Most lenders sell their loans on the secondary market the moment the deal is closed. This allows the lender to get back the cash they just loaned out, keeping as profit the loan fees they collected from the borrower. They can then lend the money again, collect more fees, - a cycle that keeps money flowing to borrowers and profit streaming into the bank.
In order to sell these loans, the bank must guarantee that there is no fraud in the loan package. For example, the borrower's income can not be inflated or the appraisal can not be inaccurate. And to keep the bank "honest", they must sign an agreement that says if fraud is found, the bank must buy back the loan.
To no one's surprise, not every loan is completely factual. In the past, the odds were pretty good that one or two lies could easily slip through the system. And if the borrower did have problems making a loan payment, the home could always be sold for a profit, since everyone knows that real estate never decreases in value...
Well - now that the bottom has fallen out of the real estate market and borrowers are defaulting at record numbers, the secondary market is taking a long, hard look at the loans they purchased. Freddie Mac and Fannie Mae, the largest purchasers of real estate loans, are reviewing every loan that defaults. If they find fraud, they are requiring the lenders to buy back the sub-standard loans.
Of course, banks are not eager to do this, partially because they do not want the non-performing loans, but also because many banks to not have the cash reserves to buy the loans. Lawsuits are being filed and the government is considering requiring banks to keep a larger cash reserve. And even if the real estate market revives soon, you can bet these loan fraud problems will affect real estate lending for many years.
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