How to Avoid Becoming a Victim of Mortgage Fraud

The threat of foreclosure looms over Americans who can no longer afford to own their home, but for prospective home buyers, there is more to worry about than just purchasing a home with an affordable mortgage. According to the FBI, another risk in this depressed housing market is falling victim to mortgage fraud schemes.

Bill Erpenbeck

Charles and Sherry Mitchell of Independence. Ky., learned the hard way. They purchased their dream home from homebuilder Bill Erpenbeck only to discover they were victims of his mortgage fraud scheme that netted him a 30-year prison sentence. Just months after they moved into their new home, the Mitchells discovered there were two liens filed against the property by frustrated subcontractors who did the work for Erpenbeck. The liens totaled more than $20,000.

Erpenbeck was a homebuilder with a good reputation, but in actuality he cheated homebuyers out of $34 million, investigators said. At real estate closings, instead of paying back construction loans that would clear title to the property, Erpenbeck deposited checks from the homebuyers directly into his company’s account. The Mitchells, along with more than 250 other homeowners, were left with additional mortgages that they were responsible for, putting them at the risk of unexpected foreclosure. For the Mitchells, the purchase of their dream home quickly became a nightmare.

How to Avoid Becoming a Victim

Although there has been a rise in mortgage fraud schemes in recent years, there are things you can do to prevent becoming a victim.

According to Claude Szyfer, a commercial litigator who specializes in all forms of real estate proceedings, the first thing to watch for is requests for cash payments from contractors, real estate agents or other parties. All money transactions should be paid out of the established escrow account, a deposit account maintained by a lender to make tax and insurance payments for the borrower, he said.

Szyfer says homebuyers need to be smart borrowers.

“There should always be loan disclosures that are provided to you,” he said.

He also recommends using the Federal Trade Commission’s website before entering into any mortgage transactions. It provides tips and early warning signs to look out for.

Not only is it important to understand the mortgage agreement ahead of time, it is important to know the local market, according to real estate expert Brendon DeSimone. He recommends going on the Internet and using such sites as Zillow, a real estate information marketplace with details on more than 100 million U.S. homes.

The real estate agent who helps you with your search is also important.

“Find a reputable agent who is local, who knows the customs of that market,” DeSimone said.

On Zillow you can find consumer reviews of more than 120,000 real estate agents to help buyers find the right agent for them. A qualified agent could make the process more manageable.

DeSimone also says there are ways to avoid being scammed when the deal closes.

“You should never be handing money directly to a seller,” DeSimone said. “There should always be a third party handling the transaction—an escrow agent or attorney."

Charles and Sherry Mitchell’s nightmare finally ended after years of court proceedings. The bank that allowed the illegal deposits in the first place paid off the construction mortgages that Erpenbeck had left on their home.

Erpenbeck is now behind bars. He pleaded guilty to bank fraud and obstruction of justice and in 2004 was sentenced to 30 years in prison.

To hear the full story of Bill Erpenbeck, watch "American Greed" Wednesday at 10 p.m. Eastern/Pacific on CNBC.