MORTGAGE LOAN FRAUD
Alex S. Gabor
January 03, 2007
Civil suits between private parties engaged in real estate transactions has risen by 25% in the third quarter of 2006 while notices of default, foreclosures and bankruptcies are expected to reach all time highs across the nation in 2007.
Although various organizations, both governmental and private have devoted considerable effort to the prevention, investigation and prosecution of mortgage loan fraud, there has emerged a massive amount of evidence that securitized mortgages collateralized by state income-stated asset loans contain the highest incidence of fraud of any other loan product with several major financial institutions at severe financial risk of having many of these loans become non performing as rates adjust upward during the next 12 months.
The United States has experienced substantial growth in mortgage lending markets and of unusual loan products that have fraudulently expanded consumer access to home finance. 97% of those who currently own homes in California and New York do not qualify to buy their own homes.
At the same time there has been a significant increase in filings of complaints from the general public and suspicious activity reports from financial institutions accepting cash deposits of over $4 trillion during the past six years as the refinance boom came and went. Most of these deposits were from loan proceeds on refinances of existing equity in homes.
According to one researcher suspected activity reports and formal complaints are expected to increase by an additional 1,000 per cent during the next five years as lenders, investors and foreign government controlled institutional investors bring more pressure to bear on mortgage bankers and brokers who have been involved in the various ways in which mortgage fraud can be accomplished, particularly after a loan has gone into default and pending foreclosure action.
High home prices coupled with rising mortgage rates results in a reduction in housing affordability. In response to this trend, the housing industry is experiencing a major slow down in mortgage loan originations, a decrease in housing sales, and dropping housing prices.
Refinancing activity is down between 50 to 75% in some markets and more than two dozen mortgage companies and brokers have either gone out of business or laid off thousands of employees in the past few months.
Many of those employees have taken it upon themselves to write up what they know and send in anonymous complaints to the FBI, or file them online with the Financial Crimes Task Force which was originally set up to deal with terrorism but which now handles more traffic related to the financial crimes enforcement network than any other form of complaint.
A loan obtained through fraudulent means and then deposited into a bank account is considered a form of money laundering. Large cash withdrawals are also considered the same if the funds came from loan proceeds.
The major slow down in the growth of housing prices is resulting in the housing industry becoming less attractive to investors, which in turn has resulted in an increase in the numbers of reports of fraud for profit, as those private money investors and partnerships that are getting burned during the downturn seek ways of recovering their lost equity and borrowed or leveraged funds. When they cannot afford lawyers, citizens usually turn to their government law enforcement agencies seeking their help in bringing justice to bear on the fraudsters.
The recent housing trend had lead to an increase in fraud for housing as the increased costs of housing decreased the number of persons who qualified for mortgage loans, subjecting more people to being seduced by commission only salespeople into fraudulently obtaining loans for house purchases or refinances. Low teaser rates were the primary means of seduction along with the promise of a never ending boom in real estate appreciation.
The current trends of rising real rates of interest, a falling and rapidly devaluing dollar, ongoing trade deficits and evaporating housing equity is also resulting in an increase in debt elimination fraud schemes, especially for homeowners with adjustable rate mortgages and interest only loans.
One explanation for the increased reporting of mortgage loan fraud is increased awareness of the potential for fraud in a dynamic real estate market.
Another is many disgruntled employees, as in the wake of the Enron and WorldCom debacles, have taken it upon themselves to blow the whistle on their former employers, particularly if their retirement accounts have evaporated due to internal problems with finances at failed finance institutions such as brokerages and wholesale bankers.
Many areas in the United States saw double-digit growth in real estate values between 2003 and 2005. At the same time, mortgage loan interest rates were at historic lows. By the end of 2005 however, growth in the housing industry began slowing and by the first quarter of 2006, it was apparent that it would begin to impact prices and values along with inventories held by builders across the nation, resulting in more exposure of sour deals getting worse as the market tanked.
Home buyer, home owner, how can I defraud thee? Let me count the ways. If Shakespeare were alive today he would probably be writing this story.
One method of fraud is to use a straw buyer if your credit is poor and you need fast cash to clean up your past debts and collections and cash to boot to make payments on your house loan, even if you currently don't have a job.
A straw buyer is someone who purchases property for another person in order to conceal the identity of the true purchaser. The true purchaser is usually someone with bad credit who then winds up with a chunk of cash after the straw buyer comes in and buys the property at either an inflated price, or a net price to the seller that is substantially less than fair market value.
