In the late 1990s, a widespread mortgage scam targeted at low-income
neighborhoods was uncovered in the Minneapolis-St. Paul metropolitan
area. Predatory lending, in the form of property flipping, had taken
hold in the Twin Cities.
Predatory lending in brief
Predatory lending is difficult to define, but it usually involves
at least one of the following practices:
- Asset-based lending, or basing a loan on the value of a customer's
home equity instead of his or her ability to repay the loan.
- Loan flipping, or convincing customers to refinance repeatedly.
High points and fees are added each time the loan is refinanced;
- Fraud and deception, which usually consist of using false loan
documentation or other falsified documents to conceal the true
nature of the loan. 1/
The last practice reflects what happened in Minneapolis. Twin Cities
mortgage-foreclosure-prevention counselors and housing professionals
noticed an alarming increase in the number of low-income homeowners
who were on the verge of losing their homes. Many of these homeowners
had high-interest-rate mortgages, hidden second mortgages and no
escrow accounts. The purchase prices of their homes were much higher
than the market values of other homes in their neighborhoods. In
addition, many of their homes had been purchased and sold on the
same day. As Twin Cities housing leaders investigated further, they
found that phony appraisals and loan documentation were being used
to finance home purchases for low-income borrowers. This fraud and
deception formed the basis of one of the more extreme examples of
predatory lending: property flipping.
Property flipping defined
Property flipping is the practice of purchasing a home and rapidly
reselling it at an inflated price to an unsuspecting borrower. Fraudulent
documentation and misleading loan agreements are used to trick the
buyer into thinking that the property is worth more than its actual
value and that the mortgage terms are reasonable.
A property flip might work like this: an investor purchases a home
for its market value of $50,000. The investor obtains a fraudulent
appraisal stating that the house is worth more than its market value.
The same day, the investor sells the home for $100,000 to an unsuspecting
The fraud doesn't stop there. To finance the purchase, the investor
seeks a mortgage from an out-of-town subprime lender for 70 percent
of the inflated price, or $70,000. The lender, seeing a low loan-to-value
ratio and having little knowledge of the local housing market, is
inclined to approve the loan. In some cases, the investor will also
falsify loan documentation, such as income verification, in order
to ensure that the loan is approved. The investor offers to pay
the closing costs for the borrower and also agrees that the remaining
30 percent of the home price, or $30,000, will be financed through
the use of a second mortgage. The investor promises that the second
mortgage will be forgiven in full if and when the homeowner sells
the home. Despite this promise, monthly mortgage payments include
hidden second mortgage payments.
In the end, the investor makes a large profit on the deal. By purchasing
the house for $50,000 and helping the homeowner secure financing
for $70,000, he or she makes $20,000 when the house is sold. The
homeowner, on the other hand, is left with an inflated mortgage,
a high monthly payment and a home in need of significant repair
Task force addresses the issue
In order to determine the extent of the problem and identify possible
solutions, the Property Flipping Task Force was organized in Minneapolis.
Under the leadership of city officials, numerous nonprofit organizations,
government agencies, lenders, secondary market representatives,
legal firms, and others joined together to pool resources and help
families who were victims of property flipping.
The first goal of the task force was to identify the extent of
the problem. Task force members conducted outreach and research
to identify the number of properties involved. They estimate that
450-500 properties were flipped. A local newspaper's analysis of
the problem resulted in similar numbers. According to the StarTribune,
300-450 properties were flipped between 1995 and 1999. 2/
A comparison of the homes' original sales prices (the prices the
investors paid) to the flipped sales prices (the prices the homebuyers
paid) revealed that on average, homebuyers were paying twice the
market value of the home. See the table below for more information.
Original Prices vs. Flipped Prices
A comparison of original sales prices to flipped sales prices
in the Twin Cities between 1997 and 1999.
