Continued demand and rising interest rates put constraints on the housing market in 2018, making it a difficult year for buyers trying to claim their spot in the housing market. These hot housing market conditions had an indirect effect on lenders, who saw the risk of mortgage application fraud increase by 10% last year, according to CoreLogic.
While the rise in fraud was attributed to genuine buyers trying to qualify for a mortgage (albeit with questionable verification sources), the trend is nonetheless worrying for the industry, which faces increasingly tight margins. As we make our way into 2019, what are the most common risks for lenders to consider? How can we, as an industry, tackle this changing mortgage fraud landscape effectively? The answers lie not in adding more steps to the already lengthy underwriting process, but in understanding the risks associated with mortgage fraud and the options currently available to mitigate those risks.
The current estimate is one in 109 mortgage applications contain an element of fraud. One noted upward trend is income fraud risk — where borrowers misrepresent the source, continuance, amount or existence of income — which had the highest year-over-year increase at 22.1%.
Short employment tenure — less than one year — has been a tactic used in income fraud, as lenders cannot verify recent records of income through a legitimate source like the IRS. This trend has been amplified by technology, which makes it easier to purchase or create fraudulent documents. A simple search online can bring up websites that generate fake pay stubs and services that will "confirm" income or employment to lenders. In May 2018, Fannie Mae released a "Misrepresentation of Borrower Employment Scheme" fraud alert about a large number of employment fraud schemes occurring in California, where housing prices have seen record highs. Similar instances are taking place across the country.
In addition to income and employment fraud, there has been an increase in out-of-state investor loans, which have a higher risk of inflated values and undisclosed real estate, and higher reported fraud rates overall (140%). Between 2013-2017, the number of out-of-state investor loan applications increased by 25% and now account for 20% of all investment applications.
Multi-lien fraud involves a borrower obtaining multiple concurrent equity loans on the same property. While these fraud attempts decreased in 2018, the anticipated rising interest rates and stronger home equity positions make this method likely to increase this year. Because the loans often total far more than the property is worth (the average loan size for this scheme is over $225,000), the entire loan amount may be a loss.
So, what can lenders do to reduce their susceptibility to fraud risk in 2019 and beyond? The solution requires more than adding tasks to the origination process. In fact, some of the controls put in place since the financial crisis to prevent repurchase risk and losses due to fraud may be limiting a lender’s ability to mitigate fraud effectively. Exhaustive due diligence on each application and overzealous audits can add costs and time to the lending process but still fail if staff become numb to the volume of tasks or do not understand the objectives.
The steps to improving fraud defenses depend on a lender's current practices. Those relying on internet searches and underwriter identification of red flags are at risk of hidden labor costs and inconsistent outcomes. Adopting an automated mortgage fraud tool brings thoroughness, consistency and transparency to resource use. It's great if lenders are already using an automated mortgage fraud tool but they should review how it's used to ensure it's not adding unnecessary work to the process.
While home price gains are slowing, all signs still point to a strong economy, which may continue to squeeze buyers. At the same time, fewer loans in the marketplace are putting additional pressure on originators, possibly leading to riskier behaviors to maintain volumes. As technology makes committing fraud easier, lenders should be mindful of suspicious transactions like new employment with a large income increase, alternative documentation, gift letters, and other down payment assets that cannot be verified by a trusted source. It's critical for lenders to be in a position where they can recognize fraudulent loan applications quickly — and it is easier when they have the right tools at their disposal.