Borrower Ethics and Industry Fraud - Chapter 12

Question 1

The Formula For Fraud

Answer 1

1. Is It A Truth Or A Lie?
2. Morality
3. Intent

Question 2

The Formula For Fraud: Is It A Truth Or A Lie?

Answer 2

At the beginning point of the discussion with the borrower, the MLO should set the proper expectations for honesty and truthfulness in the process. Being honest and providing correct information will provide for the best loan process experience for the borrower.
Did the borrower provide true information on their application?

Question 3

The Formula For Fraud: Morality

Answer 3

Once the borrower has provided their basic information, but before the MLO completes the initial application process, it might be a good time for the MLO to review the impact false information can have on the loan.
Negative impacts to the borrower include a suspended or denied application, or the lender could provide a loan that is improperly qualified.

Question 4

The Formula For Fraud: Intent

Answer 4

This is a chance for the borrower to reconsider the information they’ve provided to the MLO. At this step the MLO may be requesting documents for verification and the borrower will have to determine if they gave proper information initially, or if they need to change some of the things they told the MLO. If the borrower insists on submitting false information, their actions should be considered fraud.

By using this test and the steps provided above the MLO can taken an ethical approach to their interaction with the borrower, and be certain that they’ve taken the extra steps necessary to ensure they’ve done the right thing.

So let’s add it up. If we take a lie, add the question of morality, and then consider active intent, we have a pretty good system for determining fraud.

Question 5

Example Of Fraud:

Answer 5

Let’s apply our equation to the mortgage industry!

Assume a borrower lies about their income on the application hoping to get a higher loan amount than they would qualify for. To support this lie, the borrower manipulates (alters) their pay stubs to show a higher income amount. Based on what we’ve already covered let’s see if this is fraud:

1. The borrower intends to deceive the lender = LIE
2. If the lender makes the loan to the borrower at the higher amount, there’s a possibility that the borrower may not be able to make the payments with their lower actual income, and default on the loan. The possibility of default is bad for the lender = IMMORAL
3. The borrower manipulated their pay stubs to support their lie = ACTIVE INTENT In this case we have a fraudulent act!

Question 6

Example Of NOT Fraud:

Answer 6

A borrower tells the MLO that their income is $2,000 per week because the last time they were paid, that’s how much they earned. The borrower hopes the lender will use the $2,000 amount as the basis for qualification because it will allow him to get the mortgage he needs to buy the home he wants. As part of the loan process the lender reviews the borrowers pay stubs and finds his income to be lower than the $2,000 per week he provided during the initial application call. Let’s review to see if this should be considered fraud:
1. The borrower intends to deceive the lender = LIE
2. If the lender makes the loan to the borrower at the higher amount, there’s a possibility that the borrower may not be able to make the payments with their lower actual income, and default on the loan. The possibility of default is bad for the lender
= IMMORAL
3. The borrower submitted legitimate documents for processing = NO ACTIVE INTENT In this case we do not have fraud.

Question 7

Borrower Fraud: Suspicious Activity

Answer 7

To protect the lender and ensure they are meeting the ethical requirements, mortgage loan originators should be on the lookout for suspicious activity on the part of the borrower.

Suspicious activity includes a borrower with:
• Multiple properties and mailing addresses
• Unusual or unverifiable income sources
• Lack of necessary documentation
• Untraceable funds
Keep in mind, just because someone demonstrates one or more of these behaviors doesn’t mean that they’re committing fraud, but they should trigger a higher level of scrutiny on the MLO’s part.

Question 8

Impact Of Borrower Fraud

Answer 8

Typically when a borrower commits mortgage fraud they do so with the desire of benefiting from the property gained or the improved circumstance of the new loan. While on its face this seems innocent because the borrower commits the fraud without intending to harm anyone, the impact of their fraud can have far-reaching victims.

