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An Industry Assessment based upon Suspicious Activity Report Analysis
In recent years federal and state law enforcement and regulatory agencies have devoted considerable effort to the prevention, investigation and prosecution of mortgage loan fraud. The United States has experienced substantial growth in mortgage lending markets and of innovative loan products that have expanded consumer access to home finance. At the same time there has been a significant increase in filings of Suspicious Activity Reports (SARs) pertaining to suspected mortgage loan fraud.1
FinCEN’s Office of Regulatory Analysis conducted this assessment to identify any trends or patterns that may be ascertained from an analysis of SARs regarding suspected mortgage loan fraud. Analysts searched the Bank Secrecy Act database for SARs 2 from depository institutions filed between April 1, 1996 and March 31, 2006 that contained “Mortgage Loan Fraud” as a characterization of suspicious activity. The search retrieved 82,851 reports, which were examined to discern the trends and patterns revealed in this assessment. A random sample of 1,054 narratives was reviewed for additional analysis. The parameters for the sample size were set to provide a 95 percent confidence level with a plus or minus three (+/-3) confidence interval. The analysis revealed - among other trends addressed in this report - a sharp increase in the number of SARs reporting mortgage loan fraud beginning in 2002. This trend is depicted in Figure 1 below.Executive Summary
SARs pertaining to mortgage loan fraud increased by 1,411 percent between 1997 and 2005. This report filing trend continues apace in 2006, with 7,093 reports filed on suspected mortgage loan fraud during the first quarter, an increase of 35 percent over the SAR filings in the first quarter of 2005. One explanation for the increase in SARs reporting mortgage loan fraud is increased awareness of the potential for fraud in a dynamic real estate market. Many areas in the United States saw double-digit growth in real estate values during 2003 and 2004. At the same time, mortgage loan interest rates were at a historic low. Although growth in the housing industry appears to be slowing in the first quarter of 2006, opportunities for fraud are still present.
Reports of mortgage loan fraud rose significantly in 2003. The Federal Financial Institutions Examination Council reported an increase in the number of mortgage loans beginning in 2003: “The 2003 data include a total of 42 million reported loans and applications, which is an increase of about 33 percent from 2002, primarily due to a significant increase in refinancing activity (approximately 41 percent).” 3 SARs on mortgage loan fraud increased over 92 percent between 2003 and 2004. The increase in filings may be attributed to an increase in overall mortgage lending concurrent with the decline in interest rates in the 2002 – 2005 timeframe and a broader awareness of this fraudulent activity. Figure 1 depicts the filing trend between 1997 and 2005.
Mortgage loan fraud represents a growing percentage of total depository institution SARs. In 1997, reports of mortgage loan fraud comprised 2.12 percent of total depository institution SAR filings. In 2005, reports of mortgage loan fraud had increased to 4.94 percent of total depository institution filings. Figure 2 provides a comparison of the percentage of change in the number of total depository institution SAR filings to the change in the number of SARs reporting mortgage loan fraud.
Mortgage loan fraud can be divided into two broad categories: fraud for property and fraud for profit. Fraud for property generally involves material misrepresentation or omission of information with the intent to deceive or mislead a lender into extending credit that would likely not be offered if the true facts were known. The fraudulent activities observed in the SAR narratives describing fraud for property include: asset fraud; occupancy fraud; employment and income fraud; debt elimination fraud; identity theft; and straw buyers. 4 Fraud for property is generally committed by home buyers attempting to purchase homes for their personal use. In contrast, the motivation behind fraud for profit is money. Fraud for profit is often committed with the complicity of industry insiders such as mortgage brokers, real estate agents, property appraisers, and settlement agents (attorneys and title examiners). Typical fraudulent activities associated with this category in the SAR filing sampling are: appraisal fraud; fraudulent flipping; 5 straw buyers; and identity theft.
