2007 Mortgage Fraud Report

April 2008

The above photos are from condos that were involved in a mortgage fraud. The appraisal described “recently renovated condominiums” to include Brazilian hardwood, granite countertops, and a value of $275,000.

Key Findings

• Mortgage fraud continues to be an escalating problem in the United States. Although no central repository collects all mortgage fraud complaints, Suspicious Activity Reports (SARs) from financial institutions indicated an increase in mortgage fraud reporting. SARs increased 31-percent to 46,717 during Fiscal Year (FY) 2007. The total dollar loss attributed to mortgage fraud is unknown. However, 7 percent of SARs filed during FY 2007 indicated a specific dollar loss, which totaled more than $813 million.
  
  
• Subprime mortgage issues remain a key factor in influencing mortgage fraud directly and indirectly. The subprime share of outstanding loans has more than a doubled since 2003 putting a greater share of loans at higher risk of failure. Additionally, during 2007 there were more than 2.2 million foreclosure filings reported on approximately 1.29 million properties nationally, up 75 percent from 2006. The declining housing market affects many in the mortgage industry who are paid by commission. During declining markets, mortgage fraud perpetrators may take advantage of industry personnel attempting to generate loans to maintain current standards of living.
  
  
• Analysis of available information indicated that mortgage fraud was most concentrated in the north central region of the United States. Data from law enforcement and industry sources were compared and mapped to determine which states were most affected by mortgage fraud during 2007 and indicated that the top 10 mortgage fraud states for 2007 were Florida, Georgia, Michigan, California, Illinois, Ohio, Texas, New York, Colorado, and Minnesota. Other states significantly affected by mortgage fraud according to available sources included Arizona, Maryland, Utah, Nevada, Missouri, Indiana, Tennessee, Virginia, New Jersey, and Connecticut.
  
  
• The downward trend in the housing market provides an ideal climate for mortgage fraud perpetrators to employ a myriad of schemes suitable to a down market. Several of these schemes have emerged with the potential to spread as the recent rise in foreclosures, depressed housing prices, and decreased demand place pressure on lenders, builders, and home sellers. Emerging and re-emerging schemes for 2007 included builder-bailouts, seller assistance, short sales, foreclosure rescue, and identity thefts exploiting home equity lines of credit.

“The potential impact of mortgage fraud on financial institutions and the stock market is clear. If fraudulent practices become systemic within the mortgage industry and mortgage fraud is allowed to become unrestrained, it will ultimately place financial institutions at risk and have adverse effects on the stock market.”

-Chris Swecker, former FBI Assistant Director, Criminal Investigative Division, Introductory Statement: House Financial Services Subcommittee on Housing and Community Opportunity, 7 October 2004

Introduction

Mortgage Fraud is defined as the intentional misstatement, misrepresentation, or omission by an applicant or other interested parties, relied on by a lender or underwriter to provide funding for, to purchase, or to insure a mortgage loan. Combating mortgage fraud effectively requires the cooperation of law enforcement and industry entities. No single regulatory agency is charged with monitoring this crime. The FBI, Department of Housing and Urban Development-Office of Inspector General (HUD-OIG), Internal Revenue Service, Postal Inspection Service, and state and local agencies are among those investigating mortgage fraud.

Mortgage fraud is a relatively low-risk, high-yield criminal activity which is accessible to many. However, according a Financial Crimes Enforcement Network (FinCEN) report, finance-related occupations, including accountants, mortgage brokers, and lenders were the most common suspect occupations associated with reported mortgage fraud.¹ Perpetrators in mortgage industry occupations are familiar with the mortgage loan process and therefore know how to exploit vulnerabilities in the system. Victims of mortgage fraud may include borrowers, mortgage industry entities, and those living in the neighborhoods affected by mortgage fraud. As properties affected by mortgage fraud are sold at artificially inflated prices, properties in surrounding neighborhoods also become artificially inflated. When property values are inflated, property taxes increase as well. Legitimate homeowners also find it difficult to sell their homes as surrounding properties affected by fraud deteriorate. When properties foreclose as a result of mortgage fraud, neighborhoods deteriorate and surrounding properties depreciate.