If the borrower is unable to repay the loan due to lack of income, the owner (lender or investor) of the loan may be harmed. If the borrower is unable to handle the expense of maintaining their property due to the over-
whelming cost of repaying the loan, the appearance of the home may negatively impact the value of surrounding properties. Additionally if the borrower defaults on the mortgage the scar of foreclosure and vacant property can also hurt nearby property values. In situations in which wide spread foreclosure occurs an entire community can be devastated. All of these are examples of unintentional impacts caused by a borrower’s seemingly innocent yet fraudulent actions

Question 9

Types Of Borrower Fraud

Answer 9

• Asset Fraud
• Income Fraud
• Bank Fraud
• Occupancy Fraud

Question 10

Asset Fraud

Answer 10

Asset fraud on the part of the borrower simply involves the borrower providing false information about their assets. Things like artificially increasing their account balances or creating fictitious accounts to make their qualifications better. As the technology and pace for MLOs improves to verify and confirm borrower assets, so do a fraudulent actor’s ability to manipulate the system. Moving monies from account to account or using borrower funds to temporarily inflate account balances are just a few of the ways this fraud can be perpetrated.

Question 11

Income Fraud

Answer 11

Income fraud involves the borrower falsifying income information to provide a better qualification profile. Income fraud can occur through verbal, or conspiratorial means as well as through document modification.

A recent increase in income fraud has been through conspiracy methods in which a fraudulent borrower will conspire with a friend who will claim the borrower works for them in a part-time contractual capacity. The friend may provide a loan to the borrower through repeated payments that seem to be income when initially reviewed. Once the loan closes the borrower will return the loaned payments to the friend. This is income fraud because the contract income was actually a loan.

Question 12

Bank Fraud

Answer 12

Bank fraud is a form of borrower fraud similar to asset fraud. Bank fraud relies on the fraudulent borrower’s manipulation of accounts through money transfers and short term loans.

An example of bank fraud is something known as check kiting. This happens when the fraudster will write a check from one account to another without the funds to cover the amount written on the check. At the time the check is deposited in the borrower’s account, it appears that they have the money. If reviewed at the right moment, the borrower could use the account balance to support their application qualifications. This is fraud because the borrower is demonstrating a balance on paper that doesn’t actually exist.

Bank fraud scenarios such as this require a high level of sophistication on the part of the borrower and fairly limited underwriting standards on the part of the lender.

Question 13

Occupancy Fraud

Answer 13

Occupancy fraud occurs when the borrower applies for a mortgage claiming a less risky occupancy type than they actually intend to use the home for. As we already know, the riskier the loan, the higher the qualification standards and costs. So a borrower might claim that the mortgage they seek is for their primary residence rather than an investment property - even though they intend to use the home as a rental unit.

The borrower may do this because they know that they may need at least a 25% down payment for an investment property, and the interest rate is likely to be substantially higher than for a primary residence. Certainly, the borrower’s knowledge and intent demonstrate this as fraud.

Occupancy fraud is one of the most prevalent forms of borrower fraud occurring today. In some cases, the fault lies as much with the mortgage loan originator as with the borrower.

Question 14

3 different ways a borrower can occupy a property:

Answer 14

• Primary Residence: The borrower lives in the property for more than 6 months out of the year. The borrower’s primary residence is most likely the address on their IDs, and where they get their mail.
• Secondary/Vacation Home: The borrower lives in the property less than 6 months out of the year. This property must be a reasonable distance from their primary home.
• Investment Home: The borrower does not live in the property, and intends for someone else to live there. Typically a family member/friend lives here, or the property is rented out.

Question 15

Fraud Methods: Verbal Fraud

Answer 15

Fraud through verbal actions can be tricky to determine. A verbal action could be something as simple as talking to a client as we assist them in filling out the URLA. As we’ve already covered, it’s quite possible for the client to lie to you, but not with actual fraudulent intent. This is even more difficult to determine if the fraud is occurring through verbal means.
Apply the TRUTH/LIE + MORALITY + INTENT formula.

Question 16

Fraud Methods: Conspiracy Fraud

Answer 16

A conspiracy is when more than one person works together to commit an act. A conspiracy to commit mortgage fraud on the part of a borrower is when the borrower is working with others who commit fraud.

An example could be a borrower providing their conspirator’s name and phone number as their place of employment. When the MLO, processor or underwriter calls the phone number to confirm the borrower’s employment information, the conspirator provides false information to the caller.

