by John R. Erdmann
There is much talk within the mortgage industry these days about the need to cut costs and speed up loan closings. Many believe that soon the typical loan origination will be shortened from 30-45 days to just five days or less.
With these advances, loan underwriting will change dramatically. Automated systems will replace human judgment in the handling of loan applications.
The obvious risk attending these changes is that greater opportunities will be created for fraud and circumvention of lender requirements.
We in the title industry, who perform closings or escrows, and who search and insure land titles, have a great opportunity to improve our level of service to the mortgage industry, and provide greater benefit to customers as a whole, by redoubling our efforts to detect and prevent fraud in real estate transactions.
The following article is derived from a course prepared for the New Jersey Land Title Association by First American's in-house counsel, John Erdmann.
New Jersey real estate closings are customarily conducted by attorneys and independent closing agents, who, for the purposes of this article, will be collectively referred to as "closers."
In the past several years administering claims for First American I have seen some recurring patterns in fraud cases. Most fraudulent schemes and forgeries are perpetrated by amateurs who either have not thought through the entire plan or are counting on you not asking that one question that unravels the scam. Here are some"red flag" situations to watch for.
Forgery
Forgery is still a big problem and is one of the "basic risks" typically covered by title insurance. We all rely on documents we find in the public records, and we rely on notaries to determine the identity of persons executing documents when we make a determination as to a document's validity.
Unfortunately, people who sign their mom's name to that note to the teacher sometimes grow up and learn to solve other problems the same way. These people rely upon us not to check for identification when we acknowledge their signature. They assume we will not compare the signature on various prior documents of record to the signature that is being presented on the document before us. We need to know better.
"Knowing Better" Rule Number One: Always ask for positive identification when you acknowledge signatures. It is also a good idea to photocopy the identification presented for your file. Every excuse you get explaining why they do not have identification is a red flag. These people are buying a home and/or borrowing a lot of money. They must have identification.
I know of one refinance closing that was complete except for handing over checks when the settlement agent said "Oh, I almost forgot, the bank wants me to get photocopies of your driver's licenses." The woman at the closing said "I left my bag in the car; I'll go and get it." Her male companion waited a minute or so and excused himself to use the rest room. Neither of them ever returned, and we learned later that the woman was an imposter posing as the man's wife.
Rule Number Two: An important document that has been notarized elsewhere, not at your closing, is always suspect. Add two more red flags if the document is purportedly executed by a spouse, parent or business partner. Add five red flags if it is a release or mortgage discharge.
If the absent person is unable to come to the closing there may be a very legitimate reason. However, you can verify by phone with the notary or the person who signed the document that the document is genuine and they approve of the transaction. You may get some resistance from the parties, and if you do, you can bring your underwriter in to back you up while you check the document's authenticity. Remember, any strong resistance you may get for wanting to check the document is also a red flag.
It's always good practice to instruct your searchers to obtain photocopies of the signature pages of the back mortgages and deeds in the chain. You will then have a reliable handwriting sample to compare with the signature on the deed or power of attorney in front of you. Contrary to popular belief, most forgeries are very obvious. In almost every forgery case I have seen, the signatures are not even close. I even have a case where, according to our expert, the husband had three different "wives" sign three different mortgages, leaving his real wife home with no knowledge of any of them. Each imposter had a different handwriting style.
And never be reluctant to ask questions when a party misspells his or her own name.
Rule Number Three: No one owns a home or property "free and clear." Only people who have hit the lottery or lived through the Depression own their homes free and clear. If you get a title report or you search the record and it shows no current mortgage on the property, check it again, you probably missed it or it's mis-indexed. If upon rechecking, the record still comes up clear, look at the releases or discharges on the prior mortgages. Any atypical form of release should raise two red flags.
When in doubt, call the bank or mortgage company and verify that the mortgage has been paid and released. If all else fails, ask the property owner about the past mortgage. The owner just might tell you about it, or you might hear a story about the Great Depression...or that great night at the track.
Control of Closing and "the Gap"
The time gap between the day that a document is presented to the clerk for recording, and the day it is indexed in such a way that a title searcher can find it, is a problem that varies with the efficiency of the different county recording offices. Even the best system in New Jersey takes several days, and more than a few leave us blind for several weeks.
Too many real estate scam artists know all about the gap. They know that by carefully timing their closings they can mortgage the property two or more times, promising each lender the same priority. Still others may time their mortgages to get their equity out of the property just before a tax lien or judgment lien is recorded against them.
"Knowing Better" Rule Number Four: If you are the designated closer it is important that you, and only you, control all critical aspects of the closing.
As discussed above, this means that you notarize all important signatures or at least verify the genuineness of signatures with great care.
This also means that you control the recording of documents and the payoff of liens or encumbrances being satisfied and cleared of record. Be wary of the customer who offers to deliver original documents for recording. My all-time favorite story is of the borrower who was entrusted with an original partial release, releasing a blanket mortgage as to just one of his properties. By the time he delivered it to the county recorder's office the "partial" release had been altered to include eighteen additional properties. And by the time this scam was discovered the properties involved were over-encumbered by more than one million dollars.
Likewise it is essential to control payoffs. Be wary of the customer who asks to receive loan proceeds earmarked to pay off prior debt, based solely on the borrower's word that the debt will be cleared in the near future from proceeds of some future deal, or by virtue of some side agreement with the prior lender. It ain't gonna happen. You will be hung by rope made up of all the red flags you ignored. Truthfully, title company executives have been sentenced to prison for such things.
Fraudulent Affidavits of Title
Probably the most common form of fraud in our industry involves fraudulent affidavits of title, especially when the affiant has been asked to state that certain judgments turned up in a search are not against him but against persons with similar names. I have often said that such affidavits should be stored on rolls mounted in the stalls of rest rooms.
