Emerging Fraud Trends: "The Builder Bailout"
Fallout from the shifting real estate and mortgage market includes excess inventories of unsold newly constructed homes. As many begin to feel the pressure to liquidate these inventories to meet the demands of their construction contracts and loan terms, some may employ deceptive practices and fraudulent measures commonly referred to as the builder bailout scheme.
What is builder bailout?
Typical financing of construction costs include drawing on open lines of credit and/or securing construction loans that mature within short-term periods of 12- to 18-months. The builder must arrange new financing or sell a sufficient number of housing units to meet the loan obligations before the loan matures.
If efforts to secure new financing have failed or not enough units have been sold, alternative means of financing the debt need to be explored. In response to this convergence of unsold homes, lenders wanting to be paid off, and the absence of buyers, many may attempt to creatively disguise a fraudulent home sale as a legitimate transaction, colluding with real estate appraisers, mortgage loan brokers, and settlement agents in the perpetration of this type of fraud.
How is builder bailout fraud committed?
Builder bailout schemes are complex and the following scenarios offer some examples:
- Convincing buyers to purchase a property by offering to pay excessive incentives that are undisclosed to the lender. This could include down payment and/or closing cost assistance, or "no money down" promotions.
- Forming one or multiple false corporations that purchase their inventory at inflated market values. The builder finances 100 percent of the closing costs and in some cases gets cash out. Additionally, this shifts the personal liability for repayment of the loans to the corporation, falsely inflates property values throughout the subdivision or project, and falsely promotes the builder's ability to sell inventory.
- Offering secondary purchase financing in order to create a position of "equity" for the borrower (i.e., 80/20 or 80/10/10 loans).
- Forming a mortgage loan origination affiliate that originates fraudulent loans. The loans can contain credit misrepresentation, falsified appraisals and false certificates of completion and occupancy.
- To lure real estate speculators or investors, some may commit to offering property management services, including an agreement to absorb any negative cash flow for an agreed period of time. Once the properties are sold, the fraud perpetrator, having both overstated income potential and understated operating expenses, reneges on its commitment to manage the property.
- When possible speculators/investors are exhausted, the fraud perpetrator may employ straw buyers to purchase the properties.
When does builder bailout occur?
Builder bailouts are common to any distressed real estate market. Markets, saturated by overbuilding, plus an unfavorable housing climate are generally more vulnerable. Builder bailouts can involve whole developments consisting of both completed and partially built homes, or occur when the bulk of inventory is sold but there are still unsold homes remaining.
What are the red flags of a builder bailout scheme?
Remain alert to the following fraud triggers, which may suggest a builder bailout:
- The builder is desperate to sell the property
- The borrower is barely qualified or unqualified
- The sales price and appraisal show signs of inflation
- No money down sales are heavily promoted
- "Silent" second mortgages are involved
- The source of funds is questionable
- Incentives such as buy-down funds appear excessive
- The source of secondary financing on the HUD-1 or purchase contract is unclear or indeterminable
- Parties to the transaction are affiliated, or the transaction does not appear to be an arms length transaction
- Indicators of straw buyer activities
To report incidents of fraud that might affect Freddie Mac or if you have any fraud-related questions, please contact our Fraud Hotline at (800) 4 FRAUD 8.