Raising the Drawbridge Against FRAUD

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1 C o v e r R e p o r t : F ra u d / L e g a l I s s u e s Raising the Drawbridge Against FRAUD BY G R E G H O L M ES Lenders and servicers are taking the battle against mortgage fraud to a new level. The trick is finding really good armor. REPRINTED WITH PERMISSION FROM THE MORTGAGE BANKERS ASSOCIATION (MBA)

2 Mortgages have been around since the 12th century and, undoubtedly, so has mortgage fraud in some form or another. The events of the past couple of years have been like having dragons at the door with no shield strong enough for protection. The word mortgage comes from the Old French word mort, which means dead, and the Old English word gage, which means pledge. A mortgage was, therefore, a dead pledge for land buyers in the Middle Ages. A buyer would lose the property if he didn t make his payments. The pledge itself was considered dead once the loan was paid in full. Today the basic premise remains the same, even though the process has changed. We now are dealing with a record number of dead properties (2.8 million foreclosed properties in 2009 alone), many of them the result of mortgage fraud. Foreclosure filings in 2009 were 21 percent higher than in 2008 and a whopping 120 percent higher than in 2007, according to RealtyTrac Inc., Irvine, California. I believe a lapse of judgment in lending standards... is what allowed fraud to become rampant, says Elizabeth Roush, co-founder and vice president of Veritas Funding LLC, Murray, Utah, a correspondent lender. Lenders were encouraged to help put as many Americans into homes as possible over the past 15 years or so. Lending standards were tremendously relaxed and, unfortunately, lenders stopped being mortgage advisers and lost sight of whether or not people could actually afford the homes they were buying. In addition to loose lending standards, buyers wanted to be in homes regardless of whether or not they could afford the payment. Industry experts agree that there is a direct link between fraud and distressed real estate markets. The funding from recent economic stimulus legislation, as well as the large number of Federal Housing Administration insured (FHA-insured) mortgages, is

3 creating additional opportunities for unscrupulous people to take advantage of the industry, according to the Federal Bureau of Investigation (FBI). Two categories of mortgage fraud The two primary categories of mortgage fraud are fraud for housing and fraud for profit. Fraud for housing generally involves a borrower who inflates his or her income in order to afford a property. Generally, the buyer has every intention of repaying the loan even though this action is illegal. Fraud for profit, also known as industry insider fraud, typically involves several people working together to defraud a buyer or a mortgage lender and gain illegal profits from selling property. The mortgage fraud problem in this country is primarily associated with fraud-for-profit schemes. The most common types of fraud, in our experience, relate to income fraudulent pay stubs and W-2 forms as well as false verification of employment and owner occupancy, says Roush. Some of the newer types of fraud that we re seeing relate to property ownership and illegal flipping practices. Investors are flooding the market buying short sales and real estate owned [REO] property. While those purchases are perfectly legal, we ve noticed investors trying to sell properties they don t even own, Roush says. A lot of the fraud-for-profit scenarios involve illegal property flipping, or buying something cheap, getting inflated appraisals and reselling the property quickly for a profit, says Greg Shumate, president of Duluth, Georgia based Brand Mortgage Group. New rules that prohibit loan officers from ordering appraisals have really helped to curb this type of fraud. The regulations require appraisals to be ordered independently, without any influence from the seller or Realtor. A third party also reviews them before they go to the mortgage company. Companies are getting more accurate appraisals by removing influence from the appraisal process, Shumate says. The FBI s Top 10 Mortgage Fraud States in 2008 California Illinois Texas Georgia Ohio Colorado Maryland Florida Missouri New York Even though products and programs that allowed mortgage fraud to flourish are no longer available (stated-income and stated-asset loans; W-2 stated loans; no seasoning; and more), lenders are still seeing an increase in fraud coming from borrowers. We ve been seeing borrowers misrepresenting their debts, says Timothy Baise, president and chief executive officer of Top Flite Financial Inc., Williamston, Michigan, a mortgage lender. We also are seeing borrowers trying to purchase multiple properties through multiple lenders in an effort to buy more properties than a traditional lender would normally allow at once. Almost all the new cases we re seeing involve borrowers not properly disclosing income, says Vince Liguori, sales manager at Cincinnati-based Emery Financial Services, a subsidiary of Cincinnati-based Emery Federal Credit Union. Sometimes it s an accident, but often it involves improperly declaring rental income, or having two sets of tax returns one for a mortgage and one for getting a larger tax rebate. The new look of mortgage fraud Many of the current mortgage fraud schemes have been around for a long time, such as property flipping, builderbailouts, seller assistance, short sales, air loans, foreclosure rescues and identity theft. Tightened lending practices due to rampant housing market fraud and the economic meltdown have resulted in the emergence of several new schemes, according to the FBI. Reverse- mortgage fraud: A small number of unscrupulous mortgage, real estate or building professionals are using Home Equity Conversion Mortgages (HECMs) (reverse mortgages) to defraud senior citizens. The most common scams involve equity theft, foreclosure rescue and investment schemes. We ve seen situations where the senior citizen is a straw buyer, says Baise. An investor will purchase a bank-owned home, do a little rehab work, then move the elderly person into the home with a contract signed and not recorded. The senior citizen, after living in the house long enough to qualify for a reverse mortgage, turns the proceeds over to the investor, thus purchasing the house in reverse. Credit-enhancement fraud: This fraud takes many forms. Some examples include borrowers adding their names to the bank accounts of friends or family members in order to circumvent underwriting requirements, originators depositing money temporarily into loan applicants accounts, and borrowers filing amended tax returns and paying back taxes on unreported income to create a higher income. Modified builder-bailout fraud: Two new builderbailout schemes have emerged during the recent downturn condominium conversion, and a practice known as pump and pay. Because developers can t sell many of the apartments that were converted into condos during the housing boom, they may try to entice investors with offers of cash back at closing; paid condo association dues; and promises to find renters, collect rent and oversee management. Perpetrators typically inflate the condominiums value in order to get a higher sales price to cover the cost of the incentives. Pump and pay involves builders inflating the appraised value of their properties, then distributing the false equity to the perpetrator disguised as set-asides for future maintenance, insurances and tax payments on the property. Arson fraud: Arson is being used by property owners to illegally get proceeds from a property to avoid foreclosure. Foreclosure prevention: Perpetrators pretending to be working on behalf of a homeowner facing foreclosure instruct the homeowner to send his or her house payments to the perpetrator. Then the perpetrator files for bankruptcy on the homeowner s behalf, without the

