The Snake Under the Rug
Once upon a time there was a rug merchant who saw that his most beautiful carpet had a large bump in its center. He stepped on the bump to flatten it out—and succeeded. But the bump reappeared in a new spot not far away. He jumped on the bump again, and it disappeared—for a moment, until it emerged once more in a new place. Again and again he jumped, scuffing and mangling the rug in his frustration, until finally he lifted one corner of the carpet and an angry snake slithered out.
This story written by Peter Senge, an American scientist, is quite interesting and I believe very relevant in today’s mortgage market. Fraud is the mortgage industry’s snake under the rug. Fraud is very much like the snake, it moves and responds and adapts as lenders take aggressive measures to stamp it out. Like the rug merchant, lenders need to be careful while they attempt to crush fraud that they do not create other problems such as over-burdensome policies and expensive verification procedures. Unfortunately, lenders will never be able to simply lift up the rug and let the snake out – this snake is here to stay. Fraud will never be completely eliminated.
In this issue of Fighting Fraud with Frank, I want to discuss the changing face of fraud. I believe 2011 will be a year of increasingly better-hidden and non-origination based fraud. The fraudsters are changing and adapting to every new opportunity the market provides. Here, I have provided five key trend areas where CoreLogic predicts the snake under the rug will begin to appear.
Trend #1 - Short Sale Payoff and Flipping Will Increase
CoreLogic estimates 400,000 short sales will be processed in 2010. That number will inevitably increase throughout 2011 as lenders are required to deal with the growing glut of defaults in their portfolios. Short-sale fraud occurs when investors and/or real estate agents negotiate a short sale with a lender but rip off the lender by not disclosing the true buyer of the property. They buy the property for pennies on the dollar, and flip the house to someone else for a much higher profit.
We know that significant increases in any type of mortgage market activity are hotbeds for opportunistic fraudsters. Well, short sales have fraudsters literally licking their chops at the potential to defraud lenders out of the properties. The CoreLogic annual estimate for short sale fraud in 2010 is $310 million. Approximately one in every 53 short sales appears to be a short-sale fraud flip and lenders lose an average of $41,500 for each short-sale flip that occurs. Lenders are currently losing, and will continue to lose, significant sums of money to short-sale flipping. I believe these estimates are conservative, and by my estimates, lenders will experience losses that far exceed this.
Trend #2 – REO Flipping
REO flipping is very similar to short-sale fraud, and will increase in a big way next year. Given the recent perceived failures of the HAMP and HARP programs to keep borrowers in homes, foreclosure in most cases will be the only remedy left. The glut of REO homes creates another opportunity for investors and real estate agents to buy distressed properties and deflated valuations and then flip them instantly for a profit by not disclosing the true buyer of the property.
CoreLogic analysis suggests that lenders lose approximately $61,000 in loan value when there is an REO flipping scheme on a property. When an REO property is fraudulently flipped, it represents approximately 30 percent in lender losses on the face value of the property.
Trend #3 – Increased Undisclosed Hidden Debts
Undisclosed debts of all types appear to be on the increase. Lenders are cracking down on income misrepresentation, leading borrowers to change their behaviors to hide debt in order to qualify for loans. One of the primary characteristics that lenders rely upon to determine if a borrower is credit worthy is the calculation of that borrower’s debt to income levels. Now that borrowers are forced to disclose their true incomes, lenders are reporting that they are also hiding debts to ensure that DTI ratios will still fit within the lenders’ guidelines.
Trend #4 – Increased Asset Misrepresentation
Lenders are reporting increases in asset misrepresentation in their loan findings. Asset misrepresentation involves inflation of bank account balances or outright fabrication of accounts to make the borrower appear wealthier than they are. The reason this type of fraud is on the increase appears to be because clever fraudsters have found that higher assets will help them navigate the underwriting process more quickly. Automated or streamlined underwriting programs utilize asset levels to determine which borrowers are more credit worthy. Wealthy borrowers with high bank account balances can be streamlined for less scrutiny since they are more likely to be able to afford the property. This is generally true, unless of course the claimed assets are misrepresented or outright fraudulent.
Trend #5 - Increased Closing Agent Fraud
Lenders’ aggressive push to prevent mortgage fraud has focused primarily on the origination process. As this has happened, fraud has moved increasingly outside the origination process to new areas such as the closing process. Lenders are reporting increasing levels of closing-agent fraud found in their post-funding loan reviews. The most notable scheme occurs when closing agents embezzle real estate proceeds from the current transaction for their own gain. Given the very limited insight a lender has into the closing process, CoreLogic expects this type of fraud to increase as well.
How We Solve for the Snake Under the Rug
There is no single solution for solving the issue of the snake under the rug. We know that lenders who aggressively detect where the snake is, and take aggressive actions, are often able to move the snake outside of their organizations. The strongest lenders that take the boldest actions have the most success in migrating fraud out of their organizations because they become the hardest to commit fraud against.
Here at CoreLogic, we are constantly adapting our tools and technologies to help lenders uncover new types of frauds that are evolving. This year, we’ve launched several new cooperative approaches to solving fraud.
Some of those include:
Short Sale Monitoring – A solution which provides alerts to lenders about potential non- disclosed offers on a property in short sale.
REO Monitoring – A solution which provides surveillance on REO properties to watch for flipping or egregious schemes.
EWS Alerts – Addition of new alerts to our LoanSafe® Risk Manager product which indicate to a lender when a borrower has committed fraud or account abuse on a checking or debit account.
PatternWatch – Cross loan monitoring service which alerts lenders to clusters of fraudulent behavior by individuals or organizations.
I truly believe a combination of better data, tools and cooperation within the industry will help us slow down this snake under the rug.
Frank McKenna is vice president of fraud strategy for CoreLogic in Santa Ana, CA. Previously, he was the co-founder and chief fraud strategist for BasePoint Analytics based in Carlsbad, CA. He may be reached at (760) 602-4971 x104 or via email at
