Mortgage Asset Research Institute

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1 White Paper Mortgage Asset Research Institute Seventh Periodic Mortgage Fraud Case Report to Mortgage Bankers Association By: William H. Matthews Merle Sharick Erin E. Omba Catherine B. Montero D. James Croft This report was combined and published before the acquisition of LexisNexis and ChoicePoint.

2 June 24, 2005 Dear MBA Member: Mortgage fraud continues to receive much attention throughout the real estate finance industry. Through education, research and advocacy, MBA strives to equip our members with the knowledge and tools necessary to catch and avoid fraud in their operations. One such tool is the cooperative databases of the Mortgage Asset Research Institute, Inc. (MARI). The most prominent of these is the Mortgage Industry Data Exchange (MIDEX), which is a database system where lenders, insurers and agencies exchange information about companies and parties that have originated loans containing fraud. Enclosed you will find the Seventh Periodic Case Report to the Mortgage Bankers Association produced by MARI. MARI provides MBA members these annual reports as well as discounted fees to participate in MARI s database. Over this past year, MBA has been at the forefront of efforts to help lenders detect, investigate and prevent mortgage fraud. On October 7, 2004, MBA testified at the House Financial Services Committee s Subcommittee on Housing and Community Opportunity s hearing on mortgage fraud s impact on mortgage lenders. As part of our testimony, MBA advanced three principles: Communication between mortgage lenders and the state and federal agencies that investigate and prosecute mortgage fraud needs to improve. Investigation and prosecution of mortgage fraud by law enforcement agencies needs to increase. The mortgage industry needs to continue to innovate with the development of better industry tools and intra-industry communication to combat fraud.

3 On March 10, 2005, MBA hosted a National Fraud Summit that brought together a broad cross-section of the real estate finance industry, government and law enforcement officials to discuss the impact of mortgage fraud on the lending industry. Each Summit attendee participated in one of four closed-door, roundtable discussions: Fraud Schemes and Information Sharing, Oversight of Industry Professionals, Law Enforcement and The Importance of Accurate Valuations. MBA developed a summary report from the Summit that includes 26 potential action steps to be undertaken by industry, government or both. MBA is pursuing these steps with its members. Finally, on March 31, 2005, MBA launched the Mortgage Fraud Against Lenders Resource Center Website ( The Website serves as a one-stop web resource with comprehensive information on mortgage fraud, including: fraud alerts, legislative and regulatory updates, industry news and fraud detection and prevention resources. It is a tool created for and by MBA s members. I encourage you and your staff to visit the site and incorporate it into your company s efforts in combating mortgage fraud. We will continue to keep you apprised of our efforts in the fight against mortgage fraud. Most sincerely, Jonathan L. Kempner President and Chief Executive Officer

4 12030 Sunrise Valley Drive Suite 200 Reston, Virginia Tel: (703) Fax: (703) SEVENTH PERIODIC MORTGAGE FRAUD CASE REPORT TO MORTGAGE BANKERS ASSOCIATION By William H. Matthews Merle Sharick Erin E. Omba Catherine B. Montero D. James Croft Mortgage Asset Research Institute, Inc. A ChoicePoint Service

