Mortgage Loan Fraud - Holding the Lender Accountable

by Beth Cary, Certified Senior Escrow Officer

Loan fraud is a hot topic in the news lately. It seems that reported cases of loan fraud are on the rise and governmental agencies are struggling to get a handle on the situation. The reality is that loan fraud hurts us all. It results in the limitation of the financing options available to the average home buyer. But who is responsible for the increase in loan fraud and how do we stop it?

In 1934 the US Congress created the Federal Housing Authority (FHA) to assist in making home ownership affordable for the common man. Prior to that time, mortgage lenders were primarily banks who provided repayment terms of 10 to 15 years and loan to value ratios below 50%. At that time, only 40% of households were owner occupied. (HUD, 2006) Today, borrowers can get repayment terms of up to 40 years and finance up to 100% of the purchase price (value) of the home. According to Insurance Information Institute, currently homeownership is almost 70% (III, 2006). These are wonderful statistics and just quoting them creates a warm fuzzy feeling, but Nevada’s fraud claims tell a different story.

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In September 2006, according to RealtyTrac, 1 in 452 Nevada households had notices of default filed, signifying the beginning of foreclosure procedures. (Wargo, par. 8) Although a foreclosure rate of less than one quarter of one percent, 0.22%, seems fairly reasonable, that is a significant increase over the approximate foreclosure rate of 0.07% from September 2005. In addition, regulatory bodies and policing agencies in Nevada are seeing increased reports of mortgage fraud (Wargo, par. 8). According to Pete Dustin with the Las Vegas Metropolitan Police Department, mortgage fraud complaints have increased from 1 or 2 a month to 30 or more. (Wargo, par. 5). Another important piece of the puzzle is that loan fraud is only reported when someone involved makes a complaint and, in most cases, loan fraud goes unreported.

If you follow the mainstream media and take the regulators’ word for it, the culprits in loan fraud are numerous. They blame the borrowers, hungry to become homeowners; greedy mortgage brokers, wanting to generate fees; sellers who play along with schemes to inflate the value for an additional dollar or two or a quick closing; and shifty investment groups that pull in unsuspecting citizens to assist in their dubious plans. Oddly enough, no one is questioning the lender’s role in the process.

What the lenders know, but are not broadcasting, is that almost every loan application contains some element of loan fraud because, without it, mortgage loans would never be funded. In fact, lenders encourage loan fraud on a minor scale. In example, underwriting guidelines require that everything disclosed on the mortgage loan application line up with the consumer’s credit report because this is how lenders verify that the information is correct. If a consumer has other obligations which are not shown on the credit report, they are encouraged not to show them on the application because of the difficulty it presents to the mortgage underwriters. In most cases, the information from the credit reporting agency is 60 to 90 days old. Then the lender requires that the borrower sign a sworn statement that no information provided to them in the loan application was inaccurate. If the borrower changes the information contained in the application or refuses to sign the certification, the lender will not fund the loan and the borrower can not purchase their home. Consequently, most mortgage professionals counsel the borrower to sign the incorrect application and then the sworn statement that it is correct.

Still, big lenders are the primary direct victim of loan fraud. Certainly there are smaller victims, and others, who are damaged collaterally by the scams, but in general, it is the large major lenders who are losing money when loan fraud is brought to light. So, why would a lender encourage consumers to not follow the rules? The answer to that is “upfront fees”.

“Upfront fees” are those fees charged by a lender to the borrower for the creation of the loan. Once upon a time, lenders made the bulk of their money on the interest earned over the life of the loan, but today that is not the case. Large investment pools in the form of publicly traded corporations provide money for the investment in mortgage loans. These corporations form a collective body known as the “secondary market”. The private investors in “secondary market” receive the interest paid on the loans, after the expenses of the corporations, as dividends. Because the lender is making their money on the generation of the loan and not the interest, they have a financial incentive to have loan approval guidelines be as lenient as possible. They understand that the loosening of those guidelines will result in mortgage brokers submitting applications which contain less than truthful information, and they don’t care. In fact, as long as the borrower pays the loan, they are happy. They got their money.

The only reason the lender cares about loan fraud is that, when it is exposed, any lender who is regularly originating fraudulent loans may lose their ability to sell those loans on the secondary market. If they are unable to sell the loans to the secondary market, the amount of funds available to that lender for the generation of new loans is greatly reduced. When this happens, they are not able to generate the upfront fees causing their stock and financial ratings drop. This, of course, is bad for the banking industry in general. The lender is unhappy and the only way to save face within the industry is to somehow make it everyone else’s fault.

Bottom line, if every mortgage lender were to return to underwriting guidelines that require evidence and verification of the borrower’s credit worthiness and the ability to repay, there would be very little loan fraud. Until the consumer holds the lenders responsible for their complicity in the fraud cycle, it will continue. Mortgage originators are both the cause and the solution to the mortgage fraud cycle.

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©Copyright Beth Cary. All rights reserved. Working in the industry since 1982, Beth Cary’s experience spans from loan orignation and sales to title underwriting and escrow. In addition, she is an approved instructor with the Nevada Division of Real Estate and an active member of the California Escrow Association. She currently serves as Escrow Operations Manager for Financial title Company, Clark County, Nevada. For more about Beth, please visit GoGetEscrow.com/Get/Beth.

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