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Are Russ Whitney' property improvement loan techniques illegal? by John T. Reed 2 Amount of markup Whitney says the general contractor' markup, "can be anywhere from 25% to 400%, and more." (Building Wealth p. 69). In one deal he brags about, he told the lender that work which actually cost $3,000 was going to cost $17,000 (Building Wealth p. 70) That' a 567% markup. You can take courses in estimating at many community colleges. It is a rather complex skill and art. There are a number of companies that continuously analyze construction costs. They sell their results in the form of books, CDs, and on-line services. Here' what three construction costs books that I have say about contractor profit and overhead. Book Profit and overhead (varies according to size of job and nature of work) Saylor Residential Construction Costs 6.5% to 25% of total Means Repair and Remodeling Cost Data 5% to 40% of total National Construction Estimator 20% of total You can find the current editions of these or other similar books in your local book store or library. One of the things that real estate gurus I do not recommend all seem to do is make real estate investing sound far more profitable than it really is. That' how you sell real estate investment seminars. Whitney' 400% to 567% markups are prime examples of that. Other laws The Title I law and regulation I quoted above are not the only ones pertinent to misleading a lender with regard to what work is being done, who is going to do it, and what its actual cost is. There are other more general federal laws that prohibit misleading someone in a federally related matter either by false statements or by concealing material facts. Here are the ones most often used against perpetrators of mortgage fraud. 18 USC 1014 prohibits making false statements to a federally-related lender. If the loan involves HUD, like a Title I home improvement loan, 18 USC 1012 applies. Banks are generally federal lenders because of federal deposit insurance or federal charters as well as because of federal loan insurance programs like HUD' Title I. 18 USC 1010 prohibits the following in HUD lending: "¢ false statements "¢ counterfeiting documents "¢ overvaluing security, asset value, or income The use of "proposal and contract " forms with the names of companies that appear to be unrelated to the borrower may constitute counterfeiting under this law. Marking up cost estimates may constitute "overvaluing security or asset value." 31 USC 3802 prohibits false claims and statements. Concealment of a material fact Concealment of a material fact from the bank is prohibited by 18 USC 1001. That law is also often cited in the

sentence just above where you sign a mortgage application. The application my wife and I signed in 10/02 to refinance our home cited this statute. Some of the forms Whitney Information Network, Inc. has filed with the Securities and Exchange contain the phrase, "ATTENTION"”INTENTIONAL MISTATEMENTS OR OMMISSIONS OF FACT CONSTITUTE FEDERAL CRIMINAL VIOLATIONS (SEE 18 U.S.C. 1001)" On page 75 of Overcoming the Hurdles and Pitfalls of Investing in Real Estate, Whitney says, regarding a deal where he is putting a third mortgage on the property right after the bank second, ""¦you"ll note on the "Projected Rent Role [sic]" statement there is no mention of a third mortgage. Is that dishonest? No!" Yes, it is. It is concealing a material fact in a federal matter. It is a felony punishable by a fine and/or five years in prison or both. Whitney goes on, "It is not the bank' business if we have a third mortgage." Who is Russ Whitney to make this determination? The money that is being loaned belongs to the bank' depositors and shareholders. Ultimately, the taxpayers" money is at risk. If you cannot tell the truth, the whole truth, and nothing but the truth to the lender, then you are behaving unethically and probably illegally. Whitey continues, "As long as their money is protected in the second mortgage position the bank' loan is safe." The fact is a third mortgage makes the loan far more risky. The main cause of foreclosure is lack of borrower equity. A third mortgage reduces or eliminates borrower equity. That, in turn, reduces the borrower' incentive to keep the payments current in the case of difficulty with this property or another or financial difficulty in any other aspect of the borrower' life. Whitney would not know that because he was never a lender and apparently never studied sound lending practices. Whitney: "I just want you to understand that business is business." What does that mean? Nothing. The fact is page 75 of Overcoming"¦ is Russ Whitney' tortured attempt to rationalize mortgage fraud. I left out more of the same on that page. Mortgage applications generally ask for the whole story of the transaction. You are required to sign the loan application saying that you have told them the whole story. They often ask if there is any secondary financing or loans junior to the loan they are making. If you sign it and do not tell them the whole story, you have committed fraud as well as violating the federal law against concealing material facts. The fact that the real estate industry has a name for this tactic"”"sneaky second" or "sneaky third" in this case"”indicates it is well known to be improper behavior. Whitney knows what would happen if he told the whole truth. Continuing on page 75, he says, "If I approached the banker and told him I bought the Spanish mansion for $90,000 with no money down and I need to borrow $15,000 to boot, what do you think my chances would be for a loan? Exactly, zero. This is a chess game. A battle of brains and wits." So there' the proof of intent. Whitney knows if he tells the whole truth, he won"t get the loan. So he tells less than the whole truth"”maybe lies depending on the wording of the loan application and/or discussions with the lender. The "chess game" comment is more rationalization. In games like chess, you sometimes feint and bluff. But borrowing thousands of dollars from a federal lender is not a game of any sort. It is a transaction where the stakeholders on one side"”the bank' owners and depositors and the U.S. taxpayers"”entrust the person on the other side"”Russ Whitney"”with a substantial amount