Once the credit of the true purchaser is cleaned up and their credit score skyrockets, which usually takes 60 to 90 days, the true buyer steps up to the plate and takes out his own loan, giving his straw buddy a bit of a profit and pocketing even more cash as part of the scheme.
Another method of defrauding a financial institution is known as Flipping. This had become a national pastime during the last decade and became so popular several versions of the scheme became popular cable television shows and one prime time comedy. Property flipping generally involves the buying and selling of the same property within a short period of time with the intention of making a quick profit.
Mortgage loan fraud can be divided into two broad categories: fraud for property and fraud for profit. Fraud for property generally involves material misrepresentation or omission of information with the intent to deceive or mislead a lender into extending credit that would likely not be offered if the true facts were known.
The fraudulent activities describing fraud for property include: asset fraud; occupancy fraud; employment and income fraud; debt elimination fraud; identity theft; and straw buyers.
Fraud for property is generally committed by home buyers attempting to purchase homes for their personal use. When the intent is to "flip" the property is clear, it becomes fraud for profit as typically lenders will not loan you money for 60 to 90 days to make a quick profit from the sale of property.
They are quite stingy when it comes to making profits for themselves and sharing it with others other than their own stockholders. That is why many lenders build in pre-payment penalties of between 1 to 3% of the loan amount if the loan is paid off early. Some penalties go even higher.
In contrast, the motivation behind fraud for profit is money. Fraud for profit is often committed with the complicity of industry insiders such as mortgage brokers, real estate agents, property appraisers, and settlement agents (escrow officers, attorneys and title examiners).
Typical fraudulent activities associated with this category: appraisal fraud; fraudulent flipping; straw buyers; and identity theft.
Identity theft has seen a dramatic rise in credit card fraud but lately it has shown up in mortgage fraud as well. For example, a growing number of drug addicts in the Portland area have used the internet to steal confidential personal information such as social security numbers, addresses and other vital data needed to order a credit report.
The identity thieves then use the information to order a credit report then apply for a home equity line of credit on a property owned by the victim and has the loan proceeds wired to an account that can be quickly depleted or transferred to other accounts, all over the internet and without the victim knowing it.
In some cases forgery is used when original signatures are required. Typically the money is used to buy drugs which is then laundered back into the banking system in lots smaller than $10,000 to avoid the filing of more suspicious activity reports. (SARs)
Real estate mortgage loan fraud poses a growing risk to financial institutions. The Federal Financial Institutions Examination Council reported: "Mortgage loan fraud is growing because it can be very lucrative and relatively easy to perpetrate, particularly in geographic areas experiencing rapid appreciation."
It is harder to catch mortgage loan fraud if there is no default. No harm no foul as law enforcement is prone to view it.
However, when the market turns down as it is doing now, an increasing number of fraudulent transactions come to light when borrowers are unable to explain why their income went from a stated amount of $20,000 per month to less than $5,000 within a short span of 90 to 180 days.
That is usually when investigators digging into loan documents, loan applications, bank records and tax returns usually turn up the majority of fraud.
The true level of mortgage loan fraud is unknown; the growing awareness of mortgage loan fraud is confirmed by the year to year increase in the number of SARs describing this activity.
Depository institutions filed 82,851 SARs describing suspected mortgage loan fraud between April 1, 1996 and March 31, 2006. This represents 3.57 percent of all depository institution SAR filings submitted during that time period. Over the past 30 years (1975 – 2005), house prices at the national level have grown at about a six percent annual rate.
However, in the first quarter of 2005, the national average percentage increase was 12.5 percent. Many U.S. coastal states saw housing prices increase by as much as 20 percent or more during 2004. By contrast, growth rates in many states in the South and Midwest fell below the national average.
Interest rates for 30-year mortgages declined throughout the period from 1997 through 2004, with the exception of the first three quarters of 2000.9
The number of residential loans increased steadily by 153 percent between 1997 and 2003, according to the Federal Financial Institutions Examination Council. "Adjusted 2003 data show that low and moderate-income census tracts taken together experienced the largest increase percent in home purchase lending. Such lending for middle and upper-income census tracts increased by 9 percent , respectively, from 2002 to 2003, according to the adjusted 2003 data."
The rapid growth in mortgage lending activity that resulted from the boom in the real estate industry has resulted in increased risk in the mortgage loan industry.
The use of the Internet and related technology to receive and process loan applications has become almost company wide. There are very companies out there today that process loan applications without some sort of automated loan processing program. This also makes it easier to overlook the facts and enter into the program that will make "the loan work" or as many in the industry like to say, "make a round peg fit into a square hole".
