Wednesday, August 22, 2007

Fudging - aka - Lying

n. fudge
· A soft rich candy made of sugar, milk, butter, and flavoring.
· Nonsense; humbug.

v. fudged, fudging, fudges
· To fake or falsify: fudge casualty figures.
· To evade (an issue, for example); dodge.
· To act in an indecisive manner: always fudged on the important questions.
· To go beyond the proper limits of something: fudged on the building code requirements.
· To act dishonestly; cheat.

I could tell a story or two about fudge (not the candy) of the mortgage fraud variety of which I have some fairly detailed knowledge. If I did tell some of these stories in their entirety, I am certain I would get into some sort of litigious situation.

In the effort to stay away from lawyers and out of trouble with my employer I will tell you about some scenarios of which I have no personal knowledge, do not involve anyone I know directly and I cannot verify the facts. I can say with certainty that I do not doubt the truthfulness of these scenarios based on my experience. These scenarios come to me from people I know in the financial planning business who do not work for the same institution as me.

As an aside, it is utterly ignorant to suggest that we do not have significant mortgage fraud in Canada, especially in the overpriced markets of the Lower Mainland and Vancouver Island where I may suggest a vast number of approved mortgages are of the ‘fudge’ type.

1) Mortgage Fraud Type 1 – Income Magnification
a. The most blatant form of income magnification strategies that mortgage brokers use is complete fabrication of employment. I have heard of situations in which the applicant tells the mortgage broker – “I work part time as a clerk at a local store and I make $n per month.” The mortgage broker hears – “I own a small company which I work in 6 days a week and collect a salary of $n x 5 per month.” The mortgage is approved under the false pretense of the income being many times larger and more secure than it really is.
b. The more subtle form of income magnification works like this. Mortgage broker is consulting an applicant who does not qualify for the mortgage he wants. Mortgage broker suggests that he install a suite in the home or have foreign home-stay students to increase his qualifying income by $800 per month. The income does not exist and may never exist but the applicant receives the mortgage based on the inflated ‘expected’ income.

2) Mortgage Fraud Type 2 – Disappearing Debts
a. We live in a debt ridden society and consequently many people struggle just to make the minimum payments on their credit cards and lines of credit. People buy trucks, cars, appliances, and home décor on payment plans which all combined can add up to a significant amount of debt with severe restrictions on monthly cash-flow. Mortgage brokers often ignore debts on mortgage applications or move the debts around to make them appear as if they have been paid off so that the mortgage applicant can be approved under the Gross Debt Service Ratios that the lender uses to determine suitability.

3) Mortgage Fraud Type 3 – Anomalous Assets
a. In the heady days of unprecedented real estate appreciation it seems as if an individual can get through life without ever saving a penny in a RRSP account, company savings plan, or just a plain old savings account. After all can’t we all just count on our houses appreciating into infinity providing us with a life of luxury and leisure? Back in the stodgy world of mortgage lending, it still seems as if lenders would like to see that mortgage applicants have assets to prove that they are reputable with a net worth that is more than zero! Mortgage brokers often overestimate what an “asset” is worth, whether it is a vehicle, RRSP account, personal items or an ownership stake in a company to inflate an applicant’s net worth.
b. A variant of the anomalous asset is the Divine Down-Payment or the down-payment that just appeared out of seemingly thin air. This is typically related to parents “helping” their children with a down-payment on a first home.


Inwonderment said...

was wondering if any one has seen the work of an Australian women named Sheila Newman. She has written a number of interesting articles on "What and Who is Driving Population Growth in Australin", "Future Settings" as well as thesis comparing Australian and French housing policy with respect to population growth. "Future Settings" examines population growth and housing in the period after what is deemed the petroleum interval.
"What and Who is Driving Population Growth in Australia" also connects the dots between lobbist, the development community, the push for more immigration, and the high cost of housing in Australian cities.

I think it goes to prove that this whole mess was engineered for short term economic growth that in the long run is going to hurt our economy and many people.

AndrewJ said...

Does having substantial other assets like RRSPs increasing the amount lenders are willing to lend you?

freako said...

Great post. I think you may be first to "formally" adress this important topic ANYWHERE.

I have seen it repeated ad nauseum in the MSM that we don't have sub-prime, exotic mortgages etc in Canada.

By definition we probably don't. And in most of Canada, things are probably as they have always been. But in Vancouver it doesn't add up.

I don't care if you are bear or bull, it is an all our interest to know the true state of the situation.

