REQUIRED READING: Creative financing, relaxed underwriting guidelines, layered-risk loan programs and an emphasis on speedy decisioning during the real estate boom created an environment that allowed fraud to flourish. Today's investigations into defaulted loans prove that mortgage fraud played a major role in boosting origination volumes and property values to unsustainable levels during the boom years, which sparked the collapse of the economy when millions of ‘liar loans’ went into default.
The past few years have been painful for the industry, but they have also presented us with an opportunity to change the way we approach risk mitigation.
By mid-2008, the industry was able to significantly reduce the incidence of fraud in new originations by eliminating 100% financing and low- or no-document loan programs, and by verifying borrowers' income directly with the Internal Revenue Service. Encouraged by that success, many in the industry believed that fraud had been permanently beaten into submission, because the most instances of fraud that occurred during the boom involved flipping properties at artificially inflated values – and that feat was believed to be no longer possible in this era of declining property values.
Yet mortgage fraud flourishes in both up and down markets, and especially in communities where property values are uncertain, which is nearly everywhere today. Couple that with the overall economic climate – which is pretty dismal, with no hope for improvement in the immediate future – and conditions are ripe for a resurgence in fraudulent activity.Â
In order to predict where criminals are likely to strike going forward, let's analyze the three basic components of criminal activity: motive, means and opportunity.Â
What's your motive?
There are two basic motivations for mortgage fraud: greed and desperation. Greed is the main driver for out-and-out criminals, who are often enabled by equally greedy and corrupt industry insiders. Borrowers who are underwater or in default on their mortgages are driven by economic desperation, which leaves them vulnerable to foreclosure rescue scammers and professionals who may encourage them to ‘fudge’ whatever facts are necessary to achieve the desired outcome in loan modifications, short sales and refinancings.
Desperation also drives many commissioned industry professionals whose income, which depends in whole or in part on getting loans to closing, has been severely impacted by the drop in mortgage origination volumes due to the current economic climate. As this article was being written, existing-home sales had fallen to the lowest levels in more than a decade, and prices had fallen 30% from their peak. With approximately 7 million households in default or in foreclosure, it would appear that prices have not yet hit bottom.
These economic pressures provide ample motive for fraud by – and on behalf ofÂ – borrowers, and greedy profiteers are ready, willing and able to capitalize on homeowners' pain. Thus, mortgage fraud risk will likely remain extremely elevated for the foreseeable future.
Means to an end
Although lenders have made great strides toward reducing fraud in the pre-funding stage by verifying borrowers' incomes, requiring full documentation in support of an application and raising minimum FICO scores, perpetrators have easy access to a wide range of tools to defeat these defensive measures. A quick Internet search produces literally millions of sites that offer fake identification; financial, banking and utility records; and hundreds of thousands of sites that offer advice on how to improve a FICO score by ‘piggybacking’ into someone else's credit lines.Â
For example, if you need to prove a low value in order to obtain a loan modification or to ‘flop’ the value in a short sale in order to create a profit margin on the resale, there are many sites that give advice on how to influence or manipulate a broker price opinion to get your desired value – which includes providing interior photos from other properties, or inflicting cosmetic damages like removing screws from cabinetry, pulling light fixtures apart, putting off all needed repairs and neglecting the yard. Or, if you need a proof-of-funds letter in order to complete a cash short-sale purchase, there is a plethora of sites that will issue one for any property at any amount desired – all you have to do is fill in the blanks.
(As an aside, one of our employees – in an exercise to show how easy it is to pull off mortgage fraud – was able to obtain a letter attesting that she has $850,000 that will enable her to buy the Federal Bureau of Investigation's headquarters building in Washington, D.C.)Â
Another example of fraud occurs in the following scenario: If you need proof of an actual bank account with sufficient funds to support the purchase of a residence or a commercial property, there are ‘leased collateral’ account providers that will add your name to an existing account or sub-account for a small fee, with the assurance that your lender will never find out that it is not really your account – and the fine print makes it clear that you will not be able to actually access the funds.
If you need real money to fund back-to-back short-sale or real estate owned (REO) flips, just Google ‘transactional funding’ or ‘dough for a day,’ and you'll find a virtually unlimited supply of companies that are willing to loan you what you need to make your pre-flip acquisition, as long as you have your end buyer lined up and you pay it back within 24 to 48 hours. And if you need to disguise seller financing or the fact that you acquired the property yesterday, you can easily try a land trust.
