Mortgage Fraud, or . . . "Creative Financing

James L. Goldsmith, Esquire

With mortgage underwriting standards tightening, there is added pressure on buyers to find available funds to make their purchase. This is where parties become susceptible to "creative financing." Beware! Consider this Hotline call:

Q.) After executing the Agreement of Sale, the buyer applied for her mortgage. It was rejected due to her lack of funds. She was about $2,000 short of the money she needed and there was no hope of her scraping it together. While the seller was willing to increase the amount of seller assist, the mortgage company could not approve the loan because the increase in seller assist would not meet underwriting standards.

Rather than search for a less expensive home, the buyer agent passed along the suggestion of the mortgage broker, which was as follows: the listing broker would increase his commission by three percent but would pass it off to the buyer agent as a "cooperating fee." The buyer agent would, in turn, pass the increase to the buyer. The payment from the buyer agent to the buyer would be "off-the-record" and would not appear on the HUD-1 Settlement Statement.

The listing broker felt uneasy about this arrangement and placed a call to the HotLine. Was the arrangement legal? Because the mortgage broker suggested this arrangement, are the real estate licensees exonerated from any liability?

A.) Run! The fact that the mortgage broker proposed this "creative financing" doesn't mean that it's legal, and it offers no measure of protection to the licensees who could face a myriad of problems, including losing their real estate licenses. Yes, the arrangement would have provided the buyer with the necessary cash and served to get her into a home. It would have helped the seller get rid of a home that he so desperately wanted to sell, so much so that he was willing to increase his seller assist by several thousand dollars. With the brokers making no more money than they originally intended, there seems to be no loser in the picture.

Consider the lender. The underwriting standards imposed by a mortgage company are designed to minimize loans to those buyers most likely to fail in meeting payment obligations. Lenders have determined that the greater the financial contribution made toward the purchase, the less likely that the buyer will default. It's not just a question of the buyer scraping together adequate funds, it's the source of the funds that the lender considers critical in the approval process.

In short, participating in a scheme to route funds from the seller to the buyer and hiding this fact from the lender is conspiracy to commit fraud.

While the listing broker did not fully appreciate the reason why the arrangement was illegal, he knew it didn't pass the "smell test." Now that he is told of the mortgage fraud involved with the arrangement, what should he do? At the very least, the listing broker should inform his seller, in writing, of his opinion that the "arrangement" is illegal and of the seller's need to seek an independent assessment by engaging legal counsel. Further, the broker should indicate his unwillingness to participate in the arrangement and of his unwillingness to increase the amount of his commission. With luck the seller will understand the broker's unwillingness to participate in the arrangement, even though it may cost the seller the sale of this house to this particular buyer. It is not a breach of any duty to refuse to be a participant to fraud.

In today's market there are more and more programs promising "free cash" to buyers in their purchase of a home. Each program has to be eyed suspiciously. Do not hesitate to engage legal counsel to provide you with the advice you need to protect your client -- and yourself.