The growing faceless nature of these transactions increases the opportunities for fraud (especially identity fraud) and, coupled with "low-document" or "no-document" loans, creates a condition vulnerable to fraudulent activity. In fact it encourages fraud at all levels of the mortgage origination and closing process. Underwriting guidelines have become so slack it is easier for a potential borrower to buy a home than for a sovereign nation to get a loan from the IMF. It used to be the other way around.
Using the Internet or telephone to receive and process mortgage loans means that lenders may never meet borrowers, even during the loan closing process. In some cases, lenders forward the loan documents to borrowers by courier service and the documents are returned to lenders in the same manner.
Sub-prime lending involves higher-interest loans extended to consumers with impaired or non-existent credit histories stemming from modest incomes or excessive debts.
The mortgage industry has designed seductive loan packages to allow more low-to-moderate income borrowers to qualify for loans. Some of these loans carry higher interest rates, better rebates, and more profit for the originator who is typically motivated by collecting his commission rather than what is best in the long term for the borrower. It's their living.
There is a growing pattern of the use of exaggerated or fabricated income information associated with sub-prime loans. Such activities are part and parcel to the added efforts by many lenders to qualify borrowers in the sub-prime market. After all, if the loans don't get closed, they don't get paid, so there is a built in incentive in the market to fudge flakey loans into acceptable boxes that make underwriters jobs easy and smooth in the approval process, even though underwriters may throw in all kinds of conditions to protect themselves or their institutions from fraud or default, the biggest omission during the past decade has been "show me the proof of your assets and income".
The National Association of Mortgage Brokers reports that as many as two-thirds of mortgage loans are now originated by mortgage brokers.
Currently there are no national standards for licensing and oversight of mortgage brokers. Some states license mortgage brokerage offices, but not individuals; 24 states have no specific educational or experience requirements for mortgage brokers; and only a few states require criminal background checks on mortgage brokers making it possible for unethical individuals to move from one mortgage brokerage firm to another.
Identity theft has been associated with both fraud for property and fraud for profit, and is recognized as one of the fastest growing crimes in the United States.
Recent news reports of personal information theft from commercial data brokers, corporate databases, and credit report companies demonstrate the potential for large-scale identity theft.
Low- or fixed-income retired persons are often targeted for fraudulent schemes. The growing number of retired and elderly citizens could provide a burgeoning target for mortgage loan fraud.
Identity fraud is differentiated from identity theft. Identity fraud as used here refers to the loan applicant's use of a non-existent social security number or a number taken from the social security death index, along with the use of the borrower's true personal identifiers (name, date of birth, address).
The loan applicant intends to use the Social Security number to qualify for a loan, either because the borrower does not have a number or because the borrower's credit rating associated with their true number is inadequate for approval. Identity theft, on the other hand, is an attempt to obtain credit in another person's name.
Borrowers committing the acts of material misrepresentation, false statements and Identity fraud in complicity with Mortgage brokers or correspondent lenders initiating loans have used the following types of loan falsifications: Altered bank statements; Altered or fraudulent earnings documentation such as W-2s and income tax returns; Fraudulent letters of credit; for example, getting your landlord to say you make more than your true rent payment to give the lender the impression that you can afford a larger mortgage for a bigger house, even though you don't qualify for one; Fabricated letters of gift; Misrepresentation of employment; Altered credit scores; Invalid social security numbers; forged documents, phony verifications of deposit, phony mortgage credit history from private third party hard money lenders and dozens of other "tricks of the trade" have been employed to get a loan approved, closed and a paycheck deposited into the loan officers bank account.
A silent second trust occurs when the seller takes back a second deed of trust from the buyer in lieu of a cash down payment. The lender is not made aware of the second trust deed and by withholding it; the borrower commits fraud in representing the true nature of the transaction.
The list goes on: failure to fully disclose the borrower's debts or assets; or mortgage brokers using the identities of prior customers to obtain loans for customers who were otherwise unable to qualify; misrepresentation of loan purpose or misuse of loan proceeds; misuse of FHA Title One loans.
FHA Title One loans may be used to finance permanent home improvements that protect or improve the basic livability or utility of the property. The funds cannot be used for debt consolidation, cash-out, or any non-home related expenses, or for luxury items such as swimming pools or hot tubs.
The most commonly reported misrepresentation is occupancy fraud, which occurs when the borrower fails to occupy the property, although the loan application specified the property was the borrower's primary residence. This is a common practice of flippers, especially those who claim they are buying a second home when in fact they are only seeking to make a quick profit by "flipping" the property as soon as the loan is closed.
