3501 Fairfax Drive Room B3030 Arlington, VA 22226-3550 (703) 516-5588 FAX (703) 516-5487 http://www.ffiec.govThe Detection and Deterrence of Mortgage FraudAgainst Financial Institutions: A White PaperProduced by the July 13 – 24, 2009FFIEC Fraud Investigations SymposiumParticipants:Donald Buford, James McGraw, Jeffry Petruy, Debra Stabile, Edmund Wong, FDICJacqueline Dreyer, FRB-Richmond, Elton Hill, Federal Reserve Board, Jason Tarnowski,FRB-Cleveland, Deanna Wilner, FRB-ChicagoDennis DeGrave, Vickie Apperson, NCUAJoanna Beazley, Debra Harwood, Joseph Smith, OCCEdward Bodden, Alan Faircloth, OTSChuck Cross, CSBS on behalf of the State Liaison CommitteeDarlene Callis, Senior Program Adminstrator and Moderator, FFIEChttp://www.ffiec.govBoard of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National CreditUnion Administration, Office of the Comptroller of the Currency, Office of Thrift Supervision, State LiaisonCommittee
The Detection and Deterrence ofMortgage Fraud Against Financial InstitutionsTable of ContentsSection 1: OverviewPagePurpose1Introduction1Background2Basic Mortgage Transactions4Common Mortgage Fraud Schemes6Common Mechanisms of Mortgage Fraud Schemes9Common Participants10Conclusion11Section 2: SchemesBuilder Bailout13Buy and Bail16Chunking18Double Selling21Equity Skimming23Fictitious Loan25Loan Modification and Refinance Fraud27Mortgage Servicing Fraud31Phantom Sale34Property Flip Fraud36Reverse Mortgage Fraud39Short Sale Fraud42
Section 3: Fraud MechanismsAsset Rental45Fake Down Payment47Fraudulent Appraisal49Fraudulent Documentation54Fraudulent Use of a Shell Company68Identity Theft70Straw / Nominee Borrower72AppendixesGlossaryAMortgage Transaction Flow ChartsBCriminal StatutesCAdditional ResourcesDDisclaimer: Definitions used in this White Paper are intended to provide generalinformation to the reader and are not intended to supersede any regulatory or legaldefinition.
Section 1: Overview
PURPOSEThis White Paper is intended to raise the awareness of and assist examiners in identifying variousmortgage fraud schemes perpetrated against financial institutions. The White Paper also providesbest practices for deterring such schemes.INTRODUCTIONIn February 2005, the FFIEC agencies (Agencies) 1 issued a White Paper entitled The Detection,Investigation, and Deterrence of Mortgage Loan Fraud Involving Third Parties (2005 White Paper).The 2005 White Paper focused on methods to detect, investigate, and deter third party mortgage fraud.Financial institutions have experienced an increase in the number, volume, and types of mortgagefraud schemes resulting in significant losses. The 2009 White Paper updates mortgage fraud trendsand schemes currently impacting financial institutions. This White Paper is divided into three parts,followed by appendices that include a glossary, mortgage 2 transaction flow charts, listing of applicablecriminal statutes, and reference materials. The first section covers:Background: Information on the proliferation of and losses resulting from mortgage fraud.Basic Mortgage Transactions: Descriptions of basic mortgage transactions for retail andbroker-originated loans, as well as mortgage loans purchased from a correspondent.Common Mortgage Fraud Schemes: Definitions of common mortgage fraud schemes used toperpetrate mortgage fraud.Common Mechanisms of Mortgage Fraud Schemes: A list of common mechanisms used toperpetrate mortgage fraud schemes.Common Participants: A list of common participants who can be engaged in mortgage fraudschemes.1 The FFIEC was established in March 1979 to prescribe uniform principles, standards, and report forms and to promote uniformity in thesupervision of financial institutions. The Council has six voting members: the Board of Governors of the Federal Reserve System, the FederalDeposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, the Office of ThriftSupervision, and the State Liaison Committee. The Council's activities are supported by interagency task forces and by an advisory StateLiaison Committee, comprised of five representatives of state agencies that supervise financial institutions.2 For the purpose of this paper, the term Deed of Trust is considered to have the same meaning as “mortgage” and the latter term is usedthroughout.1