Total original sales price
Total flipped sales price
The property flippers recruited buyers from homeless shelters,
laundromats and churches. Most of the homebuyers were low-income,
and the flips were geographically concentrated in North Minneapolis
Next, the task force studied how property flipping affected Twin
Cities neighborhoods. The effects proved to be far-reaching and
- Increased foreclosures and/or bankruptcies due to high housing
costs and repair bills;
- Increased property values—and, consequently, an inflated real
estate market—due to fraudulent appraisals;
- Destabilized neighborhoods due to increased foreclosures and
property deterioration; and
- Increased demand for legal resources to undo fraudulent transactions.
Once the task force felt confident that the extent and effects
of the problem were understood, members formed Home to Stay, a multiagency
program to help victims of property flipping avoid foreclosure and
decrease their monthly housing costs. Home to Stay partners identified
the mortgage company that held the majority of the fraudulent loans.
They then negotiated to modify the loans and replace mortgages in
default with deed-in-lieu-of-foreclosure agreements. (A deed-in-lieu-of-foreclosure
agreement involves giving the property deed to the lender in order
to avoid foreclosure. In exchange for the deed, the borrower is
allowed to stay in the home for a set period of time and, depending
on the terms of the agreement, may make rent payments to the lender.)
The program also partnered with Twin Cities Habitat for Humanity
and Fannie Mae to refinance a portion of the loans. The mortgages
refinanced by Fannie Mae were pooled, converted to government-backed
securities and sold to the Evangelical Lutheran Church of America
and United Methodist Church pension funds.
In some cases, refinancing required the borrower to take on as
many as four mortgages: the first were 30-year, fixed-rate mortgages;
the second helped to reduce the principal in order to keep the monthly
payment affordable; the third was dedicated to rehabilitation costs
and the fourth paid for closing costs. The second, third and fourth
mortgages were financed with help from state government and nonprofits
and are deferred until the home is sold.
As of December 2001, a $2 million investment by Fannie Mae had
helped 29 families refinance their mortgages. Twin Cities Habitat
for Humanity's $400,000 investment helped six additional families.
Families assisted through the program have, on average, four members
and a total household income of $31,750. Before refinancing, their
average monthly mortgage payment was $872.22. The new average payment
is $588.57—nearly $300 less.
The task force built an education component into the Home to Stay
program. Because refinances make up a large portion of predatory
loans, the task force wanted to increase borrowers' awareness of
predatory lending to prevent them from refinancing into another
predatory loan. The task force also wanted to ensure that homeowners
were equipped with the information they needed to maintain and,
in some cases, significantly rehabilitate their homes. To meet these
education goals, the Home to Stay program required the borrowers
who received refinanced loans to attend two years of homeowner education
and counseling and to either contribute 50 hours of sweat equity
to their homes or perform 50 hours of community service.
Lessons learned: partnerships and prevention are key
Property Flipping Task Force members learned two major lessons
as they addressed the issue of property flipping in the Twin Cities.
First, they learned that partnerships were essential for their success.
The task force relied on numerous partners—including nonprofit organizations,
state and city governments and private lenders—to pool resources
and identify flipped properties, rework the loans, develop the Home
to Stay program and provide counseling. Volunteer legal help was
key in correcting the deceptive loans and negotiating with the lenders
that held the first mortgages. Legal assistance also resulted in
the prosecution of close to 20 parties involved in the property
flipping. All of the partners provided unique expertise and helped
ensure that scarce resources were leveraged to help as many families
Second, task force members learned that prevention may be the most
cost-effective way to address property flipping. On average, it
cost $40,000 per family to correct the predatory loans, and more
than 50 families are currently waiting for assistance. The task
force faces the continuing challenge of committing resources to
help the remaining families. As the task force reflected on the
enormous cost of correcting fraudulent loans, members agreed that
the best way to prevent future property flipping and other predatory
practices may be to educate and counsel homebuyers. Armed with knowledge
of the mortgage process, homebuyers might be less likely to enter
into costly or fraudulent transactions. The task force now focuses
on homebuyer education initiatives, and its members have joined
Don't Borrow Trouble, a public education campaign designed to draw
attention to predatory lending and provide all potential homebuyers
with information that will help them avoid deceptive or abusive