Wednesday, March 15, 2006

Appraisal Fraud - A Reader's Comment

A mortgage loan officer and a reader of this blog sent me this email regarding appraisal fraud which I found interesting; he gave me his permission to share it on this blog. So here it is in its unadulterated entirety (although I did remove his place of employment and contact information from his signature):
Marinite:

Thought you would be interested to read this. Among all the investigations of appraisal fraud and fraudulent activities and title companies, the FBI is striking out bad on their fraud investigations. Stated income loan fraud is so wide-spread in areas of the East and West coast, there are actually mortgage brokers who openly admit to doing it. I myself am a broker and am subscribed to an industry internet message board at www.brokeroutpost.com. I posed this question: "What causes you to use a stated income loan program?". The following are some of the answers I received:

Quote: "boarder income..."

Quote: " Another reason is the wife or husbands credit is garbage"

^^^ That would imply that they are stating the spouse's income that is not on the application as the income that the spouse who IS on the application receives from their employment. Fraud.

Quote: "I write them all the time. Often if the wife has a higher credit score and less income."

^^^ Same deal. Using income from a borrower that is not on the loan application to qualify the loan.

Quote (in response to me saying that the previously mentioned activities are fraudulent): "You are getting confused. We aren't using the co-borrower's income for the borrower. You can "state" the income for both borrowers. Stated Income does not mean we are making John Doe who works at Burger World suddenly make $125,000 a year. Nor are we making someone unemployed suddenly employed. The employment is still verified, the income is not. And yes, it is legal and there isn't anything unethical about it."

^^^ Simply amazing. Basically, this loan officer was implying that he can put whatever income he wants on the loan application, as long as he verifies the person works at the place of employment they claimed. Apparently, he believes that their actual level of income is irrelevant. Fraud.

This was my response:

"Have you read the little print on the 1003 right above where the borrower signs? You do understand that is a federal document, correct?
The FBI or DoJ investigators must just jump with glee every time they log into this website."

Now, here is my point:

These people are so naive, crooked, or comically misinformed that they are actually posting this on a PUBLIC internet forum! Considering the fact that there are actually enough mortgage companies participating in this that they have LO openly discussing it on an internet message board, how many "smart" crooks do you think there are that DON'T discuss it?



The following is an article I wrote on the state of mortgage fraud in the world of mortgage brokers. Somebody had better stop this stuff, fast:

http://mortgagecents.blogspot.com

Rough times ahead for people who bought houses at inflated prices:

This is a bit of an elaboration on the consequences that some individuals in certain sections of the nation are about to experience as the result of fraudulent loan activity and property values that are overly inflated:

Stated income mortgage fraud.

You can bank on the prediction that stated income loan programs will be the subject of massive federal investigations in the coming months and years. In a stated income loan program, the loan officer takes the loan application, and puts the income the client says he makes on the application. The bank does not verify that income. Instead, the bank simply approves the loan based on the word of the loan officer and loan applicant.

How does it get abused?

When a borrower can't afford to buy the house because their debt ratios are too high, an unscrupulous loan officer says, "well, gee, Mr. and Mrs. Borrower, if I put you in this stated program, we can say that you make any income that we want!" At that point, the loan officer puts in some arbitrary number that is supposed to be the amount of money the borrower makes every year. Instead, it's the amount of money that the application needs to show to make the debt ratio fall into the range that makes the loan approvable.

The worst part is, a BUNCH of lenders have this program and it allows you to borrow 100% of the purchase money for the home. So now, the borrower is not making a down payment, has no equity in the home, and they have been convinced by the loan officer to sign a fraudulent loan application so that their debt ratios will make the loan "work". Incredibly, loan officers will openly admit that they practice this in expensive markets on the east and west coast.

Apparently, they do not realize that a mortgage loan application is an official Federal document, and lying on it makes you subject to jail time, huge fines, and other penalties. Additionally, unscrupulous loan officers have made statements similar to this: "Hey, I didn't realize they were lying, it's not my fault!" Give me a break. Just who do you think the Federal Government is going to pursue in these fraud cases? The little borrower who claims "I was just doing what the 'professional' said I could" or the loan officer that pleads ignorance about the borrower's financial situation. The entire situation can be compared to negligence suits where an individual's irresponsible actions (in this case, the loan officer either "coaching" the borrower on what income needed to be shown on the loan application or otherwise not properly investigating a borrower's income) results in harm to others. That individual pays fines, goes to jail, or is otherwise punished. If loan officers think they are going to be immune to this, they are kidding themselves.