Identity theft was frequently reported in conjunction with the commission of suspected mortgage loan fraud. Reports of identity theft increased nearly 102 percent between 2004 and 2005. The depository institution SAR form began collecting data on identity theft in July 2003. The SAR Activity Review – By the Numbers, Issue 6 (May 2006) reported that identity theft was observed in nearly two percent of the total depository institution SARs. Identity theft was characterized as a suspicious activity on over two percent of the total mortgage loan fraud SAR reports. This is significant given the relatively brief amount of time specific data on identity theft has been collected in SARs.Overview
Real estate mortgage loan fraud poses a growing risk to financial institutions. The Federal Financial Institutions Examination Council reported: “Mortgage loan fraud is growing because it can be very lucrative and relatively easy to perpetrate, particularly in geographic areas experiencing rapid appreciation.”6 Although the true level of mortgage loan fraud is unknown, the growing awareness of mortgage loan fraud is confirmed by the year to year increase in the number of SARs describing this activity. (See Figure 1, Mortgage Loan Reporting Trend.) Depository institutions filed 82,851 SARs describing suspected mortgage loan fraud between April 1, 1996 and March 31, 2006. This represents 3.57 percent of all depository institution SAR filings submitted during that time period.
Over the past 30 years (1975 – 2005), house prices at the national level have grown at about a six percent annual rate. 7 However, in the first quarter of 2005, the national average percentage increase was 12.5 percent. Many U.S. coastal states saw housing prices increase by as much as 20 percent or more during 2004. By contrast, growth rates in many states in the South and Midwest fell below the national average. 8 Interest rates for 30-year mortgages declined throughout the period from 1997 through 2004, with the exception of the first three quarters of 2000. 9 The number of residential loans increased steadily by 153 percent between 1997 and 2003, according to the Federal Financial Institutions Examination Council. 10 “Adjusted 2003 data show that low and moderate-income census tracts taken together experienced the largest increase, 16 percent, in home purchase lending. Such lending for middle and upper-income census tracts increased by 9 percent , respectively, from 2002 to 2003, according to the adjusted 2003 data.” 11 The only year experiencing a decrease in the number of home loans was 2000, possibly due to concern over fluctuating interest rates during the first three quarters of 2000. The rapid growth in mortgage lending activity that resulted from the boom in the real estate industry could result in an increased risk in the mortgage loan industry.Vulnerabilities Identified in SAR Narratives
The use of the Internet and related technology to receive and process loan applications is increasing. The growing faceless nature of these transactions increases the opportunities for fraud (especially identity fraud) and, coupled with “low-document” or “no-document” loans, creates a condition vulnerable to fraudulent activity.
Using the Internet or telephone to receive and process mortgage loans means that lenders may never meet borrowers, even during the loan closing process. In some cases, lenders forward the loan documents to borrowers by courier service and the documents are returned to lenders in the same manner.
Filers reported use of the telephone or Internet in origination of mortgage loans on 106 reports of mortgage loan fraud (less than one percent). Figure 3 depicts the reports of suspected fraudulent loans originated via telephone or Internet since 1998. (Note that the filings for 2006 occurred during the first three months.)Sub-prime loans associated with suspected fraud
Sub-prime lending involves higher-interest loans extended to consumers with impaired or non-existent credit histories stemming from modest incomes or excessive debts. The mortgage industry designed innovative loan packages to allow more low-to-moderate income borrowers to qualify for loans. Filers reported a pattern of the use of exaggerated or fabricated income information associated with sub-prime loans. Such activity may be part of added efforts by some lenders to qualify borrowers in the sub-prime market.
Loans specifically identified as sub-prime appeared in 68 (less than one percent) of the total reports of mortgage loan fraud. Figure 4 depicts the number of report narratives that describe sub-prime loans in SARs reporting suspected mortgage loan fraud.Mortgage broker originated loans
The National Association of Mortgage Brokers reports that as many as two-thirds of mortgage loans are now originated by mortgage brokers. Currently there are no national standards for licensing and oversight of mortgage brokers. Some states license mortgage brokerage offices, but not individuals; 24 states have no specific educational or experience requirements for mortgage brokers; and only a few states require criminal background checks on mortgage brokers making it possible for unethical individuals to move from one mortgage brokerage firm to another.
