The Efforts to Deter Mortgage Loan Fraud

If you got a group of economists in a room in 2013, and asked them if they had to name one factor- just one, as to what brought down the world economy in 2008, there might be quite a few diverse answers to the question. Many of those in the room might say that out of control speculation, in stocks and other investments had caused the devastating economic collapse when the economic bubble burst. This could certainly be justified when describing the tech bubble that burst just before 9/11. Others would say that it was 9/11 itself, with the accompanying  deflation of consumer confidence- not to mention, right after the terror attacks, a basic fear of gathering in public places, such as shopping malls.

But I’d be willing to bet that the number one cause of the economic debacle that started in the last decade would be attributable to the mortgage meltdown. It was bad mortgages that brought down Lehman Brothers to a great extent, and put insurance giant AIG on the ropes due to the large stake they had in insuring mortgages. And of course there was the tremendous collapse in real estate values. As the U.S. went, so went the rest of the industrialized world, as many foreign investors has placed their money in what seemed like a rock solid investment- U.S. mortgage-backed securities.

To take this line of thinking to an even more micro level, it is widely felt by many economist and analysts that what brought down the mortgage market was fraud. There was fraud in the fact that many who applied for a mortgage made up their financial profiles out of mid air.  It’s hard to believe now, but as late as 2008, an individual or a couple could finance a home purchase strictly by stating their income, their liquid assets, and put next to nothing down with a credit score as low as 580! This is thought of a preposterous today, but until the middle of 2008 it was a common occurrence. And by the way, the mortgages that were obtained with these types of fantasy financials might very well have allowed for a balance that rapidly increased and/or monthly payments that could quadruple in a single month under the perfect storm of circumstances.

It’s seems harsh today to blame to near collapse of world markets solely on the U.S. mortgage industry, but bad mortgage loans made on fraudulent information certainly played a major; if not the major, role in the economic meltdown.

Mortgage lenders have learned plenty from their mistakes, however. In 2013, it is virtually impossible to obtain a mortgage loan without documenting the borrowers’ financial profile every which way from Sunday. It might even be said that in today’s environment, lenders are overbearing on their insistence for documentation on the part of those who would like to borrower money.  Overbearing it may be, but in light of the aftermath of the mortgage-induced economic crisis that still affects us today, it is also understandable.

There is really no room for fraud in today’s mortgage market. I’m not just talking in a legal sense here, but also from an auditing sense as well. There are so many checks and cross-checks in mortgage lending today, that fraud is next to impossible to pull off.

Let’s take income verification for an example. Whereas pre-2008 a borrower could state their income and have the lender believe whatever they were told, today a borrower must present their income taxes for the last 2 years, and these taxes are audited between the lender and the IRS. The buyer must sign a form called the 4506-T, which allows the IRS to provide transcripts of the borrowers’ 1040’s. The numbers on transcripts must match what is on the 1040’s supplied to the lender, or there is no deal.  Even if the transcribed tax returns would otherwise qualify the borrower, the fact that they don’t match the 1040’s presumes that there has been an attempt at fraud and the borrower will have no recourse with the lender. In the case where taxes were amended, most lenders will not accept a 1040-X if it was filed after the initial loan application; and furthermore, the IRS will not usually verify amended returns for the lender for 6 to 12 weeks after they are filed.  And of course, increasing the income on an amended return will almost always increase the tax liability to the tax payer. Let’s just say that filing an amended return in the midst of applying for a mortgage loan is, well… messy!

Then there’s the question of assets. A lender will want to verify that the borrower actually has the money that they need to close a real estate transaction, and there are some sources of funds that are not acceptable to most lenders. If a buyer’s bank statement indicates a deposit that cannot be linked to his payroll that deposit will have to be explained and sourced. Maybe the large deposit was a tax refund. In the rare instance that the refund is not direct deposited (in which the bank statement would indicate that it was derived from the U.S. Treasury), then a copy of the tax refund check would have to be displayed to the lender. Deposits that derive from strictly cash for the most part must be discounted; that is, removed from the total of acceptably certified funds. For instance if a borrower shows $15,000 in a bank account, but $5,000 can be explained only as a cash deposit, the borrower generally gets credit for only $10,000. If the extra $5,000 is needed to close the real estate transaction, then it must be gotten from another acceptable source. In many cases this can be a gift from a family member. But even then, the donor must fill out a gift letter and supply his bank statement to show an ability to provide the gift. This can be a severe nuisance, especially to the donor. But it also guards to some extent against money laundering; that is, having the borrower supply non-sourced funds to the donor only to be given back to the buyer in the form of a gift. It’s not going to happen!

In regards to appraisals, those who originate loans, and those staff people who support them, cannot order appraisals. In the old days, pre-2008, a loan officer could call up his favorite appraiser and ask him to appraise a property and to hit a certain value. Most appraisers were honest, but there were a few here and there that, out of fear of not getting future business from the loan originator, would massage a number to make it come out just right. These days an appraisal must be ordered by someone within the mortgage company that will not benefit based on whether or not the appraisal comes in at value. Appraisers are usually picked in rotation from a panel or gotten from appraisal agencies that work with the lender. And in most companies, loan originators are not allowed to have any salient conversations with the appraiser as to property value. In the case of a purchase, the appraiser will obtain a copy of the buyer/seller contract, but influence on the part of the originating party is severely reduced or even prohibited.
Another important aspect of mortgage fraud prevention that was not around in force a few years back are  Mortgage Electronic Registration Systems reports; otherwise known as MERS reports. These reports are particularly adept at finding other properties that may be owned by the borrowers but were not reported on the loan application. This would apply to properties that are free and clear- even out of state vacant land.  If other properties are revealed in the report, they must be accounted for by the buyer and taken into consideration in regards to the borrower’s qualifications.

It’s simply amazing that there are still those who attempt to pull off mortgage fraud. Every month, many of us in the mortgage business received electronic newsletters from a couple of prominent real estate law firms that tell us who has just been indicted for mortgage fraud throughout the U.S. and its territories. How anyone thinks that can get away with this is beyond me. All the time, in these newsletters, we hear of people going to prison for 10 to 20 years or more, and being fined 100’s of thousands of dollars for being implicit in mortgage fraud. Sometimes I think that the perpetrators’ prison sentences should be doubled just for the stupidity that they demonstrate!

I’ve heard from many people, and sometimes feel myself, that mortgage lenders are a bit overbearing in their zealousness to stop mortgage fraud. I’m mean; let’s face it, just because person deposits cash into their checking account doesn’t mean that they’re trying to pull of the crime of the century! But as I’ve said many times before, the key to getting though that gauntlet that is very often a part of obtaining a mortgage loan in just knowing that rules that are in play. This is where an experienced mortgage professional can be invaluable to prospective borrowers. The housing market is way up, in California at least. So there are an awful lot of folks who are succeeding in financing home purchases. It can be done with a professional team comprised of a knowledgeable lender and experienced Realtor®. There are plenty of examples out there.

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