Here are the original purposes behind the stated income loan program:

If you are dealing with a borrower that has maybe been working a side-job for the last couple of years doing lawn care, and they get paid entirely in cash, but never document that income, this was supposedly a way to use that income to qualify the loan. Of course, it begs the question: "Why wasn't this person reporting this income on their taxes?" Additionally, if you had a borrower that was working on a job where most of the income came from tips, such as a hair-stylist or restaurant worker, this was supposed to be a way for them to document their cash income from tips. Yet again, the question arises: "Why aren't they reporting it on their taxes?”

If you are a borrower who is self-employed and has very strong credit, trying to document their income from the business they own can be difficult. If they claim large amounts of deductions on their taxes, a traditional loan must be qualified on the income AFTER deductions. The stated program was intended to allow you to use the income level BEFORE the deductions.

If you are a borrower that has income coming in from all over the place, and very strong credit history, you can simply elect to do a loan that has reduced income documentation to save you the time of verifying 5-10 different sources of income.

The purpose of stated loan programs was never to artificially inflate a borrower's income, but that is what is happening. On one popular internet discussion forum for loan officers, the discussion at that site on this issue is mind-boggling. There are loan officers on there who outright admit that they use stated income programs to exaggerate income, because they claim that without them, they could never approve anyone for a loan in expensive areas. That raises more questions.

Do these loan officers understand that the FBI regularly reads that site, and that just because an agent isn't knocking on their door with a search warrant today hardly means that they are immune to prosecution in the future. A lot of mortgage fraud cases take a long time to investigate. At this site: www.mortgagefraudblog.com you can read about some of the cases of fraud that have been uncovered in recent years. They are very complex, but are also easy to uncover. It is stunning that individuals actually believed they could get away with some of this stuff.

I wonder if the loan officers understand that part of the reason that housing prices exploded to ridiculous levels in the last few years is because of the ease of obtaining credit to purchase homes. When credit is easier to obtain, more people can qualify for the purchase. When there is more demand, prices are higher.

Potential long-term implications of fraud:

Part of the reason for the rapidly appreciating property values we have seen in the last few years have been historically low interest rates and loan programs that make it possible for people to purchase homes that they have no business purchasing, when taking their income into account.

What do you all think is going to happen when easily defrauded loan programs start to disappear and interest rates continue to rise?

First, houses are going to be a tough sell, because they are going to be unaffordable until prices adjust in a downward direction to a level that makes it realistic to buy them. Loan programs that allow easy approval of loans for people that otherwise should not be able to afford a house are about to disappear.

Second, when the values shift downward, you are going to have these “home owners” who were put into incredibly bad loan programs, didn't make a down payment, and can't afford their house payment. When they try to sell the depreciating property, they aren't even going to be able to pay off their mortgage in its entirety. If they don't pay it off, then the next buyer can't finance the purchase.

As a final slap in the face, people that are in terrible loan programs such as an adjustable-rate mortgage in which they lack equity to refinance will be faced with increasing payments that they cannot afford. Since they can't sell the house to get out from under the mortgage that they can’t pay, they will just foreclose. That translates into a massive loss for the banks, which means further evaporation of bad mortgage programs and tightening of requirements on existing programs (if we're lucky).

In a strange sense of irony, all of the foreclosures will actually result in housing that may once again be affordable. It's an interesting cycle.



Hope you have time to read all of this.


Sincerely,

Matt Norris

____________________________
Matt Norris
Mortgage Loan Officer

21 Comments:

Blogger Former Apt. Broker said...

A few years back I was driving with a co-worker to meet another apartment broker and I mentioned that a friend a mortgage broker told me that they have a tax return and credit report from a strong borrower that they use again and again to originate loans for crappy borrowers by cutting and pasting the crappy borrower info to the top of the good tax return before making copies. My co-worker found it hard to believe that anyone would risk jail time for a couple thousand dollars. When we got to the meeting with the other apartment broker he mentioned that he used to be a residential mortgage broker and my co-worker almost fell out of his chair when he said that "over half" of all the residential loan applications his old office did had fraud...

Mar 15, 2006, 10:47:00 AM  
Blogger Matt Norris said...

