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UNDERSTANDING THE BASICS OF
MORTGAGE FRAUD
The Life Cycle of a Mortgage Loan
THE LIFE CYCLE OF A MORTGAGE LOAN
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Learning Objectives
Identify the players in the mortgage loan process and their responsibilities.
Understand what is important to look for in critical documents.
Introduction
A key to fraud detection, prevention, and investigation is to understand the weaknesses and stress points
in the mortgage loan process. Those who commit mortgage fraud understand how to exploit those
weaknesses. In this section, we will look at the mortgage loan process as a fraudster would, and point
out its weaknesses so that we can become better at enacting controls, detecting red flags, and
investigating fraud.
The majority of fraud is committed by, or with the direct assistance of, industry insiders (such as
builders, property sellers, loan officers, appraisers, realtors, attorneys, and title agents). One study
indicates that more than 81% of all mortgage fraud is committed with the knowledge and often the
participation of an industry insider.
Fraud can be perpetrated at any stage of the process, but the majority of mortgage fraud is perpetrated
at origination. Fraud can be committed by anyone who has access to the loan application and supporting
documents.
Following is a discussion of the players, the expectations (from the perspective of a fraud investigator),
and the fraud trends among each of the players involved in a mortgage loan transaction.
Property Seller
In a purchase transaction there is a property seller. The seller should be the individual listed on the
public deed records found in the county courthouse where the property is located. It becomes
problematic when someone other than the owner of record enters into a transaction to sell a property
he doesn’t own.
A refinance transaction should not involve a property seller because, technically, the borrower is the
owner of record at the time of the refinance. Exceptions to this include divorce and inheritance.
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The Life Cycle of a Mortgage Loan
A property seller can be an individual home owner, a builder or developer, a manufactured housing
dealer, a real estate investor, or a bank.
Individual Home Owner
In the majority of residential home transactions, the seller is an individual whose desire it is to sell his
property, with knowledge and in good faith, near its market value, and who seeks to profit only from the
sale of the home, whether it is his primary residence, an investment property, or a second home.
Builder or Developer
If someone is purchasing new construction, the seller is likely to be a corporate builder or developer.
Sometimes, builders also purchase and renovate older apartment complexes into individual
condominium units. A builder profits only when the property sells. Builders and developers have a
vested interest in finding buyers that qualify for financing.
Builders are generally prohibited from requiring the use of a specific lender or title agent as a condition
of the sale. Allegations against builders for this practice include:
• Raising the prices of homes when buyers decline to use the builder’s mortgage affiliate or
subsidiaries.
• Requiring buyers to deposit extra money in escrow accounts if they refuse to use an affiliated lender.
• Coercing buyers into using a designated lender with the threat of withdrawing a seller’s credit toward
closing costs.
Manufactured Housing Dealer
Manufactured housing is now considered real property. Buyers purchasing manufactured units can
obtain permanent financing through mortgage loans rather than chattel loans from banks. Therefore,
manufactured home dealers now participate as sellers in mortgage transactions. In some cases, the
manufactured home dealer may also own the lot and sub-development where the manufactured home
unit is or will be located.
Real Estate Investor
Investors who purchase properties, renovate them, and resell them are known as property flippers. It is
not uncommon for such a property seller to be in title for a short period of time, usually just long
enough to renovate the property and find a buyer. The flipper may take title to the property under a
corporate name or an LLC and, therefore, when the property is sold, the property seller might be a
corporation rather than an individual.
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The Life Cycle of a Mortgage Loan
Bank-Owned Real Estate
When a bank takes a property back due to foreclosure, the property becomes an asset of the bank.
Therefore, a bank (or investor) can become the property seller when that property is sold. This property
is often referred to as real estate owned (REO).
Expectations of a Property Seller
• To sell his property in good faith and at market value. In a distressed situation, the value might be at
the lower end of what the market will bear.
• To be the owner of record of the property when entering into a purchase contract to sell it.
• In an arm’s length transaction, to expose the property to the open market so that competition will
dictate its market value.
• In a non-arm’s length transaction, to disclose the relationship between the seller and buyer.
• To list in the purchase agreement all the contributions the seller is willing to make toward the
buyer’s purchase of the property.
• To require a good faith earnest money deposit (EMD) from the buyer to be placed in escrow with a
title agent.