The proof is in the pudding. The pudding in this case is defaults. If anybody has any recent stats, I'd love to hear them. My guess is that they are very low. Most likely people are making their payments. A couple of questions though:

What happens in Canada when borrower falls one payment behind? Or two? At which point would the lender take action?

Obviously the more recent buyers will be most at risk, but as we have seen in the U.S., many defaulting borrowers actually bought early in the boom. The first wave of defaults will be involuntary due to inability to make payments. Later waves may occur if prices fall and borrowers make a calculated decision to walk away from negative equity.

Patiently Waiting said...

Awesome post. I've seen some of this, especially the Divine Downpayments.


On the HBB, I've noticed that some of the first mass defaults were in Michigan and Ohio. States where there has been years of economic decline and real estate should have gone down instead of going up at all. This makes me think there may also be funny lending in places like St. John NB and Windsor ON, thus a possible high risk of many defaults.

mohican said...

rentingsucks: mortgage underwriters use assets and liabilities to judge an applicant's ability to pay and the overall financial stability of the person.

freako: thanks - I have searched high and low for good information on the Canadian mortgage market but without much success - especially regarding the default question.

I would not expect the same level of default / foreclosure that we see in the US for one reason - we don't have too many 'teaser rate' mortgages. There are some to be sure but not anywhere close to the level of the US. Where I see Canada having a high level of foreclosures is if wages are stagnant, there is substantial job loss or underemployment.

In Vancouver and other high priced markets I think we could see a lot of flipper foreclosures once the cash available to subsidize renters dries up and the flipper is unable to sell. Even if prices went down 5% I would guess that many would walk away from the negative equity position because, with 100% financing, they have nothing to lose.

freako said...

we don't have too many 'teaser rate' mortgages.

True enough but my null hypothesis is that our affordability is WORSE than even their post-teaser rate. I'd love to prove or disprove this hypothesis.

Many of us who called bubble two or three years ago have been derided (one of these years you will be right blah blah blah) by the usual gang of uncritical cheerleaders. Basically the missing piece was that traditional affordability constraints MUST have been tossed out. Subprime by any other name.

To early to tell, but maybe I was "wrong" for the wrong reason.

freako said...

But if my null hypothesis is correct, where are the foreclosures? In the pipeline?

Fencesitter said...

What happens during a foreclosure, and what is the recourse following? I've heard talk about people "walking away" from their house, and it makes it sounds as if they are then free and clear.

Do you not need to go through personal bankruptcy before the debt is discharged? Can someone provide some insight, or perhaps this is better as a new topic?

freako said...

.Do you not need to go through personal bankruptcy before the debt is discharged?

AFAIK yes.

AndrewJ said...

I have one more data point. Another friend looking for a loan said the banker told him they would allow a gross income percentage in the low forties.

The difference between this and the other case I mentioned previously is that the downpayment would have been 5 percent, no RRSPs, some credit card and student loan debt. Also they would allow 50 percent rental income but you would have to have a signed lease. (Logistics of this seem weird how would you have a signed lease before you actually bought a home.)

When I talked to a mortgatge broker 3 years ago 32 percent of gross income was a hard limit (I maybe had 15 percent down at the time) and rental income was 1/3. So I think the standards have definitely loosened up.

The big question I have is why would the banks do this? What is their motivation? Why now and not 3 years ago? Did we confirm that all loans made by the bank even if the aren't explicitly insured are going to be funded by the taxpayer? Even so if this was always the case why now and not previously? Something just doesn't seem kosher.

AndrewJ said...

When I said funded by the taxpayer above I meant in the case of default are taxpayers on the hook.

freako said...

When I talked to a mortgatge broker 3 years ago 32 percent of gross income was a hard limit (I maybe had 15 percent down at the time) and rental income was 1/3.

Ok, more questions. Was this "hard limit" voluntarily imposed, and then gradually crept up? Or did a rule change somewhere?

What exactly did the 32 percent come from? CMHC requirements? Or just convention?

And what is the cut-off today? Is there one?

AndrewJ said...

When I say hard limit it was that the mortgage broker qualified me for X and no more which was essentially 32 percent. This is the limit they use in how much can I afford mortgage calculators like the TD Bank one here:

Enter in any numbers and you will see that essentially your maximum mortgage payement is .32 gross monthly income - property tax - heating.

It is also CHMC requirement for them to insure the loan. So I could understand for non CMHC loans that banks would bend the rules a bit but my above exmaple would be a CMHC insured loan. So I'm not sure what gives.

Here is the CMHC requirements from their website which mentions the 32 percent requirement although I notice it says "shouldn't" which seems a little softer than my impression.

AndrewJ said...

