Periodic Mortgage Refinancings: Who Gets Conned?

 January 25, 2001, Revised November 26, 2008, August 31, 2009

"I have a friend who refinances his home every three months. He has refinanced six times in the last two years. His mortgage broker buddy gives him a kickback of about $5,000 every time he refinances. He wants me to do the same deal and I'm tempted, but I'm concerned that it may be illegal or have other bad consequences."

This is a scam directed toward wholesale lenders. It requires the cooperation of venal borrowers who participate in it, of which your friend is one. The larger the loan, the more profitable the scam.

Lenders pay rebates on high-rate loans. For example, a lender who offers a 30-year FRM at 7.875% and zero points might pay a rebate of four points for a 9.5% loan. Lenders know that 9.5% loans have relatively short lives because borrowers refinance them as soon as they can. Nonetheless, the lender will recover the four points through the above-market rate in 30 months, and most such loans last longer than that. Or rather, they last longer unless there is a scam to pay off in three months.

On a loan of $350,000, the lender pays a rebate of 4% of $350,000, or $$14,000. Over three months, the lender collects only about $1,400 in excess interest. The broker pays the borrower’s closing costs of about $4,000 and $1,400 to cover the higher interest payment on the 9.5% loan for three months. The balance of $8,600 is split between them, with the broker keeping most of it. After three months, they do it again, but with a different lender in order to avoid disclosure.

This scam can be executed by a broker, or by a correspondent lender who sells all his loans but they require a naive or corrupt borrower as an accomplice. The victim is whoever ends up owning the mortgage and finds that they have paid a premium price for a high-rate loan that they expected to have for 2-3 years, but which is paid off in 3 months.