What a difference five years make. Back in 2005 lenders didn’t have the same incentive they have today to use technology and analytical services on their loan originations because they didn’t have much, if any, skin in the game.
The hungry secondary market saw to that.
Lenders could sell loans and securitize them under the comfortable assumption that home prices would go up forever, so any accountability (read: problems) down the road would be easily mitigated by lower LTVs.
Now, of course, it’s quite the opposite and in many ways we’re paying the price for the structural weakness in lending processes that ruled the market in mid-decade. Not surprisingly, technology services and loan analytics are in great demand today, critical in identifying bad loans of the past and vital in preventing new loan misrepresentations and fraud.
Underwriting has markedly improved and accountability has risen. I don’t know of a lender out there who isn’t verifying a borrower’s income, for example, in more than one way.
But make no mistake: Lenders, servicers, and investors must remain on heightened alert for mortgage discrepancies—the battle is far from over.
While technology has certainly helped the mortgage industry combat fraud in recent years, it’s also made it easier for borrowers—and originators—to commit fraud. Indeed, it’s easier now than ever for a borrower to lie on a mortgage application.
As Americans continue to be heavily leveraged—total consumer debt remains high at $11.7 trillion, down just 6.5% from its peak in the third quarter of 2008—qualifying for a mortgage remains difficult. That makes more people feel compelled to lie on their mortgage applications to qualify (don’t believe it if someone tells you there are no “liar loans” anymore). Indeed, recent industry data shows that mortgage fraud is returning in a big way after a momentary lull.
The data show that mortgage fraud rose 17% last year after declining 57% the two previous years. In 2009, about $14 billion in loans were originated with fraudulent application data, according to the data.
If you want to find out how easy it is for a borrower to produce a phony pay stub, just type “novelty pay stub” into an Internet search engine and see how many hits you get.
There are offshore companies all over the Web who will “rent” you assets long enough for you to (fraudulently) qualify for a mortgage and all the while the lender will never know what’s really happening.
Mortgage Fraud Now a 'Crime of Necessity’
Clearly, then, the industry must remain vigilant, keeping up with and staying ahead of fraudsters.
As Merle Sharick, real estate solutions consultant at LexisNexis Risk Solutions, told professionals attending SourceMedia’s Loss Mitigation Conference this summer, mortgage fraud used to be a “crime of opportunity, but now it’s a crime of necessity.
There’s a lot of people and companies that have been around the mortgage and real estate industry for a number of years that became accustomed to a lifestyle that’s no longer available.” The fraudsters, he noted, are “focusing on the back-end right now because they’re waiting for the dust to settle on the front-end with all the new regulations that are coming down.”
Front or back, one enduring burden for the residential mortgage industry is the “shadow inventory” of distressed mortgage loans.
There are approximately five million loans in some state of delinquency (but not in foreclosure). These are borrowers still living in their homes who are not paying their mortgages or paying less than what they’re supposed to be paying, but not being foreclosed on.
The government and the private sector have been trying for at least the past two years to put such troubled homeowners into some kind of loan modification program.
But there are many who just can’t fulfill the requirements of the modification. As a result, delinquencies are starting to slow down and foreclosures accelerate.
Without improvement in the larger economy, foreclosure numbers will continue to accelerate. Both the government and the private sector have a vested interest in keeping this “bubble” of borrowers out of foreclosure in order to prop up home prices.
They have done a great job of keeping that from happening over the last two years. If we had started foreclosing on borrowers from the beginning we would have seen a downward spiral effect on home prices that would have been a disaster. But if we keep doing what we’re doing there’s a chance we can keep home prices either stable or only declining slightly.
The government is also trying to do short sales. The objective there is to get the proverbial pig out of the python. A short sale is less damaging than a foreclosure.
Short sales reduce home prices less than foreclosures will. It’s all about keeping home prices as stable as possible and avoiding a spiral effect.
Making Decisions One Loan at a Time
In addition to combating fraud, mortgage technology and analytics can help by providing the loan level analysis to make decisions on loans one loan at a time: which loans can be salvaged with a modification, which ones are candidates for short sales, and which are too far gone and must go to foreclosure.
Technology companies are working with government entities, lenders, investors and servicers to try to modify loans.
Servicers are the front-line parties dealing with these modifications and they are overwhelmed.
The health of the market really depends on jobs, but also on how we manage these five million loans that are hanging out there.
At least one Wall Street firm believes those five million loans represent 47 months of supply of homes. Do the math: that puts us out to 2014 where we’re still dealing with loans that were originated between 2005 and early 2008.
I’m pretty confident to say that this problem is going to extend into 2011 and the first half of 2012. Others think it will last until at least 2014.
I’m a little more optimistic that the economy will rebound sometime next year to enable some of these borrowers to resume paying their mortgages, refinance into new, more affordable loans, or do short sales. 
Alex Santos is president of Digital Risk, New York. He may be contacted at asantos@digitalrisk.com.