I see what they've done. They have always had two affordability limits. One was for .32 what your mortgage should be and the other was .4 for what your total debt servicing ratio should be. Now they are letting the mortgage bleed up to the .4.

Although in my example above my friend had debt and they said low forties so there is still something going on.

freako said...

When I say hard limit it was that the mortgage broker qualified me for X and no more which was essentially 32 percent

Yes, all references have this as a "rule of thumb." But clearly we now go beyond. Why on earth would a lender accept a higher GDSR only when prices are up (and the risk is higher)?

It is also CHMC requirement for them to insure the loan. So I could understand for non CMHC loans that banks would bend the rules a bit but my above exmaple would be a CMHC insured loan.

Ok, so for CMHC insured loans, the 32% GDSR must be followed? I can't see how that is possible. I presume this is where the fudging comes in. But still, I find it very unlikely that we would have the sales volume we do if the 32% was followed.

Roberto said...

The big question I have is why would the banks do this? What is their motivation? Why now and not 3 years ago? Did we confirm that all loans made by the bank even if the aren't explicitly insured are going to be funded by the taxpayer? Even so if this was always the case why now and not previously?

3 years ago there weren't six or seven years of continuous 15-25% annual house price increases behind them. They're extrapolating, just like the buyers.

freako said...

Ok, wiseman & fun&mental posted on REtalks and shed some light on the situation.

Quote from F&M's post:

several months ago, the insurance companies (CMHC and genworth) decided to lighten up the qualifying guidelines based on credit.

now if you have a credit score of a certain amount, they will waive the gds requirement and let you go to a total of 44/44
for those whose credit scores don't meet that standard they raised the qualifying levels to 35/42
0 down mortgages are still qualified under the old guidelines at CMHC, they only go 32/40
although genworth will go 40/40

He thinks the relaxed CMHC requirements are due to competetion from Genworth. That makes no sense to me. CMHC's mandate is not to be competitive, but to ensure access to affordable housing by guaranteeing mortgages. If the private sector undercuts them, well who cares?

On the topic of fraud, he had the following to say:

i've worked on many applications where i could not get the financing approved, only to lose the deal to the royal bank who magically got the mortgage approved at cmhc.
is there fraud happening out there? both at the branch level and thru brokers? absolutely. i have no idea how much, but i know in 8 years that i've been doing this i've been approached many times. sometimes by realtors, sometimes by clients, sometimes by financial advisors.

As for conventional mortgages, from what I gather, the banks set their own standards and are on the hook unless sold into the NHA MBS pool.

Did I get this right?

fun and mental said...

ok so i finally made a google account.

i think it's competition between the 2 insurers because before genworth came along there was 0 changes in lending and insurance guidelines for many years. since genworth entered the market several years ago we've seen many significant changes.

new products, especially those aimed at the self-employed, 0 down, hi ratio rentals,
cheaper insurance premiums
relaxed qualification guidelines

i don't believe we would have seen so much so quickly if it was just cmhc doing the insuring. to me that is competition.

does it make sense? not really, if the private sector wants to be in the insurance game and it's profitable, and now aig is entering maybe we don't need government intervention.

but any time you have a large government body, you have budgets and mandates and people who want to keep their jobs.

cmhc does a lot of things other than mortgage insurance.
anyways, it may not make sense, but i believe it is the case.

as far as fraud goes, i don't really have too much to say. there are bad apples in every industry, and any time big money is on the line, you're going to have people cheating and cutting corners to try and take their share.
one point that i was trying to make was that the term mortgage broker was being used a little too frequently for my liking, since brokers only originate something like 30-33% of mortgages in canada.
as i said at ret, i'm blessed with an excellent client and referral base, really quality people, i don't get very many shady types sent my way, but i know it's happening out there.
there's lots of fraud type stories that i could tell, but have to get on with my work.

as far as conventional lending goes, you've got it. big lenders like td and rbc have lots of funds to lend and don't have to sell mortgages into the market, they can set their own guidelines.
other lenders may only have securitized funds, and they may have to follow insurance guidelines even if someone was putting 80% down.

i'll try to write more when i have time, especially if mortgage questions come up.

AndrewJ said...

Well no wonder sales are up and there is a draw down in inventory. So on top of allowing people with good credit to borrow up to 44 percent of their gross income they fudge on top of that.

This sucks. The bubble was deflating until they did this. They're all a bunch of bastards as far as I'm concerned.

It might take longer for the bubble to pop but it is going to be so much worse. How long do you think this will prolong the bubble? I'd say at least a couple years unless we get hit but the US Tsunami.

Shouldn't this be front page news?