Financial Institution Reporting of Mortgage Fraud Increases

Although no central repository collects all mortgage fraud complaints, Suspicious Activity Reports (SARs) from financial institutions indicated an increase in mortgage fraud reporting. Financial institution reporting indicated that 46,717 SARs were filed during FY 2007 (see figure 1).

The dollar losses attributed to mortgage fraud are unknown. However, 7 percent of SARs filed during FY 2007 indicated a dollar loss of more than $813 million (see figure 2)².

The fact that only 7 percent of SARs from financial institutions documented a loss may be attributed to the fact that losses were unknown at the time of reporting, or fraud was discovered before loan funding, and therefore a loss was not incurred. The $813 million statistic is significant, as it hints to the total amount of financial institution and industry entity losses not subject to SAR filing.

Mortgage Fraud in a Depressed Housing Market

During 2007, mortgage loan originations, including purchases and refinances, were down from 2006 and foreclosures were up nationally, contributing to a slump in the housing market. Many mortgage industry professions are paid by commission. During declining markets, mortgage fraud perpetrators may take advantage of industry personnel attempting to generate loans to maintain current standards of living.

The housing market is expected to continue its downward trend. The Mortgage Bankers Association (MBA) estimates that mortgage loan originations will continue to decline through 2009 (see figure 3).³

According to an MBA report from January 2008, existing home sales are expected to decline by 13 percent during 2008 from 2007. Likewise, new home sales are expected to decline 15 percent from 2007 figures. Median home prices are also expected to decline in 2008.⁴ The current and future market conditions will have mortgage industry professionals pursuing a smaller pool of customers. As such, professional fraudsters will devise new and improved schemes to exploit the weaknesses in the housing market.⁵

The financial impact subprime lending has had on the mortgage industry and the economy as a whole has been widely reported. The subprime share of outstanding loans has more than doubled from 2003, putting a greater share of loans at a higher risk of failure (see figure 4).⁶

Subprime mortgage loans are designed for persons with blemished or limited credit histories. To compensate for the increased credit risk, subprime loans carry a higher rate of interest than prime loans.⁷ According to First American CoreLogic LoanPerformance data, 64.5 percent of the securitized subprime loans originated during 2005 had adjustable rates; 79.4 percent of these loans were 2/28 hybrid adjustable-rate loans (HARMS).⁸ These HARMS had fixed mortgage rates for the first two years after origination and were subject to reset in 2007. Therefore, once the loan introductory “teaser rate” expired, the rate was subject to increase.

The upward movement in interest rates and the declining housing market subjected borrowers to increased payment shock and elevated the possibility of default. The recent decline in the housing market and property depreciation exacerbated the subprime problem. As properties depreciated and demand decreased, property owners could not sell their homes to satisfy their debts.

A report by MARI indicates that two factors pressured the industry into non-traditional lending practices that contributed to fraud. The first includes the persistent drive of mortgage lenders to hasten the mortgage loan process, and the second involves the escalation of home prices of recent years.⁹ According to congressional statements, by the spring of 2004, regulators began to document the fact that lending standards were easing. Also, interest rates were increasing.¹⁰ Notably, mortgage fraud SARs filed during 2004 more than doubled from 2003 (see figures 1 and 4). These recent events likely resulted in an increase in mortgage fraud as higher housing prices tempted borrowers to exaggerate income and assets to qualify for a mortgage loan. Mortgage fraud perpetrators also likely seized the opportunity to take advantage of the relaxed lending practices to commit fraud for profit.

Alt-A loans are designed for prime-quality borrowers, and in many instances do not require documentation, making them ideal for fraud exploitation. Alt-A loans include stated income, stated income/stated asset or no income/no asset loans that are offered by both prime and subprime lenders. BasePoint Analytics, a fraud analysis and consulting service, analyzed loans that were originated between 2002 and 2006; nearly 1 million Alt-A loans and 3 million nonprime loans were evaluated. The relative fraud-loss rate of Alt-A loans was more than three times higher than nonprime loans. Losses within Alt-A loans were caused by income misrepresentations, employment frauds, straw buyers, investor-related frauds, and occupancy frauds.¹¹ The Federal National Mortgage Association (Fannie Mae) conducts random post purchase reviews. Statistics generated from these reviews indicate that misrepresentations within Alt-A loans are higher than the overall population of loans (see figure 5).¹²

