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Combating Mortgage Fraud

Jenny Brawley, CFEMortgage Fraud Investigation Manager

Freddie Mac

[email protected]

ACFE Webinar SeriesMarch 15, 2007

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Topics

� Background

� Legal Aspects

� Schemes and Trends

� Indicators – Types of Misrepresentations

� Elements of Detection and Investigation

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Polling question

� Financial/mortgage service industry professional (including audit, originations, compliance)

� Law enforcement or government regulator

� Service provider to mortgage industry (preventive, detection or investigative services)

� Other

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Polling question

Years of experience in the industry� Over 10 years

� 5 – 10 years

� 2-5 years

� Under 2 years

� No prior experience

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Topics

� Background

�� Legal AspectsLegal Aspects

�� Schemes and TrendsSchemes and Trends

�� Indicators Indicators –– Types of MisrepresentationsTypes of Misrepresentations

�� Elements of Detection and InvestigationElements of Detection and Investigation

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Mortgage Fraud Defined

“Material misstatement, misrepresentation, or omission relied upon by an underwriter or lender to fund, purchase or insure a loan.”

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San Jose Mercury –

May 5, 2005

“ Husband of “Wendy’s Chili” case defendant arrested on loan fraud charges”

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Fraud for Housing

� Perpetrator is typically the borrower� Involves a single loan� Loan level misrepresentations� Borrower seeks housing and/or cash from

loan� Borrower intends to repay – loan usually

current

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� Dateline January 2007– Anchorage, AK –Loan Loan OriginatorOriginator Indicted for $5M mortgage fraud scheme with stated income documentation

� Dateline February 2007 – Centreville, VA -Loan Loan ProcessorProcessorsentenced in mortgage fraud case

� Dateline January 2007– Luzerne County, PA -LawyersLawyers indicted in mortgage fraud scheme

� Dateline January 2007– Shakopee, MN –Real Estate Real Estate AgentAgent charged with identity theft in $3M mortgage fraud

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� Dateline January 2006– Houston, TX – Indictments handed down in $5M straw borrowerstraw borrower scheme

� Dateline January 2006– St. Louis, MO - Former Title Insurance ExecutiveTitle Insurance ExecutiveSentenced in Mortgage Fraud Scheme

� Dateline April 2006– Pittsburg, PA - Unlicensed Pennsylvania AppraiserAppraiser Indicted for Inflated Appraisals

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Fraud for Profit

� Often involves industry professionals� Multiple transactions� Includes numerous, gross misrepresentations

and omissions� Participants frequently paid for participation� Borrowers may not be aware of the scheme� Most have property value issues� Do not intend to repay

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New Players

� Dateline November 2006– Chicago, IL - “Reputed gang membersgang membersarrested in mortgage fraud probe.”

� Dateline April 2005– Milwaukee, WI – “There is growing evidence that a lot of criminals are using the mortgage finance industry to launder money - people like drug dealersdrug dealersand terroriststerrorists…” said Tim Doyle, the Mortgage Bankers Association's director in government affairs.

� Dateline July 2005– World News Tonight with Pierre Thomas reporting – “Across the country, con men, scam artists, evendrug dealersdrug dealersare increasingly turning to mortgage fraud… with a scheme known as property flipping.”

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New Players

� Dateline August 2005 – Herndon, VA - Mortgage Fraud Charges Against Man Linked to Osama Bin Osama Bin LadenLaden

� Dateline April 2006 – Salt Lake City, UT - Loan fraud suspect may have terroristterrorist links

� Dateline December 2006 – “Organized crime Organized crime finding mortgage fraud.”

� Dateline October 2004 – Atlanta, GA - “ Antifreeze Antifreeze killerkiller charged with forgery in mortgage fraud.”