• To disclose addenda with all incentives on the purchase contract.
Fraud Trends – Property Sellers
• In many cases of mortgage fraud, the property seller is the orchestrator.
• The seller may have a mortgage broker’s license or may steer a buyer to a certain loan officer with
promises of instant qualification or reduced origination points.
• Property sellers may recruit borrowers via advertising or real estate investment clubs.
• A seller may enter into a purchase contract with a borrower on properties not currently owned by
the seller (misrepresenting himself as seller).
• A buyer may provide all documentation to the property seller and have no contact with the loan
officer.
• The seller may coach the borrower through the loan application process.
• The seller may access the loan officer’s credit bureau subscription and run a credit report.
• The seller may order and pay for the appraisal, and supply comparable sales for the appraiser to use.
• The seller may offer lavish undisclosed incentives to borrowers.
• The seller may make an undisclosed offer to pay the borrower’s down payment.
• The seller may offer a turnkey property management service.
• The seller may float a loan by making the first year’s mortgage payments.
• The seller may misrepresent the condition or construction of the property he is selling.
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The Life Cycle of a Mortgage Loan
Real Estate Listing Agent
Real estate listing agents are usually independent sales workers who provide their services to sellers and
buyers through a licensed real estate broker on a contract basis. The listing agent is paid a commission
on the sales price received for the home.
Licensing and Regulation
Every state requires real estate brokers and sales agents to be licensed. For more information about each
state’s licensing and regulation, visit the National Association of Realtors State and Local Leadership
Directory at www.realtor.org/leadrshp.nsf/?OpenDatabase.
Multiple Listing Service
The multiple listing service (MLS) is a database that allows real estate agents representing sellers to share
property information with other brokers who may represent potential buyers. The MLS combines the
listings of all available properties within a given MLS service area and can be utilized by any broker who
is a member of the National Association of Realtors (NAR).
The purpose of the MLS is to enable efficient distribution of information so that when a real estate
agent finds a potential buyer, that agent may search the MLS and retrieve information about all homes
for sale in a given area or price range.
The MLS is governed by private entities, such as a county or regional board of realtors, and the rules are
set by those entities with no state or federal oversight, beyond any individual state rules regarding real
estate. MLS systems set their own rules for membership, access, and sharing of information.
Listing agents create the listings for properties being sold by their clients, the property sellers. Only the
listing agent can modify, update, and change the information in these listings.
A person selling his or her own property, or for sale by owner (FSBO), cannot put a listing for the home
directly into the MLS. Similarly, an agent who chooses not to join the trade association or operate within
the association’s rules cannot join or access the MLS.
In many transactions where sellers are looking for buyers, the property will be listed in the MLS.
Typically, a sale listed in the MLS is considered exposed to the open market. Sales that occur between
two people and have not been exposed to the market are considered private sales. Because of their
limited exposure, these sales may not be good indicators of market value.
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The Life Cycle of a Mortgage Loan
Limited Service Listings
The real estate industry offers flat fee MLS or limited service listings, which entail a licensed subscribing
agent placing pertinent information about a property into the MLS for a flat fee. FSBO properties are
sometimes listed this way.
Expectations of a Real Estate Listing Agent
A real estate broker who becomes an agent of a seller is called a fiduciary. As a fiduciary, a real estate
broker is held by law to owe specific duties to his or her principal (the seller). The following services are
typically provided by the listing agent:
• Running a market analysis to help determine the fair market value.
• Advertising the property.
• Negotiating the best possible price and terms.
• Reviewing all written offers with the seller.
For representing the seller, the agent receives a commission when the house is sold. A typical
commission for listing a property is between 3% and 6%.
Fraud Trends – Real Estate Listing Agents
• The listing agent’s fiduciary duty may be to someone other than the client.
• The agent may also be the loan officer.
• MLS listings may be created after the property has been put under contract or has sold.
• The agent may recruit emerging market buyers and provide fraudulent identifying information.
• The sales price may be negotiated over and above the listing price with a stipulation that the excess
goes to the perpetrator.
• An earnest money deposit (EMD) may be held from the borrower rather than placing it in escrow
with a title agent.
• As the listing agent for a bank REO division, he or she may provide a fraudulent BPO value under
the market value, purchase the property from the bank, and then flip it to someone else.