Top Areas for Mortgage Fraud

Data from law enforcement and industry sources were compared and mapped to determine which areas of the country were most affected by mortgage fraud during 2007. Information from the FBI, HUD-OIG, FinCEN, Mortgage Asset Research Institute (MARI), Fannie Mae, RealtyTrac Inc., Interthinx®, and Radian Guaranty Inc., indicated that the top 10 mortgage fraud states for 2007 were Florida, Georgia, Michigan, California, Illinois, Ohio, Texas, New York, Colorado, and Minnesota (see figures 6 and 7 for a breakdown of source data). Other states significantly affected by mortgage fraud according to aforementioned sources included Arizona, Maryland, Utah, Nevada, Missouri, Indiana, Tennessee, Virginia, New Jersey, and Connecticut.

Analysis of available information indicated that mortgage fraud was most concentrated in the north central region of the United States (see figure 7). This region is followed by the west and southeast regions.

Breakdown of Sources Used to Identify Top Mortgage Fraud Areas

Federal Bureau of Investigation Regional analysis of FBI pending mortgage fraud-related investigations as of FY 2007 revealed that the north central region of the United States led the nation with the most pending investigations. The north central region was followed by the west, southeast, south central, and northeast, respectively (see figures 7 and 8).

FBI mortgage fraud investigations at the end of FY 2007 totaled 1,204, a 47-percent increase from FY 2006 and a 176-percent increase from FY 2003 (see figure 9).¹³ Fifty-six percent of pending FBI mortgage fraud investigations in FY 2007 were associated with dollar losses of more than $1 million (see figure 10). FBI field divisions that ranked in the top 10 for pending investigations during FY 2007 included Los Angeles, Chicago, Detroit, Dallas, Atlanta, Miami, Denver¹⁴, Houston, Cleveland and Salt Lake City¹⁵ (tied for 9th), respectively.¹⁶

Financial Crimes Enforcement Network

According to SAR reporting, the Los Angeles, Miami, San Francisco, Chicago, Atlanta, New York, Sacramento, Detroit, Tampa, and Phoenix Divisions, respectively were the top 10 FBI field offices impacted by mortgage fraud during FY 2007 (see figure 11).¹⁷

US Department of Housing and Urban Development - Office of Inspector General

HUD-OIG is charged with detecting and preventing waste, fraud, and abuse in relation to HUD programs. As part of this mission, HUD-OIG investigates mortgage fraud related to Federal Housing Administration (FHA) loans. As of 30 September 2007, HUD-OIG had 466 single family (SF) residential loan investigations pending. In FY 2007, HUD-OIG opened 151 SF mortgage fraud investigations, a decline from the 239 SF mortgage fraud investigations opened during FY 2006. This decline can be attributed to the substantial decline in FHA market share. One reason for the FHA loss of market share was the increased prevalence of subprime loans from commercial lenders; many of those who might typically have applied for FHA loans instead opted for subprime loans. In addition, FHA loan levels were often not competitive in many real estate markets. Consequently, HUD-OIG witnessed a parallel decline in FHA mortgage fraud investigations. Recently, FHA has made several significant changes in its SF loan program, including substantially increasing loan levels in high-cost areas, and making efforts to have those currently holding subprime loans, or facing foreclosure, to refinance those loans with FHA. As a result, the FHA market share is expected to increase, with a parallel increase anticipated for HUD-OIG’s investigative case load.¹⁸

HUD-OIG’s top 10 mortgage fraud states based on investigations opened during FY 2007 included Ohio, Maryland, Illinois, Georgia, Texas, Virginia, California, North Carolina, Michigan, and New York, respectively. Also, the top 10 state for pending investigations during the same time period included California, Illinois, Texas, Maryland, Ohio, Georgia, New York, Colorado, Florida, and Missouri.¹⁹

