Insiders Fret Over Income, Hardship Fraud

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As fraudsters reinvent themselves, insiders warn about recent increases in short-sale fraud and call for preventive monitoring.

Some homeowners try to manipulate a short sale deal using fraudulent claims of financial hardship, says Rachel Dollar, an attorney based in California who also is the editor of the Mortgage Fraud Blog. She recalls boyfriend and girlfriend stories where the girlfriend owns the house, files for a hardship and gets a short sale deal on owed balances of up to $100,000, short sales it to the boyfriend and the boyfriend deeds it back to her.

“They’re getting creative with that stuff as well,” she said, and servicers are screening these homeowners to determine their level of hardship, which is “very difficult to determine” after they claim hardship and submit their bank statements. Lenders and servicers do not want another short sale on their books if they can avoid the foreclosure, more so if said “homeowners in hardship” drive nice cars and have nice houses and “don’t really have a hardship, or they can’t really justify it.”

“A dramatic increase” in short sales is bad news for lenders and servicers, says Susan Allen, vice president of strategic relations at CoreLogic, since short sales are representing a higher share in the number of distressed home sales.

Data also support these observations. The fourth-quarter 2011 Interthinx Mortgage Fraud Risk Report shows property valuation fraud risk, often the starting point for short-sale fraud, increased nearly 8% compared to the previous quarter. It follows “a period of decline and stability” in valuation-related fraud.

The Agoura Hills, Calif.-based company also reports that recent analysis shows certain regions of the New York Tri-State area—which includes the Connecticut metros of Bridgeport and New Haven and the New Jersey metros of Atlantic City and Ocean City—have moved into the “very high risk” category also primarily due to property valuation fraud.

The national Mortgage Fraud Risk Index, which uses a loan-level fraud detection tool to analyze data from over 12 million loan applications and monitor variations in fraud risk, shows fraud increased 1.4% quarter-to-quarter and 3.6% year-over-year to 145 (neutral is 100). So far, over the last seven quarters the index had fluctuated between 140-145.

The income and employment fraud risk index, which increased only 1% compared to the third quarter of 2011, jumped nearly 14% compared to a year ago and 46% compared to 2010, putting lenders at high risk for this type of fraud.

“Valuation fraud continues to be a problem for lenders,” says Mark Chapin, chief valuation officer for Interthinx. It is a trend that indicates “the collateral valuation process” is a very sensitive issue in the current marketplace when many areas around the country are still experiencing home value declines.

“Fraud is more of a problem for servicers than it has ever been,” agrees David Kittle, senior director of industry relations for IMARC, which specializes in fraud detection. He finds that fraud is on the rise on the origination side as well, “which is amazing in and of itself” because regardless of how “lean and fiscal” loans are, fraudsters are becoming more creative. About 90% of the fraud committed is on employment and income, he said, as a W-2, employment verification, or a tax return forms can be remanufactured almost better than the originals. “It’s pretty scary.”

In some cases, Kittle says, servicers are stuck with homeowners who “could not afford the house to begin with and should have never bought it,” but nonetheless have their loans modified down to a payment that takes almost 100% of their current income on a legitimate verification of employment. Modifications on such loans are going to redefault. How many of these people who committed fraud initially are we going to give $10,000 so they can reduce their mortgages, he argues. “We’re just going to overlook that? There’s a moral question there.”

Fraud is difficult to detect due to a combination of factors. Scott Stoddard, CEO of Quandis, a firm that provides post-closing and post-delivery loan monitoring to ensure compliance, finds fraud has not necessarily changed or turned more sophisticated. “We’re checking and then checking again and checking it one more time. So as you kind of narrow that filter down, we start to catch more of it. In essence it’s 200% compliance, is what it ends up being.”

Fraud cases differ. Dollar recalls how call centers would go out of business or disappearing shortly after they had verified employment or deposits. Now servicers are going through audits, auctioning and secondary market reviews and it seems not much fraud is going through into the mortgage backed securities market. Dollar says servicers’ branches are seeing more false employment documents coming through W-2s or pay stubs either because they get caught before mortgage loans are securitized or because the fraudsters are so good they are not being caught at all before a few years have passed.