Buy and Bail – The Latest Flavor of Real Estate Fraud
June 13th, 2008 by Mark Flanders“Do you think its okay to help a client who wants to buy a new home now, so she can then let her current home be foreclosed on?”
This question was posed to me 2 weeks ago in a meeting at my office. The Loan Officer asking the question has been originating loans for many years. She’s a wonderful person, but suffering from a lack of business just like many other Loan Officers around the country. It was an unexpected meeting as we no longer work together. She just stopped in for a visit. We were catching up on each others lives, both professional and personal.
This was the first time I heard of a new form of Real Estate Fraud called “Buy and Bail”. The process goes like this. A homeowner, realizing that they have either no equity in their home, or worse yet, negative equity, attempts to buy a new home, with the intention of letting the old home go into foreclosure after the new transaction is complete. In order to pull this off, the homeowner often provides the lender with a Lease Agreement to artificially inflate their income so the homeowner can qualify for both mortgages at the same time.
After my initial “You’ve got to be kidding me” response, I asked some more questions, thinking maybe I had misunderstood the buyer’s intent. I hadn’t. This was a deliberate, planned attempt to get a new mortgage by misleading the new lender. The buyer had no intention of telling her new lender what she was planning.
This story is morally repugnant on so many levels, I don’t even know where to start. My first reaction was, “this client will have a difficult time finding real estate professionals willing to get involved”, then I found out the client already had a Real Estate Agent working for her, and the Agent was fully aware of what the client intended. The client also had engaged a willing Loan Officer to handle the new mortgage.
I told my friend simply, “If you have information about a transaction that you deliberately withhold from the lender, you are colluding in a deception”. I walked away, shaking my head, hoping she had heard me and would stay as far away from this transaction as she could.
A Wall Street Journal Article
Yesterday I was not surprised read an article in the WSJ, detailing an instance of this scam that is happening in California. The buyer not only thinks nothing is wrong with her plan, she has let herself be quoted in a major newspaper. Her Real Estate Agent’s quotes make it obvious the Agent sees nothing wrong with the plan either, calling it “a business decision”. I hate to state the obvious but “a business decision” to screw a lender, is not a good “business decision”. And any Agent who helps promote it puts themselves in legal harm’s way. The same goes for any Loan Officer who might get involved. And any appraiser (if they are privy to the plan). Not to mention the (probably ficticious) “renter” who signs the lease agreement.
Difficult economic situations, like we have in America today, are just that; difficult. It doesn’t give any of us the right to lie, cheat or steal to improve our own financial situation. Nobody forced this woman to buy a house in the first place. She bought a home, most likely, because she thought she would benefit financially. She made a decision, hoping to improve her personal situation. Now that she finds her decision has hurt her, she wants someone else to pay for a bad decision.
If you are a consumer, and have heard of this ploy as a possible way out of your negative equity, go talk to a lawyer as fast as you can. If you are a Loan Officer; run. And the same goes for any Real Estate Agent who might read this article. Contact your brokerage’s attorney before getting involved. This isn’t the newest opportunity in real estate, this is dangerous territory.
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Tags: buy and bail, ethics, real estate fraud
Folks….so many people telling what is wrong and illegal…so few know the truth.
Real Estate Attorneys will tell you there is no issues with the buy and bail as long as you don’t misrepresent the renting piece. How do I know: Just did it all!
The banks/mortgage lenders lied! To me and to others….When signing my loan I was “assured” that I would be able to refinance my loan in a few years…oh…and that “we would be happy to provide that service for” me! I took the loan because it was the only way I could get into the house…$80000 balloon payment was coming due! No ability to refinance…oh, the banks refused to even speak to me! The quote: “We will not discuss any type of loan modification/assistance unless you are 90 days overdue/late on your payment”. What?
Every preachy person needs to step back and have a reality check! There is no help for anyone! The only person that is going to help me is me!
The underlying problem is that real estate has become too pricey to buy without taking on an inordinate amount of risk. There is ONE, and ONLY ONE, way to alleviate this situation: allow prices to fall to where incomes and prudent risk management can support them. Once we get to that point (80% off the 2007 peak valuation, IMHO), buying a home will not be a big deal.
Home prices need to reflect the following:
-Price/income ratio in the 2.5x – 4x range (with planned undershoot below the 2.5x range until the glut clears itself.) Keep in mind that as prices fall with the larger deflationary forces, incomes will also fall.
-Rent will be at a slight premium to PITI. Yes, you read that correctly.
-”Rental value” will be EBIT/(interest rate + risk premium). If you “net” $10K/yr on a rental (assuming no principal and interest payments), and the interest rate you need for that level of risk is 10%, then the house rental value (its investment value) is $100K.
-Debt/income ratios need to go back to historical and sustainable levels. 28% housing expenses or 42% total debt+housing expenses were battle tested metrics. As college level debt continues to grow with a declining baccalaureate job market, it will be difficult to stay under that 42% for the under-40 crowd of young professionals.
