Fraud and Prevention

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High Altitude Sickness

Perspectives by Michael S. Richardson
July 22, 2009

I know many people, including me, have been sitting back, waiting, watching and reading the comments of various individuals making decisions about our mortgage industry. However, here is the problem: they are attempting to solve the dilemma from a high altitude view. The real estate crisis needs to be viewed at the origination level by all parties involved in the loan, current and future, in order to avoid high altitude sickness.

The solutions to the fraud epidemic can and will come from observing at origination level. Loans must be scrutinized one at a time, because the industry is based on people and relationships. It all starts with a homeowner or homebuyer working with a loan officer and or a real estate agent. Within these working relationships, trust is established, most for good, but some with the intent of defrauding the client.

In short, the solution to the crisis is to retool and improve the prefunding process of loans, including a better education of the individuals involved with the origination of each individual transaction. This does not have to be a major retooling, more like a tweaking of the internal processes for the origination of mortgages. We need an "is it really clear to close" attitude. The majority of the tools needed to prevent mortgage fraud already exist, they just need more oxygen, so to speak; and access to better education must be available in the industry, as to how to utilize these tools correctly.

Every part of the mortgage lending process presents another window of opportunity for people in our industry who, by the very nature of their job description, are exposed to unscrupulous loan originators, builders, real estate agents, borrowers, processors, underwriters, appraisers, lender account reps and title closers. Each one of these positions or areas, needed to obtain a mortgage, leaves an opportunity for fraud.

In reading various congressional solutions, it is obvious they have a high altitude view and most of the ideas they recommend have signs of high-altitude sickness. Honest, ethical mortgage brokers, smaller mortgage bankers, builders and homeowners should not have to be hurt by these solutions, although a few impulsive unfavorable changes have and will continue to happen if we do not bring this down to sea level.

One idea that has surfaced as a solution to the dilemma is to hold back 5% of loan amounts. We already insure against most of these loans with mortgage insurance, FHA-MIP (mortgage insurance premium), title insurance and more. Holding 5% of amounts funded as a reserve is, in my opinion, an unnecessary admission that the industry cannot stop mortgage fraud and would eliminate healthy competition solely on that holdback. This single idea in itself could bring back old fraud schemes, further complicating any recovery effort in progress.

A straightforward notion would be to increase the existing insurance premiums during the riskiest period - when fraudulent loans currently surface. Also, a closing fee to pay the "clear to close" related costs of the transaction (for all parties involved in the contract), would be disclosed on the HUD-1 settlement statement and used to partially offset the costs of preventing mortgage fraud. This is a fee that should be split and paid by all parties to the transaction (i.e., homeowners, real estate agents, loan officers and all others). The industry or your company should also add a disclosure that states the parties to the HUD-1 settlement statement are not knowingly participating in any activities that are against the law. This disclosure should define real estate fraud and list the penalties. In implementing a closing fee similar to this one, mortgage companies would have ample revenue to monitor for fraud and set a level playing field. The fee would be used to audit for prefunding fraud prevention, handle the compliance implications, and educate the prefunding staff in mortgage fraud prevention.

We need a Trusted Origination Source or similar validation that helps to prevent mortgage fraud. A stronger compliance program, a forensics mortgage system, and proper training must be in place in order to gain and keep the trust of the consumer and the secondary market buyer's long-term investment. Until we bring the view of mortgage fraud down to the origination level the high-altitude sickness will continue. The need to establish significant penalties earlier in the process within our industry and to implement sobering preventative measures is crucial. If not, mortgage fraud will continue to reach epidemic proportions in our industry.

The secondary market should be rewarding mortgage brokerage, mortgage banking entities and others for originating mortgages that perform. It should provide a long-term incentive during the loan performance period by using a defined standard, especially where the originated loan does not possess fraud in the original loan file.

We should all know by now, while busy running our companies - whether we are reviewing appraisal values, processing loans, or sitting at the closing table - that fraudsters are spending all their time - and I do mean all, as in every waking second - thinking of new, inventive and difficult-to-detect ways to do what they do. It is nearly impossible to keep up with such dedicated, aggressive and workaholic criminals from such a high altitude.

For example, the latest opportunity for the fraudsters is the first-time homebuyer's new source of downpayment, where the homebuyer is permitted to turn their $8,000 tax credit for purchasing a property into downpayment money. Moreover, with government being the largest source of mortgage money in this credit environment, people are already trying to take advantage. The unscrupulous fraudsters have most likely launched "homebuyer tax-credit programs" of their own, profiting from the publicity over HUD's initiative.

These new government programs are implemented with the best of intent, but the fraudsters find ways to profit from one and all. The program is similar to downpayment assistance programs in a few states around the country. These programs and states offer bridge loans that allow buyers to borrow against their tax credit for downpayment and closing costs, then repay it when their tax refunds arrive.

Here is where the fraud starts to grow: if the borrower does not pay, the unpaid loan becomes a lien on the property, at a slightly higher interest rate, which means the borrower faces higher monthly payments. This requires no actual cash at risk to the borrower, just an unknown amount of equity value is at risk, negative or positive at this early stage of the purchase.

Another example of "high altitude sickness" shows itself when we have some individuals making statements "that the economy trumps the risk concerns on these types of downpayment programs." With this mindset, mortgage fraudsters are working hard to develop or change the schemes to take advantage of the consumer.

On the surface downpayment assistance programs have been developed to help people buy homes, but have we reviewed the risks based on mortgage fraud or only traditional risk models. The most recent months and years have proven that we do not know what the actual financial risk costs are yet with mortgage fraud, but we do know it is more than anyone predicted.

We should all know individuals commit the act of fraud not companies. Only when mortgage fraud is viewed at the origination level will we be able to cure high altitude sickness and begin preventing the majority of mortgage fraud loan by loan.

It is my firm belief that every company should use a "Clear to Close," or some variation thereof, and then educate the staff on how to properly implement the plan. With a proper system in place those who would commit fraud would at least think twice before doing so, and possibly be caught along the way, this would happen with stopgap measures in the design of a proper forensic mortgage plan.