Question 17

Fraud Methods: Modified Documentation

Answer 17

Today’s technology makes it very easy for a fraudulent actor to commit fraud through document modification. Using a computer scanner and some simple software, a borrower could change pay stubs, W2s, tax returns or other documents to support a fraudulent claim.

Question 18

Examples Of Borrower Fraud: Property Flipping

Answer 18

Means buying a house, and then selling it in a short period of time at a higher price, creating a profit for the seller. Property flipping, when bona fide work is performed to warrant the increased sales price, is
completely legal and ethical. Property flipping in cases in which a home is purchased at a price lower than market value (such as a foreclosure auction) and then resold at market price is also legal.

When false representation of improvement and property value occur, property flipping becomes fraudulent. This fraud scheme typically involves an appraiser who inflates the value of the home; a seller and even buyers in a cash- out property flip purchase.

In a cash-out property flip the buyer may approach the seller and make a considerably higher offer than the asking price. As a condition of this offer, the buyer may ask for part of the difference, between the offered price and asking price, back in cash after closing.

Regardless of the type of property flipping, some red flags include appraisals that lack sufficient information to back the value given, the property being sold at a higher value than the market area, or the seller claiming significant renovations without proof.

Question 19

Examples Of Borrower Fraud: Straw Buyer

Answer 19

Another way an unqualified buyer may attempt to obtain a mortgage loan is by employing a straw buyer. As it relates to mortgage loan qualification, the real buyer will use the straw buyer’s name and qualifying information on the mortgage application to mask the actual buyer’s intent to purchase the property.

The straw buyer is often paid for their participation, but may also do so voluntarily. For example, family members may voluntarily agree to purchase a home with the intention of transferring ownership to another family member after closing. Although it may be done with good intentions, this seemingly innocent act is considered mortgage fraud.

As the first point of contact with the borrower, the mortgage loan originator must be diligent to ensure that a straw buyer is not being used for qualification. Some common red flags indicating a potential straw buyer scheme include the use of funds from more than one entity for the down payment or to pay fees, exercising a power of attorney when closing the loan, possible signs that the buyer will not occupy the residence (such as an unrealistic commute), or a big downgrade in value or size from the buyer’s previous home.

Question 20

Examples Of Borrower Fraud: Buy And Bail

Answer 20

One qualification fraud scheme that is becoming more prevalent is a direct result of the recent mortgage meltdown and foreclosure crisis. The “buy and bail” scheme involves a borrower buying a new home and then immediately bailing, or going into foreclosure, on their old home.

During the recent financial crisis, many homeowners found that their home was no longer worth the balance of their current mortgage debt or because of loss of income were unable to pay the mortgage. Faced with these challenges, some homeowners took advantage of the situation and used foreclosure as a way to cancel the mortgage debt.

To accomplish this, the borrower would make every effort to keep their qualification factors (the 4 Cs – cash, credit, capacity and collateral) current and in good standing until they were able to qualify and purchase a new home. To supplement their qualifying information the borrower will often create fraudulent documents such as rental agreements showing that they intend to rent their current mortgaged residence to offset the cost of the new home, or fake income documents.

Once the mortgage is approved and the purchase of the new home closes, the borrower vacates the old home and occupies the new home. At the same time, the borrower allows the old home to be foreclosed upon and may no longer be liable for the debt on the previous property (this is a simplistic explanation for the purpose of example because liability is dependent upon the mortgage contract and the legal jurisdiction).
The mortgage loan originator can help prevent the occurrence of buy and bail schemes by looking out for the following red flags: the buyer’s new home being significantly lower in value than their current home, rental agreements without deposits, or current loan terms that may increase the chance of foreclosure.

Question 21

Examples Of Borrower Fraud: Seller-Buyer Collusion

Answer 21

One of the most frequent instances of buyers and sellers working together to defraud the mortgage lender can be found in undisclosed kickbacks. While there is nothing unethical or fraudulent in the buyer and seller working together to accomplish the most favorable transaction for both parties, it is necessary for their activities to be open and transparent for all of the parties involved – including the lender.

