When Zhu Chenxia bought a flat early last year from Lei Yarong in the up-market Nanshan district of China's southern metropolis of Shenzhen, the two women drew up three purchase agreements to cover the deal.
Only one was genuine.
In the legitimate contract, Zhu agreed to pay Lei 6.49 million yuan (about $980,000) for the 96-square-meter apartment near the city's border with Hong Kong, according to records filed in a Shenzhen court. With the help of her property agent, Zhu cooked up a second contract with Lei that overstated the value of the flat at 7 million yuan. This one was for the bank.
If Zhu had presented her lender with the true purchase price, she would only have been entitled to borrow up to 70 per cent of that amount, or 4.54 million yuan. Chinese regulations stipulate that first-home buyers in some major cities must make a down payment of at least 30 percent to reduce bank exposure to risk. The higher valuation convinced the Bank of China to lend Zhu 4.85 million yuan, leaving the lender less buffer against a price drop.
Details of the deception are contained in a court judgment from a subsequent dispute between Zhu and Lei over the transaction. Remarkably, Zhu herself disclosed the fraud to the court when she gave evidence that showed the pair had conspired to cheat the bank and the government.
Mortgage fraud like the pair's flouting of rules designed to protect banks is rampant in China's roaring property market, according to interviews with buyers, sellers and dozens of property market insiders including real estate agents, lawyers, bankers, valuers and loan middlemen from three of China's major cities and four smaller cities. Many of these people declined to be identified because they were familiar with or involved in "re-packaged" loan applications, the industry euphemism for these frauds.
A Reuters examination, including a review of court records of cases such as Zhu's dispute with Lei, shows that across China, unqualified borrowers use fake documents to secure mortgages, while loans deceptively obtained for other purposes are funnelled into property. These frauds are often committed with the consent and encouragement of other parties to the transactions, including lending brokers, property agents, valuation companies and the banks themselves.
And these alleged crimes are rarely punished. Neither Zhu nor Lei suffered any penalty for the fraud.
Hu Weigang, a senior partner at Guangdong Shen Dadi Law Firm, would like to see the law enforced on the mainland as it is in Hong Kong, where creating a bogus document can lead to jail. But, he acknowledges, the scale of this cheating makes it virtually impossible.
"When everyone is doing it, you can't put everyone in jail," says Hu, who specializes in real estate litigation.
While property prices in China continue to rise, mortgage fraud remains largely a hidden danger, much as subprime loans in the United States remained mostly out of sight ahead of the 2008 global financial crisis. The fear is that in a property correction, fraudulent mortgages would unravel, accelerating a collapse of housing prices in the world's second biggest economy. This, in turn, would imperil China's debt-laden financial system.
The danger from gravity-defying home prices is clear to the ruling Communist Party. In his marathon speech at the 19th Party Congress in October, Chinese President Xi Jinping warned about the overheated property market. "Houses are built to be lived in, not for speculation," he said.
Top bank officials are also worried. Xu Zhong, head of the research bureau at the central bank, the People's Bank of China, sees pitfalls ahead. "We must be very aware that rapidly rising housing prices could not only hamper our economic development, but could easily result in systemic risks and negatively impact the macroeconomy, " Xu wrote in an op-ed for a central bank-controlled magazine in September.
The motive for widespread mortgage fraud is simple: fear of missing out.
Millions of homeowners are enjoying the sensation of ever-expanding wealth. The average value of residential housing in China more than tripled between 2000 and 2015 as a huge property market emerged from the early decades of economic reforms.
So far, China's new home-owning class has yet to experience a sustained downturn in housing values. Official data showed prices grew 12.4 percent in 2016, the fastest rate since 2011. A report tracking home price trends by the Chinese Academy of Social Sciences, a state think tank, showed prices in 33 major cities soared 42 percent in 2016. Private estimates and anecdotal evidence suggest prices in most big Chinese cities actually doubled or tripled since late 2015.
For millions of Chinese, buying a home is now a rite of passage to the middle class. In 2016, the rise in property prices boosted total household wealth in 37 of China's most developed cities by 24 trillion yuan, almost twice the value of total disposable income of 12.9 trillion yuan, according to a March research note from Deutsche Bank.
For many buyers without the required down payment or income to qualify for a mortgage, a fraudulent loan application is a tempting if illegal sidestep. Home values in the Haiyue Garden complex where Zhu bought her flat have increased 40 percent in the last two years, according to local property agents.
Zhu stood to make a tidy profit. She was not so keen to share gains with the government. Under the third contract she drew up with Lei, the Shenzhen flat was valued at only 2.8 million yuan, less than half its true value, the court records show. That contract was for showing to the taxman. At that value, Zhu would have saved more than 50,000 yuan in taxes, according to Shenzhen regulations.
