What is Mortgage Fraud?
Mortgage Fraud is a willful misrepresentation or omission of facts such as an overstatement of an ability to repay the loan or any such material information, which lead the lenders of the loan to approve or relax the terms and conditions of the loan such as the interest rate or the repayment schedule. This fraud falls under criminal offense, and if found guilty, the fraudster can get imprisonment of up to 30 years.
- The above definition is in alignment with the view of the Federal Bureau of Investigation (FBI) and implies that when a borrower is not conveying the whole truth about his capacity and intentions for the borrowed funds sought by him, and such hidden information can impact the lender’s ability to take the decision regarding the approval of a loan or determining the terms of the loan, the prospective borrower is committing mortgage fraud.
- The aim of the borrower gets maligned because he is withholding information for his interest at the loss of the lender’s interest. If the borrower overstates his earning capacity, then he might lead on the lender to think that the borrower is in a better position to repay the same and thus the lender might approve his loan application when in fact he shouldn’t.
- It may also be the case that the lender might be misled to think that the loan is less risky than it actually is and sanction the same at a lower interest rate or defer repayment to later dates than he would, had he had the entire information about the borrower.
- Fraud for Profit: This type of fraud is of greater interest to the FBI and it involves an institutional borrower who has insider informationInsider InformationInsider Information is a piece of fact, information or an understanding (M&A, New Contracts, R&D breakthrough, new product launch etc.) which could impact the prices of a listed entity or publicly-traded organizations once disclosed in the public domain. Trading based on such information is considered to be illegal. or greater industry knowledge and makes use of the same to dupe the lender and extort money from him without backing it with commensurate collateral.
- Fraud for Housing: In this, a retail borrower overstates his capacity to secure a housing loan which he actually is not capable of paying off.
#1 – Occupancy Fraud
- Here the borrower conveys to the lender that he needs the loan to purchase a property for his own living purpose, however, the actual reason is to resell the same at a better price when such is available and therefore it is actually an investment rather than a necessity.
- In such cases, if the entire loan is not paid off and the title of ownership is passed on to the new buyer, there might be a possibility that he may not pay off the loan. Because of this reason, the loans for investment propertyInvestment PropertyInvestment property refers to the real estate acquired to earn returns on the investment through rental income, royalties, dividends or future appreciation, usually in the name of an individual investor, a group of investors or an investment company for a short-term or a long-term investment. attract higher interest rates, and therefore the primary borrower has committed fraud by not mentioning the actual reason for borrowing the money.
#2 – Income Fraud
Here the borrower conveys a higher income than his actual income so that he may get a higher loan or a lower interest rate because a higher income conveys a better repaying capacity.
#3 – Incomplete or Non-Disclosure of Liabilities
This is the case when the buyer doesn’t give a complete picture of the liabilitiesLiabilitiesLiability is a financial obligation as a result of any past event which is a legal binding. Settling of a liability requires an outflow of an economic resource mostly money, and these are shown in the balance of the company. that he is indebted by and secures a higher quantum of loaned funds or a lower interest rate due to a misrepresentation of the riskiness of the loan.
#4 – Acquiring Loaned Funds for Purpose other than Purchase of Property
- Under this type of fraud, the borrower overstates the value of the property he wishes to purchase from the loaned funds and therefore manages to acquire a greater amount of loan funds than necessary. These funds are then used by the borrower for another purpose.
- This is fraudulent because the lender is exposed to a risk he is not aware of and had he been informed, he might not have lent the funds or might have done so under different terms and conditions. At the time this fraud is also known as appraisal fraud.
#5 – Shotgunning
Here several loans are taken out on the same property each of almost the same value as that of the property itself, therefore the loaned amount becomes 2x or 3x and so on of the actual value of the property. This is a fraud because only one of these loans might be actually paid off by selling the property if the borrower defaults and therefore the loans taken after the first loan get lower priority and might not get repaid.
#6 – Air Loans
This involves frauds conducted by a financial intermediary where they borrow funds for a property that actually doesn’t exist at all. In such a case, these intermediaries falsify proofs of the existence of such properties and borrow funds without actually providing any collateral. The lender being unaware of sanctions the loan and later faces the issue of not being able to recover the same by selling the collateral in case of a default because the collateral doesn’t exist.
Example of Mortgage Fraud
On November 4rth, 2019, the US department of justice sentenced Manuel Herrera & Moctezuma Tovar for wire fraud and mortgage fraud along with several other defendants. In this case, the defendants, who worked for a company called Delta Homes & Lending Inc. created false loan documents and homebuyers to secure loaned funds. They overstated the incomes liabilities employment, and citizenship of these home buyers to secure funds and provided them money so that their balance sheet looked better than it actually was. Once the funds were secured in the name of these homebuyers, it was returned to Herrera and Tovar and their accomplices.
In this process, the lenders lost $4 million. As of now, the final decision is pending but the penalty can extend up to 20 years of imprisonment and $250,000 fine per defendant.
Following are potential red flags which should be taken care of and investigated by the lenders to ensure that there is no possibility of mortgage fraud
- The same phone number is mentioned for the borrower and the employer in the loan application. This could be the case of an employment fraud where the borrower might be misrepresenting his employment.
- Income specified is above the industry standards in the particular field mentioned on the application.
- Assets stated seem higher than that of an average individual in the profession stated on the loan application
- Background verification took less than usual time to proceed with the loan application to the next step of the evaluation process.
How to Prevent Mortgage Fraud?
- Conducting thorough due diligence is one of the most important components of the loan sanction process. If it is conducted in a proper manner, there is a lower possibility of mortgage fraud occurring, however, it doesn’t completely eliminate this risk because a fraudster may come up with a new technique of conducting a fraudulent activity of which the lender might not have prior experience.
- A deeper investigation in case of appearance of any of the above mentioned red flags is a prudent way of ensuring no mortgage fraud.
- Third-party evaluation and appraisal of the borrower and the subject property can lead to an unbiased opinion based on which an informed decision can be made regarding loan approval.
- Mortgage fraud was on the rise before the 2007-08 housing bubble financial crisisFinancial CrisisThe term "financial crisis" refers to a situation in which the market's key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors. and the FBI warned about the same in its press release in late 2004 and early 2005. Post the crisis, the Fraud enforcement and recovery act came into force in 2009 as an outcome of the market crash to prevent the same from happening again.
- Therefore, it is prudent to conduct a rigorous background check of the borrower and all the parties involved in the process including the financial institutions so that the possibility of fraud is minimized.
This has been a guide to What is Mortgage Fraud & its Definition. Here we discuss the top 5 types of mortgage fraud and categories along with examples, indications, and how to prevent it. You can learn more about from the following articles –