Question 22

Seller-Buyer Collusion: Undisclosed Kickback

Answer 22

When selling a home, the seller is allowed to offer seller concessions to the buyer to help with any repairs needed for the home (on some USDA programs), or to help pay for closing costs. Each program has a maximum amount of allowable seller concessions, and these concessions can go towards closing costs and prepaid escrow deposits, but never towards the down payment. For example, in an FHA loan, no matter how much the buyer receives in seller concessions, they must bring the 3.5% down payment to the closing table.

If the buyer doesn’t have the money for a down payment, they may resort to accepting undisclosed kickbacks (an undisclosed kickback is a financial incentive that a seller gives a buyer at closing without informing the lender) to help qualify for an otherwise unobtainable mortgage. This could involve agreeing to a higher than originally set purchase price, so the seller is repaid from the borrowed money, or it might involve the buyer paying the seller after closing using their own funds. Regardless, it involves misrepresentation on the application and is considered mortgage fraud.

To thwart the impact of undisclosed kickbacks, the lender should be aware of some red flags including: a different sales price in the Closing Disclosure and sales contract, family members or business relations on both sides of the transaction, funds paid to undisclosed third parties on the Closing Disclosure, and alteration of the sales price to fit the appraised value.

Question 23

Seller-Buyer Collusion: Silent Second Mortgage

Answer 23

A fraud element that may be used by an unethical buyer and seller to subvert a loan’s down payment requirement involves a silent second mortgage on the property. While second liens are perfectly legal, they become fraudulent when the second lien is not disclosed to a lender participating in the property’s financing.

A seller’s silent second involves the seller giving the buyer a loan for the down payment, and then immediately after closing the seller records a second lien on the property ensuring repayment, without informing the lender.

Lenders can avoid the problems of silent second mortgages by looking out for red flags such as “boiler plate” sales contracts that have very limited details (because the seller and buyer have a separate seller’s contract containing the majority of the details including verbiage for the silent second).

Question 24

Seller-Buyer Collusion: Short Sale Fraud

Answer 24

As a result of the recent financial crisis and mortgage meltdown many homeowners found themselves in the difficult position of owing more on their home than the home was worth. This situation known as being
“underwater” coupled with other financial pressures caused some homeowners to re-evaluate their responsibilities as mortgagors and seek a way to get out from under with their current mortgage debt.

To accomplish this many used the short sale process to meet their needs. Typically in a short sale, a homeowner will need to demonstrate to their lender that they’ve exhausted every option to sell their home for a price at or above the current mortgage balance, and now have a potential buyer willing to purchase the home at an amount less than the balance.
If the lender agrees to accept the lesser amount from the buyer, a short sale transaction can occur. The result of the sale is that the previous owner may be released from their mortgage obligation and the buyer receives a clean title on the property.

Question 25

Seller-Buyer Collusion: Flopping

Answer 25

One of the more recent forms of mortgage fraud - flopping, is a symptom of the significant rise in short sales. A typical flopping scheme works as follows:
• The home’s current owner convinces their lender that they are unable to sell their home for an amount that will allow the homeowner to payoff their existing mortgage balance. The homeowner will request that the lender consider a short sale.
• The homeowner then works to ensure that no quality bids are made on the property. This may be accomplished by making the property appear undesirable to potential buyers by enhancing cosmetic problems (smells, flaking paint, false water damage) that can be easily remedied.
• An accomplice working with the owner approaches the lender with an extremely low bid on the property. Based on analysis and limited investigative resources the lender accepts the low bid and releases its lien on the property so that the seller can transfer clean title to the accomplice. The accomplice then resells the home at a much higher price than was paid and splits the profit with the original owner.

Flopping schemes work best when a lender is overwhelmed by the volume of troubled mortgages on their books and does not have the time or money to do thorough research on properties and homeowners looking to short sell. It is estimated that in 2011 the average profit gained by fraudsters through flopping was $55,000 per short sale.

Question 26

Short Sale Fraud Red Flags

Answer 26

In order to prevent fraud there are a number of red flags that lenders should be wary of when entering into a short sale. These include:
• The borrower going into default without warning and making no attempt to find a solution for the debt. This would be
immediately followed by a short sale offer.
• The homeowner citing various unusual and contradictory reasons for defaulting on the mortgage.
• No other evidence on the part of the borrower that they are having financial difficulties with the exception of the mortgage delinquency (all other accounts and credit are intact).
• Someone with the same last name or obvious affiliation makes the short sale offer.