5 SEVENTH PERIODIC REPORT TO MORTGAGE BANKERS ASSOCIATION OF AMERICA Executive Summary Mortgage originations approached nearly $3 trillion in 2004, down from a record $4 trillion in Although the 2004 numbers on residential mortgage fraud and misrepresentation are still preliminary, it appears that problems are on the rise. The FBI recently reported that 2004 mortgage related suspicious activity reports (SARS) were almost 2.5 times higher than the 2003 level. 1 It also appears that there are subtle changes in the incidence and types of fraud lenders, mortgage insurers and secondary market agencies are seeing. If there is another significant reduction in originations for 2005, additional future cases could surface at a rapid rate as some originators try to maintain high origination levels. This is the seventh annual report by the Mortgage Asset Research Institute, Inc. (MARI) to MBA members. These annual reports examine the current composition of residential mortgage fraud and misrepresentation in the United States. (See Appendix I at the end of this report for information about MARI and the methods it uses to collect data on mortgage fraud.) The highlights of this report are as follows: During the past four years, there has been a shift in the states that have the greatest problems. For the second year in a row, Georgia and South Carolina have had very high rates of reported fraud. Florida continues to have a high fraud score, but is no longer entrenched in its historical second-place position on the national list of hot spots. Reported fraud in California has dropped significantly, but many of its problems are likely being masked by high real estate appreciation. When fraud reports are broken out between prime and subprime lending, the state indices and ranks are somewhat similar. Some major exceptions are New York, Arizona and Mississippi, which are showing a rise in subprime lending problems. Problems continue to rise in the Midwest, and cities of moderate size appear to have particularly serious problems with recent originations that become seriously delinquent. Serious early default information from LoanPerformance, Inc. appears to lead, by about one year, the results of fraud investigations reported to MARI by its database subscribers. The types of problems found in loan fraud files seem to have been relatively stable throughout the last four years. The body of this report presents the data behind the conclusions cited above Mortgage Asset Research Institute, Inc. Page 1

6 Information Sources Over the last ten years, major mortgage lenders, agencies and insurers have been submitting information describing incidents of alleged fraud and material misrepresentation to a central database. The database is MARI s Mortgage Industry Data Exchange (MIDEX ). MARI can mine the MIDEX database to obtain statistics on a wide range of mortgage fraud characteristics. Geographical Distribution of Mortgage Fraud Table 1 below was developed from fraud cases submitted to MARI by MIDEX subscribers, and it shows the rankings of states with the most serious mortgage fraud problems in loans originated 2 during the past four years. In Table 1, a MARI Fraud Index (MFI) of 0 would indicate no reported fraud from a state. An MFI of 100 indicates that the reported fraud for a state is exactly what one would expect in terms of fraud rates, given the level of loan originations in that state. That is, a state with an MFI of 100 is average. Appendix II at the end of this report explains the MFI in greater detail. For most of the past decade, fraud rates from California and Florida have led the nation by substantial margins. In the past few years, Georgia has become the hottest spot in the country for incidents reported to the MIDEX database, and recently South Carolina moved into second position by a substantial margin. California lost its leadership position three years ago, and currently has a below average MFI of only 89. Table 1 MARI Fraud Index (MFI) All MIDEX Contributors by State 2001 through 2004 Rank State MFI 1 Georgia South Carolina Florida Utah North Carolina Missouri Nevada Texas Illinois Michigan 121 Source: Case submissions to the MIDEX system 2005 Mortgage Asset Research Institute, Inc. Page 2

7 California A Special Case? California s low MFI score may be somewhat deceptive. Many lenders are concerned that fraud is still very high in California loan applications, but much of that fraud is being masked by unusually high property appreciation, especially in Southern California and the San Francisco Bay area. In addition, these rapidly rising property values may be adding to the fraud problem. Some potential homeowners in hot real estate markets feel panicky about ever being able to afford a home. This leads to problems where borrowers, often with the help of loan originators, misrepresent their circumstances in an effort to get into a home before they are further priced out of the market. Lenders active in California also have reported several cases where multiple families have purchased a home together. However, the loan application is made in the name of the family that has the best credit record and highest credit score. The income shown on the application is really the pooled income of all the families. Lenders that find such situations are in a quandary about whether to report the application as fraudulent since often the mortgage records show timely payments. Many of these fraud for housing cases are quite different from the fraud for profit lenders are reporting in other parts of the country. Other States Along with Georgia, the states of South Carolina, Florida, Utah and North Carolina comprise the top five states for fraud in the time period. Each has an MFI that is more than 150% of what we would expect, based on each state s origination volumes over the past four years. The problems, as one would anticipate, occur primarily in these states larger cities. The Midwestern cities of Detroit and Chicago continue to have problems, and generally, the states of Michigan, Missouri and Illinois are climbing in the MFI rankings. Their numbers square with anecdotal reports that have been circulating among quality control and fraud investigation departments in the recent past. Prime v. Subprime Fraud Levels The MARI Fraud Index can be broken out for prime v. subprime lenders. Table 2 and Table 3 on the next page present this breakout. For the most part, positions among the top ten states shift only slightly. There are, however, some exceptions. Texas appears to have more serious problems in prime lending (MFI = 160) than in subprime (MFI = 79, not shown in the Table 3). Also, New York, Arizona and Mississippi do not make the top ten list for prime lending, but they appear to be creeping up the rankings in the subprime arena Mortgage Asset Research Institute, Inc. Page 3

