In today's rocky climate, the very last thing mortgage bankers need to face is a new wave of fraud. This week, MortgageOrb chats with Felice Kesselring, director of collateral risk products at First American Corelogic in Santa Ana, Calif., to discuss the state of mortgage fraud.
Q: The origination market is down significantly, and underwriting is much tighter. Does that mean fraud is down as well?
Kesselring: You'd think that would be the case. But we're seeing industry statistics that suggest not only is fraud not down, but it is increasing. One reason for the increase may be that there is a new heightened awareness of fraud. Until recently, lenders focused primarily on fraud for profit and tended to be less concerned about fraud for housing. But that's changed now that lenders and title companies are getting hit with losses and repurchase demands tied to overstated income, owner-occupancy concerns and missed liens. Many clients are adhering to a zero-tolerance policy on fraud.
Also, while lenders have tightened underwriting and are reacting more vigorously to fraud, we're seeing new organized fraud schemes crop up in various parts of the country. This suggests to us that intent to commit fraud is not down. Anecdotally, many fraud experts are also concerned that as more lending and real estate professionals find themselves out of work or under-employed, they will be tempted to commit fraud.
Q: What types of fraud are you seeing in today's market?
Kesselring: The ‘fraud du jour’ usually depends on the economic and lending climate and what fraudsters can slip through the system. A couple of years ago, when the subprime market was booming and stated income was the norm, we were seeing a great deal of appraisal fraud.
Why? Because the value of the property, not the capacity to pay, was driving the size of the loans. By the end of 2006, we saw the early multi-lien, ‘shotgunning’ schemes and new fraud rings – first in Illinois and New Jersey, and then in California. Shotgunning is very elegant fraud, because it doesn't require any accomplices. In its original form, it worked like this: A fraudster either bought a house outright or put down a significant down payment, say 50 to 60%.
Let's use as an example a $250,000 home with no mortgage. The buyer would then go to 10 home equity lenders and simultaneously apply for a $100,000 home equity line of credit.
The process in those days was more simple; in fact, the industry used to boast about what it called ‘coffee cup’ closings, which meant you could qualify almost on the spot and get your money in a few days. To do that, of course, the lender had to forgo a title search and base its decision pretty much on a credit report and an AVM.So, the fraudster would close the lines, write 10 checks for $100,000 checks and clear $750,000 in profit before the lenders realized that instead of being in second-lien position, they were really in eighth or ninth.
Recently, our clients have been very concerned about undisclosed debt. Another term for this is ‘stacking.’ It occurs when an investor buys several properties simultaneously. This isn't a new problem but it is causing a great deal of financial pain for lenders now that real estate prices have fallen and lenders are realizing that instead of financing homeowners, they have been facilitating speculators or fraudsters using straw buyers in a new twist on flipping schemes. We're also seeing new types of players, including more insiders and larger, organized white-collar crime rings.
Q: How is shotgunning evolving from a home equity to a first-lien problem?
Kesselring: As mentioned, the beauty of shotgunning in the home equity space was that it required fewer players, and the fraudster could simply write the checks to himself. But a combination of trends – less equity, tighter underwriting on home equity products, new technology and industry cooperation Â- have made this type of fraud more difficult. As a result, shotgunning in the home equity market is down, and what is still occurring is primarily directed at smaller home equity lenders.
But what has happened is that the schemes, like viruses, have mutated. Now they are targeting first mortgage lenders. For example, a fraudster buys a home with a big mortgage, and makes the payments. He then forges a lien release and files it at the courthouse. After a while, he goes to another first mortgage lender, or more likely, several simultaneously, and applies for a large cash-out refi.
We're seeing this happening in parts of California, Atlanta and Florida. As you'd expect, lenders in those markets are now much more cautious about making new loans on unencumbered properties.
Q: What other types of fraud should we be worried about?
Kesselirng: When we talk to our clients, we are picking up some general concern about the large pool of unemployed and under-employed mortgage and real estate professionals in the market. They know the system, including its weaknesses, and we all know the saying about ‘idle hands.’ Valuations, in general, are a continuing concern. Some of this is fraud-related, and some is simply risk-related in a falling real estate market. As a result, we are seeing continued interest in maintaining a sound appraisal review policy with automated valuation and risk tools.
The newly announced Home Valuation Code of Conduct (HVCC) has some very positive provisions to reduce appraisal pressure and fraud, particularly the prohibition of against mortgage brokers' selecting appraisers. It also requires lenders to take new quality-control steps within the valuation process.
Q: What best practices should lenders and investors be using to detect fraud?
Kesselring: Probably the most important thing is what is already happening: There is a heightened awareness of the need to do a better job to prevent fraud. Fraud policy-makers now have a stronger voice within many organizations; production is no longer the sole driver at most mortgage companies and banks. What we are seeing is a better appreciation of risk management throughout our clients' organizations.
This is manifesting itself in more cautious underwriting, more interest in available technology, better training to help underwriters detect fraud and giving them a clear understanding of what to do if they suspect fraud of any kind.
