California Attorney General Edmund G. Brown Jr. joined with the Department of Real Estate (DRE) to warn California homeowners about the latest scam plaguing distressed homeowners: forensic loan audits.

These so-called “loan audits” encourage homeowners to pay an advanced fee for a report on their lender’s loan modification practices. The reports are claimed to help the homeowner determine their lender’s compliance with state and federal mortgage lending laws. Loan audit scammers claim homeowners can use this report as a tool to gain leverage with lenders and speed up the loan modification process.

But there is no proof that such an audit of a lender’s modification practices helps a homeowner obtain a loan modification or avoid foreclosure, even if produced by a legitimate auditor, real estate broker or lawyer.

Brown has sought to shut down more than 30 fraudulent foreclosure relief companies for misrepresenting and selling these audits.

first tuesday take: In October 2009, the California Senate outlawed the collection of up-front fees for loan modification assistance by anyone (this prohibition had little effect on real estate brokers since they nearly always operate as contingency fee advisors and negotiators, paid a fee when they get results).  Additionally, any business that offers foreclosure consulting or loan modification advice for a fee is required to post a $100,000 bond and register with the attorney general.

As for the scammers among us, they skirt these restrictions by merely re-branding what is essentially the same practice — charging advance fees in the pursuit of a loan modification that is unlikely to be granted, and if granted, is financially meaningless beyond a very few months in more than 60% of cases.

These scams feed on homeowner desperation, and homeowners are desperate because of massively excessive mortgage balances and monthly payments in relation to the fair market value of their homes and 31% of their gross income. The underlying problem here is the failure of governments, past and present, state and federal, to force mortgage lenders to correct the insolvency of roughly 2,500,000 negative-equity California homeowners. Recent legislation is a short-term remedy of political importance, but not a cure for negative equity, which is the infection. Virulent ripple effects are beginning to surface, revealing strategic defaults as the moral risks created by delaying a durable long-term fix. (In this context, moral risk is used to mean conduct generated by the existence of insurance coverage, which has nothing to do with one’s morals and everything to do with rational decisions.)

Since homeowners are receiving no government support to remedy their insolvency, they must seek loan modifications by talking to their lenders directly. Those who are considering seeking third-party advice should keep in mind that services similar to those being promised by loan modification scammers are actually offered free of charge by government-approved non-profit housing counselors. [For a list of nonprofit housing counseling agencies approved by the United States Department of Housing and Urban Development (HUD), visit For more information and additional requirements regarding advance fees, see the January 2010 first tuesday Legislative Watch]

Re: “Brown Warns Homeowners to Avoid Forensic Loan Audits” from the office of the California Attorney General