Mortgage Asset Research Institute

During 2007, Florida, Nevada, Michigan, California, Utah, Georgia, Virginia, Illinois, New York, and Minnesota were MARI’s top 10 states for reports of mortgage fraud across all SF loan types (see figure 12).²⁰ MARI maintains the Mortgage Industry Data Exchange (MIDEX) database which contains incidents of alleged mortgage fraud/misrepresentations from hundreds of mortgage industry entities including Fannie Mae, Freddie Mac, HUD, mortgage insurers, and numerous lenders. MARI annually releases a report to the mortgage industry highlighting the geographical distribution of mortgage fraud based on MIDEX submissions. Individual states are ranked using the MARI Fraud Index (MFI). The MFI is an indication of amount of mortgage fraud found through MIDIX subscriber fraud investigations in various geographical areas within a particular year relative to the amount of loans originated. New states added to MARI’s top 10 for 2007 included Utah and Virginia.

Figure 12: MARI’s Top 10 States for 2007 Reported Fraud in Single Family Loan Types

Interthinx®

Interthinx® is a provider of proven risk mitigation and regulatory compliance tools for the financial services industry. Data from Interthinx® fraud detection tools (DISSCO and FraudGUARD?) include nearly 2 million loan applications from more than 2,000 mortgage originators and loan purchasers nationally. Loans are flagged for possible fraudulent activity and scored as “Investigate” or “Critical Risk” if they demonstrate high impact variances in employment/income, identity, occupancy, straw-buyer, property valuation, or property flipping. More than 22 percent of loans submitted to the Interthinx® mortgage fraud detection tools during 2007 had at least one high impact variance in one of these categories. The top 10 states for possible fraudulent activity based on 2007 loan application submissions to Interthinx® were New Jersey, Michigan, Maryland, Florida, Illinois, New York, Georgia, Arizona, Connecticut, and Ohio, respectively.²¹

Federal National Mortgage Association (Fannie Mae)

As of December 2007, the top 10 markets (by zip code area) for mortgage loan misrepresentations according to Fannie Mae included Minneapolis, Minnesota; Atlanta, Georgia; Detroit, Michigan; Memphis, Tennessee; St. Paul, Minnesota; Pompano Beach, Florida; Miami, Florida; Fort Myers, Florida; Houston, Texas; and Dearborn, Michigan.²² Fannie Mae is the nation’s largest mortgage investor. To aid in mortgage fraud prevention and detection, the company publishes a mortgage fraud newsletter that includes information concerning misrepresentations discovered in loan files. Loans originated in 2006 through 2007 and reviewed by Fannie Mae through December 2007 were used to formulate a geographic top 10 list by zip code area for concentrated mortgage loan misrepresentations (see figure 13).

Delinquency, Default, and Foreclosure: Results of Fraud

BasePoint Analytics, a fraud analysis and consulting service, analyzed more than 3 million loans and found that between 30 and 70 percent of early payment defaults (EPDs) are linked to significant misrepresentations in the original loan applications.²³ Radian Guaranty, Inc. is a leading provider of mortgage insurance which protects lenders against loan default. Statistics maintained by the company indicated that Florida, California, Michigan, Texas, Ohio, Illinois, Georgia, New York, Pennsylvania, and New Jersey, respectively were the top 10 states for the percentage of EPDs as of 31 December 2007.²⁴ Radian Guaranty, Inc. also ranked more than half of these states in their top 10 for percent of mortgage frauds uncovered, which suggests that EPDs are potential fraud indicators. As of 31 December 2007, Radian Guaranty, Inc.’s top 10 states for percent of overall frauds uncovered included Michigan, Georgia, Texas, Ohio, California, Indiana, Colorado, Illinois, Missouri, and Minnesota, respectively (see figure 14).²⁵

During 2007, there were more than 2.2 million foreclosure filings reported on approximately 1.29 million properties nationally, up 75 percent from 2006. More than 1 percent of all US households were in some stage of foreclosure, including default notices, auction sale notices, and bank repossessions, up from 0.58 percent in 2006.²⁶ Properties in some stage of foreclosure for 2007 surpassed 2006 figures for all four quarters (see figure 15). The top 10 states for percent of households in some stage of foreclosure during 2007 were Nevada (3.376 percent), Florida (2.002 percent), Michigan (1.947 percent), California (1.921), Colorado (1.919), Ohio (1.797), Georgia (1.566), Arizona (1.516), Illinois (1.250), and Indiana (1.027).²⁷

