The Fictitious Down Payment Scam

July 10, 2000, Revised November 17, 2004

“I offered $289K for a house but was not able to make a down payment. The seller’s realtor told me that so long as I could pay all the closing costs, they would find a way to contribute 5% toward a down payment. When we sat down to sign the contract, the realtor had increased the price of the house to $304K, and had a second mortgage contract from the seller for $15K. I was told that the seller was lending me the $15K for the down payment, and would "forgive" the loan after the closing. So I end up with a house worth $289K and one mortgage for $289K, and all I bring to the table is the closing costs. Is this kosher?"

No, this is a down payment scam directed against the first mortgage lender. If you go along with it you will be a participant in the scam.

The lender is being led to believe that he is getting a loan with a 5% down payment. The paperwork shows a price of $304K for the house, and a first mortgage loan of $289K, with $15K of equity provided by the buyer. But in truth there is no equity because the house is only worth $289K.

For this scam to work, the appraisal of the property must come in at $304K. This means that the appraiser is either hoodwinked by the fictitious sale price, or is a party to the scam.

And you will be a party to it as well. For the loan to close, you will be obliged to lie about the source of the funds used for the down payment.

Assuming the deception is not caught and the loan goes through, it might be caught in a post-closing audit, in which event the lender could elect to call the loan. All mortgage loans contain an “acceleration clause” which allows the lender to demand immediate repayment if any information provided by the borrower turns out to be false.

If your deception is not caught in a post-closing audit but sometime down the road you have difficulty making your mortgage payments, the same thing could happen. If they find you lied, you will get summary justice.

If your credit is good, you don’t need to cheat to get 100% financing. It is available in the form
of combination loans – an 80% first mortgage and a 20% second mortgage. It is also available as a 100% first mortgage. You need a mortgage broker who has access to these programs.

Postscript: One reader of this article interpreted it to mean that a seller-provided second mortgage was, in itself, a scam. That is not the case, a seller second is completely kosher if it is a valid transaction that both parties intend to observe, and if it is known to the first mortgage lender. In the case described above, the transaction was phony, as we know because it was cancelled as soon as the transaction was closed. Its sole purpose was to create a fictitiously high sale price. Further, it was all done behind the back of the first mortgage lender, who was led to believe that the borrower had more equity in the property than was in fact the case. 

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