Academic journal article ABA Banking Journal

Mortgage Fraud Wave Requires Strict Regimen to Resist

Academic journal article ABA Banking Journal

Mortgage Fraud Wave Requires Strict Regimen to Resist

Article excerpt

Industry experts estimate that 10%-15% of the $2.8 trillion in home mortgage loans generated in 2005 contain some form of fraud or misrepresentation. That means that several hundred billion dollars in mortgage debt incurred last year involved some element of dishonesty.

Increasing mortgage loan fraud imposes significant costs on lenders.

One cost is readily identifiable--fraudulent loans that must be bought back out of mortgage packages, because investors typically require this when loans reveal indications of fraud. Consequently, a mortgage lender is either forced to service the loan itself (which may be under-collateralized) or sell it at a significant loss.

Even more significant are the elevated risks of reputation damage, litigation, and enforcement. Despite an increased focus on fraud by enforcement agencies, new and more sophisticated schemes evolve constantly. At best, law enforcement is mostly reacting, and just barely keeping up. Consequently, as a practical matter, lenders must look to their own efforts by implementing an aggressive fraud prevention and detection program.

More than lenders are harmed. Mortgage fraud imposes costs on a broader scale: on homeowners, who must indirectly pay for the increased costs that fraud imposes; on neighborhoods, afflicted by fraud; and on taxpayers, who must shoulder the cost of combating it.

Mortgage fraud has been defined as "material misrepresentation"--the giving of false information that deceives or misleads a lender into extending credit beyond the limits of what would normally be extended if the facts were known.

The first part of this article identifies the most common mortgage frauds and provides statistics.

The second part cites recent examples of government investigations; settlements and agreements; and enforcement actions. It also summarizes recently issued government guidance.

The third part offers options for lenders in fraud prevention and detection.

Three Faces Of Fraud

Mortgage fraud takes many forms, but three are commonly recognized:

Fraud for profit is a form of industry insider fraud. It involves such schemes as falsely inflating the value of properties and repeatedly "flipping" them. This entails issuing loans based on fictitious properties, misrepresenting investment property as owner-occupied property, misrepresenting personal identity, or using false or forged documents (often through "straw buyers") to obtain a loan, and creating fictitious or nonexistent payees of monetary instruments.

Such mortgage fraud is the most costly to lenders because the schemes often involve multiple transactions. In fact, the FBI says that 80% of all reported losses from fraud involve collaboration or collusion by industry insiders.

Fraud for housing involves an individual borrower defrauding a lender to purchase a house for the borrower's own use. Examples include the misstating of income or expenses; disguising the source of the down payment; and providing false or forged documentation.

In many instances, a fraudulent borrower receives assistance from a complicit third party, such as a broker, appraiser, developer, builder, or financial adviser. Consequently, fraud for housing also may constitute fraud for profit--albeit on a smaller scale--because complicit third parties receive compensation for their role in the fraud.

Fraud for other criminal purposes involves the perpetrator's use of illegally obtained funds in real estate transactions. For example, a drug trafficker may purchase real estate at an inflated price for the purpose of money laundering; a terrorist may purchase a safe house; or another criminal may purchase real estate to facilitate such crimes as drug manufacturing, smuggling, prostitution, counterfeiting, or running a "chop shop."

How much is out there?

The true level of mortgage fraud is largely unknown. …

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