Emerging Schemes

The downward trend in the housing market provides an ideal climate for mortgage fraud perpetrators to employ a myriad of schemes suitable to a down market. Several of these schemes have emerged with the potential to spread as the recent rise in foreclosures, depressed housing prices, and decreased demand place pressure on lenders, builders, and home sellers. As lending practices tighten, in response to the subprime lending crisis, fewer loans will be originated. Perpetrators will seek alternative methods of defrauding mortgage loan products. Identity theft is historically a popular tool for use in mortgage fraud schemes. As financial institutions begin to enforce higher lending standards, the identities of individuals with good credit will increase in value to perpetrators. As such, individuals with good credit will likely be at a more significant risk for identity theft and mortgage fraud schemes, and the continued vulnerability of identifying information will allow perpetrators the accesses necessary to commit such schemes.

Builder-Bailout Schemes

Builders are employing builder-bailout schemes to offset losses and circumvent excessive debt and potential bankruptcy as home sales suffer from escalating foreclosures, rising inventory, and declining demand. Builder-bailout schemes are common in any distressed real estate market and typically consist of builders offering excessive incentives to buyers, which are not disclosed on the mortgage loan documents. Builder-bailout schemes often occur when a builder or developer experiences difficulty selling their inventory and uses fraudulent means to unload it. In a common scenario, the builder has difficulty selling property and offers an incentive of a mortgage with no down payment. For example, a builder wishes to sell a property for $200,000. He inflates the value of the property to $240,000 and finds a buyer. The lender funds a mortgage loan of $200,000 believing that $40,000 was paid to the builder, thus creating home equity. However, the lender is actually funding 100 percent of the home’s value. The builder acquires $200,000 from the sale of the home, pays off his building costs, forgives the buyer’s $40,000 down payment, and keeps any profits. If the home forecloses, the lender has no equity in the home and must pay foreclosure expenses.

Seller Assistance Scams

Mortgage fraud perpetrators are exploiting the depreciating housing market by assisting sellers and providing buyers to conduct property sales that are based on inflated appraisals. In a typical seller assistance scam, a perpetrator solicits an anxious seller or his real estate agent and offers to find a property buyer. The perpetrator negotiates the amount that the property seller is willing to accept for the home. The perpetrator then hires an appraiser to inflate the property’s value. The property is sold at the inflated rate to a buyer who is recruited by the perpetrator. The buyer takes out a mortgage for the inflated amount. The seller then receives the asking price for the home, and the perpetrator pockets a “servicing fee,” the difference between the home’s market value and the fraudulently inflated value. When the mortgage defaults, the lender forecloses on the house, but is unable to sell it for the amount owed as a result of the inflated value.

Seller assistance programs may be easily perpetrated in any depressed market where sales of homes have languished and sellers are motivated. The current instability in the housing market and mortgage industry has created an ideal environment for perpetration of this fraud. Seller assistance schemes eliminate the need for the two property transactions that are required for illegal property flipping, which involves first purchasing and then selling a property. Some industry sources have coined the phrase “cash back purchase” or “one transaction flip” to describe the scheme because it eliminates the need for two property transactions to generate a profit.

Short-sale Schemes

Figure 17: Example of a fraudulent short sale: Perpetrator of a short-sale scheme; Perpetrator recruits a straw buyer to purchase a property. Perpetrator has straw buyer secure a mortgage for 100% of the property’s value. Perpetrator may have a straw buyer refinance the home and obtain $30,000 for “repairs.” Perpetrator pockets the $30,000. No repairs are made. No payments are made so the mortgage will default. Straw buyer informs the lender that the home will foreclose and recommends the perpetrator as a potential buyer in a short sale. Perpetrator approaches lender prior to foreclosure and offers to pay less for the home than would otherwise be received in a competitive foreclosure sale. Lender agrees to the short sale not knowing that the mortgage payments were deliberately not made to create this short-sale situation. Perpetrator sells the property at actual value for a profit, or has the property artificially inflated to conduct an illegal property flip.