8 Table 2 MARI Fraud Index (MFI) for MIDEX Reports from Prime Lenders by State 2001 through 2004 Rank State MFI 1 South Carolina Georgia North Carolina Missouri Florida Texas Utah Illinois Michigan Indiana 108 Source: Case submissions to the MIDEX system Table 3 MARI Fraud Index (MFI) for MIDEX Reports from Subprime Lenders by State 2001 through 2004 Rank State MFI 1 Georgia Florida South Carolina Nevada Utah Michigan New York Arizona Mississippi North Carolina 116 Source: Case submissions to the MIDEX system 2005 Mortgage Asset Research Institute, Inc. Page 4

9 Early Serious Delinquencies Indicate Possible Fraud Loans that become delinquent by more than ninety days or go into foreclosure in the first 6 to 18 months, Serious Early Defaults (SEDs), do not necessarily involve fraud. However, many such loans contain some form of misrepresentation and should not have been made. LoanPerformance, Inc. 4 collects monthly payment data on more than 46 million loans. An analysis prepared by the LoanPerformance staff is presented in Table 4. It shows prime loan SED scores for various metropolitan statistical areas (MSAs) around the country. (These scores are based on the dollar value of the problem loans, and an SED score of 100 indicates an area has an SED score that is average for the United States.) The years designated by columns in Table 4 refer to the origination years. The 13 MSAs listed in the first column of the table are those that have SED rates at least twice the national average for the 2004 book of business. As noted previously, California was the country s most serious mortgage fraud hotspot during the 1990s. But the 2004 prime loan SED rates for the Los Angeles and San Francisco MSAs do not appear in Table 4 since they were so low. Their 2004 prime lending SED scores were only 44 and 13, respectively. That is, both MSAs were far below the national average of 100. Again, unusually high price appreciation may be masking fraud problems, even early in the life of a loan. Table 4 LoanPerformance, Inc. Data on Prime Loans Serious Early Defaults Rank MSA Atlanta Dallas-Ft. Worth Denver 3 (tie) Orlando 3 (tie) Charlotte Memphis Scranton 7 (tie) Columbus 7 (tie) Houston 10 (tie) Salt Lake City 10 (tie) Louisville 10 (tie) Oklahoma City 10 (tie) Tulsa 10 (tie) Source: LoanPerformance, Inc Mortgage Asset Research Institute, Inc. Page 5

10 It is no surprise to those working in the mortgage fraud business that Atlanta ranks first in the nation for Serious Early Defaults. The buzz among industry members has centered on the Atlanta area s problems for at least three years. Also, Atlanta s position in Table 4 is consistent with Georgia s first place ranking in Table 1, which shows its overall MARI Fraud Index score also leads the nation. The Table 4 figures confirm the concerns currently being expressed among industry professionals. Many report seeing much of their fraud problem shifting from the larger metropolitan areas to cities of more moderate size. Memphis, Scranton, Louisville, Oklahoma City and Tulsa were not among the most seriously delinquent MSAs in past MARI reports and are new to the list in Table 4. Table 5 below shows LoanPerformance SED scores for subprime loans. The LoanPerformance information for subprime loans is not sufficiently robust to be statistically valid for all MSAs. Therefore, it must be aggregated by state. The fourteen states with LoanPerformance SED scores above 150 are shown below. Interestingly, Oklahoma s 2004 book of subprime business is leading the nation in Serious Early Defaults. This is consistent with the fact that, for reasons not fully explained, Oklahoma City and Tulsa appear to have similar problems for prime lenders. Table 5 LoanPerformance, Inc. Data on Subprime Loans Serious Early Defaults State Rank Oklahoma Mississippi Ohio Georgia Indiana Utah Kansas 7 (tie) Colorado 7 (tie) Kentucky Arkansas South Carolina 11 (tie) Minnesota 11 (tie) Michigan Illinois Source: LoanPerformance, Inc Mortgage Asset Research Institute, Inc. Page 6