4 homeowner s knowledge. The bankruptcy petition causes the foreclosure to be postponed, and the homeowner believes all is well. The foreclosure process begins anew, however, when no one attends the bankruptcy hearing. Loan-modification fraud: Recent Housing and Economic Recovery Act (HERA) and Emergency Economic Stabilization Act (EESA) laws mandate that lenders must work with homeowners using certain programs to keep them in their homes. This is being exploited by some perpetrators who offer foreclosure relief, then tell homeowners they must pay an upfront fee of $1,500 to $5,000 to participate in the loan-modification program (this is untrue; homeowners do not need to pay an upfront fee under the modification program). Serial property flipping: Perpetrators flip the same property numerous times. Modified short-sale fraud: Perpetrators pay real estate agents referral fees for the names of homeowners facing foreclosure. Those homeowners are then convinced to deed their property to the perpetrator in a land trust. The homeowner is listed as the trust s beneficiary and the real estate agent is listed as the trustor. The perpetrator then negotiates a short sale with the lender and, unbeknownst to the lender or the homeowner, the real estate agent sells the property for a profit to another buyer, often as soon as the next day. Lenders take the lead in battle The first half of last year, we saw a huge increase in shortsale frauds, perpetrated by a consulting firm that would find homeowners who couldn t sell their house or were behind on their mortgage payments, says Christine Rhea, president of Knoxville, Tennessee based Mortgage Investors Group, Tennessee s leading independent mortgage lender. Rhea says, We discovered that the consultants were negotiating very low, under-market offers with the homeowner s servicer so they could purchase the home very cheaply, then turn around and sell the home to another buyer for sometimes over $100,000 more and close both sales on the same day. Of course, the servicer believed the short-sale offer was a legitimate offer and never knew they just lost $100,000 while the consultant made a profit of $100,000. I spent a lot of time educating Realtors and the community to raise their awareness level of the potential for this type of shortsale fraud after we discovered their system. I also received guidance from Fannie Mae as to the red flags to look for in loan applications and how to combat the problem. We made several key changes to our processes that have really helped, adds Rhea. We also now require the consultant whose name is on the contract with our buyer to actually be the owner of record for a period of time before selling to our buyer. We also require an approval from the servicer indicating they know there is a second contract on the property. Rhea discussed these issues with the servicers involved to make sure they understood the importance of being sure there weren t additional contracts on the short sales with which they were involved. Some of the Q u e s t i o n s TEST YOUR MORTGAGE FRAUD I.Q. 1. More than 50 percent of all foreclosures have occurred in what four states? 2. What are the estimated annual losses from mortgage fraud? 3. What percentage of the Federal Bureau of Investigation s (FBI s) mortgage fraud cases involves foreclosure-rescue scams? 4. What is the legal penalty for submitting a falsified loan application? 5. What is the legal penalty for conspiring to commit mortgage fraud? 6. What is the statute of limitations for bringing a mortgage fraud claim? 7. What region of the country has the most pending FBI mortgage fraud investigations? 8. How many properties does Irvine, California based RealtyTrac Inc. project will enter foreclosure in 2010? 9. What year did the FBI warn that mortgage fraud was becoming so rampant that the resulting epidemic of financial crimes, if not curtailed, could become the next S&L [savings-and-loan] crisis? 10. What is the No. 1 white-collar crime in the United States? A n s w e r s 1. California, Florida, Arizona, Illinois 2. $4 billion $6 billion percent involve fraudulent mortgage modification and/or foreclosure relief 4. A maximum of 30 years in prison and up to a $1 million fine 5. A maximum of 30 years in prison and up to a $1 million fine years 7. Western United States 8. Approximately 3.9 million properties Mortgage fraud