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Role of the Mortgage Broker

� Lenders contract with independent brokers (“TPO”) to originate loans� Brokers typically responsible for meeting with

borrowers, gather documents and do initial credit report and scoring through “automated underwriting systems (AUS)” for pre approval, order appraisal report and title search

� Some brokers have delegated authority to issue final approval and issue closing funds using lender’s warehouse line

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Role of the Mortgage Broker

� Lenders rely on brokers to provide accurate and true information

� Lenders have recourse from brokers to seek repurchases under “representations and warranties” if loan is deemed fraudulent

� Brokers are not as well capitalized as lenders –may not be able to repurchase loans

� Much of the mortgage fraud reported today involves brokers rather than retail lenders

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Role of the Borrower

� Legitimate, though naïve, individual hoping to cash in on the lucrative real estate market

� Straw� “Credit for sale” – with a good FICO score, makes

$5-50K per transaction� “Buy For” family member

� Accomplice� Identity theft victim

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“I bought the property with no money down.”

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Topics

�� BackgroundBackground

� Legal Aspects




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Did you know…

� …currently there is no federal statute that makes mortgage fraud a federal crime?

� Mortgage fraud is prosecuted under one or more of the following federal statutes.

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Statute Brief Description

18 U.S.C. § 1341 Mail Fraud

18 U.S.C. § 1343 Wire Fraud

18 U.S.C. § 1344 Bank Fraud

18 U.S.C. § 1519 Destruction, Alteration or Falsification of Records

18 U.S.C. § 1951-61

Racketeer Influenced and Corrupt Organizations (RICO)

18 U.S.C. § 1956 Money Laundering

18 U.S.C. § 1005 False Entries

18 U.S.C. § 1010 Dept of HUD and FHA transactions

18 U.S.C. § 408 Fraud in connection with Social Security identification documents

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Applicable Criminal State Laws

� State of Georgia –Only State with a Mortgage Fraud Statute

� Current Applicable Statutes in Other States� Theft, larceny, theft by deception� Forgery, false documents, false swearing� Identity fraud� Racketeering� Conspiracy

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Legal Aspects

� How is the profit / money derived?

� Who gets the profit / money?

� What is the deception – the misstatement, misrepresentation, and / or omission?

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Legal Aspects

� “What are the losses?”� Many legal jurisdictions require that an actual loss

be suffered before prosecuting a mortgage fraud case

� All federal districts adhere to a different “thresholds” (losses) before taking a case

� Federal districts calculate losses differently� Unpaid principal balance + accrued interest +

expenses related to marketing and selling the property - minus any net proceeds from sale of property

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Topic



� Schemes and Trends



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Common Fraud Schemes

� Foreclosure rescue scams

� Identity theft

� Property flips

� Air loans

� Builder bailouts

� Money laundering

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Current Trends

� Highly organized fraud-for-profit schemes� Third-party originators (“TPO” or broker)

vs. retail loan officers� Orchestrated by property seller in collusion

with broker, appraiser and / or title agent� Multiple investment properties sold to single

borrower – all originated as “owner occupied”

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Current Trends

� Loans stay current but will eventually go into default

� One stop shopping

� Majority have value issues

� Movement from state to state

� Affinity group fraud

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Foreclosure Rescue Scams

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Foreclosure Rescue Scams 2

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� Home owner is solicited by “rescuer” with promise of short-term “private investor”financing and pay off delinquent loan

�� Get to stay in home Get to stay in home and rent back from “investor”

� Convinced by “investor / rescuer” to convey title to “investor / rescuer” as collateral

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� Where does “rescuer/investor” get his money to offer short term financing and pay off existing debt?� Recruits “straws” to originate mortgage loans (to

“purchase” homeowner’s house)� Straw is qualified based on material loan-level

misrepresentation� Straw usually does multiple transactions on

numerous properties, all owner occupied!