In the vast majority of cases, fraudulent loan applications remain concealed as prices continue to rise and buyers meet their repayments. In Zhu's case, the fraud only became public because she fell out with Lei, the seller.
A clause in the genuine contract between the two women stipulated that Lei, the seller, agreed to refund Zhu the extra 310,000 yuan that Zhu extracted from the Bank of China using the fake loan application. It is not clear from the court documents what Zhu intended to do with the extra money. In effect, though, the bank would have been refunding part of Zhu's down payment. However, Zhu alleges, Lei reneged and kept the money.
Court documents show that Zhu last year sued Lei in Shenzhen to recover the funds plus interest. In taking Lei to court, Zhu disclosed the details of the fraudulent contracts she signed with Lei.
In her court submissions, Zhu described her deal with Lei as a "yin-yang" contract - a widely used expression in China's property market meaning real and fake agreements operating side-by-side.
Almost all contracts for the sale of existing property in China have some "yin-yang" element, according to Denny Jiang, a former banker and recent home buyer in Beijing.
NOT A SERIOUS CRIME
Zhu's willingness to admit to wrongdoing in court suggests that this kind of deception in China is not considered a serious crime. The People's Court of Nanshan District of Shenzhen ruled against Zhu on the grounds that the seller and buyer had committed fraud.
Zhu later appealed to the Shenzhen Intermediate People's Court, arguing that her agreements with Lei showed the pair had taken part in the scheme together.
The appeals court, too, found that the two women had committed fraud. But it also accepted Zhu's argument that she was entitled to her share of the gains from the scheme. The court ordered Lei to pay Zhu the amount they had fraudulently extracted from the bank - despite acknowledging in its ruling that the pair had engaged in "illegal behavior." Lei's lawyer said she complied with the ruling. The Bank of China did not respond to questions from Reuters about the case or allegations of widespread mortgage fraud in China.
Zhu's lawyer, Zhou Zhengfeng, declined to relay questions to Zhu or answer specific queries about his client's case.
In an interview with Reuters, the lawyer was frank about the prevalence of mortgage fraud. Buyers, he said, were in reality using the bank's money to speculate in real estate. "In the last few years in Shenzhen, there have been lots of over-valuations used to get higher loans," said Zhou, a specialist in property disputes at his firm, China Commercial Law in Shenzhen. "It's been quite insane."
Lei declined a request for an interview sent via her lawyer, Xuan Hong Xia, a partner at Guangdong Wansheng Law Firm based in Shenzhen. Lei was "very unhappy" about the appeals court outcome, Xuan said.
Xuan said the dispute between the pair wasn't about Lei's refusal to hand the extra funds extracted from the bank to Zhu. Instead, Xuan said, the case arose because Zhu delayed some contract payments to Lei. In fact, Xuan said, Lei had been willing to return the extra money to the bank.
Mortgage fraud need not be as elaborate as the deal between Zhu and Lei. Simple bribery can also be effective.
A Hong Kong property investor surnamed Fu, who declined to give his full name because he was admitting criminal behavior, told Reuters that 20,000 yuan (about $3,000) in a traditional red gift envelope was enough for a valuation company to inflate the price of the apartment he wanted to buy in Shenzhen by 40 percent. That increased the amount the bank was prepared to lend him by 1.26 million yuan.
While regulators press banks to enforce prudential standards, it is clear that some lenders are aware of these deceptions. "In accordance with industry standards, using a high property valuation to get a higher loan usually involves the staff of the bank," said one 2016 judgment from a case in the Shenzhen Intermediate People's Court.
Real estate agents play a pivotal role in mortgage fraud, according to industry insiders. China has an army of these agents, many of them poorly trained but highly motivated to make sales.
It was an estate agent from Centaline, a large Hong Kong-based property agency, who helped Zhu create her fake purchase agreements, Lei told the court according to case documents. Centaline said it had not found any documents in its records of the transaction showing that the property was overvalued to secure a higher mortgage. It said it forbids its staff from assisting customers in overvaluing property.
Reuters interviewed 12 property agents selling new and existing homes who said they had helped clients dodge lending rules. Another veteran salesperson in Shanghai who works at real estate company E-House China said around 50 percent of his clients engage in some kind of mortgage fraud. The person declined to be identified, and the company didn't respond to questions.
Property agents often recommend buyers use so-called loan agents to help them secure funds from lenders. These loan agents have created an industry satisfying the demand for funds from borrowers unable to meet lending standards.
Bankers anxious to hit lending targets also introduce borrowers to these agents, according to property insiders. The use of loan agents allows the bankers to keep fraud at arm's length.