• An agent may accept limited service listings with unreasonable or unlikely listing prices.
Borrower
For the purpose of this course and the industry standard, the buyer in a purchase transaction and the
owner in a refinance transaction are referred to as borrowers.
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The Life Cycle of a Mortgage Loan
The Armchair Investor
This type of borrower is typically naïve and trusting, having been seduced into thinking that investing in
real estate is quick, easy, and profitable. This type of borrower might have read a book on how to get
rich quick by investing in real estate, or may know co-workers or family members who have profited
from recently acquired properties.
The armchair investor’s hope is to cash in on the lucrative real estate market by essentially getting
something for nothing. He believes industry insiders who claim borrowers can qualify for multiple
property purchases with no money down. The properties being sold are often in inner-city areas and
may need extensive repairs. The seller might claim that the repairs have already been made and the
property is occupied by responsible tenants. In some cases, the borrower does not even inspect the
property before closing.
The borrower may have no idea how he was able to qualify for multiple loans and might not even know
the loan officer listed on his loan application. In many cases, the borrower is unaware that his qualifying
documentation has been altered or fabricated. Even though all this information is included on the
documentation signed at closing, the closing may be rushed, and the borrower may be told to sign blank
documents, or be assured that any corrections noted by the borrower will be fixed after closing.
These investment schemes often involve affinity group fraud, which occurs when a group of individuals
who are joined together by a common affiliation or goal, such as religion, education, employment,
ethnicity, or political beliefs is targeted; often it is a trusted member who preys on the other members of
the group.
Straw Borrower
A straw borrower is someone with good credit who, for a fee, takes out a loan for the benefit of
someone else. A straw borrower believes that he will not be obligated to reside on the property or repay
the loan.
Credit for Sale
A borrower may be recruited for his good credit and then receive a fee for purchasing property. The
borrower may be told that his only contribution will be to qualify for the loan and that another party
(often the perpetrator or a recruiter) will handle all other aspects of ownership, including renovating the
property, finding a tenant, collecting rent, and making the mortgage payments, and then ultimately the
perpetrator will split the proceeds with the borrower.
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The Life Cycle of a Mortgage Loan
Sponsor
A sponsor is typically a well-meaning family member who agrees to co-sign for another family member
with poor credit, only to find out at closing that the sponsor is the only person listed on the loan. Under
duress, they are convinced to sign the closing documents as the sole borrower with the reassurance that,
in one year, the title and loan will be transferred into the other family member’s name.
In cases involving an out-of-state straw borrower, the straw may be sent one set of closing papers
thinking they are a co-borrower signing a duplicate set. Two things may then happen: either the original
borrower did not sign a duplicate set of closing papers, or those duplicate documents signed by the
original borrower are discarded after closing. In either case, the qualifying documentation in the loan file
has most likely been altered and false statements may have been made to facilitate loan approval.
Identity Fraud Victim
Identity fraud involves stealing a person’s identifying information for the purpose of committing theft.
A good example of identity fraud is using someone else’s Social Security number (SSN) to apply for a
credit card or loan. Victims of this type of fraud are often unaware that someone has used their
information illegally.
While there are many reported instances of security breaches resulting in compromised private personal
information (PPI), there have been no rashes of security breaches that have resulted in the origination of
mortgage loans. It is much more likely that industry insiders, who may retain PPI from previous
transactions, use this information over and over without the knowledge of the borrowers.
Some schemes involve the use of a deceased individual’s SSN, while other cases involve using an issued
SSN that hasn’t been used, creating a new credit profile.
Accomplice
In some cases, the borrower is an overt accomplice to the scheme, but this is the exception rather than
the rule. Since the borrower is typically the one most affected, and therefore most likely to squeal when
the loan goes into default, perpetrators prefer to use the identities of unsuspecting borrowers.
Expectations of a Borrower
• To enter into a purchase agreement in good faith and with a full understanding of the magnitude of
the transaction.
• To shop for a loan officer with the best loan product and understand the loan product being
solicited.
• To accurately represent to the loan officer the borrower’s purpose for the loan, as well as his
employment, income, assets, debts, and occupancy.
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The Life Cycle of a Mortgage Loan
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To review, or hire an attorney to review, the closing statement prior to closing.
To profit at the time of purchase only by becoming the owner of a property that is likely to increase
in value through natural appreciation over time.