That is precisely what I mean. But those guys were actually doing it the hard way:

Incredibly, there are loan programs that simply don't require you to document income. You can put whatever number you want on to the loan application, and the bank will fund the loan, provided you aren't doing something blatantly stupid like claiming a McDonald's cook makes $100,000 per year.

However, the biggest abuse probably comes when people JUST BARELY don't qualify for a given loan because they don't make enough money. The loan officer wants his commission, and he wants to make a good impression on a Realtor who he believes will send him more commissions in the form of new clients, so he does the deal as a stated income loan and just slightly fibbs their income.

The fibb isn't enough to set off alarms at the underwriting center (and frankly, since underwriters are paid on commission, too, there's nothing that guarantees they would care anyhow) and the loan closes.

So now, where you should have had real-estate price increases cut off by "normal" curbs in the market such as interest rates and wage levels, instead, the inflation of prices was extended past normal levels because of loan programs that required no income documentation.

One article I've come across claims that fully 60% of all mortgage fraud investigations involve exaggerated incomes on loan applications. The problem is, those investigations only cover blatant cases where there's an obvious paper trail (like faked paystubs, w-2, and bank statements).

The Feds are going after these "easy" cases and are missing the underlying serious problem: loan programs that don't require income documentation.

Mar 15, 2006, 11:09:00 AM  
Anonymous Anonymous said...

I agree that the Feds will likely go after those easy cases and it will take a while before the loans with no income verification come to the forefront. Why? First evidence from a relative (former Assistant US Attorney) who told me in the last market cycle the Fed's went after people who submitted false loan docs -- specifically falsified federal tax returns. (Remember, at least in CA, you sign a document that allows the holder of the loan and I think originator to request a copy of your tax returns directly from the Feds -- ouch for the guy who cut and pasted names).

Second, being self employed I understand that you have a choice -- either be honest with yourself and make a good faith and conservative estimate of your true past and projected income or hire a creative accountant to come up with the amount you need to get the loan. In terms of proving fraud / abuse, however, it can be difficult for an outside person to discern which choice was made especially if the person uses a good creative accountant. Just remember how difficult it has been for the Feds to prosecute accounting fraud.

So I bet it will take an increase in foreclosure rates before much attention is paid to these types of loans which are undoubtedly a major factor behind price spikes. I wish it would happen faster but doubt it will. But I do think the day will come (a creative accountant can make you qualify for a loan but can't get you the income to pay the mortgage into the future).

Mar 15, 2006, 11:33:00 AM  
Blogger Matt Norris said...

The thing is, you don't even need an accountant. That form DOES allow the lender to request copies of tax returns, but there is a problem with the system:

1) Most lenders don't have the resources in their Quality Assurance departments to review each of the thousands of loans that are passed through them regularly.

2) If the lenders that offer these programs were to discover large amounts of fraud, they wouldn't necessarily disclose it to anyone, because they would go out of business. If they had to pull the plug on these programs, they would no longer have a loan product they could convince brokers to use.

3) Even if they DO request copies of tax returns and find a problem, it is difficult to establish blame. The loan officer can claim "I just put what the borrower told me", and the borrower can turn around and claim "the loan officer said it was ok for me to put whatever number I wanted".

So the 4506-T form (the one you were mentioning) is definitely not an adequate safe-guard against the problem.

Mar 15, 2006, 11:50:00 AM  
Blogger Athena said...

good lord. unbelievable!

Mar 15, 2006, 12:42:00 PM  
Anonymous Anonymous said...

i spoke to a senior underwriter at after a class for new loan brokers last month who estimated 40% of the loans they approved had at least some degree of fraud.reps from lenders call stated loans "liars loans " for a reason, i would estimate that only 10 to 15% of stated income loans are appropriate for the customers who get them.....i'm probably getting out of the loan biz soon,i don't play these games,i don't like seeing people getting set up for this kind of pain...think about joe scmoe who gets in late fibs a little because the loan officer and lenders encourage it and then finds out he can't even go bankrupt...because he commited fraud on the app.i am not condonining any of this and i see a chunk of what remains of our middle class going down the drain in a hurry,but this could not go on without the cooperation and in some cases active encouragement of the lenders

Mar 15, 2006, 3:23:00 PM  
Blogger Matt Norris said...

Speaking in terms of business, the problem for me is this:

As a mortgage broker, what am I supposed to tell my client that says, "well, Joe Loan Officer at my local bank said that a lot of mortgage companies are getting in trouble for fraudulent activity."

