Mortgage fraud has already cost two of Britain’s leading building societies over £300 million and is set to spark a wave of legal actions by lenders against surveyors, lawyers and mortgage brokers, which is likely to lead to a surge in professional negligence insurance claims.
The Chelsea Building Society has lost £41 million as a result of frauds in its buy-to-let mortgage book, while Bradford & Bingley has said similar scams have cost it an eye-watering £271 million.
At the height of the property bubble, loans to buy homes, not only to live in but as investments, were easily available. Getting a foot on the property ladder became a British obsession because with property prices rising fast each year, homes were seen as failsafe assets. The mortgage market was seen as oiling the wheels of the national economy.
Banks nursing heavy losses
But since the financial crisis plunged the economy into recession and pricked the property bubble, banks have been left nursing heavy losses and are now looking to recoup some of their money from professionals who they believe have contributed to their predicament.
The Chelsea blamed its problem on the deliberate over-valuing of properties by mortgage brokers and surveyors.
Many such advisory firms have contacted their insurers recently to inform them that lenders have threatened to sue them for negligence.
“We have seen a big rise in the number of allegations of fraud in the past few months,” says David Stocks, Senior Vice President of Marsh’s FINPRO practice.
Rise in negligence claims possible
Professional liability insurers are bracing themselves for a rise in mortgage-related claims.
To make matters worse, when mortgages were easy to come by they became a target for organised crime gangs. The UK’s Association of Chief Police Officers has estimated that mortgage fraud costs around £700 million a year, while the City of London Police has reported a 72% jump in cases of financial fraud, mainly as a result of the surge in mortgage scams.
A classic example would involve a gang buying a house on a new development who would submit a mortgage application for a deliberately inflated price, with the help of a dishonest surveyor. The fraudsters would then buy other properties in the same development using that artificially high valuation as a basis for future purchases and disappear with the excess funds.
Rising property prices disguised the extent of the frauds, but since the collapse of the bubble, lenders have combed their loan books and realised their property assets are worth much less than they thought.
They are also looking into whether conveyancing solicitors did not follow guidelines or failed to pick up fraud.
Problem not just residential
The problem is not confined to residential property. In a recent court case Nationwide Building Society was awarded over £21 million from Dunlop Hayward after it was found to have fraudulently overstated the value of a commercial development. The Nationwide had lent £11.5 million for the purchase of a property that was subsequently found to be worth no more than £1.5 million.
Although agreeing that deceitful or dishonest advisors should be brought to book, surveyors, conveyancing solicitors and mortgage brokers are fearful of being made scapegoats for the market’s collapse.
But many may have strong defences against claims from lenders, says David Stocks, Senior Vice President of Marsh’s FINPRO practice.
The first is that the banks and building societies were largely responsible for their own problems, says Stocks. In the go-go days of the property boom, large mortgages were freely available with few strings attached.
Self-certified mortgages flourished. As banks made few checks on an applicant’s income they were dubbed “liar loans”, because some applicants inflated their earnings in order to be loaned higher amounts.
Regulatory changes planned
Indeed in its proposals to shake up the mortgage market the Financial Services Authority acknowledges: “our existing regulatory framework has proved to be ineffective in constraining particularly risky lending.”
The watchdog also plans to outlaw self-certified mortgages and has stated that, in future, responsibility for curbing irresponsible lending must rest on the banks, not borrowers.
Market participants are awaiting the first lawsuits involving banks and professional advisers to go to court to see what view judges will take on this issue of contributory negligence.
Underwriters say a number of out-of-court settlements have seen compensation payments slashed by up to 90% because of contributory negligence by lenders.
In the meantime, surveyors should consult their case files to help defend themselves from claims from the banks, Stocks advises.
“If they have comprehensive notes from their site visits or can provide evidence of similarly valued properties in the area to justify their own valuations, then they will have good grounds to defend claims of negligence,” Stocks says.
But it is too early to discern what the impact of the controversy will be. “It could be three to five years before we know for certain,” Stocks concludes.