11 Table 5 shows that many states in the middle of the country are experiencing early payment problems among subprime loans. In addition, many of these states have seen their problems grow steadily over the past four years. While SED scores do not necessarily indicate fraud, the conclusions that can be drawn from the LoanPerformance data are consistent with, and tend to lead, by approximately a year, the results reported by MARI s database subscribers. Types of Fraud Reported MARI s MIDEX system classifies the types of alleged fraud involved in each incident reported by its cooperating subscribers. These classifications are shown in Table 6 for loans originated in the four-year period from 2001 through The data on 2004 loans, of course, is very preliminary since frauds perpetrated in 2004 will continue to surface for another two years or more. Table 6 shows each type of fraud as a percentage of all fraud cases submitted to the MIDEX database. For instance, 56% of the fraud incidents of fraud reported to the database for mortgages originated in 2004 contained application fraud. (This is not surprising given the comprehensive nature of the application form.) Table 6 Mortgage Fraud Trends Fraud Classification Mortgage Origination Year Applications 56% 63% 64% 65% Tax and Financial Statements 33% 27% 24% 23% Verifications of Employment 12% 12% 14% 16% Verifications of Deposit 16% 14% 16% 15% Escrow/Closing 6% 10% 18% 17% Appraisals/Valuations 10% 18% 28% 24% Credit Reports 1% 1% 2% 2% Source: Case submissions to the MIDEX system 2005 Mortgage Asset Research Institute, Inc. Page 7

12 There appear to be few discernable patterns or trends in the data for this four-year period (keep in mind that the 2004 values are only preliminary). However, it is interesting to note that the total percentage for each year (the sum of each column in Table 6) exceeds 100%. This is because most reported incidents involve more than one type of fraud. Appraisal Fraud Even casual observation of Table 6 indicates that the amount of appraisal fraud reported is somewhat lower than one might expect in each of the years, especially in The low levels of reporting can be tied to the fact that, typically, reported incidents involve more than one type of fraud. If the reporting lender finds misrepresentation in the verification of employment and in occupancy status, that lender is not likely to pay for the review appraisal that would be necessary to verify appraisal fraud, even if the appraisal appears to be inflated. In addition, it should be noted that the appraisal fraud rate reported in the data for 2004 is the lowest of all years reported. But this number will increase as more misrepresentations are found in the 2004 book of business and as the sometimes lengthy process of reappraisal and value verification is completed in many investigations. Many MIDEX subscribers indicate that attempts at appraisal fraud are much higher than Table 6 shows. Of course, some loans are not closed due to the faulty appraisal s comparison to the values produced by automated valuation models (AVMs). But lenders express concerns about using AVM results in some markets. In particular, they are finding cases where such models have difficulty establishing realistic values in major urban areas, such as Detroit, where the same neighborhoods may contain diverse housing types. Nearby comparables may not really be comparable. Appraisals in these neighborhoods are far more accurate when reviewed by experienced appraisers familiar with the market. Some lenders are also concerned about the accuracy of AVMs in areas hit by property flipping. The comparables found by such models may be influenced by transactions they do not recognize as flips. Specific Cases The MIDEX database contains thousands of incidents involving material misrepresentations. While it is not possible to relate even a small fraction of these, there are a few recent cases that represent the types of problems currently being reported by MIDEX subscribers. The following paragraphs give short descriptions of incidents that have been reported in the states with high MFI values. Each incident contains short MARI staff observations in brackets Mortgage Asset Research Institute, Inc. Page 8