The second section provides a description of various schemes used to perpetrate mortgage fraud. Foreach scheme, the following information is provided: Definition Example(s) of the scheme Best practices to mitigate the scheme Red flags List of companion frauds associated with the scheme, if applicableThe third section provides a description of some common mechanisms used to perpetrate mortgagefraud schemes. For each mechanism, the following information is provided: Definition Example(s) of the scheme Best practices to mitigate the scheme Red flagsThis paper was designed for electronic usage, and can be navigated via the embedded hyperlinks.BACKGROUNDMortgage fraud has continued to increase since therelease of the first mortgage fraud White Paper in 2005.Declining economic conditions, liberal underwritingstandards, and declining housing values contributed tothe increased level of fraud. Market participants areperpetrating mortgage fraud by modifying old schemes,such as property flip, builder-bailout, and short salefraud, as well as employing newer schemes, such as buyand bail, reverse mortgage fraud, loan modification andrefinance fraud, and mortgage servicing fraud.For the purpose of this paperMortgage Fraud is defined as amaterial misstatement, misrepresentation,or omission of information relied uponby an underwriter or lender to fund,purchase, or insure a loan.Mortgage fraud can be classified intotwo general categories: fraud forhousing and fraud for profit.Source: FBI Financial Crimes Section,Financial Institution Fraud Unit,Mortgage Fraud: A Guide forInvestigators, 2003.Suspicious Activity Reports (SARs) filed by financial institutions continue to indicate that mortgagefraud is an escalating problem. According to the Financial Crimes Enforcement Network’s (FinCEN)2
most recent report, SAR Activity Report – By the Numbers (Issue 12, July 2009), SARs associated withmortgage fraud filed by financial institutions increased 23 percent from calendar year 2007 to calendaryear 2008. The charts below illustrate the increase in mortgage loan SAR filings.SARs Reporting Mortgage Loan Fraud(January 1, 2000 - December 31, 2008)70,000Total Filings60,00050,00040,00030,00020,00010,000SAR 520062007200818,391 25,931 37,313 52,868 64,816The total dollar loss amount attributed to mortgage fraud is unknown. However, during fiscal year2008, at least 63 percent of all pending FBI mortgage fraud investigations involved dollar losses ofmore than 1 million each. The losses reported on depository institution SARs approximated 1.5billion for fiscal year 2008 and 1.2 billion for the first half of fiscal year 2009 (FBI, 2008 MortgageFraud Report). It is important to note, however, that losses were reported in only 7 percent of themortgage fraud SARs filed during this period, as no loss was involved or the amount of loss wasunknown at the time of the other SAR filings.3
FI's Mortgage Fraud SAR Filings(FY 2004 - March 31, 2009)Dollar Loss in Milllions 1,600 1,400 1,200 1,000 800 600 400 200 MillionsFY 2004FY 2005FY 2006FY 2007FY 2008FY 2009 429 1,014 946 813 1,491 1,173Source: FBI - 2008 Mortgage Fraud ReportBASIC MORTGAGE TRANSACTIONSBasic mortgage transactions are generally the same whether the purpose of the loan is to purchase aproperty, refinance an existing loan, or obtain a loan against a property that is unencumbered and maybe offered through one of the channels described below:RetailIn retail transactions, the borrower makes an application directly with a financial institution loanofficer. These mortgage transactions are the most basic and involve the fewest number of thirdparties, which may include appraisers and closing agents. Usually, the application package consistingof financial information, credit report, a collateral valuation report such as an appraisal or evaluation,title information, and various other credit-related documents, is compiled and forwarded to anunderwriter for a credit decision. Upon approval, the financial institution then releases funds to aclosing agent, who disburses funds to the various parties. The loan package is returned to thefinancial institution and reviewed for quality and accuracy. The loan is either held on the financialinstitution's books or sold into the secondary market. Retail originations only include loans closed inthe financial institution's name.Broker OriginationA broker-originated loan is similar to the retail transaction, except that the borrower makes anapplication with a mortgage broker. A broker is a firm or individual, acting on behalf of either the4
financial institution or the borrower, who matches a borrower’s financing needs with an institution’smortgage origination programs. Brokers are compensated by receiving a commission expressed as apercentage of the total loan amount (e.g., 1 percent origination fee) from the borrower or through ayield-spread premium from the lender when the loan closes.Brokers have played a critical role in the wholesale loan origination process and have significantinfluence on the total loan transaction. Brokers have served as the point of contact for the borrowerand the lender, and coordinated the involvement of other parties to complete the transaction. A brokercan perform some or most of the loan processing functions including, but not limited to, taking loanapplications; ordering credit and title reports; verifying a borrower’s income and employment; etc.Once the broker has gathered the necessary information, the application is submitted along withsupporting documentation to one or more financial institutions for underwriting. The financialinstitution's underwriter reviews the information and makes a credit decision. The financialinstitution also may perform pre-funding quality assurance activities, such as