5 Common Mortgage Fraud Schemes and How to Prevent Them
Rising interest rates, record-high home prices, and tighter markets mean applying for a mortgage may be more expensive and more difficult than in the past few years. Not only will borrowers need more income to buy higher priced houses, but lenders will need to find strategic ways to originate loans, while still making a profit.
In order to stay profitable, underwriting standards have started to change. Recently, Fannie Mae raised the maximum DTI (debt-to-income ratio) from 45% to 50%, and lenders have started to originate more non-qualified mortgages. While this provides some opportunity for non-traditional applicants, the reality is that in the current housing market it may be harder to buy a home.
According to the CoreLogic Fraud Index, fraud risk rose an additional 10% this year compared to 2017. These days, lenders must be extremely diligent and proactive when it comes to preventing mortgage fraud, especially when developing new underwriting standards to fit today’s housing market.
It is important to note that there are two main types of mortgage fraud: fraud for housing and fraud for profit.
Fraud for Housing
This is committed when a borrower materially misrepresents information on a mortgage loan application such as employment, income or assets in order to obtain a mortgage.
Fraud for Profit
This type of fraud is a more complex process involving a group of industry insiders attempting to defraud lenders for profit.
While we already covered ways borrowers might falsify income or employment (the most common types of fraud), it would be beneficial to outline some additional mortgage fraud schemes and red flags.
These transactions typically fall into two scenarios – 1) more complex schemes involving multiple loans coordinated by a group of people and 2) where an individual uses their credit to purchase a home for another person. Straw borrower schemes involve real people and real information, but they are not real borrowers. The more complex schemes often result in significant losses, with most loans going into default before the first payment. Individual transactions most often involve one person applying for a mortgage for a family member or friend due to credit issues, but in some cases can be the result of identity theft.
Red flags for straw borrowers include:
- Mortgage payments are made by an entity other than the borrower
- First-time home buyer with a substantial increase in housing expense
- Buyer does not intend to occupy the property due to unrealistic commute, size or condition of the property, etc.
- No real estate agent is employed
- Signing of the contract with no changes
- Power of attorney may be used
- Income, savings, and/or credit patterns are inconsistent with the applicant’s overall profile
- High loan-to-value (LTV), limited reserves, and/or seller-paid concessions
- Inconsistent signatures found throughout the file
- Title to the property is transferred after the sale closes
These are similar to straw borrower loans in that they are loans not only to non-existent buyers but also non-existent properties. The damage is done to a lender when the loan defaults. Since there is no home to foreclose on, there is no way a lender can recoup its loss. The red flags of an air loan are similar to those of straw borrowers.
Property flipping fraud occurs when a property is purchased and resold at an artificially high price, usually after making only a few cosmetic improvements. Straw borrowers are often used in these transactions.
Red flags for illegal property flip include:
- Seller very recently acquired the property title
- No real estate agent is used
- Property was recently in foreclosure or acquired at a low price
- Appraised value is inflated
- Appraiser frequently uses other property flips as comparisons
Foreclosure rescue scams target homeowners who are facing foreclosure. A scammer will offer to prevent foreclosure by paying off the mortgage for a fee. In most cases, the mortgage is never paid and the homeowner loses the property anyway.
Red flags for foreclosure rescue fraud include:
- The borrower states that he or she will be renting back from the new owner.
- The borrower was advised by a foreclosure specialist to avoid contact with the servicer.
- The borrower states that he or she is sending mortgage payments to a third party.
- The borrower claims he or she does not have to pay because the mortgage is invalid (debt elimination).
Buy and Bail
This scheme is the mortgage industry’s version of a dine and dash. When a homeowner is current on their existing mortgage and their home value has fallen below the amount owed, they apply to purchase another home. Once the mortgage on the new home has been secured, the borrower will allow the first home to go into foreclosure.
Red flags for buy and bail fraud include:
- The borrower defaults on the original mortgage shortly after purchasing a second property.
- The borrower has minimal or no equity in the original property.
- The borrower is a first-time landlord.
It is important to note that fraud is often cyclical and heavily influenced by the economy. The popularity of short sale schemes and loan modification scams may happen at different times compared to straw borrower, air loan and illegal flipping fraud. It’s important to be aware of industry trends and what to watch for in order to avoid fraud losses.
Mortgage fraud can be discovered at various times throughout the mortgage process, but the best time to prevent it is prior to closing. On average, quality control reviews sample only about 10% of all loan originations, this is why enhancing the verification process and establishing strict underwriting and closing standards are so important.
As home prices continue to rise and availability shrinks, the frequency of fraud will likely increase in tandem. By knowing some of the more common types of mortgage fraud schemes, institutions can better protect themselves from losses. Using QuestSoft Verifications to confirm borrower information and to perform loan file reviews, provides another layer of protection. Our team of experts can help you verify employment, income, assets and occupancy. Contact us today to learn more!