The most common fraud classification in the first through third quarters of 2008, as reported by the Mortgage Asset Research Institute (MARI) by all states in mortgage originations is application fraud. Application fraud represented 61 percent of all mortgage misrepresentation in originations. Tax return/financial statements followed second at 28 percent, appraisal/valuation at 22 percent, verification of deposit at 21 percent, verification of employment 15 percent, escrow/closing documents at 10 percent, and credit report at four percent.
2008 mortgage fraud types: Mortgage origination year (all states)
Fraud classification: 2008
Tax Return/Financial Statements: 28%
Verification of Deposit: 21%
Verification of Employment: 15%
Escrow/Closing Documents: 10%
Credit Report 4%
Below is a list of the top three states by each fraud types for 2008:
Application Misrepresentation: 61% (all states)
New York: 74%
Michigan and Florida: 67%
Tax Return/Financial Statements: 28% (all states)
New York: 32%
Appraisal Valuation: 22% (all states)
Colorado and Rhode Island: 38%
Verification of Deposit: 21% (all states)
New York: 27%
Verification of Employment: 15% (all states)
Florida and New York: 21%
California and Maryland: 14%
Escrow/Closing Documents: 10% (all states)
Illinois and New York: 15%
Credit Report: 4% (all states)
New York: 12%
Rhode Island: 8%
The MARI report collected its data from industry collaborative sources where only federally-insured financial institutions and their affiliates participate. Therefore, the reporting is limited. As far as I know this does not include all lenders with pre-funding quality control (QC) and post-closing QC support. Nor does it include government agencies such as the U.S. Department of Housing & Urban Development (HUD), the Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA), who may be responsible for underwriting or funding loans. Because of the limited reporting base, there may have been different trends due to the change in the market if the Suspicious Activity Report (SAR) had a broader reporting pool.
After being involved in a number HUD audits, I see a shift. The loans that for which I am referring to was not privy to SAR during underwriting or after funding.
The trends I see appear to be mostly refinances and the bulk of the problems occur in credit underwriting. However, after in-depth investigation the findings go as deep as the lack of proper integration of QC plans and sound underwriting practices. Additional discoveries found management also failing in preparing written responses to QC reports or tracking findings from the QC reporting. There are many lenders performing cash-out refinances as a form of loan modification in order to buy homeowners more time because the homeowners are delinquent in credit payments. When all is said and done, the servicer is stuck with servicing a loan that was used to pay off other delinquent credit. In the grand scheme of things, it appears to give truth to the age-old cliché, “Rob Peter to pay Paul.”
Regardless of the fraud type, scheme or fraud category, without a solid QC or quality audit (QA) program, there will continue to be mortgage fraud. A QC/QA program is only as good as the leadership of a mortgage operation. The stronger the leadership, the better the loans and the opposite applies to the weaker leadership and the lack of implementation of a strong QC program resulting in more problematic loans and increased financial risk to the mortgage operation and the economy.
Some of the common discoveries in refinances include:
► The credit report historical mortgage payment only showed one month’s payment and not 12 months where a payment or two was missed. Twelve months of mortgage history is needed.
► The credit history, despite adequate income to support obligation, reflected continuous late payments and delinquent accounts.
► The file failed to demonstrate the borrower had established acceptable credit for a considerable time period.
► The borrower’s collection accounts, including delinquent taxes totaling $63,297, were paid at closing. The letter of explanation stated that the credit problems were due to loss of income; however, based on the borrower’s tax return; his annual income had increased by $7,366 for the respective tax year.
► The HUD-1 indicated collection accounts totaling $15,637 were paid at closing. The credit report indicated the borrower’s mortgage was over 60 days delinquent three times in the previous 12 months of closing without adequate explanations.
► The HUD-1 indicated collection accounts, including delinquent utility payments totaling $3,320, were paid at closing. The credit report indicated the borrower’s mortgage was continuously delinquent in the previous 12 months and the payoff letter showed unpaid late and non-sufficient funds (NSF) charges without adequate explanations.
I could go on and on with examples of poor underwriting and pre-funding QC. These loans had well-prepared applications; however, it was the failure to substantiate creditworthiness and history. In the majority of the HUD audits, there was no identity theft … Red Flags Rules, no collateral or valuation problems … the Home Valuation Code of Conduct (HVCC). It was poor underwriting and pre-funding QC. I strongly believe if the underwriter had placed a condition or stipulation on these refinances, the processor or loan officer would have met the request of the underwriter or the loan would have been denied for the lack of creditworthiness. The underwriter has to be the watchdog and is the source of the longevity and survival of the mortgage company.
The next question I must ask myself is … was the underwriter committing fraud by allowing these loans to be approved with such gaps? Has the mortgage fraud bubble shifted to the underwriter rather than the loan officer? I checked and there was a different loan officer for every loan, and the sampling of audited files had a broad selection of underwriters. Therefore, it is difficult to perform any patterns of link analysis. The systemic problem continues to point to leadership and the strength of the QC program.
The future fraud schemes that are on the rise include:
► Foreclosure prevention schemes: These generally involve fraudsters posing as professional, knowledgeable foreclosure specialists. Homeowners facing the threat of foreclosure and nearing eviction are contacted by this foreclosure specialist who promises to work out their loan problems.
► Elderly and immigrant identity fraud: This occurs when elderly and non-English-speaking consumers are taken advantage of by fraudsters who steal their identities and use them in straw buying or other property transactions. This is currently happening in some reverse mortgage situations.
► Builder bailout fraud: This involves the securing of funds for condominium conversion or planned community development properties that, unbeknownst to the investor, will not be completed.
With new mortgage fraud schemes, it is important to fully understand the tactics of the fraudster. However, fraudsters can easily be stopped by implementing a strong pre-funding QC with fraud detection tools that the underwriter should employ.
I have also compared successful mortgage operations with the problematic mortgage operations. The consistent parallels I see with the successful mortgage operations are those who allow the QC departments to establish and implement policy pertaining to production. In other words, the leadership listens to the QC staff, regardless of production numbers. The problematic mortgage operations are very focused on production and the QC plan is often a second thought, leadership is not proactive with the QC arm of the operation and is often ignored.
MARI plays an important role in our industry and it helps leaders to evaluate weakness in production so that the industry can adjust its focus in order to keep the industry and economy healthy. Mortgage professionals have a professional obligation to ensure quality loans and that lending practices are upheld. With the loan originator having less control of the loan, it is now up to the underwriter to ensure the proper loan is approved for funding. With the percentages provided by MARI and the fraud types listed, how many of the fraud types can be discovered at underwriting or during the pre-funding QC process? The underwriters and pre-funding QC processes are finding many of the fraud types, but there are still too many getting through. It would be interesting to know what percentages of fraud types are found and stopped compared to those that are discovered after the loan is funded.
Tommy A. Duncan is executive vice president of Quality Mortgage Services LLC. He may be reached by phone at (615) 591-2528, ext. 124.