As published in Scotsman Guide's Residential Edition, March 2007.
Fraud is a growing problem and has become a serious issue throughout the mortgage industry. As such, mortgage brokers can expect their wholesale lenders to be concerned with fraud-risk-mitigation in the months ahead. Knowing the most-common types of fraud and what lenders are doing to mitigate fraud will help make brokers better partners in the lending process.
There are three primary types of fraud that residential mortgage lenders encounter: credit-enhancement fraud, equity fraud and collateral fraud. Of these, collateral fraud, which deals with the integrity of the collateral itself, is the most dangerous and costly.
Types of fraud
Credit-enhancement fraud involves schemes designed to get borrowers into homes for which they do not qualify. They are also designed to increase loan officers' commissions.
These crimes generally involve misrepresenting information relating to the borrower's credit, employment or income. If the home is a primary residence and if the loan-to-value ratio (LTV) is low enough, lenders face limited risk when they approve these deals. Although it is certainly important to limit this type of fraudulent activity, lenders can cost-effectively manage the ultimate cost.
Equity-fraud schemes involve falsifying information to remove equity from the value of a real estate asset. This type of fraud often includes identity theft or investor schemes. In combination with national fraud databases, some tools have helped mitigate much of this activity.
Collateral fraud involves misrepresenting information to inflate the real estate asset's perceived value with the intention of profiting from the deception. Types of collateral fraud include appraisal fraud, land flips and builder bailouts. The risks associated with this and other types of mortgage fraud are compounded when the fraud on the file consists of multiple and overlapping fraud categories.
Because the collateral that underwrites the loan is the insurance policy that protects lenders from bad loans, collateral fraud is the most costly to lenders and until recently, the most difficult to detect.
The advent of AVMs
Historically, collateral fraud has been managed manually through appraisers, brokers, underwriters and other market participants in a more regional lending environment. Although this process worked adequately in typical market conditions, it strained and often broke during certain high-volume, volatile market conditions and during market consolidation.
As mortgage volumes skyrocketed at the end of the 1990s, lenders became less capable of reviewing appraisals for each deal. Quality control focused on a small subset of total loans written, and there was little information to focus lenders' attention on potential trouble spots in their lending area. This problem was exacerbated for regional and national lenders that depended even more on appraisal professionals in dispersed geographical markets.
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