The Dual Loan Scam

December 4, 2000, Updated September 31, 2002 "We just built a house and arranged a 30-year fixed rate mortgage (FRM) for $350,000 at 7.875% (no points) with a bank. A mortgage broker has proposed that I scrap this deal and go with him. He will provide the same loan and rate, and give me $1500 in cash. To do this, he wants to write a 9.5% loan, which would be replaced by a 7.875% loan after two payments, with no closing costs. The extra payments amount to $400, so I would net $1100, and I would also save the closing costs of about $4,000. This seems too good to be true." It�s too good to be honest. The broker wants to scam the lender and make you a party to it. A lender who offers a 30-year FRM at 7.875% and zero points will pay about 4 points for a 9.5% loan. (One point is 1% of the loan amount paid upfront). Lenders know that 9.5% loans have relatively short lives because borrowers refinance them as soon as they can. Nonetheless, the lender will recover the 4 points through the above-market rate in less than 3 years, and most such loans last longer than that. Or rather, they last longer unless there is a scam to pay off quickly by pre-arrangement, as in your case. The lender pays $14,000 (4% of $350,000) for this loan. If the loan is paid off in full after two monthly payments, the lender collects excess interest -- the interest on the 9.50% loan less the interest on a 7.875% loan -- of less than $1,000. The broker gets the $14,000. From this, he pays you $1500 and absorbs your closing costs of $4,000, netting himself $8,500. If you participate, you are a party to the scam. And having read this, you can�t plead that you are an innocent party. Update of September 31, 2002 I have recently run into a more elaborate version of this scam involving successive refinancings.  A borrower agrees with the scamming broker to refinance every 4 months at a high rate, sharing the rebate from the lender.  On a large loan, the rebate is substantial, and the borrower can spend it or use it to pay down the loan balance.  The broker spreads the deals around among a number of lenders so that no one of them suspects what is going on. Copyright Jack Guttentag 2002

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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