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   ARTICLE   |   From Scotsman Guide Residential Edition   |   July 2016

Beware the Paperwork Predators

Without vigilance and the right tools, mortgage companies remain highly vulnerable to fraud

Beware the Paperwork Predators

Mortgage-loan transactions feature hundreds of pages of documents that contain massive amounts of data. With regulators putting increased pressure on mortgage companies, the accuracy of this data is more important than ever.

In that pile of paperwork exists a serious threat: fraud. Whether the threat comes from outside criminals, employees who fudge some details or technology that doesn’t properly verify data, it can be serious enough to bring down mortgage companies.

The Financial Crisis Inquiry Commission (FCIC) released a report in January 2011 concerning the causes of the mortgage meltdown and the ensuing economic crisis. The report determined that the crisis was avoidable.

This past January, five years after the FCIC report was issued, the commission’s chairman, Phil Angelides, wrote about the the findings, reaffirming the report’s allegations that several core issues were at the root of the mortgage crisis. They included the following:

  • Financial-regulation failures, including a failure by the Federal Reserve to stop “toxic mortgages”;
  • Corporate-responsibility breakdowns, including large, unnecessary risks taken by Wall Street;
  • Underprepared policymakers, who didn’t have enough understanding of the financial system;
  • Accountability and ethics breaches, including widespread mortgage fraud and corruption.

Congress responded to that crisis by enacting the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act, with its thousands of pages of regulations, seeks to manage lending risk in a variety of ways, including outlawing the riskiest mortgage programs — and by defining a Qualified Mortgage (now the industry gold standard) — as well as requiring that lenders verify a borrower’s ability to repay a mortgage according to its terms.

The stringency of these Dodd-Frank regulatory requirements — including regulations codifying sound underwriting practices and imposing significant penalties for noncompliance — have led many in the industry to believe that fraud is no longer a concern.

They couldn’t be more wrong.

A new era

During the real estate boom, millions of borrowers, many with the encouragement of a mortgage professional, signed off on loan applications that seriously overstated their incomes. Since then, wages have not risen as significantly as many would have hoped, so the fact that average sales prices in many housing markets are now approaching pre-crisis high-water marks should be cause for concern. If borrowers couldn’t afford to buy at those prices back then without resorting to “liar loans,” how can they afford them now?

This economic pressure on borrowers may encourage the misrepresentation of income, assets and liabilities. In fact, misstated financial data accounted for 83 percent of the defects identified by Fannie Mae in loans submitted from January 2015 through February 2016.

Another factor to consider is that hidden among the millions of borrowers who misstated their incomes during the real estate boom were many professional criminals who orchestrated large mortgage-fraud schemes — crimes that could involve hundreds of properties and millions of dollars. It was easy for naïve and hopeful moguls to be recruited to join investment clubs on the promise of easy riches. Unfortunately, many of these people were used as marks to facilitate illegal transactions that were supported with fabricated documents and misrepresentations of income, assets, identity and the intended use of property.

It’s likely that many of the wrongdoers behind these schemes were never identified, much less brought to justice, and after some time away from the market, may now feel it’s safe to return to the origination side of mortgage lending. They will be glad to know that there are internet services that will, for a modest fee, generate fake bank statements, W-2s, identity documentation and more, showing whatever income and identity they choose.


During the real estate boom, old-school underwriters who knew how to analyze loan applications could be seen as impediments to profitability. Many were let go, possibly because of the intense pressure to produce — and increase — origination volume. As those pressures grew and new underwriters joined the industry, automated underwriting systems were increasingly relied upon to keep up the pace.

These automated systems are designed to quickly and impartially determine whether a loan’s characteristics fit a particular loan program, but some within the industry began to use them as decisionmaking tools. In these instances, if a loan generated an acceptable score, underwriters were told to approve the loan for funding without further inquiry into the accuracy of the underlying application data.

When this occurred, this checklist approach resulted in an inability to critically analyze a loan application to see if the story it tells about the borrower makes any sense. In some instances, this led to low-income workers who were able to obtain loans on expensive properties, including second homes and investment properties.

Today, meanwhile, every action taken by loan originators amounts to a legally enforceable representation about the quality of a loan, and thus its legal status. Given the regulatory complexities of the Qualified Mortgage, Ability to Repay, and Truth in Lending Act and Real Estate Settlement Procedures Act Integrated Disclosure (TRID) rules — and the potentially severe penalties for noncompliance — many lenders are rightfully choosing to rely on automated tools to do the heavy analytic lifting.

From a legal perspective, this makes sense. It can, however, cause underwriters to once again be encouraged toward a checklist approach. This leaves little opportunity for an underwriter to analyze whether all of the application data is accurate or if it tells a story that makes sense.

Insider fraud

Despite the attention generally given to outsiders who attempt to defraud mortgage companies, a big risk also is posed by industry employees. Employees, for instance, who know the intricacies of TRID timelines could be tempted to fudge critical dates on the Loan Estimate form, especially when they speak with consumers over the phone and the documentation relies entirely on employees’ honesty when making notes on the conversation.

This may seem like a relatively minor offense, especially if there is little chance of getting caught, but studies have shown that lying becomes easier with time and practice. Even typically honest people can become pretty comfortable with lying over time, so a loan officer who successfully slips an altered date into a file may later be tempted to suppress borrowers’ liabilities or to exaggerate borrowers’ income to get the loan to closing.

Mortgage lending is still an intensely paper-driven industry. In late 2013, for example, Mortgage Bankers Association CEO David H. Stevens said the average mortgage application was 500 pages.

When so much application data is manually entered into a loan-origination system, there is a significant risk of errors occurring. There also is a possibility that critical documentation involving income, assets and debt-to-income ratios has been manufactured by a con artist to create a picture-perfect loan qualification. Regardless of the motive or lack thereof, a defect is a defect, and in today’s lending environment, defects are expensive.


One of the most important provisions of the Ability to Repay Rule says, in part, that lenders must “verify the information that the creditor relies on in determining a consumer’s repayment ability … using reasonably reliable third-party records that provide reasonably reliable evidence of the consumer’s income or assets.” The rule goes on to state that acceptable records include pay stubs, W-2s and bank statements.

All of these “reasonably reliable” pieces of evidence can be manufactured, however. The good news is that today’s cutting-edge technology allows lenders to obtain critical borrower data directly from the custodians of that data, thereby reducing or eliminating fraud and data errors.

Using directly sourced data reduces greatly the opportunity for entry mistakes or data transpositions, which are typically caused when manually transferring information from an application into a loan-origination system. The use of directly sourced data also eliminates the opportunity to fabricate qualifying criteria.

The best-of-breed tools employing directly sourced data go even further. Data that is returned from depository accounts, for example, can be automatically analyzed to:

  • Determine who owns the account, which can help verify the borrower’s identity;
  • Identify automated deposits, which verifies actual income;
  • Identify repeating cash-out transactions, which helps verify liabilities and residual income.

The best tools also retain the original source data, so if a loan’s status as a Qualified Mortgage should ever be challenged, lenders have proof that they followed the statutory requirements for due diligence during origination, and that the lending decision was correct.

• • •

The bottom line is that, five years after the FCIC’s findings were released, fraud remains a major threat. The only sure way to neutralize this threat — while simultaneously complying with investor guidelines and regulatory requirements — is to use verification tools that provide incorruptible data, an appropriate analysis of that data and transparency.

These same tools also will help mortgage companies increase the efficiency and accuracy of their originations process, with the added benefit of giving underwriters more time to critically evaluate whether each loan, taken as a whole, makes sense.


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