Red Flags
•
Critical loan processing activities, such as verification of
income, employment, or deposit, is delegated to brokers.
•
Delegated underwriting allowed for correspondents that are new or
lack an established track record with the FI.
•
A growing number of loans is being repurchased due to
misrepresentations by the FI under purchase and sale agreements
with secondary market investors. The originating FI may suffer
significant financial losses in the event of a large and
unforeseen fraud.
•
Third party mortgage loan fraud is not covered in standard
fidelity bond insurance.
•
Tax returns show RE taxes paid but no property is identified as
owned.
•
Alimony is paid but not disclosed.
•
Evidence of white out or other document alterations is observed.
•
Type or handwriting varies from other loan file documents or
handwriting is the same on documents that should have been
prepared by different people or entities.
Internal Controls/Best Practices
√
Review purchase and sales agreements with brokers, correspondents,
and secondary market investors to determine if general
representations and warranties contain appropriate fraud and
misrepresentation provisions.
√
Determine the FI’s responsibility for repurchasing and putting
back loans that were funded based on misrepresentations.
√
Check whether an endorsement or rider exists to the fidelity bond
that provides coverage of third party mortgage fraud.
√
Regularly document the FI’s review of insurance coverage.
√
Establish procedures to ensure the bonding company is notified of
a possible claim within the policy’s specified period.
√
Adopt detailed policies and procedures to ensure effective
controls are in place to set, validate, and clear conditions prior
to final approval processes.
√
Base underwriter compensation on loans reviewed and not loans
approved.
√
Establish effective pre-funding and post QC programs that include
sampling, portfolio analysis, appraisal, and income/down payment
verification practices.
√
As a part of the pre-funding QC process, use AVMs to corroborate
appraised values.
√
Employ internally developed or vendor-provided fraud detection
software.
√
Institute corporate wide fraud awareness training.
√
Perform due diligence of brokers and correspondents. Understand
the risks in their policies, procedures, and practices before
transacting business.
√
Determine how and when the FI reserves for fraud and ensure
compliance with FAS 5.
√
Review the FI’s litigation roster for existing and potential class
actions, and threatened litigation that may highlight a problem
with a particular broker, correspondent, or internal practices.
√
Review whistleblower and hot line reports, which may indicate
fraudulent activities.
Mortgage Brokers
A mortgage broker is an individual who, for a fee, originates and
places loans with an FI or an investor but does not service the
loan.
o Review the broker’s financial information as stringently
as for other RE borrowers.
o Ensure the FI’s broker agreements require brokers to act
as the FI’s representative/agent.
o Independently verify the broker’s background information
by checking business history outside of given references.
o Obtain a new credit report for the broker and check for
recent debt at other FIs.
o Obtain resumes of principal officers, primary loan
processors, and key employees.
o Conduct state license verification.
o Conduct criminal background checks and adverse data base
searches, i.e., MARI (fraud repository).
√
Conduct an annual re-certification of brokers.
√
Conduct pre-funding reviews on all new production utilizing a pre-
funding checklist.
√
Conduct QC underwriting reviews.
√
Base broker compensation incentives on something other than loan
volume, i.e., credit quality, documentation completeness,
prepayments, fraud, and compliance.
√
Establish measurable criteria that trigger recourse to the broker,
such as misrepresentation, fraud, early payment defaults, failure
to promptly deliver documents, and prepayments (loan churning).
√
Hold brokers and third party contract underwriters responsible for
gross negligence, willful misconduct, and errors/omissions that
materially restrict salability or reduce loan value.
√
Establish a broker scorecard to monitor volume, prepayments,
credit quality, fallout, FICO scores, LTVs, DTIs, delinquencies,
early payment defaults, foreclosures, fraud, documentation
deficiencies, repurchases, uninsured government loans, timely loan
package delivery, concentrations, and QC findings.
√
Perform detailed vintage analysis, and track delinquencies and
prepayments by number and dollar volume.
√
Closely monitor the total number of loans and products from a
single broker.
√
Establish an employee training program that provides instruction
on understanding common mortgage fraud schemes and the roles of a
mortgage broker, as well as recognizing red flags.
√
Establish a periodic audit of the brokered mortgage loan
operations with specific focus on the approval process.
√
Perform social security number validation procedures to validate
borrower identity.
Red Flags
•
No attempt is made to determine the financial condition of the
broker or obtain references and background information.
•
A close relationship exists between the broker, appraiser, and
lender, raising independence questions.
•
The broker acts as an advocate for the borrower instead of serving
as the FI’s representative/agent.
•
High “yield spread premiums” are paid by the FI.
•
Original documents are not provided to the funding FI within a
reasonable time.
