You Can't Cheat an Honest Man - James Walsh [15]
Second Mortgages and Trust Deeds
In many cases, the zero-down investing strategy is really a funding mechanism for getting money into a Ponzi scheme. Once there, it will often disappear in a flurry of real estate-related transactions. And these will have something to do with second mortgages.
Second mortgages are a shadowy sideline to traditional real estate lending. In many states, they are regulated less carefully than primary loans. And, since traditional lenders shy away from them, second mortgages are often made by non-bank financing companies and entrepreneurial mortgage brokers placing money for people who want higher returns or more secrecy than traditional investments offer.
One FBI special agent puts it bluntly: “There’s a lot of dirty money in the second-mortgage business. Stolen money. Drug money. Mob money. Money from con schemes.”
In 1985, Guy Scarpaci started a mortgage brokerage called U.S. Funding in suburban Boston. The company advertised aggressively that it could get mortgages for anybody, regardless of financial status or credit history.
As a result of the ads, U.S. Funding attracted large numbers of low and moderate income borrowers, people with poor credit or who were otherwise in dire financial straights. In order to sell these loans in the secondary market, U.S. Funding manipulated the records of the motley borrowers to make them appear more creditworthy than they really were.
U.S. Funding also prepared phony appraisals and, in some cases, created phony title histories. As a result, loans were granted based upon the security of properties which the borrower did not own or which were already encumbered.
U.S. Funding often told borrowers and investors that the proceeds of loans would be used to pay off prior indebtedness on the mortgaged property. But the company would divert the money to other uses. As a result of these diversions, U.S. Funding was often in a deficit situation. It had to use the proceeds from later loans to pay off indebtedness associated with earlier borrowers. In effect, U.S. Funding operated as a massive Ponzi scheme.
By the fall of 1989, the company wasn’t able to write enough new second mortgages to keep its pyramid standing. U.S. Funding employees prepared for the inevitable collapse by destroying some of the documents that showed how the company had inflated borrowers’ creditworthiness and properties’ value. But there were so many incriminating documents, they couldn’t destroy them all.
The company collapsed in late 1989. A federal investigation followed.
Beginning in 1991, the U.S. Attorney’s office in Boston reached plea bargains with various former U.S. Funding employees and people related to the company. In the end, they’d diverted more than $10 million through the scheme.
There are several signs that should warn an investor that a second mortgage operation is actually a Ponzi scheme.
First, very high interest rates are always suspect. When standard first mortgages are charging seven to nine percent annual interest, legitimate second mortgages should be charging between 12 and 15 percent. Promised interest earnings of 18 percent or higher could mean the company is in trouble and desperate to attract money.
Second, in most states, mortgage brokers must have a realtor’s license, a special broker’s license or both. An investor should ask to see these licenses and make a call to the government agency that issues them to ask about any complaints made against the broker. If a broker can’t produce the licenses, he or she may be a crook.
Third, legitimate second mortgage brokers will record their loans or trust deeds at the county recorder’s office (or with an equivalent agency). A broker who claims he’s experienced but can’t show any paper trail with the county may be a Ponzi perp.
Fourth, mortgage brokers who lend money without title insurance are immediately suspect. Among other things, title insurance makes sure the owners