Before 9/11, mortgage fraud was considered to be the fastest growing white collar crime. After 9/11, money earmarked to investigate mortgage fraud nationwide was reallocated to Homeland Security.

Reports of mortgage fraud in 2000 were 3,515. By the year 2006 mortgage fraud-related suspicious activity reports rose to 28,372 or an average of 78 separate acts of mortgage fraud per day. (Source: Mortgage Asset Research Institute MARI April, 2007. Link opens PDF.)

Fraudulent mortgage activities result in artificially inflated property values, increased foreclosure rates, significant institutional financial losses, and increased costs which are passed on to consumers. This blog series on mortgage fraud will be divided up into 3 parts:

Part 1 Mortgage Fraud Basics
Part 2 Case Studies
Part 3 Recent Mortgage Fraud Developments and Future Outlook

There are three basic types of fraud in the residential mortgage industry:

1) Consumer fraud, or fraud for property, is perpetrated by borrowers when they misrepresent information on the loan application in order to purchase a more expensive home than one for which they would normally qualify. Consumer fraud is relatively minor and does not usually result in significant losses to a financial institution. However, recent statistics are alarming: Ninety percent of stated incomes were inflated by 5 percent or more, and in about 60 percent of cases, incomes were exaggerated by 50 percent or more.

2) Commission fraud is defined by one or more industry professionals misrepresenting information in a loan transaction in order to receive a commission on a loan that would not normally be acceptable to a lender. Commission fraud is a more common practice in the industry and is a concern to financial institutions. It can result in harm to the consumer and losses to lenders and insurers. Some researchers combine numbers 1 and 2.

3) Fraud for profit consists of systematic transactions by industry professionals who are attempting to steal a significant amount of the funds associated with one or more mortgage transactions. This type of fraud usually involves multiple parties in various disciplines within the mortgage industry, such as mortgage originators, appraisers, real estate agents, closing agents, builders and title companies. Fraud for profit usually results in significant—if not catastrophic—losses to financial entities involved in mortgage loan transactions and is of major concern to the mortgage industry. A few examples of this type of fraud include HUD I Settlement Statement fraud, land flips, fictitious lien releases and diversion of funds at closing.

Common Mortgage Fraud Schemes

Illegal Property Flipping
Property is purchased, falsely appraised at a higher value, and then quickly sold. The schemes typically involve one or more of the following: fraudulent appraisals, doctored loan documentation, inflating buyer income, and so forth. Kickbacks to buyers, investors, property/loan brokers, appraisers, and title company employees are common in this scheme. A home worth $300,000 may be appraised for $400,000 or higher in this type of scheme. In part 2, I’ll tell you about an illegal property flipping scheme busted in Bellevue.

Silent Second
The buyer of a property borrows the down payment from the seller through the issuance of a non-disclosed second mortgage. The primary lender believes the borrower has invested his own money in the down payment, when in fact, it is borrowed. The second mortgage may not be recorded to further conceal its status from the primary lender. In part 2, I’ll lay out the now textbook case that happened over in Spokane.

Nominee Loans/Straw Buyers
The identity of the borrower is concealed through the use of a nominee who allows the borrower to use the nominee’s name and credit history to apply for a loan. There’s a set of cases like this here in Seattle.

Fictitious/Stolen Identity
A fictitious/stolen identity may be used on the loan application. The applicant may be involved in an identity theft scheme: the applicant’s name, personal identifying information and credit history are used without the true person’s knowledge. Washington State is on the top 10 list of states with identity theft problems.

Inflated Appraisals
An appraiser acts in collusion with a borrower and provides a misleading appraisal report to the lender. The report inaccurately states an inflated property value.

Foreclosure Schemes
The perpetrator identifies homeowners who are at risk of defaulting on loans or whose houses are already in foreclosure. Perpetrators mislead the homeowners into believing that they can save their homes in exchange for a transfer of the deed and up-front fees. The perpetrator profits from these schemes by re-mortgaging the property or pocketing fees paid by the homeowner. Watch for a recent Bellingham case in part 2.

Equity Skimming
An investor may use a straw buyer, false income documents, and false credit reports, to obtain a mortgage loan in the straw buyer’s name. Subsequent to closing, the straw buyer signs the property over to the investor in a quit claim deed which relinquishes all rights to the property and provides no guaranty to title. The investor does not make any mortgage payments and rents the property until foreclosure takes place several months later.

Undisclosed Seller Concessions
A home buyer and home seller strike up a side arrangement in which money from the seller is transferred to the buyer after the close of escrow. For example, a sales price could be increased to “cover” this arrangement, yet the appraiser and lender are not informed. Sometimes escrow or the real estate agents know about this; sometimes not.

Last month, in a keynote address (link opens PDF) to the Washington Association of Mortgage Brokers, Scott Jarvis, Director of the Department of Financial Institutions (DFI), concluded that “Washington State cannot afford to ingore this national trend.

sniglet and RCC over at seattlebubble explained that bubble markets can hide mortgage fraud and that we won’t see an increase in mortgage fraud but instead, as markets cool, past mortgage fraud will be exposed. It may also be true that in a cooling market, desperate sellers and commission-based sales people are more willing to do desperate things. Also, the fraudsters switch gears and hit homeowners in foreclosure. Local case studies will be presented in part 2.

Report mortgage fraud tips to the FBI by following this link.

Part 2 Case Studies
Part 3 Recent Mortgage Fraud Developments and Future Outlook