re-verification of incomeand employment.A copy of the loan approval package, with documents prepared in the name of the financial institution,is then returned to the broker. Once the loan has closed, the completed package should be returneddirectly to the financial institution. Again, the financial institution may review the loan for qualityand either retain the loan in its own portfolio or sell it.Mortgage Loan Purchased from a CorrespondentIn this transaction, the borrower applies for and closes a loan with a correspondent of the financialinstitution, which can be a mortgage company, another depository institution, finance company, orcredit union service organization. The correspondent can close the loan with internally-generatedfunds in its own name or with funds borrowed from a warehouse lender. Without the capacity ordesire to hold the loan in its own portfolio, the correspondent sells the loan to a financial institution.The purchasing financial institution is frequently not involved in the origination aspects of thetransaction, and relies upon the correspondent to comply with the financial institution's approvedunderwriting, documentation, and loan delivery standards. The purchasing financial institution mayperform a quality control review prior to purchase. Also, the purchasing financial institution mustreview the appraisal or evaluation report and determine conformity with the Agencies’ appraisalstandards, regulations, and supervisory guidance, as well as the financial institution’s requirements.5
The loan can be booked in the financial institution’s own portfolio or sold.In "delegated underwriting" relationships, the financial institution grants approval to thecorrespondent to process, underwrite, and close loans according to the financial institution's processingand underwriting requirements. Proper due diligence, internal controls, approvals, quality controlaudits, and ongoing monitoring are warranted for these higher-risk relationships.The flow of the Retail and Broker Originated Transactions are graphically illustrated in Appendix B.Each of the Agencies has issued detailed guidance on a financial institution’s management of itsarrangements with third parties, including brokers, and associated risk. Examiners are encouraged toreview and consider the guidance issued by their Agency in evaluating broker arrangements.Additionally, the Secure and Fair Enforcement Mortgage Licensing Act of 2008 (S.A.F.E. Act) requireslicensing and/or registration for all residential mortgage loan originators. The system is also used forstate-licensed mortgage companies. More information is available at the website atwww.stateregulatoryregistry.org and contains comprehensive licensing, registration, enforcement actionthat is expected to be made available to the public through the website in the near future.Note: SARs should be filed, in accordance with the appropriate regulation, for those activitiesconsidered suspicious or fraudulent in nature, involving a fraud scheme or a fraud mechanism,as described throughout this White Paper.COMMON MORTGAGE FRAUD SCHEMESThis White Paper defines schemes as the big picture or secret plan of action used to perpetrate a fraud.There are a variety of “schemes” by which mortgage fraud can take place. These schemes can involveindividuals inside the financial institution or third parties. Various combinations of these schemesmay be implemented in a single fraud. The descriptions provided below are examples of traditionaland emerging schemes that are used to facilitate mortgage fraud. Click on the link for each fraudscheme to learn more about that particular scheme.Builder BailoutThis scheme is used when a builder, who has unsold units in a tract, subdivision, or condominiumcomplex, employs various fraudulent schemes to sell the remaining properties.6
Buy and BailThis scheme typically involves a borrower who is current on a mortgage loan, but the value of thehouse has fallen below the amount owed. The borrower continues to make loan payments, whileapplying for a purchase money mortgage loan on a similar house that cost less due to the decline inmarket value. After obtaining the new property, the borrower “walks” or “bails” on the first loan.ChunkingChunking occurs when a third party convinces an uninformed borrower to invest in a property (orproperties), with no money down and with the third party acting as the borrower’s agent. The thirdparty is also typically the owner of the property or part of a larger group organizing the scheme.Without the borrower’s knowledge, the third party submits loan applications to multiple financialinstitutions for various properties. The third party retains the loan proceeds, leaving the borrowerwith multiple loans that cannot be repaid. The financial institutions are forced to foreclose on theproperties.Double SellingDouble selling occurs when a mortgage loan originator accepts a legitimate application anddocumentation from a buyer, reproduces or copies the loan file, and sends the loan