Mortgage woes could be 'tip of the iceberg'

The majority of mortgage professionals that American homebuyers deal with are honest, decent people. But a relatively small group of bad actors has unleashed a wave of fraud and predatory lending over the past several years that threatens to ripple through the wider mortgage market, deepen the ongoing housing slump and crush the finances of countless borrowers who were victims of schemes and abusive practices that have cost them their homes — and their shot at the American dream.

The federal Truth In Lending Act, passed by Congress in 1968 to protect consumers, requires clear disclosure of all terms and costs in lending transactions. That means it’s against the law for a mortgage broker to misrepresent or fail to fully explain all the risks of a new loan — even the risk that interest rates may go up, according to David Berg, a Texas trial lawyer.

“Any promises made, fraudulently, knowing they’re not true, that cause the buyer, the mortgagee, to rely on to their financial detriment is a fraud,” he said. “It can be prosecuted on the state or federal level. But it is a fraud.”

Berg, who says he is getting calls from subprime borrowers who say they were duped, is gearing up to commit “a great deal of our resources” for what he believes “is going to occupy a large portion of our practice.”

“The reliance on false statements is there,” he said. “I think these are good lawsuits and good criminal cases.”

As prosecutors, regulators and Congress begin to unravel the problem, it’s not clear just how widely such lending abuses spread during the height of the housing boom. Because mortgage brokers are regulated state by state, there are no federal statistics on fraud and abusive practice in the mortgage industry. But the number of so-called suspicious activity reports related to mortgage fraud, filed by banks and other lending institutions, more than doubled between 2004 and 2006, according to the FBI, which investigates a variety of financial crimes.

The closest thing to a “mortgage police” is the Inspector General’s Office at the U.S. Department of Housing and Urban Development, where some 650 investigators and auditors are chasing down mortgage fraud and predatory lending cases. In the past three years, they‘ve conducted 190 audits of lenders and brokers, brought 1,350 indictments and won $1.3 billion in court-ordered restitution orders. But it’s not yet clear whether they’ve gotten to the bottom of the problem, according to Kenneth Donohue, who heads the office.

“You almost have to have a crystal ball,” he told MSNBC.com. “Are we looking at the tip of the iceberg or the iceberg itself? It’s too soon to say.”

Rising foreclosures
For many subprime borrowers, the nightmare is only beginning.

In February alone, some 131,000 foreclosure filings were recorded by RealtyTrac, a Web site that compiles default notices, auction sales and bank repossessions. For all of 2006, the site logged more than 1.2 million foreclosure filings nationwide — or one in every 92 U.S. households, up 42 percent from 2005.

“Based on our numbers for the first two months of 2007, foreclosure activity is running at a rate that would project to a 33 percent increase over 2006,” RealtyTrac’s CEO James J. Saccacio, said in a news release last month. "It appears that as subprime and FHA loans default at higher-than-anticipated rates, and lenders tighten their underwriting standards, we’re going to continue to see a spike in the number of homeowners facing foreclosure.”

These statistics represent the end of a process that is costing many borrowers their homes. A rise in delinquency rates — the number of borrowers who are falling behind in their payments — is a harbinger of more foreclosures to come. From a low in 2005, the mortgage delinquency rate has been climbing steadily and is expected to continue to rise through 2007, according to CreditForecast.com, a joint venture of moodys.com and credit agency Equifax.

And another wave of delinquencies looms, thanks to a newer family of adjustable-rate mortgage products that include “reset” clauses that can raise payments every month, depending on current market rates, and quickly bust a family’s budget. Between the beginning of this year and the summer of 2008, some $650 billion worth of U.S. mortgages — or about 8 percent of the total outstanding — face their first payment reset, according to moody’s.com.

Not all so-called “subprime” borrowers now facing financial problems have bad credit — or at least they didn’t when they originally applied for a loan. In fact, “there is a surprisingly large share of subprime borrowers with FICO scores above 720 (a level consistent with a good credit,)” Fannie Mae chief economist David Berson wrote in a recent commentary.

“What I’m looking at very closely at my firm is the idea of misdirecting a trusting individual toward loans that they don’t need,” said Berg, the Texas lawyer. “I worry about young people who’ve gotten themselves into these adjustable-rate mortgages that are going to be reloaded now at a price they can’t afford. A difference of two points can kill a family’s economics.”