•
An unusually high volume of loans with maximum loan to value
limits have been originated by one broker.
•
An uncommonly large number of foreclosures, delinquencies, early
payment defaults, prepayments, missing documents, fraud, high-risk
characteristics, QC findings, or compliance problems exist on
loans purchased from any broker.
•
A large volume of loans from one broker arrives using the same
appraiser.
•
High repurchase volume exists for a specific broker.
•
Numerous applications from a particular broker are provided
possessing unique similarities.
•
A high volume of loans exist in the name of trustees, holding
companies, or offshore companies.
•
An unusually large increase is noted in overall volume of loans
during a short time period.
Internal Controls/Best Practices5
√
Conduct an initial acceptance review and obtain documentation to
support broker approval. Examples of actions to be taken include:
Application
The mortgage application is the initial document completed by the
borrower that provides the FI with comprehensive information
concerning the borrower’s identity, financial position and
employment history.
Red Flags
•
The application is unsigned or undated.
•
Power of attorney is used. Investigate why the borrower cannot
execute documents and if formal supporting documentation exists.
•
Signatures on credit documents are illegible and no supporting
identification exists.
•
Price and date of purchase is not indicated.
•
Borrower is selling his current residence, but does not provide
documents to support a sale.
•
Down payment is not in cash, i.e., source of deposit is a
promissory note or repayment of a personal loan.
•
Borrower has high income with little or no personal property.
•
Borrower’s age is not consistent with the number of years of
employment.
•
Borrower has an unreasonable accumulation of assets compared to
income or has a large amount of unsubstantiated assets.
•
Borrower claims to have no debt.
•
Borrower owns an excessive amount of RE.
•
New housing expense exceeds 150% of current housing expense.
•
A post office box is the only indicated address for the borrower’s
employer.
•
The same telephone number is used for the borrower’s home and
business.
•
Application date and verification form dates are not consistent.
•
Patterns or similarities are apparent from applications received
from a specific seller or broker.
•
Certain brokers are unusually active in a soft RE market.
•
Concentration of loans to individuals related to a specific
project is noted.
•
Borrower does not guarantee the loan or will not sign in an
individual capacity.
•
Borrower’s income is not consistent with job type.
•
Employer is an unrealistic commuting distance from property.
•
Years of education is not consistent with borrower’s profession.
•
Borrower is buying investment properties with no primary
residence.
•
Transaction resulted in a large cash-out refi as a percent of the
loan amount.
Internal Controls/Best Practices
√
Establish an employee training program that provides instruction
on understanding common mortgage fraud schemes and recognizing red
flags.
√
Conduct pre-funding reviews on new production.
√
Closely monitor new brokers, correspondents, and products.
Scorecard criteria can be used to track performance. Typical
tracking data includes: default rates, pre-purchase cycle times,
loan quality indicators such as underwriting exceptions, and key
data changes prior to approval.
√
Verify the source of down payment funds by directly contacting the
FI where funds are shown deposited.
√
Closely analyze the borrower’s financial information for unusual
items or trends.
√
Independently verify employment by researching the location and
phone number of the business.
√
Employ pre-funding and post-closing reviews to detect any
inconsistencies within the transaction.
√
Conduct risk based QC audits prior to funding.
√
Ensure that prior liens are immediately paid from new loan
proceeds.
√
Assess the volume of critical post-closing missing documents,
determine the potential for repurchase recourse, and evaluate
reserve adequacy.
√
Monitor RE markets from the locale in which the FI’s mortgage
loans originated.
√
Establish a periodic independent audit of mortgage loan
operations.
√
Provide fraud updates/alerts to employees.
√
Review patterns on declined loans, i.e., individual social
security number, appraiser, RE agent, loan officer, broker, etc.
√
Establish a fraud hotline for anonymous fraud tips.
√
Increase the use of original supporting documentation on third
party transactions, i.e., wholesale and correspondent
originations.
Appraisals
An appraisal is a written report, independently and impartially
prepared by a qualified individual, stating an opinion of market
value of a property as of a specific date.
Red Flags
•
The appraiser is a frequent or large volume borrower at the FI.
•
The appraiser owns property in the project being appraised. This
is a violation of the appraisal regulation and raises concerns
about appraiser independence and bias.
•
The most recent assessed tax value does not correlate with the
appraisal’s market value.
•
An appraiser is used who is not on the institution’s designated
list of approved appraisers.
•
The appraiser is from outside the area and may not be familiar
with local property values. Understanding of local market nuances
is critical to an accurate property valuation.
•
An appraisal is ordered by a party to the transaction other than
the FI, such as the buyer, seller, or broker.