� Straw is usually compensated/gets a rebate from “rescuer” for his participation

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� At closing, homeowner is “tricked” into deeding property� Actually executes documents selling the house at FAIR

MARKET VALUE

� At closing, proceeds pay off defaulted loan amount� At closing, homeowner walks away with $00

� Usually have misrepresentations on closing statement (HUD-1) showing funds going to homeowner (seller)

� Instead, “Rescuer”pockets the equity and runs� “Straw” defaults on loan� Homeowner (tenant) is evicted; looses house AND equity

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Identity Theft Schemes

� Dateline April 2004– CO – brokers obtained personal information from people who thought they were applying for jobs in the mortgage industry.

� Dateline January 2007– Westchester, NY –mortgage fraud identity theft scheme nets NY youth pastor 4 years.

� Dateline February 2007 –Seattle, WA – mortgage broker and title agent facilitate massive ID theft scheme.

� Everywhere – mortgage solicitors by phone, door-to-door or Internet.

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Identity Theft - Deed Scams

� Dateline July 2005- Lee County, FL –“Investigation uncovers phony deed scam of dead man’s home”

� Dateline January 2007– Long Beach, CA –“Man charged with mortgage fraud for mortgaging grandfather’s home”

� Dateline February 2006– Detroit, MI –“Criminals steal homes out from underneath unsuspecting citizens”

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Appraiser Identity Theft

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Property Flips

� Property flipping is not illegal� Rapid transfer of title with an unjustified increase in

value. � Usually done in conjunction with investment

property originations.� Orchestrated by the property seller or recruiter.� May involve simultaneous closings in which the

second transaction funds the “purchase” of the first transaction.

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New Guidelines to Prevent Fraudulent Flips

� HUD regulations changed in 2003� Only homes purchased from owner of record are

eligible � Homes sold within 90 days of prior sale not

eligible� Homes sold between 90 – 120 days of prior sale

where selling price is 100% greater, two appraisals required

� Lenders amended closing instructions with language to prohibit flips (early 2003)

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“Buy High, Sell Higher”

� Property on the market (MLS) for $300,000� Motivated legitimate property seller (house been

on the market a long time or distressed situation)

� Schemer lines up a “straw” who makes purchase offer for $400,000 to seller

� Seller agrees to a refund a portion of difference with schemer / straw ($70,000) and seller keeps $30,000

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“Buy High, Sell Higher”

� Appraised value is inflated to support $400,000� Loan is originated based on inflated value and

misrepresentation of straw borrower’s eligibility � Seller is indifferent; gets original asking price +� One closing is held� Schemer / straw split the net of $70,000� Loan goes into early payment default

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Short Sales

� Distressed owner approached by schemer willing to buy property for $50,000 (owes $75,000)

� Appraiser undervaluesproperty

� Lender agrees to short sale of $50,000

� Schemer then obtains an inflatedappraisal of $200,000

� Flips property

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Air Loans

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Air Loans

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Builder Bailout

Property is worth $100,000 but builder sells to buyer for $120,000 based on inflated appraisal.

Buyer gets loan ($100,000). Builder provides “seller second” to finance the down payment of $20,000. Buyer often qualified based on misrepresentations.

Builder forgives the “seller second” debt. Builder gets his original asking price, the lender now has 100% LTV (no equity) and buyer has 100% financing.

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Money Laundering

� Placement – placing illegally obtained funds into the financial system by virtue of committing mortgage fraud

� Layering – buying properties with “dirty”money and flipping it to someone at fair market value

� Integration – requesting refunds of principal reduction payments

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Topic




� Indicators – Types of Misrepresentations


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Common Misrepresentations

� Inflated values� Rapid transfer of title� Fabricated/altered appraisals� Loan level misrepresentations

� Fabricated/altered employment, income and asset documentation

� Misrepresentation of borrower source of funds to close

� Occupancy misrepresentation

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Inflated Values

� Ways to “push” the value� Phantom renovations

� Inappropriate comparable sales

� Omissions and material misrepresentations of subject property

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Phantom RenovationsWhat you see…

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What you get…

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Renovations never done!!!