Operating out of small, cramped offices, often in residential blocks, loan agents "re-package" - or falsify documents for mortgage applications.
"Around 60 percent of property buyers in Shanghai are involved in some kind of re-packaging," said Jack Xiao, who worked for over a decade as a property agent in the city.
Online chat groups with names such as "Shanghai mortgage loans re-packaging" are inundated with adverts from agents touting their wares. "Doesn't matter if black or white, we can get you a mortgage," says one advert - meaning it doesn't matter how good or bad a client's credit rating is.
The price of fake documents needed to secure a loan, buy a home or dodge property taxes and fees is openly discussed on social media in China. In recent posts on WeChat, China's biggest messaging platform, users compared the price of bogus documents in various cities.
When warnings of a property bubble intensified on surging prices last year, China's state-run media carried commentaries arguing that the down payment rules were a sufficient buffer for banks if prices reversed. The requirement is a sharp contrast to down-payment ratios near zero for the deadly subprime loans that crashed the U.S. market in 2008.
In China, however, many buyers also borrow to cover their down payments. Among them is Fu, the Hong Kong investor who said he paid a bribe to inflate the appraisal for the property he wanted to buy. He borrowed a million yuan for his down payment from a finance company at a rate of 2 percent a month. When the bank advanced him his inflated mortgage, he paid for the property and repaid his down payment loan.
A senior employee of Centaline, the Hong Kong property agency, said around 30 percent of his clients have borrowed their down payments from a third party. A senior mortgage banker at Shanghai Pudong Development Bank placed the number at around 20 to 30 percent. Centaline said the employee's comments don't represent the company's view; the bank said it strictly forbids the illegal flow of funds into the property market.
Borrowing money to finance a down payment is common because small loan companies, banks and unregulated black market loan firms lack the resources to check how the money is spent, or don't care as long as their interest is paid, say employees from small loan firms.
China's banking regulator has told lenders they need to scrutinize the flow of consumer loans into property more closely. Official figures show short-term household loans soared about 243 per cent in the first ten months of 2017 from a year earlier to 1.6 trillion yuan.
Loan and estate agents also help to divert funds advanced from banks for other purposes into property. Banks, for instance, can lend money for refurbishment loans, but according to internal lending rules, the loan proceeds must be paid into the account of the company that is meant to do the work. So, the loan agents create a firm, complete with working accounts, to deceive the bank into advancing the funds.
In 2016, Li Longteng signed an agreement to buy a property from Mai Bixia in the city of Guangzhou for 1.25 million yuan. The deal later fell through because Li, a resident of Hunan, was ineligible to buy property in Guangzhou. Mai subsequently decided not to sell.
Li sued Mai, claiming contractual default fees and the return of his deposit, according to case documents from a court in Guangzhou. The records show that Mai told the court the property agent and banker together suggested she assist with Li's attempts to apply for a refurbishment loan from a bank with the intention of diverting the money to pay his down payment on the flat. Li and his property agent told the court it was the bank that suggested faking the loan application.
In the end, a fraud did not take place because the deal's collapse meant no loan was issued. And the court ruled against Li because he didn't meet the residential requirements to buy the property. Li's lawyer told Reuters his client declined to comment. Questions sent to Mai's lawyer went unanswered.
For bankers, there are rarely repercussions for failing to police the use of consumer loans or approving re-packaged mortgage applicants - as long as prices keep rising and defaults remain at bay.
Some commentators, property agents and developers argue Beijing can sidestep a market correction because China has a closed capital account, abundant reserves, a current account surplus and a financial system largely controlled by the government. The authorities also control the supply of land.
China's new home price growth has slowed this year. Still, regulators and local authorities are showing concern about the threat from a property bubble.
Since April, more than 40 major Chinese cities require newly bought homes to be held for two or in some cases three years before they can be sold, in an effort to curb speculation. The authorities are also urging vigilance to counter fraud.
In August and September, the central bank asked lenders to be wary of borrowers channelling personal loans into property, according to reports carried by state media and official documents seen by Reuters. Regulators also ordered banks to crack down on yin-yang contracts and over-valuations, according to official notices sent to the banks and seen by Reuters last month.
Property market insiders see little prospect of an effective crackdown on fraud unless banks cooperate, however. Xuan Hong Xia, the lawyer for Lei Yarong, cites a case last year in which her firm represented a seller in a property deal. The buyer and agent had overvalued the property. Xuan's law firm advised the bank of the deception, but the lender ignored the warning.
"It seems banks don't consider the issue a serious one," she said.
(By Engen Tham, Clare Jim and Yawen Chen; edited by David Lague and Peter Hirschberg)