13 The Tip of the Iceberg. An Atlanta borrower applied for a loan to finance his $150,000 home. However, a review appraisal found that property was worth only about $100,000. The appraiser had used inappropriate comparables, many of which were already owned by the borrower. There were a number of such properties to use as comparables. The loan officer failed to list $2.25 million in borrower mortgage debt secured by 28 additional properties. [Too often, the initial problem discovered, like the $150,000 appraisal, is only a symptom of more problems.] Why Misrepresent Just One Thing? A wholesale lender reported that it investigated 26 Georgia and North Carolina loans it received from one mortgage broker. It found that these loans, originated by five different loan officers, contained false social security numbers, inflated incomes, fabricated bank statements and forged signatures for borrowers and/or sellers. Nineteen of the appraisals were inflated. [Fraudulent loan applications often contain more than one type of misrepresentation. While much fraud appears to be the result of one bad apple at a mortgage originator, there are cases where major portions of the tree are rotten. It appears that a number of wholesale lenders, after finding one or two problem loans from a broker, are auditing an entire year of production they have purchased from that broker.] The Cooperative Professionals. Federal authorities in Ohio broke up a property flipping ring that involved nine real estate investors and title agents. The investors bought properties and used fabricated appraisals to flip them, only weeks later, for values up to twice their purchase price. [Property flips have to involve inaccurate appraisals be they fabricated or prepared by dishonest appraisers.] State Whatever Makes It Work. An officer at a Florida mortgage company applied to a second lender for two stated income loans. The applications were submitted 90 days apart. In the first, the borrower stated his monthly income as $24,000, and in the second he said it was $30,000. When the mortgage company officer was asked about the difference, he said, I thought that on stated income loans you could claim an income has high as necessary to bring the ratios into compliance. [Even mortgage industry professionals don t understand the rules. Stated income loans are introducing significant risk to many lenders business.] A Tight Little Group. A MIDEX subscriber found seven loan applications from a broker in a small Michigan town that contained employment misrepresentations. Some of the applications showed the borrowers employed at a company owned by the broker. Five of the loans contained CPA verification forms that were forged. The CPA s listed address was the same as that of the broker-owned employer. [Some frauds are still exposed through the perpetrators sloppy work.] 2005 Mortgage Asset Research Institute, Inc. Page 9

14 If You Don t Take This Fraud Loan, I ll Give It To Your Competitor. In Utah, a mortgage broker submitted an application for a 100% equity take-out on an owner-occupied property. Some of the verification documents in the file showed the borrower resided at a different address. When the broker was confronted with evidence that the property was not owner-occupied, he admitted he had known this from the beginning of the application process. He asked the declining lender for a suggestion of another lender to whom he could take the application. [Getting caught doesn t stop some loan officers. They will often continue looking for less vigilant mortgage companies.] 2005 Mortgage Asset Research Institute, Inc. Page 10