In the past the motivations for misrepresentation of the loan purpose would have been to purchase investment property with more favorable loan rates than would be available if a lender knew the property was intended for use other than as a primary residence, or to launder funds from illicit activity.
Appraisal fraud and fraudulent property flipping are also growing nationally. Appraisal fraud is frequently associated with fraudulent property flipping. Almost half of fraud reports filed indicated that they suspected the fraudulent activity was perpetrated with the collusion of mortgage brokers, appraisers, borrowers, and/or real estate agents/brokers.
Lenders rely on accurate appraisals to ensure that loans are fully secured. Appraisal fraud occurs when appraisers fail to accurately evaluate the property, or when the appraiser deliberately becomes party to a scheme to defraud the lender, the borrower, or both.
The Appraisal Institute and the American Society of Appraisers has testified in past hearings that "...it is common for mortgage brokers, lenders, realty agents and others with a vested interest to seek out inflated appraisals to facilitate transactions because it pays them to do so."
Higher sales prices typically generate higher fees for brokers, lenders, real estate agents, and loan settlement offices, and higher earnings for real estate investors. Appraisal fraud has a snowball effect on inflating real estate values, with fraudulent values being entered into real estate multiple listing systems and then used by legitimate appraisers as comparable values for determining market values for neighborhood properties. It was exactly this kind of activity which led partly to the S&L crisis in the last century and has played a very important and vital part in the current real estate depression being experienced in many markets.
Some commonly reported types of appraisal fraud are: Appraisers failed to use comparable properties to establish property values; Appraisers failed to physically visit the property and based the appraisal solely on comparable properties, i.e., the actual condition of the property was not factored into the appraisal; Appraisers participated in a fraud scheme such as flipping; or A licensed appraiser's name and seal were used by unauthorized persons; appraisers failed to mention that the property did not have a permit for an addition from the County; appraisers failed to mention that the house was under major renovations and the borrower would not have gotten the loan if the true facts were made known to the lender.
Fraudulent property flipping is purchasing property and artificially inflating its value. The fraud perpetrators frequently use identity theft, straw borrowers and industry insiders to effect property flipping schemes.
Ultimately, the property is resold for 50 to 100 percent of its original cost. In the end, the loan amount exceeds the value of the property and the lender sustains a loss when the loan defaults. This was rampant in California and New York, the two highest priced markets in the country.
The following fraudulent activities described property flipping; collusion by sellers, appraisers, and mortgage brokers in connection with property flipping; the use of straw buyers; appraisal fraud and phony pre-approval letters or loan commitments.
Some home builders include clauses in their sales contracts that prohibit buyers from placing their houses back on the market for a period of time after closing – usually one year.
Fraudsters have lined up for large condo construction projects, putting up small deposits as low as $1,000 to tie up a property before it is built and then reselling it before the project is completed for a fraudulent profit, allowing builders to obtain construction loans for projects that normally would have no demand. The false demand created by such schemes has skewed the markets, particularly in Las Vegas, San Diego and Miami.
Use of forged documents by correspondent lenders or mortgage brokers processing the loans is also a rampant problem in the industry. The types of activity reported included the following: Borrowers forged co-owners' signatures to loan documents (most often one spouse forging the other spouse's signature without prior knowledge or permission); Loan closing services forged applicants' signatures on loan documents (possibly to expedite the loan process); or Builders forged borrowers' names on loan draw documents.
Other fraudulent activities that could easily be passed off as mistakes include; Loan closing services failed to properly disburse loan proceeds or pay off underlying property liens, including prior mortgage deeds of trusts; Loan settlement offices were also reported for failure to pay insurance premiums from funds collected at settlement; Borrowers signed multiple mortgages on the same property from multiple lenders. The mortgage settlements were held within a short period of time to prevent the lenders from discovering the fraud; Loan closing services failed to record the mortgage in property land records; Prior lenders failed to release home equity loans in land record offices after receiving mortgage pay-off, causing the new lender's loans to have a subordinate position; Homeowners continued to use the prior lines of credit in addition to the new loan to obtain an extension of credit that exceeded the property value;
Violations of the Mortgage Broker Practices Act by mortgage brokers who abused the terms of a power of attorney; Mortgage brokers or correspondent lenders failed to ensure all loan documentation was properly signed; Real Estate Settlement Procedures Act (RESPA) violations by lenders accepting kickbacks from mortgage brokers; Non-arm's-length sales occurred when parties to the real estate transaction failed to disclose relationships between the buyers and sellers. Knowledge of a non-arm's-length sale would alert lenders to scrutinize loan packages more carefully; Elder exploitation where older individuals were persuaded to sign loan documents without understanding borrower rights and responsibilities under applicable federal and state law; Unofficial loan assumption occurred when property ownership was transferred without the knowledge of lenders. This could indicate that a straw buyer was used to obtain the loan, with the property title being transferred to the actual owner after the loan disbursement; Theft of debit card or convenience checks associated with home equity lines of credit; Fraudulent bankruptcy filings to stall or prevent foreclosure; and Suspected use of real estate purchases to launder criminal proceeds.