He'd be right. Obviously, I can sit there and show the client that I have never been investigated for fraudulent activity, and I can show him testamonies from past clients who were pleased from my service, but it is never good to have someone walk into the door with an attitude of distrust before they have ever even met you. Makes it that much harder to sell a loan to them.

In short:

Some other jerk's mistakes and crooked activities are going to make it more difficult for me to operate my business. I guess this is why I get so steamed about this and write such long diatribes. Mortgage brokers who know what they're doing can save clients a LOT of money (we can cream the local banks around here on interest rates and settlement charges).

However, when this starts getting out in the media, buyers are going to be weighing the bad stories much more heavily than the potentially good benefits the mortgage broker can provide.

Furthermore, with the screwball affect all of the fraud is having on housing prices, it makes it that much harder to qualify buyers to purchase a home. Bad situation.

Mar 15, 2006, 3:46:00 PM  
Anonymous Anonymous said...

Uh....Okay.

Mar 15, 2006, 11:20:00 PM  
Anonymous Anonymous said...

Isn't there huge opportunity for the IRS and the Feds to get together and audit all these stated income loans?

If the income is really there and hasn't been reported as income, the IRS wins. If the income isn't there and the application is fradulant the Feds win?

Either way the government could make an obscene amount of money with one small task force.

Mar 16, 2006, 1:18:00 PM  
Blogger Matt Norris said...

"Isn't there huge opportunity for the IRS and the Feds to get together and audit all these stated income loans?

If the income is really there and hasn't been reported as income, the IRS wins. If the income isn't there and the application is fradulant the Feds win?

Either way the government could make an obscene amount of money with one small task force."

There are numerous problems with this:

First of all, I'm not sure the IRS reserves the right to arbitrarily audit these loans. They might. According to the 4506-T form that every borrower signs in a loan transaction, the form authorizes the LENDER to request copies of tax returns.

However, I'm not sure the IRS can arbitrarily start telling lenders that they want to see all of their files for individual borrowers. I would think they would need a subpoena, which means they need to show probably cause that a crime has been committed.

Here is where it gets tricky:

For the LENDERS (i.e., the banks that pay brokers to send them loan) to audit the files, they must use their own internal Quality Assurance department. This poses numerous problems:

1) The lender has to pay to do the audits. This includes paying the auditors as well as paying for all the overhead involved with the audit.

2) For lenders who offer stupid programs that are easily defrauded, as soon as the fraud becomes public, they themselves are going to become the object of a criminal investigation. Here's why:

The underwriters that work for the lender are paid on commission. The account executives who work for the lender and are responsible for convincing brokers to send mortgages to that lender - they are also paid on commission.

In other words, the account executives and underwriters are involved with the fraud by telling the broker how specifically to fibb the income to make the loan work. I have investigated this and it HAS happened.

So now, if the lender's own underwriters and account executives are implicated in the scheme, that lender becomes responsible. Furthermore, it's quite possible that someone in a high position at the lender company has encouraged this. If that is the case, why would that person order an audit of all files if it results in implicating their own involvement in the fraudulent activity?

Man, if I were running some independent third-part company that the government could assign power to randomly audit the stated files of mortgage companies, I would be rich.

Going to write my Congressman about this.

Mar 16, 2006, 1:41:00 PM  
Anonymous Anonymous said...

Could we also setup a petition to have our congressman look into this, outlining the details as they are described here?

It might help create some additional weight / momentum on the issue.

I find it hard to believe that this level of fraud - while complex - isn't being more fully investigated.

Mar 16, 2006, 4:25:00 PM  
Anonymous Anonymous said...

..also...

The IRS probably can audit your home loan.

If you're living clearly beyond your means - i.e working at McDonalds and living in a McMansion, there is enough evidence of either misreported income, or fraudulent loan application - probably sufficient to get a subpoena right there.

The IRS could review all home purchases over the past 3 years - it's public knowledge - then compare that with the reported income.

All loans over the past x years might be subject to random audit of stated / under-reported income.

Am I off base here?

Mar 16, 2006, 4:43:00 PM  
Anonymous Anonymous said...

I'm pretty sure that increased risk of an IRS audit on home loan applications would quash any desire - on the borrower's part - to use a stated income loan. :)

If it were to get out into the media that the IRS / Feds were auditing stated income home loans we'd see a significant reduction in their use, a reduction in the number of buyers would lead to increased inventory, etc, etc.

