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October 09, 2001
Property Flipping Robs Homeowners of Money and Credit
    by Mark Thomsen

Community non-profit organizations, private companies, government officials and others cooperate to help victims of a complex predatory lending scheme in Minneapolis (part one of a two-part article).

It is a money-making scheme that seems almost too sophisticated to work. Buy a dilapidated property at a low price, dupe an unsophisticated buyer and a sub-prime mortgage lender with a fraudulent appraisal, and sell the house at a handsome profit in a short time. Not only that, but have a second mortgage put on the house to retain control and possibly take the house away from the buyer in the future.

Not possible? It is estimated that more than 500 families were affected by such a property flipping scam in the Twin Cities area of Minneapolis and St. Paul, Minnesota between 1995 and 1998. Property flipping is illegal if it is based on falsified documents.

The Family Housing Fund (FHF), a non-profit that seeks to preserve and expand quality affordable housing in Minneapolis and St. Paul, was one of the first organizations to identify the property flipping scheme. To deal with the various problems associated with the scam, FHF developed a multifaceted solution.

In the fall of 1999 it convened the Property Flipping Task Force, a network of organizations that have been working together on the family, community, financial and legal impacts associated with the scam. The Task Force comprises 35 organizations and individuals, including state congress members, city government officials, federal government organizations, private companies, and local non-profits.

"Property flipping has been devastating to families and neighborhoods in Minneapolis," said Task Force Chair and Minneapolis City Council President Jackie Cherryhomes. "The members of the Property Flipping Task Force need to be commended for their efforts to halt property flipping and help stabilize its victims."

Here is how a property flipping scam typically works. A middleman finds a house for sale with an estimated market value of, say, $50,000. The house may be dilapidated, but it is located in a neighborhood that is geographically close to an area where the property values are higher. Either through deceit or collaboration with an appraiser, the middleman obtains a fraudulent appraisal that inflates the house's value to $100,000.

The middleman then finds a buyer, often by directly approaching him or her in church or in a homeless shelter. The middleman helps the buyer apply for a $70,000 mortgage, which is 70 percent of the value of the house. The middleman says he will make a "carryback," or second mortgage to the buyer to cover the other $30,000.

The first mortgage application is made to a sub-prime lender, knowing that the lender is located hundreds or thousands of miles away. Because nearby properties have higher market values, the fraudulent appraisal appears legitimate to the lender.

The lender approves a variable rate loan with high caps or no caps at all. The middleman pays the closing costs, telling the buyer that he or she can use the money saved to repair or redecorate the house. The middleman makes the second mortgage with the buyer and records a second lien on the house, often without the buyer's knowledge. The middleman assures the buyer that the second mortgage does not have to be paid until the buyer sells the house in the future.

There are two mortgage closings; the seller of the house gets the $50,000 market price and the middleman gets an easy $20,000. The buyer, on the other hand, gets an overvalued property in bad condition with two liens on it, and monthly mortgage payments that are rapidly increasing.

Once state and local authorities became aware of the scam, they were swift in apprehending the perpetrators. Task Force participants have helped authorities carry out their duties by passing on information about individual victims.

Because the scam involved property liens, lawyers have been required to address legal issues. The Task Force has been fortunate to receive pro bono services from the Volunteer Lawyers Network and Faegre & Benson, a local firm. The attorneys have been working diligently to remove the bogus second mortgages.

Since last fall, the Task Force has worked directly with nearly 200 families. One of its major roles has been coordinating counseling sessions and workshops for many of the victims on such subjects as budgeting, developing financial goals, and life issues that can affect home ownership.

Autumn Lubin, who has been one of the chief coordinators of the Task Force on behalf of FHF, attributes much of the Task Force's success to the participating organizations and their willingness "to do what was needed to be done."

"All of the organizations were asked to participate in ways that are generally outside their normal business practices," said Ms. Lubin. "Nevertheless, they made the necessary accommodations to ensure that families who were so badly robbed of equity, trust and pride would be able to rebound and regain their lives and the stability that home ownership represents."

Given the staggering cost of undoing the property flip transactions, the Task Force is beginning to address the issue of prevention. A consumer education campaign designed to warn potential and current homeowners about predatory lending is being developed. The Task Force is also considering legislative and regulatory responses that might help combat predatory lending.

Tomorrow's article details how investment-grade securities have been created in helping some of the victims of the property flipping scheme.


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