Fraud Trends – Borrowers
• The borrower may use armchair investors, straw borrowers, or accomplices, or use information
obtained via identity theft.
Real Estate Buyer’s Agent
In legitimate transactions, buyers may select real estate agents to help narrow down the choice of homes
for sale. Buyer’s agents have the same duties and fiduciary responsibilities to their clients (the buyers) as
listing agents. They typically have access to the MLS but are not allowed to alter or update listings they
did not create.
Fraud Trends – Real Estate Buyer’s Agents
• There may be no buyer’s agent for the transaction.
• The realtor may also be the mortgage broker, may recruit the borrower by means of the MLS, and,
with access to the borrower’s PPI, may misrepresent the borrower’s qualifications for a loan.
• The realtor’s fiduciary duty may be to someone other than the buyer.
• The realtor may not disclose contract addenda to the loan officer.
Lender
The lender is the institution that provides the money for the loan. The loan officer may or may not be
affiliated with the lender. As mentioned earlier, many lenders are non-depository institutions. Aside
from those lenders that do loan against their own portfolios of assets, lenders typically secure loan
money from the following sources:
• The secondary market (as discussed earlier)
• A correspondent lender
• A warehouse line of credit
Correspondent Lender
A correspondent lender is an entity that typically closes mortgages it originates with a purchasing
lender’s funds. A correspondent performs some or all of the loan processing functions, such as taking
the loan application; ordering credit reports, appraisals, and title reports; and verifying the borrower’s
income and employment. The correspondent may or may not delegate underwriting. The mortgage is
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The Life Cycle of a Mortgage Loan
closed in the correspondent’s name but is funded by the purchasing lender. A correspondent may also
commission a mortgage broker to perform some of the origination or processing functions.
Warehouse Line of Credit
Many non-depository mortgage lenders, and some commercial banks, maintain warehouse lines of credit
to fund loans prior to sale to another lender or the secondary market. The lender handles all aspects of
the origination, processing, and underwriting, and closes the loan using funds from the warehouse line
of credit. The loan remains in the warehouse line just long enough for a lender to sell the loan to
another lender or in the secondary market. Once sold, the warehouse line is repaid. A lending institution
with a warehouse line of credit might commission a mortgage broker to perform some of the origination
or processing functions.
Loan Officer
The loan officer may or may not be affiliated with the lender that funds the loan. Loan officers are
typically either retail loan officers or third-party originators (TPOs).
Retail Loan Officer
A retail loan officer works for the funding lender, whether a commercial bank or a non-depository
lending institution that utilizes secondary market funds, correspondent relationships, or warehouse lines
of credit.
Loans originated by a retail loan officer are the most basic transactions with the fewest third parties
involved. All parties can be employees of the financial institution, including the appraiser. All steps in
approving the loan can be done in-house and once the credit decision is made, the transaction is often
closed in-house.
Being salaried, a retail loan officer may not make as much per loan as someone on commission, but the
retail loan officer can utilize the referral network within the lending institution to originate more loans.
A salaried loan officer is not as reliant on commissions and therefore not under as much pressure to
close the loan.
Third-Party Originator
A third-party originator (TPO) is a mortgage broker or correspondent that partially originates and
processes a loan for a funding lender. The funding lender then underwrites and approves the loan. The
funding lender rarely has direct contact with the borrower during the origination process, and relies on
the TPO to order and obtain the appraisal. The funding lender relies solely on the integrity of the
information provided by the mortgage broker when making an underwriting decision.
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The Life Cycle of a Mortgage Loan
A TPO is usually paid a commission and therefore may be more incented to produce and close as many
loans as possible. Because the TPO is in control of all information related to the loan transaction, an
unscrupulous TPO is able to misrepresent any components he wants.
Case studies and reports show that fraud involves TPOs more often than retail loan officers.
Expectations of a Loan Officer
Regardless of what state a borrower resides in, or what kind of loan officer they go to, there are duties
that loan officer performs. In general, the loan officer:
• Looks out for the borrower’s best interest.
• Interviews the borrower and takes a completed loan application, whether online, over the phone, or
in person.
• Educates borrowers regarding the mortgage loan process and available products, assists borrowers
in deciding which program is best for them, and ensures borrowers have a clear understanding of
what qualifying documentation is needed.