of their money. Applying for a loan is not a "battle of brains and wits." Defrauding lenders is a battle of brains and wits. "I don"t want to lie to him" Page 87 of Overcoming"¦: "I anticipated that the banker might come right out and ask if I put $60,000 down on the property. [It was a nothing-down deal.] I don"t want to lie to him, so how do I answer? "¦one lender did ask. I, of course, had the answer. I told him we did some trading on some "things" which resulted in the equity reduction on this property." Once again, Whitney is well aware of what he is doing. He feels the need to add, "What about morality and ethics in this case? Well, I told him the truth. We did do some trading. The seller traded us the property for no money down and we both traded agreements on not recording the third mortgage immediately." Judges call this sophistry"”fallacious reasoning; reasoning sound in appearance only. The bottom line is the lender would not have made the loan if they knew the whole truth so Whitney concealed the whole truth. His statement that he traded "things" is simply false, his strained explanation notwithstanding. Making an argument like this at your trial would likely get you chewed out by the judge in addition to your losing the case. "We did what has to be done to expedite it and make them feel good about lending the money." In other words, we defrauded the lender. "Expedite" is a wholly inappropriate euphemism. It means to speed up. In this case, as he admitted earlier, he would have been stopped cold had he told the whole truth, not just slowed down. On page 37 of Overcoming the Hazards and Pitfalls of Financing, Locating, and Analyzing of Real Estate, he says, "I have had people ask me if that is ethical or not. I don"t know." He doesn"t know?! Isn"t that kind of important? Don"t you make sure something is ethical before you do it? Actually, I have read a bunch of Whitney' books and listened to a bunch of his tapes and I found no indication anywhere that he is concerned about ethics. The next sentence on page 37 of that book is, "I have been doing it for seven years and have not yet lost any sleep over it." First, we"ll have to take Whitney' word for that. Second, the ability of a person who misled a bank to sleep afterward carries no weight in court. His student asked him a very good, legitimate question and Whitney responded, in part, with an irrelevant comment. If Whitney did, indeed, sleep well after misleading lenders, it may merely mean he lacked the sort of conscience that prompted his student to ask the question. Continuing that paragraph, ""¦I think one could certainly substantiate that even though he owns the house, he is his own contractor and does invariably deserve to make a profit for his time and effort; it is quite ethical." I disagree. If the loan in question is Title I, the regulation specifically prohibits borrowing more than materials cost. Even in non-Title I improvement loans, I suspect that the lender would not make the loan if they knew the borrower was making a "profit" on it. If you make full disclosure and the lender still approves the loan, more power to you. But all this nonsense about contractor names, "proposal and contract" forms, and marking up estimates 25% to 567% would almost certainly guarantee rejection if known by the lender. The word "deserve" is a dangerous one to use in this context. It rationalizes improper behavior. No one ever deserves to make a profit. If you work hard and smart and you are lucky, you make a profit. But the word "profit" implies that you are an independent businessperson. Entrepreneurs have an opportunity to make a profit, but they never deserve it. Finally, there is no "profit" here. This is a loan. If you are to profit on the improvement, it will happen when you sell the property. Whitney' habit of encouraging readers to view excess loans as profits is extremely ill-advised. The correct phrase in the real estate industry for this is "mortgaging out" or a "cash-out mortgage." Mortgaging out or cashing out is a very difficult trick if you make full disclosure to the lender. If you pull it off ethically, you might get a compliment from a fellow knowledgeable investor, but no one will call it a "profit." "My roof is leaking" One of Whitney' students told him he could not get a regular home improvement loan because he already had two mortgages. Whitney insisted he could and went to his hotel room to make the calls and prove it. He said of the student, "He was right." Whitney was only able to find a couple of non-Title I lenders, each of whom insisted on second mortgages. Whitney says, "I then told the banker that I already had two mortgages on my home and my roof was leaking." The lender agreed to an unsecured $7,500 property improvement loan to replace the roof. You have to admire Whitney' persistence. There' just one problem. The "my roof is leaking" statement was a lie. Had Whitney actually obtained the loan on this basis"”or had his student"”it would be fraud. ""¦You must be a little deceptive with your banker." The fraudulent nature of what Whitney advocates, and claims to have done, is starkly evident on pages 125 and 126 of Overcoming the Hazards and Pitfalls of Financing, Locating, and Analyzing of Real Estate. Here is what he says, along with my comments in [red brackets], "I must share some other realities with you"¦There are many instances where you must be a little deceptive with your banker." [Being deceptive is illegal. It is fraud. There is no distinction in the law between being a "little" deceptive and being a lot deceptive. Furthermore, I see no basis for Whitney' use of the word "little." Exaggerating improvement costs by more than double, using loan proceeds you said were going into the property improvements for down payments on other properties, etc. are fundamental and major misrepresentations.] "If, on the home improvement loan, you indicate that you are going to do the contracting yourself and take some of the money as profit, your chances of approval will diminish. I generally portray that I will not only use all of the loan money to get the work done, but that I will probably kick in a thousand or two of my own money." [This is a barefaced lie. You can go to jail for this.]

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