-20% CASH down payments. This is going to be the killer. How much ACTUAL CASH (not a cosigned “second” or PMI) does a 30-something have? Honestly? Multiply that by 5 and see what you get. Keep in mind that the 98110 zip code lost 22% last year alone! Factor in the selling fees and expenses, not to mention the time it takes to actually foreclose, and banks will be requiring more than 20% until their 3rd degree burns heal from this bubble.
What’s my point? My point is that the bankers and borrowers have a huge shock coming their way. The entire mortgage portfolio of both the bankers and the “landed class” homeowners is going to take a massive hit. Let’s allow the market to clear, carry out our dead, learn our lessons, and start anew.
A home is a place to live. Once we start treating it as an “investment,” we are subject to displaced economic priorities on the way up with misery and stagnation on the way down.
Official– Bravo! It is amazing to me that the banks-agents-title companies have knowingly pulled off the biggest scam in the last 10 years by FLEECING the middle class.. Why are THEY not prosecuted for driving prices up and preying on buyers with BS programs and tactics??
This double standard is NUTS!even after all that has happened recently, people who have called this repugnant behavior to buy and bail are ALL in the hosuing business..
The gall of these people is astonishing! If you can buy and bail GO FOR IT! I hope the buyers get away with it! The business has preyed upon us for YEARS!
Rhonda,
Nice to hear from you.
With the amount of fraud that has been originated by both lender and borrower, I seriously doubt that your odds of prosecution are very high. While I admit to being ignorant of any specific laws that may pertain, it would seem to me that someone that buys a second home, makes a few payments on both, and then defaults on the previous mortgage (which might be several years old) would be difficult to prosecute for fraud.
The new lender is going to be happy that they are receiving payments in a timely manner, and the old lender is going to have a rough time prosecuting fraud for an action that takes place several years after the loan was originated. They would essentially have to prove that Joe Hippen and Mary Trendy conceived of a plan to:
sign a mortgage for a house
live in it for a few years with a flawless payment history
buy another house
make a few more double payments
default on the first loan
They have every right to default on either loan and give the house back to the lender under NJF. The bank has to prove that their intent, at the time of contracting the original mortgage, was to default.
What if the Hippen-Trendys have some form of “life event” that strains their ability to float two payments?
I will say that if they have a dummy-lease that was used to defraud the lender (either one), they risk a very easy prosecution for document fraud.
“Buy and bail” is just one of the circumstances that bankers, whom have lived in a 40 year bull market in real estate, failed to protect themselves against. I also think their case-load will overwhelm them. They can’t even afford to sell the homes they have taken into REO in most of California – crazy as that sounds.
How many homebuyers have pulled the old trick of having two incomes to “qualify” for the loan, only to have the Mrs. get pregnant and quit her job within the first year? Most of my friends did that when we were in our 20s and 30s. I came to believe that the practice was expected by the lenders.
Again, foolishness and carelessness has always been liquefied by a rising market. Not so anymore.
It’s flat out fraud when this happens and I’m sure the banks will prosicute to the fullest extent of the law. This type of behavior will only compound the countries curent mortgage crisis. I feel for people who are losing their homes but to lie on a loan application (regardless of if they’re being encouraged to do so by their loan originator or real estate agent) is committing fraud. It will be very easy to document and I’ll bet that we see underwriting guidelines change to where someone downsizing and “renting out” their previous home will be a giant red fraud flag to lenders.
…wow…upstaged on my own blog…
I think the comment is better than the article.
Welcome to SoundBiteBlog folks!
Where the visitors write better than the blog owners!
-Michael Douglas as Gordon Gekko, ”Wall Street”, 1987
Permit me to disagree with Mr. Gekko. Greed motivates, but the motive lacks the moral compass needed to function in a society based upon honor, law, and respect for your fellow man.
The point is, ladies and gentlemen, that greed, for lack of a better word, is flawed. Greed is vacant; greed fails and eventually destroys the original goals of creativity and exploration. Greed clouds judgment; infects and corrupts the essence of the human spirit.
Apparently, the ugly reality of the backside of the housing bubble is starting to settle upon our community. As someone that has followed the rise, peak, and decline of the national housing bubble, I am well acquainted with the practice of “buy and bail.”
First, the legalities of this should be thoroughly explored with competent legal council, prior to considering such a move. In the above example where a potential “buy and bail” participant intentionally commits a fraud (bogus lease) to secure funding for a new home, the full weight of the law should be brought to bear on all parties that assisted in committing that fraud. Certainly the prospective landlord should get hit first and hardest. The willing “renter” for the property should also be charged with some form of fraud.
