How a liar gets caught


A while ago I wrote an article about what happens to a mortgage after you sign the papers. Read the article if you really want to know, but the cliffnotes version is that your mortgage gets bundled up with hundreds or thousands like it, and then sold to an investor (like a pension fund, or an asset management company). My new job in London actually involves helping banks make financial packages like this.

The sale of your mortgage not only gives the bank more money with which make another loan, but it also moves the risk of default and foreclosure to the investors. In other words, when people fail to make their payments, it's the investors, not the banks, who lose money (this isn't entirely true, but it's close enough and the truth would be a whole different article on the structure of mortgage-backed securities).

So investors know that when they buy a mortgage investment, there is a chance that they could lose money. They (and the banks) then hire PhD's in the fields of statistics to figure out how many people in each investment will foreclose. It's kinda like the national elections when we know who won the state of California, and by what percentage, even though only 5% of the votes have been counted.

These calculations are based on very specific things, ranging from income levels to credit scores to occupation (uh-huh... remember when that mortgage application asked if it was going to be your primary residence?). When the facts are right these investors are spot-on and they end up getting the return they were looking for and everyone goes home happy. But what happens when you lie on your loan application?

If the loan was fraudulent (using fake income numbers, etc.) then the investors (remember that the money being invested is usually someone's pension, or someone else's college fund) get screwed. There's a great article on CNN.com about a new industry being founded, which exists to analyze bad loans and discover if they were fraudulent.

The result is that banks are going to soon be under attack for the thousands of "liar loans" that they issued. Liar loans are already discounted at sale due to a statisically higher risk of default, but if an investigator can determine that fraud was involved (such as people falsely claiming that the house was "owner occupied", or grossly inflating income) they can push the loss back on the bank. And the bank, with the new evidence of fraud, has the ability to then pursue the borrower.

Casey Serin (someone you are probably sick of hearing about if you read any blogs about housing) is a prime example of someone who fit all of the "fraud" requirements. He lied about occupation, he lied about income and he bought multiple houses at the same time so that
the lenders wouldn't be aware of each other.

By law, if they had evidence, the banks could foreclose on Casey properties, and then sue him for any losses they took, since those losses were the result of fraudulent behaviour. The good news for Casey is that they are unlikely to pursue him. He's so deep in debt that there's nothing for the banks to go after.

But liar loans are everywhere. A wide spectrum of the population, ranging from the investor who wanted just a little bit more than he could chew, to the couple who wanted a house just a little bit bigger for their family. What do you do if you wake up one morning with the guilt (and fear) of being in a fraudulent loan? The market was going crazy and you just had to get in, and you just fudged the data a bit to make it possible.

The official advice is to gather up all of your paperwork and turn yourself in to the attorney general in your state. But no one is going to do that.

The next best thing is to re-finance or sell. Doing either will pay off your fradulent loan in full and give you a fresh start with an honest loan. Your new loan probably will have a higher rate than your old one, and your monthly payment will likely go up. But that's only fair since you payments were illegally low to begin with. Does that make everything better and your fraud go away? Of course not, it's like stealing something, but feeling guilty and returning it before anyone notices. Just like the theft, your odds of discovery will probably drop significantly by doing this, but you are still liable for your past actions.

Oh, and from now on, fill out your mortgage application honestly. The peace of mind you will get will greatly outweigh the slight loss in cashflow.

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