•
An appraisal is ordered before the sales contract is written.
•
Certain information is left blank such as the borrower, client, or
occupant.
•
The appraised value is contingent upon curing some property
defects, i.e., drainage problems or a zoning change.
•
Comparables are not verified as recorded or are submitted by a
potentially biased party, such as the seller or broker.
•
Old comparables (9-12 months old) are used in a “hot” market.
•
Comparables are an excessive distance from the subject property or
are not in the subject property’s general area.
•
Comparables all contain similar value adjustments or are all
adjusted in the same direction.
•
All comparables are on properties appraised by the same appraiser.
•
Unusual or too few comparables are used.
•
Similar comparables are used across multiple transactions.
•
Comparables and valuations are stretched to attain desired loan-
to-value parameters.
•
Excessive adjustments are made in an urban or suburban area when
the marketing time is less than six months.
•
Appreciation is noted in a stable or declining areas.
•
Large unjustified valuation adjustments are shown.
•
The land constitutes a large percentage of the value.
•
The market approach greatly exceeds the replacement cost approach.
•
Overall adjustments are in excess of 25%.
•
Photos do not match the description of the property.
•
Photos of comparables look familiar.
•
Photos reveal items not disclosed in the appraisal, such as a
commercial property next door, railroad tracks, etc.
•
Items with the potential for negative valuation adjustments, i.e.,
power lines, railroad tracks, landfill, etc., are avoided in
appraisal photos.
•
Loan amounts are disclosed to the appraiser.
•
File documentation is inadequate to determine whether appraisals
were properly scrutinized or supported by additional appraisal
reviews.
•
The appraisal fee is based on a percentage of the appraised value.
•
Independent reviews of external fee appraisals are never
conducted.
•
One or more sales of the same property has occurred within a
specified period (6-12 months) and exceeds certain value increases
(10% or more value increase).
•
A fax of the appraisal is used in lieu of the original containing
signature and certification of appraiser.
Internal Controls/Best Practices
√
Establish an employee training program that provides a good
overview of common mortgage fraud schemes, the appraisal
regulation, the RE lending standards regulation, appraisal
techniques, and red flag recognition.
√
Implement a strong appraisal and evaluation compliance review
process that is incorporated into the pre-funding quality
assurance program.
√
Ensure reviewers identify violations of regulations and
noncompliance with RE lending standards and other interagency
guidance.
√
Establish an approved appraiser list for use by retail, broker,
and correspondent origination channels. This list should be
generated and controlled by a unit independent of production.
√
Obtain a current copy of each appraiser’s license or certificate.
√
Implement “watch” list and monitoring systems for appraisers who
exhibit suspect practices, issues, and values. Include a post-
closing review to detect any transaction inconsistencies.
√
Establish a “suspended” or “terminated” list of appraisers who
have provided unreliable valuations or improper practices.
√
Implement controls to ensure that “terminated” appraisers are
prohibited from engaging in future transactions with the FI, and
its brokers and correspondents.
√
Implement third party appraisal controls to ensure compliance with
regulatory guidance, specifically as it applies to appraisals and
evaluations ordered by loan brokers, correspondents, or other FIs.
√
Develop appraisal requirements based on transaction risks.
√
Statistically test the appropriateness of appraisals obtained by
brokers and correspondents by obtaining independent AVMs and
appraisals.
√
Establish an independent appraisal review/collateral valuation
unit to research valuation discrepancies and provide technical
oversight.
√
Review the appraisal’s three-year sales history to determine if
land flips are occurring.
√
Perform detailed research on each appraiser’s business history and
financial condition.
√
Physically verify the location and condition of selected subject
properties and comparables.
√
Monitor RE market values in areas that generate a high volume of
mortgage loans and where concentrations exist.
√
Employ pre- and post-closing QC reviews to detect inconsistencies
within the transaction and hold production units financially
accountable for proper documentation and quality.
√
Conduct periodic independent audits of mortgage loan operations.
Credit Report
A credit report is an evaluation of an individual’s debt repayment
history.
Red Flags
•
The absence of a credit history can indicate the use of an alias
and/or multiple social security numbers.
•
A borrower recently paying all accounts in full can indicate an
undisclosed consolidation loan.
•
Indebtedness disclosed on the application differs from the credit
report.
•
The length of time items are on file is inconsistent with the
buyer’s age.
•
The borrower claims substantial income but only has credit
experience with finance companies.
•
All trade lines were opened at the same time with no explanation.
•
A pattern of delinquencies exists that is inconsistent with the
letter of explanation.
•
Recent inquiries from other mortgage lenders are noted.
•
AKA (also known as) or DBA (doing business as) are indicated.
