A few of us had been passing this around on e-mail. After hearing about the article in my weekly sales meeting, I decided to be the first one to jump on top of the hand grenade.
From the Arizona Republic’s online arm, azcentral.com:
Mortgage fraud could become a felony punishable by 10 years in prison in Arizona.
A day after the Republic’s special investigation into the cash-back mortgage scheme, Sen. Jay Tibshraeny of Chandler introduced today a bill he’s had in the works. The legislation, Senate bill 1221, would make it easier for prosecutors to go after mortgage fraud in Arizona.
If the bill does what it’s designed to do and if it proves enforceable, it could be a good thing. I must say the timing’s very interesting, coming just a day after the Republic’s so-called “special investigation” into mortgage fraud.
Did the Senator know that article was coming? Did the Republic know the bill was going to be introduced? Did these two related events really occur independently in a vacuum?
Leaving that aside, and also leaving aside the dubious connection that has been made between a bill “that’s been in the works” and the Republic article (the former quote not appearing in today’s print edition lest the newspaper’s consumer-protection angle be lost, let’s examine the special investigation.
According to intrepid real estate reporter Catherine Reagor, the primary fraud being perpetrated is a cash-back scheme: a buyer offers more for a house than its apparent market value and receives that cash back at the end of the transaction.
Such side deals usually take place outside escrow – this isn’t mentioned in the article. And they usually involved written or oral agreements not presented to the underwriter of the loan and not appearing on the HUD-1 – this also isn’t mentioned in the article.
In fact, it’s not until the bottom that the real issue emerges:
There are situations where cash is returned to in a home sale. For example, a real estate agent may return part of their fee to the buyer as part of the contract. But that exchange is explicitly written into the contract. Hiding cash back transactions or in any other way misrepresenting the true value of the home is illegal.
There’s one phrase there that’s troubling – misrepresenting the “true value” of a home.
How do you determine a “true value”? I’d argue there’s no such thing. An appraiser isn’t interested in a home’s true value – they’re hired by a bank to determine if a property has sufficient value to justify the risk in carrying the loan. A real estate agent can look at the neighborhood averages, but this doesn’t give a true value – just a recommended selling price. I’ll accept an argument for replacement value, though many may be surprised to find the values to be different than what would be expected.
In general, the “true value” of a home is the price at which a buyer and seller agree to the transaction. That’s the basic rule in a free-market economy.
As for the basic premise of the article (other than fraud = bad), that homeowners in general and in total are harmed by inflated home valuations due to mortgage fraud, I think it’s a severe stretch intended to find a public hook for a news story.
According to the article, “When home values are inflated …
- Owners can owe more money on their mortgage than their home is worth
- Owners who try to sell their home may find few buyers or sell at a loss (emphasis added)
- Owners who struggle with significant debt may lose their home to foreclosure
- Neighbors lose value on their homes (emphasis added)
I’ll buy the first and third sentences. But the other two are preposterous, unless you’re assuming a significant wave of foreclosures hits one particular neighborhood and drives property values down in that specific area. Ms. Reagor says her experts have identified such neighborhoods. Which ones, we haven’t the slightest idea – the article never says, outside of naming a couple of cities – some fairly large.
If the wave of foreclosures does not hit, then neighbors are not losing value on their properties if neighboring homes sell at inflated prices. Bob sells for more so Jane’s home is worth less? Um, no.
Can inflated prices due to these cash-back schemes be problematic? Absolutely. Can they be any more problematic to the neighbors than the inflated prices being paid in 2005? No. Not without making multiple assumptions.
In 2005, it was becoming common to see appraisal contingencies waived to complete a real estate transaction. If the home didn’t appraise for the agreed sales price and the appraisal contingency had been waived, a buyer had to either come up with the difference between the appraisal value and the sales price or risk losing their earnest deposit. Since the bulk of buyers knew up front the home wouldn’t appraise, they paid the extra cash.
And what did you have at the end of the day? An inflated sales price on the books. Yet unless you were one of the folks who bought during the 2004-05 run, your home value likely remains higher today than it did when you purchased your house. Higher prices lead to higher values – not right, not wrong. Just fact.
In fact, you or one of your neighbors could have inadvertently raised property values in your neighborhood and had an appraisal to back the new price. And it could have been completely legal. How? By asking the seller to contribute to your closing costs and raising the final sales price to offset some of the contribution. Happens every day – and as long as the appraisal comes in, as long as underwriting approves the loan and contribution and as long as everything is shown on the HUD-1 closing statement, it’s completely legal.
Are these values, perhaps inflated by a couple of percent over the neighborhood averages, doing harm to the Phoenix real estate market? It’s highly doubtful.
Sadly, much of the public will read this special investigation and learn very little and, worse yet, won’t know what they don’t know. The public should know some cash-back schemes are illegal and should be avoided. But the article should have stopped there.
Right or wrong, the notion of Phoenix’s real estate market as a house of cards waiting to collapse will continue. Even in my office meeting today, a handful of agents were shaking their bowed heads without any idea of how little substance was contained in the investigation or the leaps of logic taken to provide the most bang for a buck for a Sunday edition.
Entia non sunt multiplicanda praeter necessitatem.
Ockham’s razor says the simplest solution is often the correct solution. When looking for reasons why property values have declined in certain areas, market mechanics would seem like the most logical place to start. Other factors, including mortgage fraud, can have an impact but aren’t likely to be the driving force except on a micro-scale.
Discovery of possible organized mortgage fraud is relevant and should be revealed. But in the rush to turn the article in a print version of a sweeps week exclusive, the driving force of the article was lost. And the real losers (aside from the continuing demise of journalistic standards since those long-ago days when I was a J-school student) are the readers and homeowners who now have a new scapegoat for the current market.