Mar 16, 2006, 4:46:00 PM  
Blogger Matt Norris said...

" Could we also setup a petition to have our congressman look into this, outlining the details as they are described here?

It might help create some additional weight / momentum on the issue.

I find it hard to believe that this level of fraud - while complex - isn't being more fully investigated."

It's not fully investigated because they don't have the resources. So the resources they have are going to the mega-sized fraud operations that involve cooperation between mortgage brokers, title companies, appraisers, etc.

The FBI had something around 500 total pending mortgage fraud cases in the 2nd quarter of 2005 (per their website). Considering how many stated-income loans are done nation-wide every month, I have a feeling the FBI is WAY behind on this matter.

" ..also...

The IRS probably can audit your home loan.

If you're living clearly beyond your means - i.e working at McDonalds and living in a McMansion, there is enough evidence of either misreported income, or fraudulent loan application - probably sufficient to get a subpoena right there.

The IRS could review all home purchases over the past 3 years - it's public knowledge - then compare that with the reported income.

All loans over the past x years might be subject to random audit of stated / under-reported income.

Am I off base here?"

Honestly? I'm not sure. It's something I need to research more. Traditionally, the IRS investigates fraudulent reporting of income on your tax returns when you filed your taxes.

Fraudulent income claims on mortgage application have, to this point, been handled by the FBI (lying on a loan application is a federal offense).

I am not sure if the IRS would have jurisdiction to investigate mortgage fraud or not. Now, if an FBI investigation exposed fraudulent reporting of income on taxes, it is quite possible that they would pass the case over to the IRS to handle the investigation on tax evation.

Like I said, though, I am not an expert on who has jurisdiction to do what when it comes to investigating mortgage fraud. I'll speak with some folks tomorrow or next week and try to get you all some answers on that.

Mar 16, 2006, 4:53:00 PM  
Anonymous Anonymous said...

Awesome post. thankyou thankyou thankyou.

Mar 16, 2006, 9:12:00 PM  
Blogger Marinite said...

You're welcome welcome welcome :)

Out of curiosity, why so thankful?

Mar 20, 2006, 7:22:00 PM  
Blogger Marinite said...

I mean, I get a lot of flack for this blog (and I do mean a lot) so any positive feedback does me a lot of good.

Mar 20, 2006, 7:23:00 PM  
Blogger Matt Norris said...

This week, I have been trying to figure out who specifically in the state of Missouri I would contact on this matter. I have calls in with people all over the state.

The funny thing is this:

Not one person I have talked to really has a clue about mortgage fraud. They didn't know what a "stated income" loan was, so I'm having to e-mail this huge report to everyone to explain the situation.

This pretty much reinforces what I'm saying:

The individuals involved with mortgage fraud investigation are only really familiar with "cookie cutter" cases of appraisal fraud and creating false income documents. Most of them appear to not have been aware that a loan program existed that did not even require income documentation.

In short, this is a serious mess, and it appears that very little has been done to investigate the matter. The multi-million dollar appraisal fraud and document forgery schemes are what get the FBI's attention. However, I think if they started investigating individual stated loan transactions, they would uncover a much more menacing beast than what they have dealt with to this point.

Mar 21, 2006, 8:29:00 AM  
Anonymous trakz said...

I think your blog is one of the best. Please keep up the great work. Your giving us responsible savers, hard data and great facts to support or rational arguments.

This thread is especially interesting, since it seems to be an as yet unidentified gray area, that's being extensively exploited and may be contributing substantially to the run up in home prices.

If only we could get some legal help in identifying the nuances of the system I'm sure we're onto something very illegal.....

Mar 21, 2006, 12:12:00 PM  
Blogger Matt Norris said...

"I think your blog is one of the best. Please keep up the great work. Your giving us responsible savers, hard data and great facts to support or rational arguments.

This thread is especially interesting, since it seems to be an as yet unidentified gray area, that's being extensively exploited and may be contributing substantially to the run up in home prices.

If only we could get some legal help in identifying the nuances of the system I'm sure we're onto something very illegal..."

Well, there isn't much grey area, per-se. It's definitely illegal. The problem is that nobody is pursuing it, apparently. At least, not with any zeal.

Mar 21, 2006, 2:17:00 PM  
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Jun 26, 2006, 3:26:00 AM  

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