As far as the real estate agent goes, I’m not familiar with the legal requirements to disclose fraudulent actions by their client to the various supporting parties to the transaction. Obviously, the agent could tell the loan officer of what he believes is a fraudulent lease, but if he is mistaken, or the client covers his tracks by having the renter actually occupy the property, the agent and brokerage could easily open themselves to a lawsuit.
As a rule, it’s best not to have business relationships with sleazy people.
I wouldn’t be quick to fault a real estate agent, unless it was the agent that suggested the action. At some point, you can’t be responsible for everything someone does. RE agents should match buyers with sellers and receive their commission, not play hall monitor for everyone involved.
Is it ethical to represent someone suspected of “buy and bail?” I guess that depends on how overt the fraud is. If the client expressly claims that he is trying to bamboozle the new lender, by misrepresenting his creditworthiness (knowing that he plans on defaulting), I would not continue. This is a small community and people have long memories. If the buyer acts like he might “buy and bail” but says nothing, is it the responsibility of the agent to confront him? What if the client lies? After all, anyone that can “buy and bail” is certainly capable of lying to cover the scam.
Enter the banker. To me, the banker is the party that needs to bring a well-tuned “BS meter” to the transaction. After all, 80%+ of the money is theirs.
It was the banker that determined creditworthiness in the past. Unfortunately, the root-ball of the entire housing (credit) bubble was the greed of the bankers. Everyone else was merely acting out the script that was written by Wall Street bankers. The greed of the bankers necessitated the lifting of time-tested debt-to-income ratios, down payments, income verification, credit history, job continuity, and risk assessment. Because ALL of these were lifted, any person was able to get just about any amount of money to participate in the “American Dream” of home “ownership.”
In reality, the mortgage industry became a gigantic confidence game. As long as everyone played along, nobody would get hurt, or at least that is how it was supposed to work.
Today, just about every bank in the United States is insolvent. The Federal Reserve has been keeping our rancid banking system alive with direct injections of cash, and the injections are without historical precedent. This insolvency is descends directly from the abandoning of those time-tested banking regulations and practices.
How did that happen? Well, the banks found that money-market managers and retirement fund managers were eager for mortgage-backed securities and would buy them with no-questions asked. The risk to the banks declined rapidly (as it shifted to fund managers), and the only risk that remained was not getting the loan to sell into the debt markets. As the borrowers became saturated with homes, the banks needed to expand into tranches of people that were bad credit risks.
Couple all of this with the multi-generational lesson of having real estate equated with achieving the “American Dream” and a nation eager to replace stock speculation with real estate speculation, and you had no end of people who wanted to borrow money to buy real estate they could not afford or did not need.
You would think that the banks would have learned their lessons, but you would be wrong.
Banks are in a “lend-or-die” environment. They need the fees to keep the lights on and their employees’ paychecks clearing. Collecting the debt is tomorrow’s problem. Another CEO will have to answer to regulators and shareholders. Specifics of banking accounting is probably best explored in another blog, but let it suffice to say that the desperation of the banks exceeds their stupidity, and the entire industry is in on the practice.
A responsible banker would never lend to someone who is in a negative equity situation on their existing home, while they are offering to put little or nothing down on their new loan. Think about it. It is difficult to imagine that someone’s debt-to-income ratio will qualify with two mortgages. With little money down, the borrower will have, not one, BUT TWO mortgages that have almost no borrower skin in the game.
Are they insane? Would you loan money to someone in that situation? Would you write that mortgage, given that “buy and bail” is a practice that is very well known by every single lending institution in the United States?
So, where are the bankers? It’s their money, so why are they not asking the hard questions? Why does the NAR have to police this matter? Banks need to have the courage to say “no.” Unfortunately, they don’t have the financial means to do so.
Their greed clouded their judgment. They thought they were dumping shaky mortgages into a market that would never notice. They thought that real estate prices would outstrip incomes in perpetuity. They never, ever considered their exit strategy or the consequences of their actions.
Just because you are a banker does not mean you are smart.
The banks now find themselves in a position where people are essentially exercising the “foreclosure option” of their mortgage (where there is no fraud), and people are gaming the system to engage in “buy and bail,” which is fraudulent, or should be. Had banks required 20% down, people would not be willing to just walk away.
I don’t blame people in no-recourse loans that give their homes back to the bank, provided they don’t take out another mortgage without disclosing their intentions. If I were the senior underwriter for a bank, I would not issue mortgages to people with little or no equity in their existing homes.
I don’t fault the real estate agents that match buyers and sellers, provided they didn’t initiate the fraud. At the end of the day, you have to be able to look at the man in the mirror and not want to run and hide. The people that run this blog should have no problems with the person looking back from the mirror. The mere fact they are asking these questions make them people you WOULD WANT to have in a business relationship.
I fault the people who are committing fraud and banks for not doing their due diligence and allowing that fraud to continue. In other words, those motivated by vacant greed are to blame.
Greed is destructive. Greed clouds rational thinking. Greed fails.