• Gathers the appropriate documentation from the borrower and not through an intermediary (such
as the property seller).
• Maintains contact with the borrower throughout the approval process.
The Three Cs of Underwriting
Underwriting a mortgage is a fairly standard process. When lenders are considering extending a loan,
they must assess the three areas of underwriting: credit, capacity, and collateral — the three Cs.
Underwriting is a blended analysis of these three factors:
• Credit – The likelihood that the borrower will repay the mortgage.
• Capacity – The borrower’s ability to repay the mortgage.
• Collateral – What the borrower has to offer if he can’t repay the mortgage.
If one of the three Cs is weak, a borrower is still likely to qualify for a mortgage, but the risk to the
lender is greater, which means the interest rate on the loan, or the amount of required documentation
may be higher. Lenders layer the risk so if the collateral risk is low, a lender might be willing to accept a
higher capacity risk. If all three risks are low, the lender might lower the amount of documentation
required. If all three Cs are weak (i.e., the risk to the lender is high), it may be difficult to obtain a
mortgage.
Automated Underwriting Systems
One of the major changes that has occurred in the mortgage lending industry during the past few years
is the utilization of automated underwriting models to underwrite and approve mortgage applications.
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Today, automated underwriting systems (AUSs) enable lenders to obtain a risk classification without
traditional manual calculations and subjective analysis. Automated underwriting shrinks the timeline of
the mortgage approval process from weeks to minutes, saving borrowers time and money and
eliminating much of the frustration and uncertainty involved in getting a mortgage. The objectivity of
the system also assures consumers that their applications will be evaluated fairly.
The two largest mortgage investors — Fannie Mae and Freddie Mac — have each developed their own
AUS for evaluating mortgage loans. Fannie Mae’s system is called Desktop Underwriter® and Freddie
Mac’s is Loan Prospector®. These systems employ artificial intelligence with a predictive model that
assigns a quantitative risk factor to individual mortgage applications. Many lenders will underwrite their
files according to these secondary market investors’ guidelines to ensure eligibility of being purchased by
Fannie Mae and Freddie Mac.
With these systems, the mortgage broker or mortgage lender enters the loan application data into the
AUS. Based on the data entered, the system generates a Findings Report that indicates whether or not
the loan application is approved, and if it is, sets forth the documentation required to verify the
application data.
AUSs allow for multiple submissions so it is possible to adjust unknown variable data fields such as the
purchase price, interest rate, or repayment schedule in order to gain an approval. However, it is not okay
to manipulate non-variables such as income, assets, or occupancy for the sake of approval. The integrity
of the data is only as good as the person submitting it.
It is possible that the final submission will look quite different from earlier submissions. However, some
data should be relatively unchanged. For example, income does not typically increase dramatically over a
30- to 60-day period. Bank balances could change, but would require explanation. One thing that might
change is the primary borrower; it may be decided that a relative is needed to co-sign for a borrower
with poor credit.
Fraud Trends – Loan Officers
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Fraud is more likely to be perpetrated by a third-party originator (TPO) than a retail loan officer.
– A TPO may target lenders that have a reputation of lax controls, and send them all of their
loans.
– A TPO may accept completed loan packages from a property seller or other interested party. A
TPO might have no contact with the borrower.
– A TPO may accept a borrower’s qualifying documentation from someone other than the
borrower.
There may be excessive AUS submissions for one loan.
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The Life Cycle of a Mortgage Loan
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There may be consistent excessive YSPs.
A TPO may originate numerous loans with similar patterns (for example, loans using the same
appraiser, loan officer, or loan type).
The address listed on the loan application may be a post office box.
Fraud Trends – Mortgage Brokerage Firms
The mortgage brokerage firm may:
• Lack controls and procedures to prevent fraudulent originations.
• Not perform background checks on loan officers or branch managers.
• Not have adequate pre-funding quality control processes in place.
• Not properly train, monitor, or supervise loan officers or branch operations.
• Allow branch operations to operate autonomously.
Loan Processor
Some loan officers gather all documentation directly from the borrower. Others turn this duty over to a
loan processor. In smaller TPO branches, the loan officer may also be the processor, whereas in larger
companies, the processor may be at a central location removed from the office of the loan officer. A
loan processor often has access to and utilizes the AUS.