•
The borrower cannot be reached at his place of business.
•
FI cannot confirm the borrower’s employment.
•
DTI ratios are right at maximum approval limits.
•
Employment information/history on the loan application is not
consistent with the verification of employment form.
•
Credit Bureau alerts exist for Social Security number
discrepancies, address mismatches, or fraud victim alerts.
Internal Controls/Best Practices
√
Establish an employee training program that provides instruction
on understanding common mortgage fraud schemes, analyzing credit
reports, and recognizing red flags.
√
Include an analysis of the credit report in the pre-funding
quality assurance program.
√
Make direct inquiries to the borrower and creditors to get an
explanation of unusual or inconsistent information.
√
Obtain an updated credit report if the one received is older than
six months.
√
Independently verify employment by researching the location and
phone number of business.
√
Implement a post-closing review to detect any inconsistencies
within the transaction.
√
Establish a periodic independent audit of mortgage loan
operations.
√
Define DTI calculation criteria and conduct training to ensure
consistency and data integrity.
√
Clarify non-borrower spouse issues, such as community property
issues and the impact of bankruptcy and debts on the borrower’s
repayment capacity.
√
Ensure lease obligations are reflected in borrower debts and
repayment capacity.
√
Conduct re-verification of credit to ensure accuracy of
broker/correspondent provided credit reports.
√
Obtain more than one report from multiple repositories available
to corroborate the initial credit report if data appears
questionable.
Escrow/Closing
A closing or settlement is the act of transferring ownership of a
property from seller to buyer in accordance with the sales contract.
Escrow is an agreement between two or more parties that requires
certain instruments or property be placed with a third party for
safekeeping, pending the fulfillment or performance of a specific
act or condition.
Red Flags
•
Related parties are involved in the transaction.
•
The business entity acting as the seller may be controlled by or
is related to the borrower.
•
Right of assignment is included which may hide the borrower’s
actual identity.
•
Power of attorney is used and there is no documented explanation
about why the borrower cannot execute documents.
•
The buyer is required to use a specific broker or lender.
•
The sale is subject to the seller acquiring title.
•
The sales price is changed to “fit” the appraisal.
•
No amendments are made to escrow.
•
A house is purchased that is not subject to inspection.
•
Unusual amendments are made to the original transaction.
•
Cash is paid to the seller outside of an escrow arrangement.
•
Cash proceeds are paid to the borrower in a purchase transaction.
•
Zero funds are due from the buyer.
•
Funds are paid to undisclosed third parties indicating that there
may be potential obligations by these parties.
•
Odd amounts are paid as escrow deposits or down payment.
•
Multiple mortgages are paid off.
•
The terms of the closed mortgage differ from terms approved by the
underwriter.
•
Unusual credits or disbursements are shown on settlement
statements.
•
Discrepancies exist between the HUD-1 and escrow instructions.
•
A difference exists between sales price on the HUD-1 and sales
contract.
Internal Controls/Best Practices
√
Establish an employee training program that provides an
understanding of common mortgage fraud schemes, proper closing
procedures, and recognizing red flags.
√
Provide the closing agent with instructions specific to each
mortgage transaction.
√
Instruct the closing agent to accept certified funds only from the
FI that is the verified depository.
√
Require the closing agent to notify the FI if the agent has
knowledge of a previous, concurrent, or subsequent transaction
involving the borrower or the subject property.
√
Obtain a specific transaction closing protection letter from the
closing agent.
√
Implement controls to ensure loan proceeds fully discharge all
debts and prior liens as required.
√
Employ pre- and post-closing reviews to detect any inconsistencies
within the transaction.
√
Conduct periodic independent audits of mortgage loan operations.
√
Use IRS form 4506 on all loans to facilitate full investigation of
future fraud allegations.
Industry studies indicate that a significant portion of the loss
associated with residential RE loans can be attributed to fraud.
Industry experts estimate that up to 10% of all residential loan
applications, representing several hundred billion dollars of the
annual U.S. residential RE market, have some form of material
misrepresentation, both inadvertent and malicious. An in-depth
review by The Prieston Group of Santa Rosa, California of early
payment defaults, an indicator of problem loans, revealed that 45-
50% of these loans have some form of misrepresentation.
Additionally, this study showed that approximately 25% of all
foreclosed loans have at least some element of misrepresentation,
and losses on floan balance.
The second motive, fraud for profit, is a major concern for the
mortgage lending industry. It often results in larger losses per
transaction and usually involves multiple transactions. The schemes
are frequently well planned and organized. There may also be intent
to default on the loan when the profit from the scheme has been
realized. Multiple loans and people may be involved and
participants, who are often paid for their involvement, do not
necessarily have knowledge of the whole scheme.
