Mortgage Fraud By Investors Surprisingly Common

Greater number could create future issues with housing affordability

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Mortgage Fraud By Investors Surprisingly Common

Associate Professor of Economics

Mortgage Fraud is surprisingly common among real estate investors.

That is the conclusion of a recent Philadelphia Fed working paper by Ronel Elul, Aaron Payne, and Sebastian Tilson. The fraud is that investors are buying properties to flip or rent out but claim they are buying them to live there in order to get cheaper mortgages:

We identify occupancy fraud — borrowers who misrepresent their occupancy status as owner-occupants rather than investors — in residential mortgage originations. Unlike previous work, we show that fraud was prevalent in originations not just during the housing bubble, but also persists through more recent times. We also demonstrate that fraud is broad-based and appears in government-sponsored enterprise and bank portfolio loans, not just in private securitization; these fraudulent borrowers make up one-third of the effective investor population. Occupancy fraud allows riskier borrowers to obtain credit at lower interest rates.

One-third of all investors is a lot of fraud! The flip side of this is that real estate investors are much more prevalent than the official data says:

We argue that the fraudulent purchasers that we identify are very likely to be investors and that accounting for fraud increases the size of the effective investor population by nearly 50 percent.

Potential Huge Problem

Many people blame investors for making housing unaffordable for regular people. Economists tend to disagree, and one of our arguments has been to point out that investors are still a small fraction of home buyers. However, official statistics recently showed the investor share is over 25% (though dropping fast), and apparently, that may still be an understatement. If investors are a problem, there are enough of them to be a big problem.

Of course, there are other reasons economists aren’t so concerned about real estate investors. One is that they can provide the valuable service of renting out homes to people who couldn’t qualify for a mortgage themselves (especially after 2010, when Dodd-Frank made it difficult for people without great credit to qualify). Another is that many investors seem to be surprisingly bad at flipping homes for higher prices. The panic over “ibuyers” that would buy houses sight unseen based on algorithms abated when it turned out those those companies lost a ton of money, saw their stock prices plunge, and gave up.

If investors are a problem, there are

enough of them to be a big problem.

The mortgage fraud paper also provides evidence of investors losing money. In particular, rather than fraudulent investors crowding out the good ones, they are actually more likely to end up defaulting on their purchases:

These fraudulent borrowers perform substantially worse than similarly declared investors, defaulting at a 75% higher rate.

Still, such widespread fraud is concerning, and I hope lenders (especially the subsidized GSEs) find a way to crack down on it. Based on things I see people bragging about on social media, I’m guessing that tax fraud is also widespread in real estate investing, though I haven’t looked into the literature on it.

This mortgage fraud paper seems like a bombshell to me and I’m surprised it seems to have received no media attention; journalists take note. For everyone else, I suppose you read obscure econ blogs precisely to find out about the things that haven’t yet made the papers.

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