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Comparable Sales ApproachWith occasional exceptions, this is the order offeatures that have the most impact on the value ofa Property:� Location, location, location! � Design- layout/appeal/style� Room Count� Square Footage� Quality, age, condition, amenities, and other

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Inappropriate ComparablesIf appraiser has to “leave the neighborhood” to obtain a

better comp, the first question should be “why are the better

comps not located within the subject’s market area?”

How do you define the “neighborhood?” Appraisers

typically follow a 1-mile rule, but a neighborhood can

change dramatically within a 1 mile radius so look for other

landmarks such as railroad tracks, highways, school

districts, zoning, water frontage.

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Inappropriate Comparables

�Selecting comparables that will support a predetermined value

�Misstating distance between comparables

�Using “flipped” properties as comparables

�Using non-existent comparables

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Inappropriate Comparables

�Available data sources to find comps

�Multiple Listing Services (“MLS”)

�Public records

�Which is right?

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Omissions and Material Misrepresentations

� Omission of prior sales or listings of subject and comparables

� Misrepresentation of current owner

� Material misrepresentations of subject property

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Misrepresentation of Subject

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Rapid Transfers

� Many schemes involve properties that are being sold in rapid succession

� A title commitment and appraisal report are often altered or information changed to conceal a “flip” – the vested owner is incorrect

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Falsified / Altered Appraisals

� Many appraisal reports today are transmitted electronically as PDF files – using electronic signatures

� Appraisal software allows appraisers to lock signature

� Technology makes is easier to unlock PDF files and alter the report

� Many appraisers don’t adequately protect their electronic signatures

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Loan-Level Misrepresentations

� Credit� A high FICO score shows the ability and

willingness to repay

� Capacity� Has the capacity to repay based on gainful

employment and income� Has the assets to make the necessary equity

contribution

� Collateral� The lender will be secured with sufficient

collateral

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“Backward Application”

� Score loan through AUS (automated underwriting system) using arbitrary figures to get the “accept” level desired

� Back into the ratios by fabricating the necessary documentation

� Technology has made it easy to fabricate / alter employment records, bank statements, income tax returns, credit reports

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“Backward Application”� Purchase a house valued at $300,000 (sold last

week for $150,000) with 80% LTV� Need a good FICO score� Will need $60,000 at least in checking account� Loan Amount - $240,000 ( 30 year at 6.25%) =

monthly payments of $1,477.72� Using a 28% front ratio, I will need to gross

$5,277.57 a month� Appraisal report will support $300,000 purchase

price� ….no problem!

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Fabricated Bank Statement

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Correct Bank Statement

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“Asset Rental”Company on Web offers to “rent assets” for mortgage loan applications…

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Borrower Employment

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Novelty Paystubs

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Source of “Funds to Close”Misrepresentation

� Inflate the assets (bank balances)

� Inflate the purchase price

� Silent seconds

� Disguise the purchase transaction as a refinance

� Earnest money deposit paid to seller outside of closing

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Inflate the Assets

� Document loan file with significant source of funds to close by altering balance in bank accounts

� Deposit funds in borrower’s bank account and then w/d after verification comes in

� Add borrower to non-borrower account to perfect VOD

� Falsify gift funds

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Inflate the Assets� Cashiers checks for down payments not drawn

on borrowers’ banks!!!

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Inflate the Purchase Price

� Have borrower execute a purchase contract at inflated amount� Or forge a purchase contract

� Get inflated appraisal to substantiate the value

� Use this variance in inflated value as the borrowers’ down payment

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� At closing,deduct proceeds from seller’s disbursements

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� At closing, use as borrower’s funds to close

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Silent Seconds� Borrower agrees to purchase price of $90,000

� Purchase contract signed or forged for $100,000

� Appraisal inflated to $100,000

� Seller provides $10,000 second lien used for borrower’s required equity contribution

� Borrower often unaware of the silent second as loan is for agreed purchase price of $90,000