Short-sale schemes are desirable to mortgage fraud perpetrators because they do not have to competitively bid on the properties they purchase, as they do for foreclosure sales. Perpetrators also use short sales to recycle properties for future mortgage fraud schemes. Short-sale fraud schemes are difficult to detect since the lender agrees to the transaction, and the incident is not reported to internal bank investigators or the authorities. As such, the extent of short sale fraud nationwide is unknown. A real estate short sale is a type of pre-foreclosure sale in which the lender agrees to sell a property for less than the mortgage owed. In a typical short sale scheme, the perpetrator uses a straw buyer to purchase a home for the purpose of defaulting on the mortgage. The mortgage is secured with fraudulent documentation and information regarding the straw buyer. Payments are not made on the property loan so that the mortgage defaults. Prior to the foreclosure sale, the perpetrator offers to purchase the property from the lender in a short-sale agreement. The lender agrees without knowing that the short sale was premeditated. The mortgage owed on the property often equals or exceeds 100 percent of the property’s equity (see figure17).

Foreclosure Rescue Scams

As in 2006, foreclosure rescue scams continued to be problematic in 2007. Escalating foreclosures provide criminals with the opportunity to exploit and defraud vulnerable homeowners seeking financial guidance. The perpetrators convince homeowners that they can save their homes from foreclosure through deed transfers and the payment of up-front fees. This “foreclosure rescue” often involves a manipulated deed process that results in the preparation of forged deeds. In extreme instances, perpetrators may sell the home or secure a second loan without the homeowners’ knowledge, stripping the property’s equity for personal enrichment.

Identity Theft Used to Drain Home Equity Lines of Credit

HELOC Vulnerabilities HELOCs differ from standard home equity loans because the homeowner may borrow against the line of credit over a period of time using a checkbook or credit card. They are aggressively marketed by lenders as an easy, fast, and inexpensive means to obtain funds. As such, an individual may open a HELOC account much like they do a credit card. The funds may not be accessed for an extended period of time, and the account balance may not be regularly verified.

Stolen customer identification information is being used to compromise Home Equity Lines of Credit (HELOC) accounts. To facilitate this scheme, perpetrators pose as customers to establish HELOC Internet account services and manipulate customer account verification processes, including rerouting telephone calls, forging signatures, using passwords, and reciting recent account history. For example, a perpetrator uses the account holder identification information to contact a financial institution and request an advance of funds on a HELOC account. Once the advance is granted, the perpetrator sends a facsimile to the financial institution requesting that the funds be wire transferred to another account. On receipt of the facsimile request, the financial institution contacts the account holder using the telephone number on record to verify the transaction. However, the call is unknowingly forwarded to the perpetrator who verifies the account holder’s information to complete the wire transfer.

As mortgage fraud crimes escalate, the burden on federal law enforcement increases. With the anticipated upsurge in mortgage fraud cases, the FBI employed additional strategies to proactively address the crime problem. The FBI works with the Department of Justice (DOJ)-Mortgage Fraud Working Group on a number of mortgage fraud related issues, including the creation and finalization of standard loss valuation criteria associated with mortgage fraud violations, and assisting the banking industry with the construction of a centralized repository of mortgage-related documentation.

The FBI also held a mortgage fraud summit with FBI Supervisory Special Agents to address the most severe mortgage fraud problems nationally. Currently the FBI has mortgage fraud working groups or task forces in 32 field divisions, including Anchorage, Albuquerque, Atlanta, Buffalo, Charlotte, Chicago, Cincinnati, Cleveland, Detroit, Dallas, Denver, El Paso, Honolulu, Houston, Indianapolis, Jackson, Kansas City, Louisville, Memphis, Miami, Minneapolis, Milwaukee, Portland, Pittsburgh, Philadelphia, Phoenix, Sacramento, San Diego, San Francisco, Salt Lake City, Tampa, and Washington, DC. The FBI continues to encourage the use of undercover operations as an effective technique to address mortgage fraud.

The FBI continues to work closely with its government and industry partners to ensure that pertinent data is shared in a timely fashion. Efforts are ongoing to educate the American public regarding mortgage fraud crimes and perpetrators. Analytical products are routinely disseminated to a wide audience. Working groups and task forces remain ideal forms from which to coordinate multi-agency, multi-jurisdictional investigations into mortgage fraud matters.