Figure 5 depicts the number of sampled report narratives regarding mortgage broker-originated loans that involved suspected loan fraud. Note that the number of reports filed during the first quarter of 2006 equals the total number of reports filed in all of 2004.Identity Theft
Identity theft has been associated with both fraud for property and fraud for profit, and is recognized as one of the fastest growing crimes in the United States. Recent news reports of personal information theft from commercial data brokers, corporate databases, and credit report companies demonstrate the potential for large-scale identity theft. Identity theft was characterized as a suspicious activity on 1,761 (2.13%) of the reports of mortgage loan fraud filed from January 1, 2003 to March 31, 2006. Figure 6 shows the increasing incidence of identity theft in conjunction with mortgage loan fraud in the SARs reviewed for this study.Fixed income and elder exploitation
Retired persons were identified as subjects in 769 (1%) of the SARs reporting mortgage loan fraud filed between April 1, 1996 and March 31, 2006. Additionally, 25 filers suspected exploitation of older subjects in association with mortgage loan fraud. Low- or fixed-income retired persons are often targeted for fraudulent schemes. The growing number of retired and elderly citizens could provide a burgeoning target for mortgage loan fraud. Figure 7 displays the reporting trend for SARs involving this subject group.Mortgage Loan Fraud Suspicious Activity Report Findings
Many reports included more than one characterization of suspicious activity in addition to “mortgage fraud.” False statement was the most reported suspicious activity in conjunction with mortgage loan fraud. Identity theft represented the fastest growing secondary characterization reported, more than two percent in less than two years. Figure 8 reveals secondary characterizations of suspicious activities reported in conjunction with Mortgage Loan Fraud.
|CHARACTERIZATION OF SUSPICIOUS ACTIVITY||NUMBER OF SARs||% OF TOTAL SARs|
|P - MORTGAGE LOAN FRAUD||82,851||100.00%|
|N - FALSE STATEMENT||15,390||18.58%|
|S - OTHER||3,149||3.80%|
|U - IDENTITY THEFT||1,761||2.13%|
|O - MISUSE OF POSITION OR SELF DEALING||1,219||1.47%|
|G - CONSUMER LOAN FRAUD||699||Less than 1%|
|E - COMMERCIAL LOAN FRAUD||409||Less than 1%|
|M - DEFALCATION/EMBEZZLEMENT||373||Less than 1%|
|C - CHECK FRAUD||290||Less than 1%|
|A - BSA/STRUCTURING/MONEY LAUNDERING||256||Less than 1%|
|J - COUNTERFEIT INSTRUMENT (OTHER)||217||Less than 1%|
|R - WIRE TRANSFER FRAUD||169||Less than 1%|
|H - COUNTERFEIT CHECK||69||Less than 1%|
|B - BRIBERY/GRATUITY||68||Less than 1%|
|D - CHECK KITING||62||Less than 1%|
|Q - MYSTERIOUS DISAPPEARANCE||60||Less than 1%|
|K - CREDIT CARD FRAUD||57||Less than 1%|
|F - COMPUTER INTRUSION||33||Less than 1%|
|L - DEBIT CARD FRAUD||25||Less than 1%|
|T - TERRORISM||9||Less than 1%|
|I - COUNTERFEIT CREDIT/DEBIT CARD||5||Less than 1%|
Figure 9 displays the primary federal regulators identified in the reports of mortgage loan fraud. National banks with offices located throughout the country made up the largest group of lenders reporting mortgage loan fraud. The Office of the Comptroller of the Currency (OCC) is the primary regulator for national banks. National banks filed nearly 41 percent of the total reports.Fraud Locations
SARs contain data fields for subject addresses, the filer’s main office address, and the branch address where the suspicious activity was discovered. In the SARs reviewed in this study, suspicious activity occurred in - or was otherwise associated with - all 50 states, the District of Columbia, Puerto Rico, Guam, and American Samoa.