package to separatewarehouse lenders to each fund the loan.Equity SkimmingEquity skimming is the use of a fraudulent appraisal that over-values a property, creating phantomequity, which is subsequently stripped out through various schemes.Fictitious LoanA fictitious loan is the fabrication of loan documents or use of a real person’s information to apply for aloan which the applicant typically has no intention of paying. A fictitious loan can be perpetrated byan insider of the financial institution or by external parties such as loan originators, real estate agents,title companies, and/or appraisers.Loan Modification and Refinance FraudThis scheme occurs when a borrower submits false income information and/or false credit reports topersuade the financial institution to modify or refinance the loan on more favorable terms.7
Mortgage Servicing FraudThis fraud is perpetrated by the loan servicer and generally involves the diversion or misuse of loanpayments, proceeds from loan prepayments, and/or escrow funds for the benefit of the service provider.Phantom SaleThis scheme generally involves an individual or individuals who falsely transfer title to a property orproperties and fraudulently obtain funds via mortgage loans or sales to third parties.Property Flip FraudA fraudulent property flip is a scheme in which individuals, businesses, and/or straw borrowers, buyand sell properties among themselves to artificially inflate the value of the property.Reverse Mortgage FraudReverse Mortgage Fraud involves a scheme using a reverse mortgage loan to defraud a financialinstitution by stripping legitimate or fictitious equity from the collateral property.Short Sale FraudFraud occurs in a short sale when a borrower purposely withholds mortgage payments, forcing the loaninto default, so that an accomplice can submit a “straw” short-sale offer at a purchase price less thanthe borrower’s loan balance. Sometimes the borrower is truly having financial difficulty and isapproached by a fraudster to commit the scheme. In all cases, a fraud is committed if the financialinstitution is misled into approving the short-sale offer, when the price is not reasonable and/or whenconflicts of interest are not properly disclosed.Two additional fraud schemes, which are briefly addressed below, are debt elimination and foreclosurerescue schemes. While these schemes are typically not perpetrated directly on financial institutions,and therefore not expanded upon to the same degree as the above-mentioned schemes, the end result ofthe scheme can have a negative impact on the financial institution.8
DEBT ELIMINATION SCHEMEDebt elimination schemes are illegal schemes that offer to eliminate a borrower’s debt for an upfront fee. The organizers of these schemes create phony legal documents based on the borrower’sloan(s) for presentment to the borrower’s financial institution or other lending institution in anattempt to falsely satisfy the loans.The threat this fraud scheme presents to a financial institution is the borrower’s cessation of loanpayments. Financial institutions may find that the use of the false documents complicates thecollection process and may temporarily prevent any final action against the borrower.FORECLOSURE RESCUE SCHEMEForeclosure rescue schemes prey upon homeowners in financial distress or facing foreclosure,with the promise to help save their home. There are multiple variations of this scheme, oftencharging up-front fees and/or convincing the homeowner to deed the property to the fraudster,with the premise that the homeowner can rent or buy the property back once the individual’scredit has improved. The goal of the fraudster is to collect fees or mortgage payments that areintended for the lender, but are not delivered, usually resulting in the loan going into default andultimately foreclosure, causing loss to the financial institution.COMMON MECHANISMS OF MORTGAGE FRAUD SCHEMESThis White Paper defines mechanism as the process by which fraud is perpetrated. A single mortgagefraud scheme can often include one or more mechanisms and may involve collusion between two ormore individuals working in unison to implement a fraud. Click on the links to learn more about thatparticular mechanism. The following is a list of common mechanisms used to perpetrate mortgagefraud schemes:Asset RentalCash or other assets are temporarily placed in the borrower’s account/possession in order to qualify fora mortgage loan. The borrower usually pays a “rental” fee for the temporary “use” of the assets.Fake Down PaymentIn order to meet loan-to-value requirements, a fake down payment through fictitious, forged, falsified,or altered documents is used
The 2005 White Paper focused on methods to detect, investigate, and deter third party mortgage fraud. Financial institutions have experienced an increase in the number, volume, and types of mortgage fraud schemes resulting in significant losses. The 2009 White Paper updates mortgage fraud trends and schemes currently impacting financial .