Fraud for profit can take many forms including, but not limited to:
•
Receipt of an undisclosed or unusually high commission or fee,
•
Representation of investment property as owner-occupied since
FIs usually offer more favorable terms on owner-occupied RE, •
Sale of an otherwise unsalable piece of property by concealing
undesirable traits, such as environmental contamination,
easements, building restrictions, etc.,
•
Attainment of a new loan to redeem a property from foreclosure
to relieve a burdensome debt,
•
Rapid buildup of a RE portfolio with an inflated value to
perpetrate a land flip scheme,
•
Mortgage of rental RE with the intention of collecting rents
and not making payments to the lender, retaining funds for
personal use,
•
The advance of loan approvals for customers to benefit from the
commission payments, and/or
•
Misrepresentation of personal identity, i.e., use of illegally
acquired social security numbers, to illegally obtain a loan,
or to sell/take cash out of equity on a property with no
intention of repaying the debt.
The third motive, which involves additional criminal purposes beyond
fraud, is becoming more of a concern for law enforcement and FIs.
This involves taking the profit motive one step further by applying
the illegally obtained funds or assets to other crimes, such as:
•
Money laundering through purchase of RE, most likely with cash,
at inflated prices,
•
Terrorist activities such as the purchase of terrorist safe
houses and,
•
Other illegal activities like prostitution, drug sales or use,
counterfeiting, smuggling, false document production and
resale, auto chop shops, etc.
PARTICIPANTS
It is important to be aware of the different participants and
transaction flows to understand the fraud schemes described in this
paper. This section provides background information on various
participants and their roles in typical mortgage transactions.
Participants
Common participants in a mortgage transaction include, but are not
limited to:
•
Buyer – a person acquiring the property,
•
Seller – a person desiring to convert RE to cash or another
type of asset,
•
Real Estate Agent – an individual or firm that receives a
commission for representing the buyer or seller, •
Originator – a person or entity, such as a loan officer,
broker, or correspondent, who assists a borrower with the loan
application,
•
Processor – an individual who orders and/or prepares items
which will be included in the loan package,
•
Appraiser – a person who prepares a written valuation of the
property,
•
Underwriter – an individual who reviews the loan package and
makes the credit decision,
•
Warehouse Lender – a short term lender for mortgage bankers
that provides interim financing using the note as collateral
until the mortgage is sold to a permanent investor, and
•
Closing/Settlement Agent – a person who oversees the
consummation of a mortgage transaction at which the note and
other legal documents are signed and the loan proceeds are
disbursed.
Refer to Appendix A – Glossary for additional and expanded
definitions for participants and other terms used throughout this
paper.
Mortgage Loan Purchased from a Correspondent – In this transaction,
the borrower applies for and closes his loan with a correspondent of
the FI, which can be a mortgage company, small depository
institution, or finance company. The correspondent closes the loan
with internally generated funds in its own name or with funds
borrowed from a warehouse lender. Without the capacity or desire to
hold the loan in its own portfolio, the correspondent sells the loan
to an FI. The purchasing FI is frequently not involved in the
origination aspects of the transaction, and relies on the
correspondent to perform these activities in compliance with the
FI’s approved underwriting, documentation, and loan delivery
standards. The purchasing FI reviews the loan for quality prior to
purchase. The purchasing FI must also review the appraisal or AVM
report and determine that it conforms to the appraisal regulation
and is otherwise acceptable. The loan can be booked in the FI’s own
portfolio or sold.
In “delegated underwriting” relationships, the FI grants approval to
the correspondent to process, underwrite, and close loans according
to the FI’s processing and underwriting requirements. The FI is
then committed to purchase those loans. Obviously, proper due
diligence, controls, approvals, QC audits, and ongoing monitoring
are warranted for these higher risk relationships.
Financial institutions that generate mortgage loans through
correspondents should have adequate policies, procedures, and
controls to address: initial approval and annual re-certification,
underwriting, pre-funding and QC reviews, repurchases, early
prepayments, appraisals, quality and documentation monitoring,
fraud, scorecards, timely delivery of loan packages, and utilization
of contract underwriters. In addition, FIs should have contractual
agreements to demand and enforce repurchase proceedings and other
disciplinary actions with correspondents delivering loans outside of
product and other contractual agreements.
THIRD PARTY MORTGAGE FRAUD MECHANISMS
There are a variety of mechanisms by which third party mortgage loan
fraud can take place. Various combinations of these mechanisms may be
implemented in a single fraud. Some of these mechanisms and
their uses are described in this section.