While these are just a few of the ways transactions and qualifications can be manipulated, the bottom line when it comes to the means of committing fraud is that where there's a will, there's no shortage of ways to obtain whatever a fraudster needs to close the deal.
Given the realities of the current state of the economy, and the fact that a large number of negative amortization option adjustable-rate mortgages are set to recast between now and the end of 2011, one should expect that conditions will continue to favor an increase in mortgage fraud risk for the foreseeable future. Specific areas of vulnerability include the following:
Collateral value. Property valuation fraud risk has risen by over 200% in the past year. The uncertainty created by fraudulently inflated values that infected tax digests during the boom, and falling values caused by the vast number of foreclosures, give fraudsters wide latitude to manipulate property values.Â
Short sales and REOs. Distressed sales constitute a significant share of today's real estate closings. Motivated sellers and hungry real estate professionals with the ability to fabricate values and qualifications leave this segment of the market at high risk.Â Â
Refinancings. This risk is likely to continue in markets with severely falling property values, as borrowers – who may be speculative investors – seek to refinance, despite insufficient equity. Income and employment misrepresentations, along with manipulated collateral values, are hallmarks of fraud in this category.
Foreclosure rescue schemes. Underwater borrowers are highly vulnerable to con artists who promise to forestall foreclosures for a fee but do nothing, as well as from fraudsters who use that desperation to convince the borrowers to agree to artificially low short-sale values. Borrowers who fall victim to these schemes are often convinced to convey title to the home to a land trust with the perpetrator named as the trustee, and the deal may be sweetened with the promise that the home can be leased back and later purchased.
Identity fraud. This occurs most often when the borrower has a poor credit score and needs to use the identifier of a friend or a relative (which increasingly is the borrower's child) in order to qualify for a loan, or when a career fraudster is trying to obscure his or her involvement in the transaction. Since lenders have tightened FICO-score requirements – and, as of July, some 43 million people have scores of 599 or less – it is not surprising that there has been a 33% increase in Social Security number theft and misuse in mortgage originations over the last year.
Loan modifications. Historically, servicers have not been responsible for performing fraud detection or prevention, and their employees are unlikely to have had the training necessary to spot attempted frauds, which includes the deflation of collateral values, the filing of tax returns that understate the borrower's income, and intentional defaults by borrowers who have the financial capacity to repay their loans. Servicers or servicing departments typically do not communicate their knowledge of fraud to origination staff. Unless fraud-detection technology and training are provided to servicing staff, and lines of communication are established between these departments, fraud risk in loan modifications will remain elevated.
Title theft. Fabricating deeds of conveyance and mortgage satisfactions is an easy way to acquire a property for resale. Squatters, ‘sovereign citizens’ who follow their own rules of law, and professional fraudsters are taking advantage of the abundant supply of vacant homes to acquire a home or to acquire properties to lease or sell with forged deeds. Because all fraudsters need are the proper forms and a relatively small filing fee, and county recorders are generally not empowered to inquire as to the documents' authenticity, lenders will remain at risk.Â
Reverse mortgages. The elderly are increasingly being used to perpetrate mortgage frauds in the reverse mortgage market. Lured by the promise of free homes, seniors are being recruited in fraud-for-profit and builder bailout schemes. Home equity conversion mortgages (HECMs) have also been used to finance the purchase of homes for ineligible family members, children have obtained cash-out HECMs without the parent's knowledge or consent, and settlement agents have absconded with the proceeds. The danger to lenders is increased because, according to law enforcement agents, settlement instructions have not been modified from forward mortgages, so they do not adequately address the unique opportunities for fraud presented in a reverse mortgage transaction.
Fraud detection and prevention during pre-funding has certainly improved since the boom, but it still leaves much to be desired, because lenders can no longer blindly trust the participants in a transaction or their supporting paperwork. Underwriters and servicing personnel need ongoing education about evolving schemes, access to the automated tools that are on the market and training in how to use them. Documentation must be independently verified, and red flags must be vigorously investigated.Â
As we look to recover from the ‘mortgage meltdown,’ we, as an industry, must embrace this opportunity to improve our risk mitigation procedures and leverage the technology available to us. While change is often painful, this is one time that not making changes will ultimately cause a great deal more distress.
Kevin Coop is president of Interthinx, based in Agoura Hills, Calif. He can be reached at (818) 878-2800.