Commercial Real Estate Blog by Madison

Inadvertent Mortgage Fraud: A Day Late Means Many Dollars Short

There are situations that arise in real estate transactions that can result in inadvertent mortgage fraud. That’s right. Unintentional and without malice, but mortgage fraud just the same. Case in point.

Mr. Jones arrived at the sale of his property fully prepared. At the closing, all title exceptions had been cleared, and payoff letters have been obtained for the remaining open mortgages. The first mortgage, a purchase money mortgage, had a payoff of $500,000, which would be paid off at closing. The second mortgage, a home equity line of credit (HELOC), had a maximum allowable draw of $50,000. Mr. Jones had only drawn $10,000 of the HELOC. He obtained a payoff letter, confirming this amount was also to be paid at closing.

The closing proceeded smoothly and Mr. Jones left the room, confident that all of his bills had been paid and debts satisfied. Newly flush with cash from the sale, Mr. Jones invited a group of friends to his favorite restaurant to celebrate.

Back at Mr. Jones’ attorney’s office, the closer finished his work. He put the payoff funds in the overnight mail. At the same, he faxed the bank the instruction letter to close the account. He locked up the office and went home, satisfied that his job was complete.

Meanwhile, at the bank, the instruction letter from Mr. Jones’ attorney’s office arrived in the fax machine at 4:30 pm. A teller noticed the new fax and brought it over to the account manager responsible for actually closing the account. Since the account manager was in a meeting, the teller left the fax on the account manager’s desk. When the account manager emerged from his meeting after 5:00 pm, he saw the fax requesting that he close the account. It was too late in the day to get anything done, so he made a mental note to take care of it first thing the next morning.

That evening, Mr. Jones and his friends enjoyed a lengthy celebration with food and drinks. As the night came to an end, the waiter arrived with the check for $500. Mr. Jones pulled out his wallet and handed the waiter his credit card. Out of habit, Mr. Jones used the card which happened to be linked to his HELOC account. By using this card to pay $500 for the dinner, Mr. Jones inadvertently committed mortgage fraud.

The Challenge

At that point, the HELOC account was not actually paid in full. Therefore, the bank retained a position senior to the new owner’s mortgage. If Mr. Jones never paid off his restaurant charge, the bank could foreclose and force a sale of the house, ahead of the buyer’s new bank loan. This situation would have put the buyer at risk. Thankfully, the buyer had purchased title insurance. Title insurance provided coverage for such a possibility.

Mr. Jones could have prevented the situation by being more careful. If the seller had obtained a freeze letter from the bank that issued the HELOC account, there would have been no danger of committing inadvertent mortgage fraud. The seller should have requested that the bank no longer advance any funds from the HELOC account and confirm the request in writing.

Some large banks respond to this request by sending the borrower a form letter which requires the seller to sign their name to the application. A cursory perusal of this form would result in the seller realizing the account had not been frozen. The failure to sign the request and forward it to the bank left the account open and accessible until closed and paid in full. The freeze letter needed to have been signed and sent to the bank. The bank’s acknowledgement of no further advances would then have been forwarded to the title company.

Lessons Learned

It is worth noting that, with a typical mortgage, the seller requests a payoff which is picked up at closing. The careful buyer will typically make sure there is a payoff and that the mortgage is satisfied or at least paid at closing.

However, in the case of a HELOC, a typical payoff is not enough. A buyer who is not aware of these specific requirements may see the pay off, or look over the instruction letter, and think that the requirements have been satisfied. A meticulous and experienced title company will insist on the seller’s attorney obtaining the freeze letter. This would ensure that the seller clears all requirements in order to protect the new owner and lender.

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