The subject address provides the best source for identifying the geographic location of real estate involved in mortgage loan fraud because most residential mortgage loan applicants intend to reside on the property used to secure the loan. Figure 10 provides a comparison of the address states for the filer and branch offices, and reported subjects, as provided on depository institution SARs filed on mortgage loan fraud between April 1, 1996 and March 31, 2006.
During 2005, the top five reported subject address states were California, Florida, Illinois, Texas, and Georgia.Reported Suspicious Activities in Sampled Narratives
In the sampled narratives, purchase of residential property was the most frequently reported loan purpose, followed by refinance, home equity, and second trust loans. New construction loans made up a relatively small percentage of the sampled narratives:
Material misrepresentation and false statements were reported on 692 (65.78%) of the sampled narratives. 12 Identity fraud was reported on 160 (23.12%) of the narratives and identity theft was reported on 27 (3.9%) of the narratives. 13 Mortgage brokers or correspondent lenders initiated the loans in 254 (36.71%) of these reports. Following are the types of loan falsifications reported in the sampled narratives.
Misrepresentation of loan purpose or misuse of loan proceeds was described in 129 (12.26%) of the sampled narratives. Mortgage brokers or correspondent lenders originated the loans described on 37 (28.68%) of the reports of misrepresentation or misuse of loan funds.
Misuse of FHA Title One loans was reported in 20 (15.5%) of these narratives. FHA Title One loans may be used to finance permanent home improvements that protect or improve the basic livability or utility of the property. The funds cannot be used for debt consolidation, cash-out, or any non-home related expenses, or for luxury items such as swimming pools or hot tubs.
The most commonly reported misrepresentation was occupancy fraud, which occurs when the borrower fails to occupy the property, although the loan application specified the property was the borrower’s primary residence. Occupancy fraud was reported in 104 (80.62%) of these reports. Possible motivations for misrepresentation of the loan purpose are to purchase investment property with more favorable loan rates than would be available if a lender knew the property was intended for use other than as a primary residence, or to launder funds from illicit activity.Appraisal Fraud and Property Flipping
Appraisal fraud and fraudulent property flipping were described in 111 of the sampled reports (10.55%). Appraisal fraud is frequently associated with fraudulent property flipping. Filers indicated on 48 (42.34%) of these reports that they suspected the fraudulent activity was perpetrated with the collusion of mortgage brokers, appraisers, borrowers, and/or real estate agents/brokers.
Lenders rely on accurate appraisals to ensure that loans are fully secured. Appraisal fraud occurs when appraisers fail to accurately evaluate the property, or when the appraiser deliberately becomes party to a scheme to defraud the lender, the borrower, or both. The Appraisal Institute and the American Society of Appraisers testified that “…it is common for mortgage brokers, lenders, realty agents and others with a vested interest to seek out inflated appraisals to facilitate transactions because it pays them to do so.” 15 Higher sales prices typically generate higher fees for brokers, lenders, real estate agents, and loan settlement offices, and higher earnings for real estate investors. Appraisal fraud has a snowball effect on inflating real estate values, with fraudulent values being entered into real estate multiple listing systems and then used by legitimate appraisers as comparable values for determining market values for neighborhood properties. Some commonly reported types of appraisal fraud found in the sampled narratives are:
Fraudulent property flipping is purchasing property and artificially inflating its value. The fraud perpetrators frequently use identity theft, straw borrowers and industry insiders to effect property flipping schemes. Ultimately, the property is resold for 50 to 100 percent of its original cost. In the end, the loan amount exceeds the value of the property and the lender sustains a loss when the loan defaults. The following fraudulent activities were reported in the sampled narratives that described property flipping.
The number of sampled narratives that specified fraudulent property flipping activity remained steady over the past four years. A significant spike in reports describing appraisal fraud was seen in 2004, but there was a slight decrease in the trend in 2005. This does not necessarily indicate appraisal fraud and fraudulent property flipping are decreasing, especially since activities associated with flipping (straw buyers and false statements) are increasing. Figure 11 depicts the reporting trend for appraisal fraud and fraudulent property flipping as described in the sampled narratives.
