Few people would risk closing any real estate transaction without using the services of the neutral party known as an escrow holder. The neutral escrow officer holds the executed documents, money, or other items to be recorded, disbursed, or exchanged as part of a transaction. She will only record, disburse, or turn over the items to the appropriate recipient when all of the conditions to close have been satisfied by the parties—whether buyer, seller, lessor, lessee, borrower, or lender—based on the express escrow instructions each has provided to her.

Using an independent third-party escrow holder allows the parties to a transaction to avoid the difficulty of having to “trust” the other side(s) with their money, deeds or other items. Instead, the neutral escrow holder will maintain control of the items to be exchanged, disbursed or recorded until all conditions, required and agreed to by the parties, are met. Also important, the escrow holder is in a position to return items to the depositing party when the conditions cannot be met.

We know that escrow officers are diligent, hard-working people who do their best to avoid pitfalls in a transaction while maintaining that all-important neutrality to the parties. So, how do escrow officers identify the pitfalls in an escrow? In other words, how can escrow officers watch for and prevent fraud from occurring in an escrow?

Reporting over $3 billion in losses due to “suspicious activity” in connection with mortgage fraud, in recent years, both the banking and escrow industries have identified possible “red flags” that, accumulated, may be indicators that someone is trying to push a fraudulent transaction through an escrow. The FBI has been documenting and reporting on mortgage fraud investigations for several years. While one or two red flags does not always mean there was an intent to defraud, several of them may very well signal fraud in the transaction. Some fraud schemes with easily identifiable red flags are:

Straw Buyers. Escrow officers succeed by developing repeat business. It may be appropriate in certain circumstances to have steady, repeat business with the same people, such as where the client is a mortgage banker handling a number of closings on a regular basis. Nevertheless, escrow holders should be alert for situations atypical for rapid-fire repeat business, because the escrow may actually involve a “straw buyer.”

Straw buyers are loan applicants used by fraudsters to disguise the true buyer or the true nature of the transaction. Signs that you may be dealing with a straw buyer include:

  • Buyer does not intend to live or work in the subject residential or commercial property (e.g., unrealistic commute, size or condition of the property inappropriate);
  • No real estate agent is used (not an arm’s-length transaction);
  • Power of Attorney is used;
  • A residential borrower takes out loan after loan to acquire multiple houses;
  • Addresses of borrowers, employers or lenders are post office boxes; and
  • Deals occur at a quick pace with buyers and sellers sharing similar names (property flips commonly use family members as straw-man buyers).

Property Flipping. Property flipping is illegal when property is purchased and resold quickly in violation of a lender’s short-sale regulations and/or at a price that results from an artificially inflated appraisal. Sign of improper flipping include:

  • Use of straw buyers;
  • Seller recently acquired title to the property, or will acquire title concurrently with the subject escrow transaction;
  • Property was recently acquired in a short-sale or through an REO sale at a much lower price;
  • No real estate agent is being used;
  • Owner on title or appraisal does not match sales contract.

Property flipping is not automatically illegal. However, be watchful for these and other red flags, as described by Fannie Mae in its article, “Common Red Flags – Resources to Help You Combat Mortgage Fraud.

Non-Arms Length Transactions. Another sign to investigate further is when the parties appear to be connected in some way, whether through ethnic background, names, even initials. With short sales, for example, a fictitious purchase offer may be made by a straw man (the homeowner’s accomplice) to fraudulently reduce the debt secured by the property and allow the borrower/homeowner to stay in the property. Signs include:

  • The buyer appears in the property’s chain of title;
  • The buyer’s name is similar to the seller’s;
  • No real estate agent;
  • Payouts are made to unknown parties;
  • Payouts are requested after close of escrow;
  • Cash back to a buyer from loan proceeds.

What should you do when you see these red flags? While none of these activities are absolute markers for illegal behavior, in pairs or added together they may raise enough red flags to warrant further investigation. Look for suspicious payoff demands, such as those with grammatical or typographical errors, or those with low-dollar payoff demands on high-dollar loans. Watch for uninsured deeds in a transaction, or repeated refinances for the same amount on the same property in short time frames. Confirm there are no unusual payment amounts in and out of escrow, or accounting records that show stop payments. Even call the numbers on payoff demands to confirm they are real numbers, or call the spouse who purportedly executed an inter-spousal transfer deed to confirm the document is authentic. Certainly keep management apprised of red flags so that legal counsel can be consulted when appropriate.

It may seem impossible to halt all fraud that others try to whitewash through escrow. Nevertheless, bad escrow transactions can cost you a lot in claims and lawsuits, even when you do nothing wrong and if you eventually win. So, watch out for red flags, and take steps early on to avoid more expensive problems down the road.

Reprint from JDSupra.com        author: Tara C. Narayanan