The price offered for the short sale is less than the home’s current market value.

The current (delinquent) homeowner is supposed to receive cash back at closing (this is usually listed on the contract as fees for services or repairs).

Question 27

Seller-Buyer Collusion: Non-Arms Length Sale

Answer 27

Another scheme currently en vogue related to short sales is the Non-Arms Length Sale. The basis of the Non-Arms Length sale is based on the willing desire of individuals to perpetrate fraud so that they can live in their home at a reduced cost and is a variant of a straw buyer scenario. Here’s how the scheme works:
• The current homeowner works with an accomplice (typically a relative or someone in a business relationship with them). The accomplice makes a short sale purchase of the home and receives a new smaller mortgage on the property. The accomplice then deeds the title back to the original owner so that they may remain in the home and service the mortgage at a much reduced cost.
• To avoid this most lenders will require that the borrower sign an “arm’s length affidavit.” This affidavit requires the borrower to promise that they will not sell their home to someone with whom they have an existing relationship.

Question 28

Industry Fraud: Appraisal Fraud

Answer 28

This is a major contributor to unethical lending practices in the mortgage industry. In the past, mortgage professionals would work with appraisers and influence their determination of a property’s value. This often resulted in inflated appraisal values, and ultimately more money lent than the home’s true value. Real estate agents and consumers were also known to work with appraisers to get a higher value. These higher valuations allow scheme participants to profit illegally and also create a risk to the lender because the true collateral does not support the loan amount.

Question 29

Industry Fraud: Builder Bail-out

Answer 29

A builder bail-out occurs when a builder wants to quickly sell units in a subdivision, tract, complex, or condominium and uses fraudulent schemes to sell the remaining properties. The seller (the builder) may give hidden down payment assistance or seller concessions to sell the property and leave a financial institution with an LTV greater than 100%. Builders rely on consistent credit and cash
flow to maintain operation. In economically or financially stressful conditions, a builder may have a strong sense of urgency to sell remaining properties to cover financial obligations.

Question 30

Industry Fraud: Predatory Lending

Answer 30

Earlier in the course we discussed the Dodd-Frank Act and the rules created around UDAAPs (Unfair Deceptive or Abusive Acts or Practices). The UDAAP rules were created as a direct reaction to fraudulent behavior on the behalf of industry members in the form of predatory lending.

Predatory lending occurs when mortgage professionals take advantage of their knowledge and position to convince unprepared or unsophisticated borrowers into getting loans that may be harmful for the borrower. The basis of the phrase can be found in the word “prey” which means to hunt. In the case of predatory lending, the mortgage professional preys on borrowers to make an illegal profit.

Typically in cases of predatory lending loan originators and lenders are the industry players involved. Predatory lending harms many including lenders and investors, as well as borrowers and the communities in which they live.

Question 31

Industry Fraud: Chunking

Answer 31

This type of fraud is also known as Ponzi scheme and investment club. In a chunking scheme, a third party convinces a borrower to invest in a property, or multiple properties, with the third party acting as the borrower’s agent. Without the borrower’s consent, the third party submits loan applications on the borrower’s behalf to multiple financial institutions for various properties. The applications are submitted as owner-occupied or as investment properties with all falsified documents. Once the loan is disbursed, the third party keeps the loan proceeds and leaves the borrower with multiple loans and financial institutions with major financial losses. This elaborate scheme is a multi-person collaboration. It usually requires the assistance of an appraiser, broker, and title company to make sure the third party, acting as the borrower’s agent, will not have to bring money to the closings.

Question 32

Industry Fraud: Steering

Answer 32

Just like with predatory lending, steering often falls under the UDAAP regulations because it occurs when mortgage professionals use their knowledge and position to take advantage of borrowers. The MLO’s understanding of products, programs and pricing allows them to direct borrowers into loans that are more advantageous to the mortgage professional rather than the borrower.

Examples of steering include directing consumers to products that compensate the MLO better than other products or not making the borrower aware of the risks associated with the loan.

Obviously the one who stands to lose the most in cases of steering is the borrower.