Don't lose your FHA license because of a few bad loansFrank McKennafraud, early payment default, broker risk, red flags
Fraud and early payment default is
In today's market, Federal Housing Administration (FHA) licenses
are gold. As many mortgage lenders scale back their broker-related
originations, FHA programs offer brokers an important channel for
maintaining a steady state of business. However, if fraud and early
payment default rates become excessive compared to other brokers, a
broker can quickly lose the ability to submit loans for these
programs. Maintaining high quality loan packages is the safest bet
to keeping a license in good standing. The key to this is becoming
keenly aware of the red flags that might result in fraud or early
Some of the most obvious patterns that have emerged include:
•Broker risk is concentrated on a few bad apples:
Historically, only eight percent of brokers account for 100 percent
of fraud and early payment default (EPD). The overwhelming majority
of brokers did not have a single instance of fraud or EPD.
•Income levels were closely linked to EPD and fraud: In
close examination of reported income, if the income appears to be
inflated by 150 percent or more, the rate of EPD and fraud was at
•Falsifying occupancy led to higher non-performance issues:
When borrowers indicate on an application that they intend to
occupy the property when they really did not, loans are more likely
to have issues linked to EPD.
•Savings and reserve levels determined affordability: When
borrowers have substantial reserves (at least four months worth or
more) in their bank accounts, they are more likely to not have an
EPD issue. The exception to this is when savings account levels are
falsified or manipulated on the bank statements.
Spotting red flags to prevent EPD and
Four important steps a broker can take to prevent fraud and EPD
1. Know your employees
The real problem behind a broker's performance is the loan officers
hired. In some cases, the broker is unknowingly infiltrated by a
fraud ring that is churning high volumes of questionable loans
through their practice. Some of the common red flags that are
associated with this type of behavior include:
•Loan officers who submit a high volume of loans in a
short period of time.
•Loan officers who bring in potential borrowers that do not
fit the typical profile that the brokerage handles.
•Loan officers who charge excessive fees.
2. Routinely check the work of your loan officers
Reviewing your loan officers' packages can be an important step in
identifying a problem. The most common type of red flag occurs when
a loan officer re-uses the same fraudulent documentation on
multiple borrowers—this includes income documents, bank
statements and credit reports.
3. Check income documents
Because income is linked to performance, checking income for
reasonability is important for a broker to reduce defaults and
fraud. Some basic checks and red flags to look for are:
•Does the income make sense for the borrower's age?
•Does the income make sense for the occupation of the
•Does the income seem reasonable based on the type of house
the borrower is buying?
4. Check occupancy of borrower
Misstating the intent to occupy is closely linked to performance
problems. Understanding if a borrower will truly occupy the
property can prevent occupancy fraud. The most common red flags to
look for are:
•Does the commute distance between home and work make
•Does the borrower own another, more expensive property, but
claims that they will live in this property?
•Does the borrower live out of state?
Just ask, does the loan file make sense?
In most cases, loans that go on to contain fraud misrepresentations
or EPD can be prevented by asking a simple question, "Does this
loan file make sense?" The patterns that exist on files that
contain fraud often do not make sense according to expectations.
Good brokers are able to avoid the problems associated with these
loans by questioning if the loan makes sense or not.
Frank McKenna is co-founder and chief fraud strategist at BasePoint Analytics, a
Carlsbad, Calif.-based fraud analytics and consulting company
serving the mortgage and banking industries. He may be reached at
(760) 602-4971, ext. 104 or e-mail [email protected]