The loan processor carries a lot of responsibilities. The processor gathers and validates all of the
information and verifies if it is complete and accurate. Verification requests may be sent to employers,
mortgage holders, landlords, and lending institutions to verify the borrower’s monthly income,
employment history, and funds to close. The loan processor should verify that all the loan documents
are provided by the borrower and are true and correct originals, and not fraudulent.
Typical verifications sent out:
• A verification of employment (VOE) goes to current and past employers to verify employment
information.
• A verification of deposit (VOD) goes to the borrower’s banks to verify the funds in the borrower’s
accounts.
• A verification of mortgage/verification of rent (VOM/VOR) goes to any current mortgage
company or landlord to verify current payments and the timeliness of those payments.
The loan processor typically orders the appraisal and places the order for the title commitment.
When all the information is collected the processor verifies that basic lender loan requirements have
been met, and then the file is packaged in a manner that the lender specifies. The complete package,
including the appraisal and the title commitment, is then sent to the underwriter. If a loan scored high
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enough in an AUS, there may be significantly fewer documentation requirements, making the process
much quicker.
If the underwriting process (discussed later) determines that there are deficiencies in the documents
provided by the processor, the underwriter will issue certain conditions, known as stipulations, or stips.
The responsibility to satisfy these stips typically falls on the loan processor. These closing conditions can
include items that perhaps need updating or more explanation.
Fraud Trends – Loan Processors
The loan processor may:
• Work exclusively for one or more loan officers and not on a rotating basis.
• Clear conditions with fraudulent or forged documentation in order to get a loan approved and
closed.
• Hurry the loan’s turnaround.
• Accept documentation from the property seller or another third-party instead of the borrower.
• Manipulate the AUS.
• Not even exist.
Appraiser
An appraisal is usually obtained as part of the underwriting process. An appraisal is an opinion of the
quality, value, or utility of a specific property.
An appraiser is retained by the loan officer or processor. Appraisers may be employed by financial
institutions, government agencies, or real estate corporations or organizations. Many real estate
appraisers are in business for themselves and work independently.
Appraisal management companies (AMCs) are becoming more popular with lenders. An AMC offers
appraisal services to lenders by making use of professional appraisers acting as independent contractors;
a fee-sharing arrangement compensates both the AMCs for their marketing efforts and the appraisers
for their expertise. An AMC manages appraisal vendors and all of the ordering, tracking, and delivery
tasks that need to be attended to in a real estate mortgage transaction.
There are four generally accepted classifications of appraisers:
• Appraiser trainee: Someone who is qualified to appraise those properties overseen by, inspected by,
and signed by a supervising certified appraiser.
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Licensed residential real property appraiser: Someone who is qualified to appraise non-complex oneto four-unit residences having a transaction value less than $1,000,000 and complex one- to fourunit residences having a transaction value less than $250,000.
Certified residential real property appraiser: Someone who is qualified to appraise one- to four-unit
residences without regard to value or complexity. To be a state-certified residential appraiser
qualified to do appraisals for federally related transactions, a state must have requirements that meet
or exceed a minimum standard.
Certified general real property appraiser: Someone who is qualified to appraise all types of real
property. To be a state-certified general appraiser qualified to do appraisals for federally related
transactions, a state must have requirements that meet or exceed a minimum standard.
The appraiser’s responsibility is to independently determine the value of the property. Because collateral
is such a major component of a loan decision, an accurate value is critical to originating a quality loan.
Licensing Requirements
To become a real property appraiser, a candidate will need to obtain education and experience, and pass
a state-administered licensing or certification exam. The minimum number of education hours as set by
the Appraisal Qualification Board (AQB), an independent board of the Appraisal Foundation, are as
follows (many states require more):
Classification
Hours
Appraiser Trainee
75
Licensed Residential Appraiser
150
Certified Residential Appraiser
200
Certified General Appraiser
300
The AQB has set the following minimum criteria for experience:
Level
Appraiser Trainee
Licensed Residential Appraiser
Certified Residential Appraiser
Certified General Appraiser
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Hours of Experience Required
Subject to direct supervision by a
supervising appraiser who is certified in
good standing
2,000 hours in no fewer than 12
months
2,500 hours in no fewer than 24
months
3,000 hours in no fewer than 30
months
Mortgage Fraud