Identify and Prevent Mortgage Fraud in Your Financial Institution

Mortgage fraud schemes cost financial institutions billions of dollars each year, yet experts in the industry report that little is being done to prevent mortgage-fraud losses. With many institutions focusing their energy on preventing high-tech crimes such as phishing attacks and money laundering, little headway has been made to prevent damages caused by more basic fraud-for-profit schemes.

Mortgage fraud occurs when a person in the process of obtaining a mortgage loan makes a material misrepresentation that the lender then relies upon when making a financing decision. Data collected from 2016 and 2017 show that reported incidents of mortgage fraud are on the rise. Knowing what kinds of schemes are gaining traction can help you identify fraud, and prevent it from happening in the future.

Recognize common mortgage fraud schemes

One of the easiest ways to detect and prevent mortgage fraud is to watch for common red flags that accompany most fraud-for-profit schemes.

Straw buyer

In a straw buyer scheme, a mortgage broker finds a person (known as the “straw”) with good credit to apply for a mortgage on behalf of someone who is unable to acquire a loan, usually due to poor credit. The straw has no intention of occupying or paying for the mortgaged property and is typically offered a fee for participation in the scheme. In situations where both the purchaser and the property are fictitious, the scheme is referred to as an “air loan.”

Illegal property flipping

Illegal property flipping occurs when a property is purchased and resold quickly at an artificially inflated price based on a fraudulent appraisal. The fraudulent appraisal may indicate that renovations were made to the home when, in reality, only minor cosmetic improvements were made, or sometimes none at all. These flips often involve straw buyers and inexperienced purchasers.

Foreclosure rescue

A foreclosure rescue scheme is a type of fraud that targets homeowners who are facing foreclosure. A perpetrator of a foreclosure rescue scheme typically contacts the homeowner pretending to be a private investor and offers to pay off the delinquent mortgage. In return for allowing the homeowner to stay in the property as a renter, the homeowner transfers the title of the home as collateral.

Reverse occupancy

In a reverse occupancy scheme, a borrower indicates that property is being purchased as an investment property. Rental proceeds are then listed as income on the loan application for the purpose of qualifying for the mortgage loan. However, instead of renting the property, the borrower is actually occupying the home as a primary residence. Common characteristics of reverse occupancy schemes include:

• The subject properties are sold as investment properties
• Purchasers are first-time home buyers with minimal or no established credit
• Purchasers have low incomes but significant liquid assets
• Purchasers make large down payments

Occupancy fraud increased by 7 percent from the second quarter of 2016 to the second quarter of 2017, with Hawaii, Colorado, Nevada, Montana, and Nebraska showing the largest year-over-year increases.

Wire transfer fraud

Mortgage wire transfer fraud occurs when a scammer hacks the personal data of an impending mortgage transaction. The hacker assumes the identity of one of the transaction parties and attempts to convince another party to change the down payment wiring instructions so that the funds are transferred into the scammer’s account. This is a particularly concerning type of fraud because it is international in nature and extremely difficult to track. Hackers are constantly growing more sophisticated in their ability to scam innocent parties. For example, hackers can use phone porting technology to disguise their phone numbers to resemble those of authorized transaction parties.

In 2016, wire fraudsters stole a staggering $5.3 billion, while only 15 percent of perpetrated fraud attempts were actually reported. In 2016, the industry saw a 480 percent year-over-year increase in wire fraud scams reported to the Internet Crime Complaint Center.

Employment fraud

Employment fraud occurs when a borrower lists a fictitious place of employment on the mortgage loan application. This is a currently a growing trend in certain areas of California. An expanding list published by Fannie Mae names 35 fictitious employers that have been recently discovered on loan applications for properties in Southern California. In July 2018, Fannie Mae published 10 additional places of employment found on applications in Northern California whose existence could not be confirmed.

Know where to look for red flags

Inconsistencies in a loan file can often indicate misrepresentations and may be part of a larger fraud scheme. However, the presence of inconsistencies alone does not necessarily mean there was fraudulent intent. There are several common places to look for red flags that indicate the file requires a more thorough examination.

Mortgage application

The mortgage loan application is one of the primary areas where inconsistencies can be found. Potential red flags on the application include:

• Significant or contradictory changes made from the handwritten to typed application
• An unsigned or undated application
• An application for a cash-out refinance on a recently acquired property
• The same telephone number for the applicant as for the employer
• A glaring discrepancy between the applicant’s income and price of the property (which can be a tip-off that the purchaser is a straw buyer)

Sales contract

The sales contract should be read carefully for signs that an actual negotiation took place for the sale of a mortgaged property. Red flags to watch for include:

• Boilerplate provisions (indicating that the transaction is a straw buyer or air loan scheme)
• The purchaser is not the applicant
• The use of a power-of-attorney
• Deposited checks with inconsistent dates
• Excessive real estate commission

Appraisal

The appraisal should be closely examined to ensure that the report was conducted on real property for a real buyer. Red flags to watch for include:

• An appraisal ordered by a party to the transaction
• A purchase price that is substantially higher or lower than the predominant market value
• Mismatching address reflected in the photographs and the property address
• Map scale distortions in the distance of comparable properties

Even a cursory look at the appraisal report may reveal obvious indicators of mortgage fraud. Watch for:

• “For rent” signs in the photographs,
• Photographs taken from an unusual or awkward angle
• An appraisal report that pre-dates the sales contract
• The use of comparable sales that are not similar in size or style

Current mortgage fraud trends

Data from 2017 show that New York, New Jersey, and Florida, respectively, are the highest ranking states for mortgage application fraud risk. Meanwhile, Iowa, Indiana, Missouri, Louisiana, and Idaho showed the greatest year-over-year growth in risk, with Louisiana coming in with a risk level greater than the National Index.

During the second quarter of 2017, more than 1,300 mortgage applications contained fraud — a 16.9 percent increase from the second quarter of 2016.

The greatest risk increase can be seen in jumbo refinance loans. The risk index for these loans has increased 59 percent, while volumes have decreased 35 percent. Specific risk factors associated with jumbo refinance loans include rapid refinancing after purchase, home value appreciation not supported by market changes, and occupancy red flags.

Occupancy fraud had the greatest year-over-year growth in risk, followed by transaction, income, and property fraud types. Meanwhile, undisclosed real estate debt and identity risks declined.

Changes in market increase fraud risks

A key factor in the increase of application fraud is the recent shift from a heavy refinance market to a purchase market. From the second quarter of 2016 to the second quarter of 2017, purchase transaction increased from 55 percent to 66 percent, and this trend is projected to continue. Purchase transactions are at higher risk for containing application fraud due to stronger motivations and increased opportunities to commit loan origination fraud.

In addition, there was a 48 percent increase in loans originated through wholesale channels (from 5 percent to 7.3 percent). Wholesale applications have historically shown a higher risk level than retail channels.

How we can help

While looking out for fraudster activity is essential, a strong quality control program can help your institution prevent fraud in the future. CLA’s mortgage advisory services team provides re-verification services, mortgage quality control, and employee education to help residential mortgage lenders meet industry quality standards.