What is Mortgage Fraud?

Explanation

  • The above definition aligns with the Federal Bureau of Investigation (FBI) view. It implies that a borrower is not conveying the whole truth about his capacity and intentions for the borrowed funds he sought. Such hidden information can impact the lender’s ability to decide on the approval of a loan or determine the loan terms. The prospective borrower is committing mortgage fraud.The aim borrower gets accused because he is withholding information for his interest at the loss of the lender’s interest. In addition, if the borrower overstates his earning capacity, he might lead the lender to think that the borrower can better repay the same. Thus, the lender might approve his loan application when in fact, he should not.It may also be the case that it might mislead the lender to think that the loan is less risky than it is and sanction the same at a lower interest rate or defer repayment to later dates than he would, had the complete information about the borrower.

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Categories

  • Fraud for Profit: This type of fraud is of greater interest to the FBI. It involves an institutional borrower with insider informationInsider InformationInsider Information is a piece of fact, information or an understanding (M&A, New Contracts, R&D breakthrough, new product launch etc.) which could impact the prices of a listed entity or publicly-traded organizations once disclosed in the public domain. Trading based on such information is considered to be illegal.read more or greater industry knowledge. It uses the same to dupe the lender and extort money from him without backing it with commensurate collateral.Fraud for Housing: In this, a retail borrower overstates his capacity to secure a housing loan that he cannot pay off.

Mortgage Types

#1 – Occupancy Fraud

  • Here, the borrower conveys to the lender that he needs the loan to purchase a property for his living purpose. However, the actual reason is to resell the same at a better price when such is available. Therefore, it is an investment rather than a necessity.In such cases, if the entire loan is not paid off and the title of ownership is passed on to the new buyer, there might be a possibility that he may not pay off the loan. Because of this reason, the loans for investment propertyInvestment PropertyInvestment property refers to the real estate acquired to earn returns on the investment through rental income, royalties, dividends or future appreciation, usually in the name of an individual investor, a group of investors or an investment company for a short-term or a long-term investment.read more attract higher interest rates. Therefore, the primary borrower has committed fraud by not mentioning the actual reason for borrowing the money.

#2 – Income Fraud

Here, the borrower conveys a higher income than his actual income. As a result, he may get a higher loan or a lower interest rate because a higher income means a better repaying capacity.

#3 – Incomplete or Non-Disclosure of Liabilities

Such is the case when the buyer does not give a complete picture of the liabilitiesLiabilitiesLiability is a financial obligation as a result of any past event which is a legal binding. Settling of a liability requires an outflow of an economic resource mostly money, and these are shown in the balance of the company.read more that he is indebted by and secures a higher quantum of loaned funds or a lower interest rate due to a misrepresentation of the riskiness of the loan.

#4 – Acquiring Loaned Funds for Purpose other than Purchase of Property

  • Under this type of fraud, the borrower overstates the value of the property he wishes to purchase from the loaned funds. Therefore, manages to acquire a greater amount of loan funds than necessary. The borrower then uses these funds for another purpose.It is fraudulent because the lender is exposed to a risk he is unaware of. Had he been informed, he might not have lent the funds or might have done so under different terms and conditions. At the time, this fraud was also known as appraisal fraud.

#5 – Shotgunning

Here several loans are taken out on the same property, each of almost the same value as the property itself. Therefore, the loaned amount becomes double or triple instead of the property’s actual value. That is a fraud because one might pay off only one of these loans by selling the property if the borrower defaults. Therefore, the loans taken after the first loan get lower priority and might not get repaid.

#6 – Air Loans

Air loans involve frauds conducted by a financial intermediaryFinancial IntermediaryA financial intermediary refers to a third-party, forming environment for conducting financial transactions between different parties.read more where they borrow funds for a property that does not exist. In such a case, these intermediaries falsify proof of such properties and borrow funds without providing any collateral. As a result, the lender is unaware of the sanctions of the loan and later faces the issue of not being able to recover the same by selling the collateral in case of a default because the collateral does not exist.

Example of Mortgage Fraud

On November 4th, 2019, the U.S. Department of Justice sentenced Manuel Herrera and Moctezuma Tovar for wire fraud and mortgage fraud along with several other defendants. The defendants, who worked for Delta Homes & Lending Inc., created false loan documents and homebuyers to secure loaned funds. They overstated the incomes, liabilities, employment, and citizenship of these home buyers to secure funds and provided them money so that their balance sheet looked better than it was. Once they secured the funds in the name of these homebuyers, they returned them to Herrera and Tovar and their accomplices.

In this process, the lenders lost $4 million. The final decision is pending, but the penalty can extend up to 20 years of imprisonment and a $250,000 fine per defendant.

Indications

The following are potential red flags that should be taken care of and investigated by the lenders to prevent mortgage fraud.

  • The same phone number is mentioned for the borrower and the employer in the loan application. That could be the case of employment fraud where the borrower might be misrepresenting his employment.The income specified is above the industry standards in the particular field mentioned on the application.The assets stated seem higher than that of an average individual in the profession indicated on the loan application.Background verification took less than usual time to proceed with the loan application to the next step of the evaluation process.

How to Prevent Mortgage Fraud?

  • Conducting thorough due diligence is one of the most important components of the loan sanction process. If it is shown properly, mortgage fraud is less likely to occur. However, it does not eliminate this risk because a fraudster may develop a new technique of conducting a fraudulent activity with a lender who might not have prior experience.A deeper investigation in case of the appearance of any of the above-mentioned red flags is a prudent way of ensuring no mortgage fraud.Third-party evaluation and appraisal of the borrower and the subject property can lead to an unbiased opinion based on an informed decision regarding loan approval.

Conclusion

  • Mortgage fraud was on the rise before the 2007-2008 housing bubble financial crisisFinancial CrisisThe term “financial crisis” refers to a situation in which the market’s key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more, and the FBI warned in its press release in late 2004 and early 2005. Post the crisis, the Fraud Enforcement and Recovery Act came into force in 2009 as an outcome of the market crash to prevent the same from happening again.Therefore, it is prudent to conduct a rigorous background check of the borrower and all the parties involved in the process, including the financial institutions, to minimize the possibility of fraud.

This article is a guide to Mortgage Fraud and its definition. Here, we discuss 5 types and categories, and indications along with an example of mortgage fraud. You can learn more about it from the following articles: –

  • Medium-Term NotesMortgage CalculatorMortgage RecastHow Fraud Triangle Identifies Fraud?Mortgage Calculator with Taxes and Insurance