Five More Mortgage Fraud Schemes

Mortgage fraudsters are dedicated to their craft.

August 24, 2010

There are a variety of schemes by which mortgage fraud can take place—sometimes involving staff inside the financial institution.

The Federal Financial Institutions Examination Council warns financial institutions to be on the watch for these common mortgage schemes:

1. Loan modification and refinance

This scheme occurs when a borrower submits false income information and/or false credit reports to persuade the financial institution to modify or refinance the loan on more favorable terms.

Best practices for prevention:

  • Underwrite all modifications. Ensure that modification files include documentation of hardship; the borrower’s willingness and ability to continue to pay debt and retain property; independent verification of employment, income, and other information; a new credit report; an analysis of sustainability of performance post-modification; and referral to a reputable credit counseling service.
  • Establish legal department protocol for review of the modification agreement;
  • Establish strong post-modification loan performance reports; and
  • Ensure proper accounting for delinquencies, troubled debt restructuring, charge-offs, and the allowance for loan and lease losses.

2. Mortgage servicing fraud

This fraud is perpetrated by the loan servicer, and generally involves the diversion or misuse of loan payments, proceeds from loan prepayments, and/or escrow funds for the benefit of the service provider.

Best practices for prevention:

  • Perform annual on-site review of loan files and servicer reports;
  • Establish internal audit reviews that include a sampling of loans handled by each servicer and verify collateral lien status for such loans;
  • Obtain and reconcile reports to document and verify total amount of loans serviced, payments and allocation, servicer fees, delinquent loans, etc.;
  • Verify receipt of funds on loans authorized for sale by a servicer;
  • Review, at least annually, the servicer’s registration status, licensing status, financial health and capability, and compliance with the servicing contract/agreement;
  • Establish a contingency plan should the servicer be unable to perform its contractual obligations;
  • Verify current insurance policies and amounts of coverage (flood and hazard);
  • Verify payment of property taxes;
  • Establish appropriate limitations on access to internal bank systems and records;
  • Establish appropriate conflict of interest policies prohibiting compensation/payments from service providers to financial institution employees; and
  • Obtain and review samples of original payment documents to verify that the borrower is the source of payments and that funds from other sources are not being used to make payments or hide delinquencies.

Next: Property flip fraud

3. Property flip fraud

A fraudulent property flip is a scheme in which individuals, businesses, and/or straw borrowers, buy and sell properties among themselves to artificially inflate the value of the property.

Best practices for fraud prevention:

  • Closely analyze the borrower’s financial information for unusual items or trends;
  • Independently verify employment and income;
  • Employ a post-closing review to identify any inconsistencies;
  • Establish a periodic independent audit of mortgage loan operations;
  • Periodically conduct physical verification of the location and condition of selected subject properties and comparables;
  • Monitor real estate market values in areas that generate a high volume of mortgage fraud loans or where concentrations exist;
  • Review the appraisal’s three-year sales history to help identify property flipping;
  • Perform pre-funding reviews of appraisals and evaluations;
  • Establish an employee-training program addressing common mortgage fraud schemes, appraisal standards, and appraisal valuation techniques; and
  • Implement a “watch” list and monitoring systems for appraisers that exhibit suspect practices.

4. Reverse mortgage fraud

Reverse mortgage fraud involves a scheme using a reverse mortgage loan to defraud a financial institution by stripping legitimate or fictitious equity from the collateral property.

Guard against this type of fraud by:

  • Obtaining a title search and review for the types of property titles shown, type of deed transferred, the owner of record, the dates of deed transfers, and amounts and dates of any prior mortgages; and
  • Obtaining information on the borrower’s previous address and length of residence at the previous address. Determine whether the address is associated with governmental housing, homeless shelters, or group homes.

Straw borrowers are often recruited from such housing and then used by the perpetrators to meet borrower age requirements in the program.

Next: Short sale fraud

5. Short sale fraud

Fraud occurs in a short sale when a borrower purposely withholds mortgage payments, forcing the loan into default, so an accomplice can submit a “straw” short-sale offer at a purchase price less than the borrower’s loan balance.

Sometimes the borrower is truly having financial difficulty and is approached by a fraudster to commit the scheme. In all cases, fraud is committed if the financial institution is misled into approving the short-sale offer when the price isn’t reasonable and/or when conflicts of interest are not properly disclosed.

Best practices for prevention:

  • Establish a short-sale policy and review/approval process;
  • Obtain an appraisal or evaluation to determine the property’s market value;
  • Determine if the sales transaction is arms length, and identify common surnames, telephone numbers, addresses, etc.;
  • Obtain sworn statements from all parties, including the real estate agent, that the transaction is a true sale and the parties don’t know each other;
  • Require the seller to vacate the property and certify that the seller will not occupy the home again for five years;
  • Inform the seller that occupancy checks will be performed periodically;
  • Verify the borrower’s reason for financial hardship (unemployment insurance, medical payments, divorce, etc.); and
  • Include the FBI Mortgage Fraud Notice in loan documents.