Collusion
Collusion involves two or more individuals working in unison to
implement a fraud. Various third parties may conspire to perpetrate
a fraud against an FI with each generally contributing to the plan.
Each person performs his respective role and receives a portion of
the illicit proceeds. Often, but not always, third parties recruit
or bribe FI employees to take part in the scheme. The scheme may
also include additional parties not involved in the planning or
aware of all participants, but who are still part of the plan’s
execution.
Documentation Misrepresentation
Mortgage fraud is generally achieved using fictitious, forged, or
altered documents needed to complete a transaction. Pertinent
information may also be omitted from documents. The following
describes some key documents and ways they can be altered to
perpetrate fraud.
Loan Application – The application captures information needed
for an FI to make a credit decision based on the borrower’s
qualifications such as financial capacity. It may include
false information regarding the identity of the buyer or
seller, income, employment history, debts, or current occupancy
of the property. The information on the final application may
have been altered and be materially different than that
provided on the initial application.
Appraisal – An appraisal is a written statement that should be
independently and impartially prepared by a qualified
practitioner setting forth an opinion of the market value of a
specific property as of a certain date, supported by the
presentation and analysis of relevant market information. It
is an integral component of the collateral evaluation portion
of the credit underwriting process.
An appraisal is fraudulent if the appraiser knowingly intends
to defraud the lender and/or profits from the deception by
receiving more than a normal appraisal fee. This includes
accepting a fee contingent on a foregone conclusion of value,
or a guarantee for future business in response to the inflated
value. The appraiser may inflate comparable values or falsify
the true condition of the property, which can allow the
defrauder to obtain a larger loan than the property legitimately supports. An appraisal that does not include
negative factors affecting the property value can influence the
FI to enter into a transaction that it normally would not
approve. The defrauder may use comparables that are outdated,
fictitious, an unreasonable distance from the subject property,
or materially different from the subject property. Photos
represented to be of the subject property may be of another
property. Inflated appraisal values create high loss potential
and contribute to an FI’s losses at the time of foreclosure or
sale.
Credit Report – This document contains an individual’s credit
history which is used to analyze an individual’s repayment
patterns and capacity. Credit histories can be forged or
altered through various methods to repair bad credit or create
new credit histories. Fraudsters can also use the credit
report of an unknowing individual who has a good credit record.
Perpetrators have been known to scan and alter illegally
obtained legitimate credit reports that are then printed and
used as originals. Copiers can be similarly used to produce
fictitious or altered credit reports. Fraudsters have used
computers to hack into credit bureau files and have purchased
credit bureau computer access codes from persons who work for
legitimate businesses.
Alternate credit reference letters are often used for
applicants with limited or no traditional credit history. They
are usually in the form of a letter directly from a business
such as a utility, small appliance store, etc., to which the
applicant is making regular payments. These letters can be
easily altered or completely fabricated using the business’s
letterhead. As lenders expand to provide loans to more diverse
income levels, alternate credit references are becoming more
common.
Deed – A deed identifies the owner(s) of the property. It can
be altered to disguise the true property owner or the
legitimate owner’s signature can be forged to execute a
mortgage transaction. Alteration or forgery of this document
allows the fraudster to use a false identity to complete the
transaction.
Financial Information – This includes financial statements, tax
returns, FI statements, and income information provided during
the application process. Any of this data can be falsified to
enable the applicant to qualify for a mortgage loan.
Inadequate income and employment verification procedures may
allow mortgage loan fraudsters to deceive the FI regarding this information. Some perpetrators have been known to set up phone
banks to receive verification calls from FIs.
HUD-1 Settlement Statement – The HUD-1 accompanies all
residential RE transactions. This is a statement of actual
charges, adjustments, and cash due to the various parties in
connection with the settlement. Working alone or with
accomplices this document can be altered to defraud the parties
to the transaction. Information on the original HUD-1 may show
entities or persons not noted as lien holders but who still
receive payoffs from seller’s funds. These individuals may be
deleted from the final HUD-1 that is available for review prior
to loan closing. This enables individuals involved in the
fraudulent scheme to receive funds from the loan disbursement
without the FI being aware of such payments. The document may
show a down payment when none was made. The document may also
include the borrower’s forged signature.
Mortgage – A mortgage is a legal agreement that uses real
property as collateral to secure payment of a debt. In some
locales a deed of trust is used instead. A mortgage can be
altered to disguise the true property owner, the legitimate
lien holder, and/or the amount of the mortgage. Alteration or
forgery of this document allows the fraudster to obtain loan
proceeds meant for another party or in an amount that exceeds
the legitimate value of the property.