There are growing groups of individuals going around promoting debt elimination schemes, stating that the debts recorded against their properties are not valid because the money used to buy the property was not officially legal tender of the United States and all forms of real estate mortgages are unconstitutional.
They may actually be right in the long run but no Federal judge is going to acknowledge that because their paychecks depend on enforcing the banking system which has been bought and paid for by two hundred years of blood sweat and tears produced by lawyers who put our current systems into place.
Borrowers who presented these specious arguments are believed to belong to groups that believe U.S. laws and regulations, along with banking regulations, do not apply to them. A typical debt elimination fraud scheme involved the presentation of numerous documents containing frivolous arguments that the subject mortgage was invalid.
The arguments presented in the documents avowed that funds were never loaned, despite the fact that the borrower received the proceeds.
Successful culmination of this type of scheme would result in the filing of a fraudulent mortgage discharge.
Debt elimination schemes included borrowers attempting to pay off their mortgages with non-negotiable checks, or fake instruments such as bills of exchange or subrogation and security bonds. Filers described specious arguments in which the borrowers claimed the mortgage was invalid and the debt never existed. The arguments relied on an unreasonable interpretation of Section 1-207 of the Uniform Commercial Code that has never been affirmed or supported by any court or governmental authority.
Other types of debt elimination schemes include attempts to fraudulently release mortgage liens from municipal land records. Once the land title appeared clear of all mortgage debt, the homeowner could theoretically obtain another mortgage loan based on what appeared to be a clear title. The threat this fraud scheme presents is that a subsequent lender could believe it had a first priority lien on property when in reality there could be little or no equity to secure the loan.
Reports of debt elimination schemes fraud associated with mortgage loans continues to grow –although it is unclear if this is primarily due to an increase in the number of fraudulent loans or an increase in awareness of this suspected fraudulent activity.
Asset rental fraud is a fraudulent scheme designed to exaggerate or inflate the stated value of a borrower's assets. Filers reported that funds were temporarily deposited into the loan applicant's bank account for the time required to qualify for a loan.
The funds came from friends or family, or even from mortgage brokers attempting to qualify an ineligible borrower.
The temporary funds were withdrawn from the bank account after the loans were approved. One elaborate asset rental fraud scheme reported in a news article involved deposits of funds into bank accounts established in a prospective borrower's name, with the deposited funds being temporarily "rented" for a fee. The customary fee charged for this "service" was reportedly approximately five percent of the deposited funds.
The service also may include verification of employment and income in any amount for an additional fee of one percent of the claimed annual income.
It is apparent from the number of pending fraud cases reported by the Federal Bureau of Investigation, 721 in 2005, up from 534 in 2004, with estimates as high as 1,000 for 2006, that the awareness of mortgage loan fraud is increasing, however for every thousand loans that contain fraud, less than 1% are brought to justice or investigated by law enforcement for two basic reasons.
With so many in collusion there are often too few witnesses to obtain a conviction and second, the FBI, the Justice Department, local and Federal law enforcement agencies, including the SEC who should be looking into the sale of loan portfolios which contain massive amounts of fraudulent data, even the regulators such as the Office of Fair Housing Enforcement and Oversight, all of them lack the manpower and the time involved to bring true reform to the mortgage industry.
So while the market caves in due to a lack of confidence by foreign investors, perhaps those who engage in fraud of this magnitude will some day learn their lessons by going broke, but then again, we were born broke so what do they care.
They will just start the whole boom bust cycle over again. And therein lies the rub of mortgage loan fraud.
Copyright © 2006 by Alex S. Gabor. All World Rights Reserved.
Alex S. Gabor is the author of "Bonanza – Profiting During a Real Estate Depression – How to Make a Killing During a Real Estate Bust", an electronic book being readied for release in 2007. He is a freelance writer living in Hollywood. He spent 25 years investigating and working in the mortgage banking industry and is the inventor of zero interest mortgages. He is a major proponent of changing the current tax laws to eliminate mortgage interest deductions and replace them with principal reduction credits to encourage debt free home ownership and affordable housing.
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