� Seller never records this second lien and “forgives” it

� See in builder bailout schemes

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Silent Seconds

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Disguise Transaction as a Refinance

� WHY?�Don’t need a down payment for a refinance

�LTV based on appraised value and not a purchase price

�No seasoning requirements required by some investors

� Usually orchestrated by property seller

� Borrowers are told they can purchase property with no money down

� Borrowers attend only one closing

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Disguise Transaction as Refinance

� Loan officer / broker structures loan as refinance (scores it through AUS as a refinance)

� Conveys deed to borrower about one week prior to closing / file fictitious mortgage as evidence of prior lien; OR

� Conveys property to borrower using a land contract (backdated) and arranges an immediate “refinance”

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Disguise Transaction as Refinance

� At closing, money is disbursed to pay off seller’s lien

� Title agent usually part of the collusion� Often will list borrower as “vested owner” on title

commitment

� No funds to close required of borrower

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Earnest Money Paid Outside Closing

� Pay substantial (5-20%) earnest money deposit to seller outside of closing (not escrowed at title company)

� Seller usually in collusion – money does not really change hands but is listed on the HUD-1

� Lender assumes borrower has made an equity contribution

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Occupancy Misrepresentation

� Credit header report never lists property address� Utilities never transferred into borrower’s name� Fabricated lease agreements often put in file to

justify WHY moving from current, encumbered residence that shows up on credit report

� For multiple properties per borrower, SSN is altered for each loan

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Topics





� Elements of Detection and Investigation

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Elements of Detection and Investigation

� Profile of borrower

� Re verifications

� Appraisal review

� “Follow the money”

� Look for patterns

� Servicing records

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Profile of Borrower

� 28 years of age� Works at minimal wage job� $100,000 in 401K� $90,000 in non-interest bearing accounts� Bank statement has NSF or service charge fees� Rents � Has high interest rate credit card balances and

collection accounts

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Borrower Profile

� Re-verify employment� Do background on employment company – who

owns it? What is located at the address listed on the loan application and VOE?

� Re-verify income� Many lenders have borrower fill out a Form 4506

� Re-verify assets� Contact the bank about the bank statements

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Profile of Borrower

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www.salary.com

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Appraisal Review� Look at the photos, map and the sketches

� Use valuation models� Is this property an anomaly? Is it in a high-flip

area?

� How many homes sold in that neighborhood as of the appraisal date?

� Utilize databases to determine prior sales history of subject and comparable sales

� Verify owner of record as of the appraisal report date

� Order field review appraisal

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Sketches

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Appraisal Review

� Who ordered and paid for the appraisal? Was it the property seller or realtor in behalf of the lender / broker

� Is appraisal dated before the purchase contract or loan application?

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Appraisal Review

� Check licensing board for license and any disciplinary actions or instances of identity theft

� Interview appraiser� Gather work files from appraiser

� Print out of list of all comparable sales under consideration (what data source did he use)

� Source document to verify owner of record as of appraisal report date

� If identity theft is asserted, gather documentation of actions taken by appraiser

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Follow the Money

� Obtain the title agent’s disbursement summary sheet for list of funds received� When is the check representing “funds to close”

dated?� Are funds to close provided from same bank in

which borrower has funds?� Are funds to close deducted from seller?

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Follow the Money

� HUD-1 disbursements - obtain the title agent’s disbursement summary sheet for list of disbursements� Unusual payoffs on to non-lien holders?

� Repair allocation� Referral fees� Consulting fees

� Seller proceeds going to “shell companies” not listed on the HUD-1?

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Look for Patterns

� Same broker or loan officer� Check for disciplinary actions and license

� Same appraiser� Same property seller� Same borrower� Same street� Loan purpose (all refinances?)� Early payment default (“EPD”)

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What Pattern do you see?