Property flipping and appraisal fraud have received a lot of attention from the media, real estate professionals, and lawmakers. Some actions taken to combat fraudulent property flipping are:
The use of straw buyers to obtain mortgage loans was specifically described in 27 (2.57%) of the sampled narratives. Mortgage brokers or correspondent lenders processed loans in 21 (77.78%) of these sampled narratives. Straw buyers are reported in the narratives of 2,566 SARs (3.1% of the total of 82,851) reports. Figure 12 displays the total number of mortgage loan fraud SARs that revealed the use of straw buyers.Forged Documents
Use of forged documents was reported on 20 (1.9%) of the sampled narratives, with correspondent lenders or mortgage brokers processing the loans described in five of those reports. The types of activity reported include the following:
Other types of fraudulent activity reported in the sampled narratives included:
Nine (less than one percent) of the sampled SAR narratives reported asset rental fraud. Mortgage brokers or correspondent lenders processed the loans in six of those reports. This is a fraudulent scheme designed to exaggerate or inflate the stated value of a borrower’s assets. Filers reported that funds were temporarily deposited into the loan applicant’s bank account for the time required to qualify for a loan. The funds came from friends or family, or even from mortgage brokers attempting to qualify an ineligible borrower. The temporary funds were withdrawn from the bank account after the loans were approved.
One elaborate asset rental fraud scheme reported in a news article involved deposits of funds into bank accounts established in a prospective borrower’s name, with the deposited funds being temporarily “rented” for a fee. The customary fee charged for this “service” was reportedly approximately five percent of the deposited funds. The service also may include verification of employment and income in any amount for an additional fee of one percent of the claimed annual income.17Debt Elimination Fraud
Debt elimination schemes were reported in ten (less than one percent) of the sampled narratives. Filers described borrowers attempting to pay off their mortgages with non-negotiable checks, or fake instruments such as bills of exchange or subrogation and security bonds. Filers described specious arguments in which the borrowers claimed the mortgage was invalid and the debt never existed. 18 The arguments relied on an unreasonable interpretation of Section 1-207 of the Uniform Commercial Code that has never been affirmed or supported by any court or governmental authority.
Other types of debt elimination schemes reported in the SARs were attempts to fraudulently release mortgage liens from municipal land records. Once the land title appeared clear of all mortgage debt, the homeowner could theoretically obtain another mortgage loan based on what appeared to be a clear title. The threat this fraud scheme presents is that a subsequent lender could believe it had a first priority lien on property when in reality there could be little or no equity to secure the loan.
Reports of debt elimination schemes were described in 430 SARs (less than one percent of the SARs reporting mortgage loan fraud) filed between April 1, 1996 and March 31, 2006. Figure 13 depicts the filing trend for debt elimination fraud through March 31, 2006.Conclusion
The study of the depository institution SARs describing mortgage loan fraud confirms reports of fraud associated with mortgage loans continues to grow – although it is unclear if this is primarily due to an increase in the number of fraudulent loans or an increase in awareness of this suspected fraudulent activity. It is apparent from the number of pending fraud cases reported by the Federal Bureau of Investigation (721 in 2005, up from 534 in 2004) that the awareness of mortgage loan fraud is increasing. 19 See Figure 2 for a comparison of the percentage of growth in total depository institution SARs filings to the growth in reports of mortgage loan fraud.
High home prices coupled with rising mortgage rates result in a reduction in housing affordability. In response to this trend, the housing industry is expecting a slow down in mortgage loan originations, a decrease in housing sales, and a slowing in housing price gains. The slow down in the growth of housing prices could result in the housing industry becoming less attractive to investors, which in turn could result in a reduction in the reports of fraud for profit. The current housing trend could also lead to an increase in fraud for housing as the increased costs of housing decreases the number of persons who qualify for mortgage loans. The current trend of rising interest rates and slowing housing equity growth could result in an increase in debt elimination fraud schemes, especially for homeowners with adjustable rate mortgages and interest only loans.