15 Appendix I Source and Analysis of MARI s Mortgage Fraud Data The data presented in Tables 1, 2, 3 and 6 of this report was taken from a cooperative mortgage fraud database operated by the Mortgage Asset Research Institute, Inc. (MARI). 5 MARI has designed and offered various mortgage industry databases for the past fifteen years. Its most recognized database system is the Mortgage Industry Data Exchange (MIDEX ) that contains information about licensing, public sanctions and incidents of alleged fraud reported to MARI by MIDEX subscribers. The MIDEX data discussed in this document was taken from the incidents that MIDEX subscribers describe in reports to MARI. (Agreeing to submit reports describing their fraud investigation findings to the non-public section of MARI s MIDEX system is required for those who wish to access other subscribers non-public reports.) Only material misrepresentations are included in these reports. That is, companies only submit reports to MIDEX in those cases where, knowing what they know after their thorough investigations, they would not have originated, bought or insured the loans in question. The reports submitted to MARI include the following information about each incident: Location of the collateral (state, city and address, to the extent known) Names of the originating entity and the loan officer who took the application Date the misrepresentation took place The method used to verify the existence of the reported misrepresentation(s) A short narrative description of the misrepresentation(s) found during the MIDEX subscriber s investigation Names of any other professionals that appear to be in a position to influence the accuracy of the information found to be misrepresented, e.g. the name of the appraiser and appraisal firm in cases where the property value is found to be significantly inflated A certification from an officer at the submitting mortgage entity that the report is, to the best of his/her knowledge, complete and accurate MARI staff reviews the reports to assure they meet submission standards for severity and consistency. Data entry staffers convert them to a standard, searchable format for inclusion in the MIDEX system. After reading the report s narrative description, a MARI staffer will classify the incident as involving one or more of the types of misrepresentations listed in Table Mortgage Asset Research Institute, Inc. Page 11

16 If MARI makes any changes to the submitted reports, they are returned to the submitting subscriber for review prior to their being entered into the system. The subscribers participating in the MIDEX system represent a wide range of mortgage entities. They include secondary market agencies, all the major private mortgage insurance companies, and lenders that account for more than 80% of wholesale lending in the country. Go to and click on About MARI to access a Client List Mortgage Asset Research Institute, Inc. Page 12

17 Appendix II Computation of the MARI Fraud Index (MFI) The MARI Fraud Index, or MFI, is an indication of the amount of mortgage fraud found through MIDEX subscriber fraud investigations in various geographical areas. It involves very straightforward calculations. To come up with Table 1 s 2004 MFI for loans in a state such as Georgia, MARI staff determines the percentage of all U.S. MIDEX fraud reports that were submitted for loans originated in Georgia between 2001 and 2004, inclusive. They determined that 8.57% of MIDEX reports submitted across the country by subscribers for those four years originations involved loans on Georgia properties. But according to HMDA data, Georgia had only 2.89% of the nation s total mortgage originations in a similar four-year period. If mortgage fraud were distributed throughout the country like originations, then we would expect 2.89% of mortgage fraud to occur in Georgia. But 8.57% for the Georgia fraud figure was almost three times higher than its origination figure. Therefore, the 2004 MARI Fraud Index for Georgia, as of this report s date, is: (8.57/2.89)x100 = 297 But this is a dynamic figure. Often, a fraud investigation is not completed until a year or two after the loan was originated. MARI will continue to receive Georgia fraud reports for another two to three years from its MIDEX subscribers that find misrepresentations in their book of business. Therefore, the Georgia s (and all other states ) MFI figures for recent years will continue to change somewhat in future MARI Periodic Reports to the MBA, especially those containing recent years like 2003 and It should be noted that the MFI is based on the number of fraud incidents reported for each state, and not the dollar amounts of those mortgages. Therefore, a fraud on a $120,000 loan in Des Moines, Iowa, is counted the same as a fraud on a $720,000 loan in Los Angeles, California. Also, there is currently no distinction made between purchases, refinances or home improvement loans in these figures Mortgage Asset Research Institute, Inc. Page 13

18 Endnotes 1 Financial Crimes Report to the Public, Financial Crimes Section, Federal Bureau of Investigation, May, The dates used in MARI s Fraud Index are when the fraud occurred, which are typically the loan origination dates. Subscribers to the MIDEX system may not discover that a loan involved fraud for several months, or even one or two years after it was originated. So numbers for recent years are dynamic. 3 It seems improbable that Georgia s MFIs in Tables 1, 2 and 3 are all virtually identical, but they are, after rounding. 4 Formerly Mortgage Information Corporation, aka MIC. First American recently announced that is has acquired LoanPerformance in a transaction that will close in the near future. 5 MARI was purchased by ChoicePoint Services, Inc. in June of Prior to that, it was privately held Mortgage Asset Research Institute, Inc. Page 14

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