980s produced insider trading scandals. The ’90s stock bubble was busted for biased investment research.
And so it is with real estate, the hottest market of the past eight years. The urge to cash in on rising home values has spawned a growing share of hucksters, schemers and rip-off artists.
So far, it is tough to know exactly how widespread the problem is. Just as conflicts with stock analysts and bankers didn't come to light until after the Internet bubble popped in 2001 and investors started to get hurt, only now, as the market starts to turn, are complaints over shady real estate practices pouring in.
Internal Revenue Service figures show that the agency initiated 235 real estate fraud cases against individuals in 2005, more than double the number it brought in 2001. The IRS expects that figure to remain steady this year. The Feds are taking it seriously — they've stepped up penalties to fight mortgage fraud, doubling average jail terms to four years for those convicted, says Andre Martin, a director in the Criminal Investigations Division of the IRS.
Trying to make a fast buck
“The market was so hot that everyone was looking to jump in and make a fast buck,” says Martin. “You have a lot of property flipping and false appraisals.”
On July 7, the New York attorney general's office indicted six men for grand larceny, for a scam known as “straw buying.” The sellers would allegedly set up their own friends as phony buyers and inflate the value of their properties with forged appraisals. After the lending institution issued a mortgage and the seller collected his money on the inflated sale, the “buyer” would disappear, never to make even one mortgage payment. The phony deal would leave the bank holding the title to a property worth much less than the loan it had out on it, while the collaborative buyer and seller divvied up the profits. A trial date has yet to be announced.
Moderate-income home owners tempted to extract cash from the equity in their homes have been hard hit by scamsters. In one of the most common rip-offs, according to the Federal Trade Commission, customers would sign away the deeds to their homes as “collateral” or take on loans they couldn't afford, leading to foreclosure. Another method unscrupulous lenders use is to convince desperate borrowers to fudge annual income claims on applications to qualify for a bigger loan than they can afford. An applicant who can't make the payments can lose his property and end up in bankruptcy.
Stripped of home equity
Stripping people of their home equity has become rampant in the subprime lending market. Credit-challenged home owners who often don't know exactly how much home equity they're sitting on are easy targets, says Allen Fishbein, director of housing and credit policy for the Consumer Federation of America.
“It's pushed by mortgage brokers, who are largely unregulated,” he says. “They have no fiduciary duty to the borrower.” Subprime borrowers, who typically pay 2 or 3 percentage points more than borrowers with better credit, should shop around and get at least three separate loan offers, Fishbein says. They should also ask plenty of questions on points and fees before signing on the dotted line.
Another common victim is a renter with steady income who lacks the down payment and qualification for a mortgage. Landlords sign them up with an option to buy the property — at a cost of as much as $10,000 up front, plus $300 more than fair market value each month. That extra money is supposed to go toward a down payment, should they exercise their option to buy. The deal makes a family feel like they are practically buying the house, so it can be very tempting.
The problem? In nearly all cases, the family's financial situation doesn't change much after a year or two, so they're just as unlikely to qualify for a mortgage. What's more, savvy landlords have a feel for what the house will be worth in a year or two, and they price the optional purchase at a level likely to exceed that worth, making the option to buy a bad decision anyway.
‘Like selling stock options to an old lady’
“It's like selling stock options to an old lady. It's unsuitable,” says John T. Reed, editor of Real Estate Investor's Monthly and an author of numerous books on real estate investing. He adds that in the rare case when a house is priced at a level that makes sense for the renter to exercise the purchase option, the landlord, who never really intended to sell the home, is immediately on the phone to his lawyer looking for a way to weasel out of the deal.
Another thing you should know: Not all real estate rip-offs are illegal. Laws on lending vary from state to state. And while the Truth in Lending Act, enacted by Congress in 1968, requires disclosure of all key features and costs associated with a real estate loan, sneaky practices can often skirt the law as long as terms are technically disclosed. Lenders are required to disclose the amount financed, any finance charges, the annual percentage rate, the total amount financed and the total of all payments. A creditor who fails to comply with the law can be sued by the consumer for up to twice the amount of the finance charge.
But as regulators will tell you, the best way to protect yourself from all of these dubious practices is to practice a “buyer beware” mentality. Make sure you read the fine print, ask a lot of questions and call your state attorney general's office or real estate commission if something doesn't seem right or seems too good to be true.
All in all, between the actual scams and the plethora of “get rich quick” real estate books that have hit the market, it’s enough to make once-proud real estate experts run for cover. Reed says he remembers a time when people seemed impressed when he told them he made a living writing about real estate investing. No more.
“Now it's, ‘Oh, you're one of those guys,’ ” he says.