Quitclaim Deed – This is a document used to transfer the named
party’s interest in a property. The transferring party does
not guarantee that he has an ownership interest, only that he
is conveying the interest to which he represents he is
entitled. Fraud perpetrators may use this document to quickly
transfer property to straw or nominee borrowers without a
proper title search. Straw borrowers are discussed on page 17
under Third Party Mortgage Fraud Schemes. This technique can
disguise the true property owner and allow the mortgage
transaction to be completed quickly.
Title Insurance/Opinion – Either of these documents confirms
that the stated owner of the property has title to the property
and has the right to transfer ownership of that property. They
identify gaps in the chain of title, liens, problems with the
legal description of the property, judgments against the owner,
etc. Title insurance schedules or opinions can be altered to
change the insured FI or omit prior liens. This can be part of
the falsification that occurs when a perpetrator attempts to
obtain multiple loans from different FIs for one mortgage transaction. Alteration of title insurance or opinions occurs
in other fraud scenarios, as well.
Identity Theft
Identity theft means the theft of an individual’s personal
identification and credit information, which is used to gain access
to the victim’s credit facilities and FI accounts to take over the
victim’s credit identity. Perpetrators may commit identity theft to
execute schemes using fake documents and false information to obtain
mortgage loans. These individuals obtain someone’s legitimate
personal information through various means, i.e., obituaries, mail
theft, pretext calling, employment or credit applications, computer
hacking, and trash retrieval. With this information, they are able
to impersonate homebuyers and sellers using actual, verifiable
identities that give the mortgage transactions the appearance of
legitimacy.
Mortgage Warehousing
Mortgage warehousing lines of credit are used to temporarily
“warehouse” individual mortgages until the mortgage banker, who may
be acting as a broker, can sell a group of them to an FI. If a
dishonest mortgage banker has warehousing lines with two FIs, he can
attempt to warehouse the same mortgage loan on each line. The
individual FIs may not be aware of the other’s line. One FI may be
presented with the original documents, while the delivery of the
documents to the other FI is indefinitely delayed. The second FI
may fund the line without the documents if previous dealings with
the mortgage banker have been satisfactory. It is only after
transferring funds that the second lender realizes it has been
defrauded. The Mortgage Electronic Registry System (MERS) can also
be used as a valuable control tool.
The mortgage warehouse lender often relies on the mortgage banker’s
internal loan data regarding FICO, loan-to-value (LTV), debt-to-
income (DTI), appraised value, credit grade and aging, making them
vulnerable to fraud if the provided data is not accurate. The
mortgage warehouse lender should have proper procedures and controls
to provide ongoing monitoring, verification, and audits of the loans
under this line of credit. It may also want to consider scorecards,
due diligence, and customer identification policies and procedures.
Negligence
Negligence occurs when people who handle mortgage transactions are
careless or inattentive to the accuracy and details of the documents
or disregard established processing procedures. This often happens
when an FI is experiencing fast growth and uses temporary and part-time
employees to process a large volume of mortgages without proper
controls or oversight. Inattention to detail provides perpetrators
with the opportunity to submit documents containing fraudulent
information with the probability that the fraud will not be
detected. Fraudsters may target FIs once they identify these
weaknesses.
THIRD PARTY MORTGAGE FRAUD SCHEMES
The purpose of this section is to describe some of the most
prevalent types of mortgage fraud that have resulted in significant
losses to FIs. Fraud schemes using one or more of the mechanisms
described earlier are limited only by the imagination of the
individuals who initiate them. The following scenarios are not
intended to be an all-inclusive list. Specific examples for most of
these schemes are detailed in Appendix C.
Appraiser Fraud
A person falsely represents himself as a State-licensed or State-
certified appraiser. Appraiser fraud also can occur when an
appraiser falsifies information on an appraisal or falsely provides
an inaccurate valuation on the appraisal with the intent to mislead
a third party or FI. Appraiser fraud is often an integral part of
some fraud schemes.
Double Selling
Double selling is a scheme wherein a mortgage loan broker accepts a
legitimate application, obtains legitimate documents from a buyer,
and induces two FIs to each fully fund the loan. In this scenario,
the originator leads each FI to believe that the broker internally
funded the loan for a short period. Since there is only one set of
documents, one of the funding FIs is led to believe that the proper
documentation will arrive any day. Double selling is self-
perpetuating because different loans must be substituted for the
ones on which documents cannot be provided to keep the scheme going.
Essentially, the broker uses a lapping scheme to avoid detection.
Another variation of double selling entails a mortgage loan broker
accepting a legitimate application and proper documentation, who
then copies the loan file, and presents both sets of documents to
two investors for funding. Under this scheme, the broker has to
make payments to the investor who received the copied documents or
first payment default occurs.
