Winning the mortgage fraud game
Mortgage fraud continues to increase, despite the numerous news articles and media attention that bring to light the many schemes designed to take advantage of mortgage processes. National banking, financial and mortgage trade associations invariably include, in their annual events, specific topics for fraud detection and mitigation strategies. Individual state legislatures are taking action in an attempt to stabilize internal economic factors; including property values. Incidences of reported fraud have increases so consistently that trending charts can be confused for those measuring the popularity of leading video games. With increasing pressure on mortgage income streams due to newly enacted legislation, it is fair to ask if it would have been less turbulent to have chosen a career in politics. In July 2009, the Federal Bureau of Investigations (FBI) released its mortgage fraud statistics for 2008. The report identified an increase of reported fraud of 36 percent over 2007’s totals. Figures for 2009 were also reported as showing “significant” increases. The FBI Web site categorizes mortgage fraud as either, “Fraud for Property” or “Fraud for Profit.” “Fraud for Property” entails the borrower misstating income and/or debts in order to qualify to purchase a property. The borrower usually enters the transaction with the full intent of making payments, although their plan may be short-term in areas where property values are rapidly increasing. “Fraud for Profit” usually involves, “multiple loans and elaborate schemes,” in order to gain large proceeds from the purchase transaction. These schemes often leave the loan origination company facing indemnification since any government insurance program (FNMA, FHLMC, FHA, VA) would be withdrawn once fraud is identified. The FBI clearly states that fraud is, “The intentional misstatement, misrepresentation or omission by the applicant or other interested parties, relied on by a lender to provide funding for, to purchase, or to insure a mortgage loan.” Government insuring programs and recent laws are now being designed to strictly follow the historical definition of fraud, and not allow anything into the loan decision that has not been verified and validated through independent sources. On the heels of the demise of popular mortgage programs that were designed to “Trust” the word of the borrower, it appears that the legislative pendulum has swung in the opposite direction. Although in some circles, the past programs of NINA (no income, no asset) and SISA (stated-income, stated-asset), are remembered with fondness, mostly for the ease of processing and the profits they generated, it can well be argued that they represented the brink of disaster for the mortgage industry, especially when allowed for the salaried borrower. What cannot be questioned is the demise of many origination companies that relied heavily on these programs and upon ever increasing property values and funding volumes. Many company income strategies fell victim to the lure of easy profits and were crushed by unscrupulous borrowers who chose to lie or scheme their way through the mortgage process. Mortgage companies can successfully navigate these potentially dangerous waters by recognizing the changes in the industry and responding with a strong fraud policy that focuses quality control (QC) resources heavily upon prevention. Preventative audit and systemic controls provide the ability to mitigate risk, while managing large loan populations and large numbers of satellite branches, yet remaining flexible enough to meet each borrower’s individual financial needs. Although individual companies must set policies that best suit their corporate objectives, the prudent executive will be sure their policy includes these basics. Be aware of your environment With advancing technology, it is becoming increasingly difficult to combat those who intentionally work to defraud the mortgage lender. This enables the mortgage lender increased preventative controls without excessive additional costs. Mortgage industry leaders know that following the required Federal Housing Administration (FHA) Quality Control Plan offers only minimal protection against fraud for mortgage origination. Historically, it has been the standard to review 10 percent of closed loans to ensure compliance with the FHA post-close audit requirement and hope that fraud was never detected. This needle-in-a-haystack approach often produced the desired result of finding nothing. Shifts in the market have required more vigilance on the part of the lender and a more comprehensive fraud net. The adage, “fight fire with fire,” seems to apply here as lenders have an arsenal of electronic measures available at the touch of a button, and the payment of a fee. Names such as Compliance Ease, Loan Safe, and Fraud Guard once thought of as luxuries are now becoming staples in mortgage processing. Technological advances enable the lender to review information from multiple databases that can provide critical data right up to the closing date. Although this may mean an increase in processing costs, it is a far more expensive lesson to learn after the loan has closed, that there are property valuation or borrower income related issues. Obtain accurate collateral values “Fraud for Profit” schemes are attractive due to the lucrative payoff. Inaccurate property valuations are often at the root of such attempts where the property values have been exaggerated, frequently through manipulation of the appraisal. This leaves the lender or the insuring entity holding the bill when the scheme unravels. Again, use of industry software that accesses database information enables systemic review of values for the appraised property and the appraisal comparables with a comparison to current local market values. Identified exceptions can then be reviewed manually to ensure validity of the appraisal value. Verify once, verify twice and then verify again The Mortgage Asset Research Institute (MARI) produces a quarterly report on fraud and notes that the most common categories include misrepresentation of the application, income, employment, assets or debts, and/or occupancy. FHA processing requires independent validation of each of these critical loan elements. However, the need to provide immediacy for the customer in loan processing has pressured some lenders to take shortcuts that can lead to an unhappy ending where fraud is concerned. Many fraud schemes involve critical timing on the part of the borrower. For example, in an investigation of employment prior to funding, it is critical to perform a new validation rather than just initial the preliminary verification of employment (VOE), or mark it as, “same.” More than one potential fraudulent borrower has been stopped with a late stage VOE that was unanticipated. Follow the common red flags In November 2009, during the Fannie Mae Mortgage Fraud update, Senior Industry Relations Manager Amy Heinz stated that the published “Common Red Flags” could assist in fraud prevention. The red flag categories posted by Fannie Mae include key areas to monitor for the Mortgage Application, Sales Contract, Title, Employment and Income Documentation, and Asset Documentation. Including key red flag data points, such as unsigned or undated applications, same telephone number for applicant and employer may seem like obvious additions. However, postmortem examination of files gone wrong, often prove that elaborate schemes are the minority. It is more frequent that the simple requirements become stumbling blocks for even the giants of the mortgage industry. These common Red Flags form the foundation to a secure fraud policy. Zero tolerance for fraud Part of the validation process may determine that internal documentation may be a contributing factor to discrepancies detected in a file. Maintaining a zero fraud tolerance, both internally and externally, ensures that the company can continue to focus resources and fight fraud as an external foe. Any violation, no matter how insignificant, must be excised like a cancer. The origination company graveyard is filled with those who thought that doing business meant turning a blind eye at times. All too infrequently, requests are received to review tax returns where the borrower has not disclosed certain incomes, but requests that the loan officer include the figures when calculating the debt ratio. There are no grey areas! There are no allowances for either the customer with this mindset, or a loan officer that would even consider allowing this manipulation. These scenarios should be avoided as the ticking time bombs in your loan portfolio which they truly represent. No matter how large the borrower’s income, no matter how high their FICO score, if they receive the IRS audit phone call, its game over. Finally, I am frequently asked, “What is the reimbursement recovery potential for money lost due to fraud?” Although each situation is unique in some way, with fraud schemes the money disappears quickly and most often is not recoverable. In a USFN article in 2007 by Bruce Bergman, he concludes that suing for fraud is a less profitable route than merely foreclosing on the property. Although it may not offer the satisfaction of seeing punishment enforced, it does have the benefit of returning funds to the company coffers. This is, after all, the primary goal when a fraud investigation turns into a loss mitigation scenario. A successful fraud prevention policy will ensure that the company dollars never fall into the category of potential recovery. John Frank is the vice president of quality control for Primary Residential Mortgage Inc. He graduated from the University of Utah in 1988, and has been in the banking industry for almost 25 years. His background includes management positions with Norwest Bank, The Associates and Citi Group.