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More Home Buyers Stretch Truth, Budgets to Get Loans

As Southland housing cools off, reports of fraud grow, raising fears of a wave of foreclosures.

September 29, 2006|David Streitfeld | Times Staff Writer

Mortgage fraud continues to escalate in Southern California, FBI figures show, raising concerns of increased defaults and foreclosures as the housing market cools down.

Lenders filed 4,228 reports of suspicious activity in the region during the first 11 months of the government's fiscal year, which ends Saturday, the FBI said. That puts 2006 on track to nearly double last year's total.

The jump in reports of suspicious activity even as home sales have declined may stem in part from a lag in reporting. But the FBI and industry experts say the trend also reflects growing deceit by average borrowers who overstated their income, exaggerated their assets or hid their debts simply to qualify for a mortgage in the region's sky-high housing market.

"There's more of the little guy running around -- people committing fraud for housing," said Ronda Heilig, the bureau's mortgage fraud program manager.

A seven-county region from Orange County to San Luis Obispo County has seen a fourfold increase in suspicious loan activity since 2003, largely coinciding with sharp run-ups in housing prices and lending activity. But with home sales slowing and prices leveling off, the explosion in small-scale duplicity could have serious consequences, industry experts believe.

During the boom, people who lied about their income to get a loan -- and then struggled to make the payments -- had the option of making ends meet by tapping their newfound equity through refinancing or by selling the property for a profit.

But now, with prices flattening out or declining, those without sufficient equity could be forced to sell for a loss or even default on payments. That could accelerate any downturn in the market by swamping it with foreclosed and bargain-priced properties.

"This is the calm before the storm," said Steve Smith, a Redlands appraiser who lectures frequently about real estate fraud to industry groups.

When home prices in California began to throttle up in the early years of the decade, people needed bigger loans but sometimes couldn't prove they could handle the debt. To accommodate them, lenders started to offer loans that required little or no documentation.

For example, in a so-called low-doc loan, also known as a stated-income loan, the lender doesn't verify the borrower's income. With a "no-doc" mortgage, the lender doesn't check income, assets or employment.

Such loans, which carry higher interest rates than traditional loans do, were originally designed for people whose income swung widely, like the self-employed, or high-wage earners in unusual circumstances -- a doctor who had just moved to a new community and hadn't set up a practice yet, for instance.

As the state's boom went on, the mortgages became so popular that they now account for a third of new loans, according to data tracking firm First American LoanPerformance.

Industry insiders have a nickname for low-doc and no-doc mortgages: liar's loans. The phrase reflects the suspicion that many of the borrowers who get such loans don't have the income or assets to qualify the old-fashioned way.

One lender recently compared 100 stated-income loans with the borrowers' tax returns and found that only 10 of the borrowers were telling the truth about their wages, according to Mortgage Asset Research Institute, a division of data firm ChoicePoint Inc.

Sixty of the borrowers had exaggerated their incomes by more than 50%, according to the institute, which didn't identify the lender.

The loans first gained popularity in the 1980s, but many lenders got burned by them when property values turned down in the early 1990s, said the institute's founder, James Croft. "We're seeing some of the same loans today, and so we'll go through an 'Oh, whoops' realization and a tightening up."

The recent boom in such loans also has been driven by people who bought homes in hopes of "flipping" them for a quick profit, industry experts say.

"I saw a lot of people stretching their income to get into investment properties, and not disclosing the purchase of multiple concurrent investment properties," said Rachel Dollar, a Santa Rosa, Calif., attorney who runs a blog documenting mortgage fraud cases. "They were buying more than they could afford, believing the increased equity was going to bail them out."

In what might be a sign of trouble ahead, the U.S. Department of Housing and Urban Development's Office of Inspector General said in July that it had audited 41 loans that had gone into default. All of the loans had been made by National City Corp., a Cleveland-based bank that is one of the biggest lenders in the country, and had been insured by HUD. The location of the borrowers was not identified.

In 20 of the loans, or just about half, the inspector general found "errors and documentation omissions clearly contrary to prudent lending practices."

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