Documenting and verifying a borrower’s income is one of the most basic tasks for an underwriter. While this appears to be relatively simple, validating income has become increasingly complex and susceptible to borrower fraud.
Income verification relies on a variety of Internal Revenue Service documents, including pay stubs, W-2’s, tax transcripts and tax returns. Borrowers perpetrating fraud against lenders have become increasingly sophisticated in their ability to replicate these documents. The Interthinx Mortgage Fraud Risk Index report for 2011 showed that income and employment fraud risk has risen 45% since 2009. Given fraudulent documentation capabilities and current economic conditions, borrower income misrepresentation will likely continue to be a problem for lenders for the foreseeable future.
Borrower income misrepresentation is certainly not a new phenomenon. Investor requirements and underwriting norms were considerably relaxed prior to the 2008 financial crisis and passage of the Dodd-Frank Act. Forensic reviews of loans originated during the boom are revealing widespread income fraud. Since income misrepresentation results in unaffordable mortgages and high levels of default, it represents a considerable percentage of the volume of GSE repurchase demands, which total nearly $100 billion since 2009. These demands place substantial liability and financial burdens on lenders, particularly small lenders.
Income misrepresentation was epidemic in subprime mortgage loans. With products such as stated income and stated assets, lenders determined borrower income qualifications based on little or no verification or documentation. Systemic income misrepresentation during the subprime boom and the losses it created for lenders demonstrate the importance of prudent underwriting guidelines and the need for technology to see beyond fraudulent documentation in order to verify borrower income.
In today’s mortgage servicing industry, income qualification is a fundamental factor used to qualify a borrower for a loan modification or refinance. The Federal Bureau of Investigation reports that some borrowers artificially decrease their income in order to qualify for principal reduction loan modifications. This form of income misrepresentation ultimately harms mortgage investors.
As the regulatory landscape changes, income verification will remain an essential underwriting metric as well as an opportunity for lenders to manage risk in anticipation of new regulatory regimes and requirements. Two of the Dodd-Frank Act’s most defining and important rulemakings contain income underwriting requirements. The Qualified Residential Mortgage under the proposed risk retention rule governing mortgage securitizations includes income calculation requirements, as does the proposed ability to repay rule, which will be enforced by the new Consumer Financial Protection Bureau.
Meeting the mandate of the ability to repay rule will require analysis and verification of the borrower’s employment, debt-to-income, and residual income calculations, among others. If done properly, such verification should result in a Qualified Residential Mortgage and lenders should be shielded from borrower suits through either a safe harbor (borrower suits are barred) or a rebuttable presumption (borrowers must prove that the lender failed to properly verify income and ability to repay).
As regulations and oversight seek to address existing forms of fraud, new forms of income misrepresentation will emerge, and lenders must be prepared to manage that risk. Recent years have proven lenders cannot confidently rely on documentation provided solely by the borrower. Since it is likely that mortgage investors will also require more extensive income verification in the future, lenders should invest in their defenses. Services such as The Work Number which Interthinx now makes available within FraudGuard, can easily confirm a borrower’s ability to repay and meet Dodd-Frank and Consumer Protection Act requirements. Using the technology and tools that are available will help defend the industry today as it plays defense, and protect it tomorrow as it works on restoring integrity to, and confidence in, the private mortgage securities market.
