Loan Modification

Real estate flipping & the FHA

By Peter G. Miller

Government attorneys in New York have filed a “civil fraud lawsuit against 14 defendants — including sellers, lenders, and appraisers — alleged to have engaged in an elaborate conspiracy to commit mortgage fraud in New York City that caused at least 17 home buyers to default on their mortgages and face foreclosure.”

The government alleges that 17 homes were bought “and promptly re-sold, or ‘flipped,’ them ­without substantial improvement — to inexperienced, low-income buyers, duping them into buying properties they could not afford at falsely inflated prices. The appraiser defendants then fraudulently overstated the value of these homes in their appraisal reports so that the buyers would take out home mortgage loans far in excess of the property’s true value.”

So where do FHA loans come in?

“All 17 loans, which were insured by the U.S. Department of Housing and Urban Development (“HUD”), defaulted, often within just a few months after the closing, exposing HUD to millions of dollars in losses. In addition to the losses to HUD, the fraud also left the buyers facing foreclosure and eviction from their homes.”

I bring up these allegations for several reasons.

First, it’s not a crime to buy and quickly re-sell real estate, any more than it’s a crime to buy and sell stock with minutes.

Second, it’s not a crime to sell property to “to inexperienced, low-income buyers.” That’s an expression that could define much of the first-time buyer market. All first-time buyers can be defined as “inexperienced” and “low income” does not mean “low credit.” Hopefully purchaser inexperience will be offset with the use of buyer brokers and surely there should be FHA loans for people with bad credit and limited income (or, at least credit which is less than sterling).

The government’s complaint is only an allegation, no one has been convicted of anything. It claims that an effort was made to materially inflate values when seeking a mortgage so that the lender would not know the true worth of the property. In this case the government alleges that “the mortgage fraud conspiracy included the participation of several appraisers who allegedly submitted false appraisal reports that ‘hit the numbers.’”

There is much written about “illegal flipping” with the result that honest rehabbers who fix-up and restore properties are often seen as somehow shady. The real problem is not that homes can be quickly repaired by skilled and well-equipped professionals, rather the issue is that mortgage fraud creates additional risk for FHA lenders and thus FHA insurance and today’s FHA premium rates.

For several years FHA loan guidelines prohibited the use of FHA-insured financing when a property had been re-sold during the past 90 days. In January the FHA suspended the rule until February 1, 2011. It is unknown whether HUD will bring back the rule in February, continue the suspension or modify the guidelines.

HUD has every right to hold down the risks which result from mortgage fraud. But quickly buying and selling property is not by itself evidence of improper activity. My hope is that HUD will either continue the rule suspension announced last January or opt for a an alternative such a requirement that when someone quickly buys and sells they must show the lender the appraisal and photographs from when was bought to compare with a new appraisal and pictures. A requirement to produce repair bills and cancelled checks hardly seems unfair. In addition, lenders should be required to use different appraisers for each valuation.

Full post as published by FHA Mortgage Guide on December 15, 2010 (boomark / email).