Partners (Number 3, 2008)

Mortgage Fraud in the Sixth District

Over the last several years, upsets in the home finance market have exposed extensive mortgage fraud. Although consumers have become increasingly aware of the problem, opportunists will always try to stay a step ahead by developing new ways of perpetrating mortgage fraud.

Image What is mortgage fraud? The Federal Bureau of Investigation defines mortgage fraud as "any material misstatement, misrepresentation or omission relied upon by an underwriter or lender to fund, purchase or insure a loan." Mortgage fraud schemes range in complexity from misrepresentations by a single borrower concerning income, assets or property occupancy to complex schemes orchestrated by loan officers, attorneys, appraisers, title agents, recruiters, straw buyers and others acting in collusion to defraud financial institutions and private investors of millions of dollars.

Three primary types of mortgage fraud
Mortgage fraud typically falls into three categories. In fraud for housing, the intent is to obtain housing or, in the case of refinancing, cash equity. In this case, the borrower intends to repay the loan but has misrepresented information such as income or assets that otherwise would have caused the loan to be denied. In the past, fraud for housing was typically committed by a borrower acting alone. But in recent years it has increasingly involved industry insiders who conspire to qualify borrowers for loans—sometimes without the borrower's knowledge.

In fraud for profit, the perpetrator's intent is to bilk the mortgage lender of as much money as possible. These fraudsters do not intend to repay the loan. Property values are typically inflated to provide as much profit as possible. Industry insiders such as mortgage brokers, appraisers, title companies and loan officers collude in this type of fraud, which often involves multiple transactions and borrowers.

Fraud for criminal enterprise uses proceeds from a mortgage fraud scheme to fund criminal activities and to launder money. Prostitution, drug manufacturing, smuggling, terrorism, false document production and counterfeiting are among the crimes that have been underwritten by mortgage fraud. For example in the Atlanta area, straw borrowers were used to purchase residential homes in upscale neighborhoods for the purpose of growing indoor marijuana crops.

Factors driving mortgage fraud
Fierce competition in the mortgage industry prompted lenders to cut costs and expedite loan closings. To cut costs, many lenders shifted resources from quality control, which is how questionable loans are detected, to loan production. Limited documentation loans, also known as stated or "low-doc loans," were introduced to reduce costs and hasten loan closings. Low-doc loans were justified by the expectation that property appreciation would offset the risks. Lenders simply relied on the borrower's word that income and other financial information stated on the application were true.

In addition, rapidly increasing property values made homeownership less affordable to consumers. The industry responded by introducing nontraditional loans, including subprime loans, to help more consumers purchase homes. Nontraditional loans allow borrowers to defer principal and interest payments over a specified time period. Competition for subprime loan clients induced lenders to relax underwriting criteria and offer low-doc subprime loans. Lenders have generated significant profits by selling subprime loans to Wall Street. Wall Street's appetite for higher yielding mortgage obligations has been cited as a primary reason the subprime market grew so rapidly.

Nationwide Mortgage Fraud SARs Filed 1996–2007
Nationwide Mortgage chart
Financial Crimes Enforcement Network (FinCEN), The SAR Activity Review - By the Numbers, Issue 10 - May 2008.

Technology and the Internet also made mortgage fraud easier. Employment and income verifications are easily purchased over the Internet, as are false identities. Fraudsters use photo editing software to enhance appraisal photos that support inflated property values. Individuals with poor credit could increase their credit scores, for a fee, by piggybacking on the credit of individuals with high credit scores. Fraudulent documents such as mortgage satisfactions, leases, bank statements and brokerage statements are now easily created using common software. In larger-scale mortgage fraud operations, fraudsters use prepaid cell phones and mail drops to verify fraudulent employment and income information.

Because compensation in the mortgage industry is commission- and fee-based, brokers and other industry participants are motivated to originate and close as many loans as possible to maximize personal income. Relaxed underwriting criteria and low-doc loans reduce the time from loan application to loan closing and enable brokers to generate greater loan volumes. In some instances, industry professionals were driven by personal gain to do whatever was necessary to qualify a borrower for a mortgage. Developers and builders with large inventories of lots and homes that were not selling conspired with individuals in the mortgage industry to move properties. Documents were altered and new documents were created.

Borrower misrepresentations concerning employment, income, assets, liabilities, and occupancy were commonplace and often necessary to get a loan approved. Freddie Mac estimates that misrepresentation concerning borrower capacity (employment, income, assets and liabilities) account for more than 50 percent of common misrepresentations. In some instances, the borrower is unaware of these misrepresentations. Other common misrepresentations concerning collateral value, down payment, occupancy and property type make up an estimated 35 percent of common misrepresentations. The remaining misrepresentations involve credit score and identity.