Once a money judgment is entered in court it may be perfected, under state law, to create a lien against all real property owned by the judgment debtor within the covered jurisdiction.
When a search turns up judgment liens filed against names similar or identical to the name of your customer, the title insurance we are asked to provide must include exceptions for such liens unless it can be shown, by reliable evidence, that the liens do not attach to covered property because they are against some person other than the owner with whom we are dealing.
Too many closers seem to believe that a reasonable solution to the problem of suspected judgment liens is to merely obtain the affidavit of their customer, swearing that he or she is not the person against whom the liens were filed. With this affidavit in hand the attorney or agent may then close and issue title insurance without any exception for the suspect liens. This is not good practice.
Rule Number Five: Take the time to examine judgment liens and court records to see what additional information is supplied about the judgment debtor (i.e., addresses, name of spouse, social security number, businesses operated). Then make an informed judgment as to which liens may be ignored based on an affidavit only.
And, of course, the same rule applies to tax liens.
Partnerships, Limited Partnerships and Corporations
The claim files of every title underwriter are full of cases involving double-dealing partners and corporate officers. The typical problem is that partnership or corporate property is mortgaged and loan proceeds have been used for the rogue partner's or officer's personal benefit. This is frequently claimed to be "unauthorized borrowing" which renders the mortgage vulnerable to being set aside.
Rule Number Six: Be very careful in matters involving individual authority to act on behalf of a business entity; do not turn a blind eye to what is being mortgaged, who it benefits, and where the money really goes.
Artificial Inflation of Property Value
This scam has been around for a long time. Two, three or more parties get together and "create" one or more transactions between them which appear of record to be arms-length transactions but in fact are not. In each transaction they inflate the purchase price to misrepresent the true value of the property. They pay the proper transfer tax and title is properly transferred in each case. There is nothing wrong with the title to the property.
Our conspirators now look either for a lender to loan them more than the actual value of the property based on its artificially inflated value, or they find some poor soul to purchase the property at the inflated value, or both. A key aspect of this plan involves the appraisal of the property by the lender's appraiser. The appraiser is either in on the plan or the conspirators rely on the fact that some appraisers may not do a thorough investigation of the property and the market when they prepare their report. These appraisers make the mistake of assuming that the prior transactions were arms-length and legitimate and they give improper weight to the artificially inflated "sales" price. Then one of our conspirators goes to the final closing, signs all the documents, takes the money and runs.
These are sometimes referred to as "straw man" or "land flip" transactions.
Where is the title insurance connection? There is none. The deeds and mortgages are perfectly good. The problem is that the lender has loaned, say $180,000, secured by a property that in a good market may be only worth $100,000. Probably sooner rather than later the loan will be in default and the lender must recognize a big loss. If there is a downturn in real estate values, as we have seen in parts of New Jersey in recent years, it gets even worse.
Obviously, neither a closer nor a title underwriter should be considered responsible for problems with value or condition of a property involved in a transaction. Still, in recent years, lenders faced with major fraud losses have asserted claims, particularly targeting closers, based on allegations that the closer "knew or should have known" of fraudulent conspiracy.
I believe the majority of such claims I have seen were absolutely unfounded. Still, the pattern of these frauds presents reality to which we should adapt.
"Knowing Better" Rule Number Seven: Avoid closing transactions where there appears to be fraud directed against a party, or where there appears to be a material misunderstanding between the parties. If an apparent misunderstanding can't be resolved before closing, watch out!
Unqualified Borrowers
A commonly seen lender requirement in closing instructions is that the buyer or borrower bring cash to the closing, as a down payment or to help refinance existing debt.
While loan underwriting guidelines may differ between lenders, and in some cases this requirement may be more important to one loan than to another, such requirements should never be taken lightly at closing.
Sometimes the parties will, usually at the last moment, try to circumvent this requirement by claiming that a payment has been made outside closing, or by substituting some other form of consideration instead of cash. For example, a seller may agree to take a second mortgage instead of a cash down payment, or a seller may agree to accept precious gems with a stipulated value. Of course, the parties expect the closer to prepare the settlement statement for delivery to the lender indicating cash rather than the substituted consideration.
Closers should be wary of such requests, even where the loan officer appears to go along. If the lender later has to foreclose and suffers a loss, in hindsight it may be claimed that the closer's failure to comply with this lender requirement and/or to provide an accurate settlement statement was the cause for the loan closing with an unqualified borrower.
Rule Number Eight: Do your best to comply with lender requirements, as you should do with all closing instructions. Do not knowingly issue a settlement statement that misrepresents the source, nature or value of consideration handled by the closer.
Whenever it may be considered appropriate to include in the settlement statement consideration paid outside closing, the item should be clearly identified as "paid outside closing" or "p.o.c." and identities of parties representing the value of such consideration should be clearly stated on the settlement statement form. Note that HUD has special rules under the Real Estate Settlement Procedures Act (RESPA) and Regulation X for reporting and certification of "p.o.c." items. (See 24 C.F.R. §3500, Appendix A, and HUD Mortgagee Letter 91-9, dated February 11, 1991.)
Conclusion
As title professionals, we have a tremendous amount of knowledge and experience to be applied to every transaction. Trust your instincts. If something seems a little odd, look into it. When in doubt, take a few extra minutes and get a second opinion. Cultivate a good working relationship with your underwriter, and learn to use the underwriter's resources of knowledge and experience as effectively as you use your own.
John R. Erdmann is Assistant Vice President, Associate Regional Counsel; Iselin, New Jersey.
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