False Down Payment
Another third party mortgage fraud involves false down payments. In
this scenario, a borrower colludes with a third party, such as a
broker, closing agent, etc., to reflect an artificial down payment.
When this scheme is carried out with collusion by an appraiser, the
true loan-to-value greatly exceeds 100% and has the potential to
cause substantial loss to the FI.
Fictitious Mortgage Loan
A fictitious mortgage loan scheme is perpetrated primarily by
mortgage brokers, closing agents, and/or appraisers. In one version
of this scheme, the identity of an unsuspecting person is assumed in
order to acquire property from a legitimate seller. The broker
persuades a friend or relative to allow the broker to use the
friend’s or relative’s personal credit information to obtain a loan.
The FI is left with a property on which it must foreclose and the
third parties pocket substantial fees from both the FI and buyer.
Straw Borrower
The straw borrower scheme involves the intentional disguising of the
true beneficiary of the loan proceeds. The “straw”, sometimes known
as a nominee, may be used to:
•
conceal a questionable transaction,
•
replace a legitimate borrower who may not qualify for the
mortgage or intend to occupy the property, or
•
circumvent applicable lending limit regulations by applying for
and receiving credit on behalf of a third party who may not
qualify or want to be contractually obligated for the debt.
The straw borrower scheme is accomplished by enticing an individual,
sometimes a friend or relative, to apply for credit in his own name
and immediately remit the proceeds to the true beneficiary. The
straw borrower may feel there is nothing wrong with this and fully
believes that he is helping the third party. He expects the
recipient of the loan proceeds to make the loan payments, either
directly or indirectly. The recipient may be unable to or may never
intend to make the payment. Over time, default would occur with the
FI initiating foreclosure proceedings. This scheme can involve FI
personnel, as well as other third party participants. The straw
borrower may or may not be paid a fee for his involvement or know
the full extent of the scheme.
In summary, millions of dollars have been lost because of the
mortgage fraud schemes described above. These schemes produce many
indicators that are apparent to an educated observer. The next
section identifies these red flags and provides best practices that
FIs can use to mitigate risk of loss.
RED FLAGS, INTERNAL CONTROLS, and BEST PRACTICES
Prudent risk management practices for third-party originated loans
are critical. Strong detective and preventive controls are an
integral part of a sound oversight framework, including adequate
knowledge of the FI’s customers. Knowledgeable, trained employees,
coupled with disciplined underwriting and proactive prevention
controls, are an FI’s best deterrent to fraud. Implementation of
strong controls does not prevent human errors or oversight failures,
but documentary evidence of QC measures taken by the FI can be a
useful defense against a repurchase request from an investor.
As a part of the exam process, examiners should assess actions taken
by the FI to document its controls over internal fraud, relative to
safe and sound FI practices and individual agency regulatory requirements. Examiners should also include Patriot Act and SAR
requirements in their evaluations.
The following list of red flags3, which is not intended to be all-
inclusive, may be used to identify and deter misrepresentations or
fraud. Other automated systems for fraud detection, if used in
conjunction with this list, are dependent on the quality of the
input and analysis of the output. The presence of any of these red
flags DOES NOT necessarily indicate that a misrepresentation or
fraud has occurred, only that further research may be necessary.
APPRAISAL GUIDANCE
Congress enacted Title XI of the Financial Institutions, Reform,
Recovery and Enforcement Act of 1989 (FIRREA) requiring member
agencies of Federal Financial Institutions Examination Council
(FFIEC) to issue RE appraisal regulations to address problems
involving faulty and fraudulent appraisals. One of the cornerstones
of the regulation was a requirement that a regulated financial
institution or its representative select, order, and engage
appraisers for federally related transactions to ensure
independence. The agencies’ expectations on this subject are stated
in an interagency statement dated October 27, 2003 entitled
Interagency Appraisal and Evaluation Functions. This statement
provides clarification of the various agencies’ appraisal and RE
lending regulations and should be reviewed in conjunction with them.
Specifically, the October 2003 statement primarily addresses the
need for appraiser independence. A regulated institution is
expected to have board approved policies and procedures that provide
for an effective, independent RE appraisal and evaluation program.
Basic elements of independence are discussed such as separation of
the function from loan production and engagement of the appraiser by
the institution, not the borrower. A written engagement letter is
encouraged. An effective internal control structure is also
necessary to ensure compliance with the agencies’ regulations and
guidelines. This includes a review process provided by qualified,
trained individuals not involved with loan production. The depth of
review should be based on the size, complexity, and other risk
factors attributable to the transactions under review. For the full
text of the October 27, 2003 statement please refer to Appendix G.