Tips for Avoiding Mortgage Fraud

For Consumers >>
bullet image Don't overstate (or let your lender overstate) your income or assets to qualify for a loan.
bullet image Don't state a company as your employer if you are not employed by that company.
bullet image Don't overstate your position with your employer.
bullet image If you don't intend to live in the property, don't promise that you will.
bullet image Don't state in the purchase contract that you paid a deposit unless you have.
bullet image Don't state that you received a gift for the deposit if it is a loan and has to be repaid.
bullet image Don't sign two purchase contracts for a property and give the lender the contract with the higher purchase price in hope of qualifying for a larger loan.
bullet image A loan officer who is the property listing agent may not protect your interests.
bullet image Don't accept seller incentives unless you disclose them to the lender.

For Financial Institutions >>
bullet image Conduct due diligence on all third-party originators. Know who you're doing business with.
bullet image Don't fund the loan if all pre-closing conditions are not met.
bullet image Don't allow payments from the seller's funds to non-lien holders.
bullet image Don't accept an appraisal that is dated prior to the application date.
bullet image Don't accept an appraisal with comparables that are clearly superior to the subject property.
bullet image Don't accept bank statement deposits that are not consistent with income or payroll dates.
bullet image Don't fund a loan if the applicant has an unusually high income given his profile, especially for a
stated income program.
bullet image Don't fund a loan until you can explain inconsistency of ownership between the title commitment, appraisal and sales contract and unexplained variations in the borrower's name that appear on documents.
bullet image Understand why there are cross-outs on the title commitment, sales contract or other loan documents involving the borrower's name.

Mortgage fraud in the Fed's Atlanta District
Depository institutions are required to file Suspicious Activity Reports (SARs) with the Financial Crimes Enforcement Network (FinCEN) when fraud is suspected. The number of SAR filings is often used to measure mortgage fraud. The chart on page 10 shows mortgage fraud SAR filings nationwide from 1996 through 2007. During this period the number of SARs filed by depository institutions grew from 1,720 to 51,458.

As a percentage of SARs nationwide, those filed in the Federal Reserve's Sixth District peaked between 1999 and 2003. In 2003, Sixth District mortgage fraud SARs represented 16.7 percent of those filed nationwide. The percentage dropped to 8.7 percent in 2007 when a record number of SARs were filed nationally. Among Sixth District states, Florida has filed the most mortgage fraud SARs, followed by Georgia and Tennessee.

Although SAR filings are commonly used to measure mortgage fraud and identify states with high rates of mortgage fraud, there are several reasons why SAR data may not be an accurate indicator. Depository institutions are required to file a SAR when fraud is detected or suspected, but filing is not proof that fraud actually occurred. Private mortgage lenders, which account for approximately half of all mortgage originations, are not required to file SARs. In addition, some SAR filings report individual mortgage fraud transactions while other SAR filings report multiple transactions originated, say, by the same employee. The SAR data reported by FinCEN does not take into consideration multiple transactions or the dollar amount of fraudulent mortgage transactions.

Are foreclosures a better indicator of mortgage fraud? Like mortgage fraud, foreclosures have always had a presence in the mortgage industry. But mortgage fraud is only one of the reasons for foreclosures. A borrower's ability to meet mortgage obligations can change suddenly due to divorce, unemployment, loss of income due to poor health, medical expenses and a range of situations that have nothing to do with mortgage fraud. Nevertheless, borrowers do face foreclosure as result of mortgage fraud. Law enforcement officials report that the full cost of mortgage fraud, though estimated in the billions of dollars, will never be known.

Mortgage fraud assumes many guises. For example, individuals have been lured by the prospect of big returns at the point of sale into financing construction of homes in developments with slow sales. In a Louisiana scheme just prior to Hurricane Katrina, many individuals colluded to recruit investors to obtain a construction loan while misrepresenting that the properties would be owner-occupied.

Prosecuting mortgage fraud
Mortgage fraud in Sixth District states is being aggressively prosecuted. In June 2008, the U.S. Department of Justice and the Federal Bureau of Investigation (FBI) announced a national takedown of mortgage fraud schemes in Operation Malicious Mortgage. From March 1 to June 18, 2008, Operation Malicious Mortgage resulted in 144 mortgage fraud cases cited in every region of the country. At least 406 defendants were charged. The FBI estimates that the various schemes employed in these cases caused approximately $1 billion in losses. U.S. Attorney's Offices throughout the Fed's Sixth District announced indictments from Operation Malicious Mortgage in South Florida, Jacksonville, Fort Myers, Atlanta, Nashville, New Orleans and Jackson.

Is the worst over?
Is the worst mortgage fraud behind us? The recent escalation in fraud has prompted lenders to tighten underwriting standards and increase pre-funding quality controls. But we can expect new and existing variations of mortgage fraud schemes to continue, such as air loans, builder bail-outs, chunking or gunning, illegal property flips, the one-transaction flips, foreclosure rescue scams, equity stripping, identity theft schemes, phantom second liens, churning, phantom leases, and pot houses, perpetrated by individuals with and without co-conspirators motivated by greed.

This article was written by Linda Word, senior examiner in the Atlanta Fed's Anti-Money Laundering Group.