5 servicers added language to their own contract nullifying the sale if there was an additional, undisclosed contract on the property. Many servicers now have their fraud teams perform a follow-up check a month after closing to make sure a second closing hasn t occurred soon after the first. Eliminating the use of broker price opinions (BPOs) could help prevent this fraud, according to Rhea. Some Realtors are very, very honest and others were, unfortunately, getting sucked in by the fraud perpetrators to provide the servicer with below-value BPOs, she says. We recommended to our servicers that they stop using BPOs for that reason and, instead, utilize only licensed appraisers who know the market and will give the servicer an honest opinion of value. Getting help from many sources Mortgage Investors Group now uses third-party services and organizations such as the Social Security Administration, the Internal Revenue Service (IRS), depository banks and employment verification to confirm 100 percent of the information provided by loan applicants. Its arsenal of fraud-prevention weapons also includes Mortgage Electronic Registration Systems (MERS ); fraud-evaluation software; credit reports with Hawk Alert TM from Credit Plus Inc.; automated valuation models (AVMs) on all loans; and, often, a field-review appraisal is ordered on the property as well. We are first alerted of any potential stolen identity through Safescan on the credit report, Rhea adds. And we begin a more in-depth discovery process if red flags are presented. As a result of our efforts, and by utilizing the many validation services through Credit Plus and other third-party vendors, we ve been able to bring fraud, including short-sale fraud, to a halt at Mortgage Investors Group, says Rhea. One of the most important steps Veritas Funding took to reduce fraud was carefully hiring, training and evaluating its employees. The company looks for employees who take a long-term approach to their careers and don t focus on making a quick buck. Our employees are trained to spot the potential signs of fraud, and then act accordingly, says Roush. Additionally, the focus of our quality control and compliance efforts has moved more into credit-risk management. This includes a more stringent evaluation of a borrower s willingness and capacity to repay the mortgage. She adds, We ve discovered fraudulent pay stubs and W-2 forms while reviewing files. We also discovered employment verifications were sometimes completed by someone other than the actual HR [human resources] department. In addition to relying on the skills of its employees, Veritas Funding also utilizes two Credit Plus tools to stay ahead of the curve. High Risk Fraud Alert or Hawk Alerts enable them to spot discrepancies in addresses, phone numbers and Social Security numbers. Obviously, a Social Security number that was issued 50 years ago for a borrower who is 22 years old is a red flag, she says. The other tool we use is a check with the Office of Foreign Assets Control [OFAC] to make sure we re not lending to a person on the restricted list. We ve taken many steps to detect fraud and protect our clients, says Emery Financial Services Liguori. We don t keep any information on the hard drive of a computer anymore. All the loans go into Pleasanton, California based Ellie Mae Inc. s Encompass360 and are stored securely. No stand-alone version of Encompass sits on any individual computer or laptop now. Documents sent via are encrypted, the client must use a password to access the information, and everything that goes back and forth is tracked to the Internet service provider [ISP] address of the computer to which it was sent. Top Flite Financial is now using LexisNexis, MERS and Credit Plus Level 1 authentication in its efforts to prevent mortgage fraud. It also pulls a tax return verification prior to funding any new loans. All files are quality-control-checked prior to closing, and again afterward, says Baise. We ve also implemented a fraud hotline. Fraud prevention has its costs Most lenders are finding that new regulations and more stringent evaluation of a borrower s ability to repay the mortgage are slowing the lending process, and most expect the overall cost of mortgages to rise as a result. Average time to close a loan used to be about 30 days. Now the average is closer to 60, says Brand Mortgage Group s Shumate. Stricter credit standards, increased anti-fraud measures and additional government regulations are slowing the mortgage process and increasing expenses incurred by lenders, says Roush. Lenders are increasing their quality control and compliance departments at tremendous cost. This expense will ultimately be passed on to the consumer. Get the armor you need The current economic climate, with its proliferation of fraud, can make mortgage industry professionals feel like they are under siege from unscrupulous buyers. Retreat isn t the answer; pulling up your drawbridge only makes life more difficult in the long run. Lending professionals instead need to arm themselves with a variety of tools to help them uncover attempted mortgage fraud early in the application process. One of the most efficient ways to do this is to utilize tools such as tax return verification reports to confirm income, and credit reports that screen applicant information against a national database and alert the user to suspicious information or discrepancies in addresses, Social Security numbers and phone numbers. Fraud-prevention programs, such as these, provide mortgage professionals with the armor they need to prevent financial loss. These programs also supply the weapons mortgage professionals can use to remain confident they can slay the dragon at the door. MIB Greg Holmes is national director of sales and marketing at Credit Plus Inc., Salisbury, Maryland, a provider of credit and mortgage information services since He can be reached at beyondbundled@creditplus.com.