Smithski 2305 SECO ADOBE Mayberry $196,000.00 12/31/199 6Joneski 102 AUTUMN LANE Mayberry $207,000.00 12/31/1996Brownski 108 AUTUMN LANE Mayberry $207,000.00 2/28/1997Phillipski 110 AUTUMN LANE Mayberry $206,500.00 4/7/199 7Cervaski 114 AUTUMN LANE Mayberry $207,000.00 2/28/1997Cloudski 118 AUTUMN LANE Mayberry $207,000.00 4/17/1997Kotterski 119 AUTUMN LANE Mayberry $206,500.00 4/7/1997Asterski 128 AUTUMN LANE Mayberry $207,000.00 4/17/1997

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One Document – Numerous Files

� Compare similar documents found in numerous loan files� Same employer

� Pay stubs look similar/same control number on W-2

� Same bank

� Alternative credit letters

� Gift letters

� Purchase agreements

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Servicing Records

No valid phone number – Collector is unable to contact borrower

Returned mail with no forwarding address

Immediate address change requested

Social Security number change requests

Insurance changed from occupant to investor

Work number is disconnected or…Borrower’s employer does not know borrower or borrower was terminated from employment prior to theclosing date

Loan is coded owner occupied, but the borrower states reason fordefault is “tenant not paying rents”

Borrower requests refund of substantial principal reduction

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Servicing Review“Oh…this isn’t my loan. I let someone use my name and they were supposed to make the payments”

“My broker/realtor/seller is supposed to be making the payments”

“I’m not responsible for the payment. I only purchased the house for a friend/relative”

“I deeded/sold this property to_____. Contact them for the payment”

“I bought multiple investment properties from the same person andthey are all vacant and in disrepair”

“Yes, my name is Jane Borrower, but I’ve never lived at or heard of a property located at 555 Scammed Street”

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Servicing Portfolio Analysis“This isn’t my loan. I never owned property at that address”

“I don’t have a loan payment on this house”

Review for first payment defaults and early payment defaults

Focus on geographical areas where the default rate is above average

Review production of branches or loan officers whose loan default rate is above average or increased dramatically

Review monthly production to identify geographical concentrations

Periodic review of high volume producers

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http://www.fbi.gov/publications/financial/fcs_repor t2006/financial_crime_2006.htm

FBI Publications: Report to the Public

http://www.fbi.gov/page2/dec05/mortgagefraud121405. htmFBI Publications: The Rise of Mortgage Fraud

http://www.appraisalfoundation.org/s_appraisal/sec. asp?CID=3&DID=The Appraisal Foundation

http://www.legis.state.ga.us/legis.2005_06/fulltext /sb100.htmGeorgia Residential Mortgage Fraud Act

http://www.ffiec.gov/exam/3P_Mtg_fraud_wp_oct04.pdfFFIEC White Paper – Detection, Investigation and Deterrence of Mortgage Fraud

http://www.fraudproblem.com/where-to-complain/Mortgage Broker Regulators

http://www.mari-inc.comMortgage Asset Research Institute Inc

http://www.asc.govAppraisal License Check

http://www.realtor.comFind current MLS listings

http://www.searchsystems.netGuide to finding county tax records and deed transf ers

http://www.salary.comSalary

http://www.seachbug.netSearchbug (people and company finder)

http://www.lexisnexis.comLexis Nexis (business affiliations and property records)

http://www.mapquest.comMapquest

http://www.freddiemac.com/dgtq/pdf/fr.pdfFreddie Mac – Red Flags of Fraud

http://www.freddiemac.com/dgtq/pdf/dgtq_qc.pdfFreddie Mac Best Practices – Quality Control

http://www.zillow.comZillow – aerial shots of properties

See Links BoxProperty Flip

http://www.consumerlaw.org/news/ForeclosureReportFi nal.pdfDreams Foreclosed

http://www.mortgagefraudblog.comMortgage Fraud Blog

Online Resources

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Summary & Questions

Jenny Brawley, CFE

Mortgage Fraud Investigation Manager

Freddie Mac

[email protected]

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