Ethical violations and criminal activities in various industries have affected our economy over the past few decades, particularly in the banking, financial, and housing sectors. When it comes to financial crimes, mortgages provide ample opportunity for bad actors to steal, defraud, or cut corners. Let's examine the complex ethical and criminal issues surrounding mortgage fraud.

What Is Mortgage Fraud? 

Fraud in its simplest form is deliberate misrepresentation and deception: One party deceives another by misrepresenting information, facts, and figures. So, mortgage fraud is not just predatory lending practices that target certain borrowers.

According to the Federal Bureau of Investigation (FBI), it is any sort of "material misstatement, misrepresentation, or omission relating to the property or potential mortgage relied on by an underwriter or lender to fund, purchase, or insure a loan." With this working definition, we see that mortgage fraud can be committed by both individual borrowers and industry professionals. And the sums involved are high. For example, in Sacramento, Calif., seven people were convicted in a $10 million mortgage scam in early 2019.

There are two distinct areas of mortgage fraud—fraud for profit and fraud for housing. 

1. Fraud for profit: Those who commit this type of mortgage fraud are often industry insiders using their specialized knowledge or authority to commit or facilitate the fraud. Current investigations and widespread reporting indicate a high percentage of mortgage fraud involves collusion by industry insiders, such as bank officers, appraisers, mortgage brokers, attorneys, loan originators, and other professionals engaged in the industry. Fraud for profit aims not to secure housing, but rather to misuse the mortgage lending process to steal cash and equity from lenders or homeowners. The FBI prioritizes fraud for profit cases.
2. Fraud for housing: This type of fraud is typically represented by illegal actions taken by a borrower motivated to acquire or maintain ownership of a house. The borrower may, for example, misrepresent income and asset information on a loan application or entice an appraiser to manipulate a property’s appraised value.

To understand the implications for the housing and real estate industries, and for financial institutions, simply refer to the headlines and literature on the 2008 subprime mortgage crisis. Much of that speculative lending was based on mortgage fraud.

Why Commit Mortgage Fraud? 

Borrowers and professionals are motivated to commit mortgage fraud for many reasons. We can describe most of those reasons by defining two primary types—fraud for housing and fraud for profit. Fraud for housing is committed by borrowers who, often with the assistance of loan officers or other personnel, misrepresent or omit relevant details about employment and income, debt and credit, or property value and condition with the goal of obtaining or maintaining real estate ownership. Fraud for profit is committed by industry professionals who misstate, misrepresent, or omit relevant details about their personal or their clients' employment and income, debt, and credit, or property value and condition with the goal of maximizing profits on a loan transaction.

It is important to note here that fraud for profit can be committed by any professional in the loan transaction chain, including the builder, real estate sales agent, loan officer, mortgage broker, credit/debt counselor, real estate appraiser, property inspector, insurance agent, title company, attorney, and escrow agent. Industry professionals can also work in concert, as a network, to defraud underwriters, lenders, and borrowers, and maximize fees and share profits on all mortgage-related services. These actions are motivated either by the desire to gain extra sales commissions or simply increase an investment position.

Common Mortgage Fraud Schemes and Scams 

The most common investor mortgage fraud schemes are different types of property flipping, occupancy fraud, and the straw buyer scam.

Property flipping is generally not illegal when associated with purchasing a house, holding/fixing it, and then reselling it for a profit. On the other hand, when a property is bought below market and immediately sold at profit with the help of a corrupt appraiser who "verifies" that the value of the property is actually double the initial purchase amount, mortgage fraud is indicated.

In the case of the same-day close property flipping scheme, the chain of title and the appraisal are often fraudulent and include three parties—the seller, the flipper, and the unsuspecting end buyer. The seller makes a contract with the flipper to purchase the property at below market value. The flipper provides the end buyer with a fraudulent title insurance commitment, showing the flipper as the owner (though that's not the case) and an appraisal is made at the inflated price the flipper and end buyer have agreed on.

Occupancy fraud is a scheme used by investors to qualify for higher loan-to-value ratios and lower out-of-pocket costs on purchases, in addition to lower mortgage rates. Occupancy fraud occurs when a borrower claims that the home will be owner-occupied to obtain favorable bank status when the property will actually remain vacant. The straw buyer uses or allows someone to use their identity, credit score, and income to obtain property for another buyer who may not qualify for a mortgage (or qualify for the best rates). Straw buyers are often used by investors, either willingly or unknowingly, to cover up other forms and multiple layers of fraud.

The most common individual mortgage fraud scams are identity theft and income/asset falsification. Identity theft occurs when the real buyer fraudulently obtains financing using an unwilling and unaware victim's information, including Social Security numbers, birth dates, and addresses. Identity theft for mortgage purposes may also include stolen pay stubs, bank records, tax returns, W-2s, and falsified employment verification letters. Even property ownership records can be falsified, and borrowers can obtain a fraudulent mortgage on a property that they neither own nor occupy.

Air Loan vs. Appraisal Fraud

The most common industry professional mortgage fraud scams are air loan and appraisal fraud.

An air loan is a loan obtained on a nonexistent property or for a nonexistent borrower. A group of professionals will often work together to create a fake borrower and a fake chain of title and to get a title and property insurance binder. Additionally, the fraud chain may include phone banks and mailboxes to create fake employment verifications, home addresses, and borrower telephone numbers. The air loan scam simply puts cash into the hands of the perpetrators, and no property is ever bought or sold.

Appraisal fraud often involves a real estate agent, builder, appraiser, and loan officer working together to maximize a purchase price and loan amount in order to increase their commissions. On the other hand, corrupt appraisers will often undervalue a property to ensure that a fellow investor will be able to purchase the asset.

Some forms of predatory lending activities, foreclosure rescue, and mortgage reduction scams depend heavily on the aforementioned mortgage fraud practices. Predatory lending typically involves falsifying lenders' income figures to inaccurately reflect their ability to assume additional debt. Such activities heavily contributed to the Great Recession.

Combating Mortgage Fraud

There is no shortage of legislation at the local, state, or federal level designed to reduce mortgage fraud. States have taken a big step recently by requiring loan officer licensing and continuing education. Additionally, real estate, title, and insurance agencies are licensed and monitored by government agencies. Many states also require periodic auditing of mortgage-lending companies' activities and transactions to monitor compliance.

Professional organizations such as the Mortgage Bankers Associations (MBA) and National Association of Mortgage Brokers (NAMB) have a code of conduct and best practices that are peer-monitored. The FBI's Economic Crimes Unit - II also monitors complaints and suspicious activity in the mortgage industry.

The Bottom Line

The good news is we can improve the markets by reducing mortgage fraud. Individuals must set realistic expectations for borrowing and homeownership experience. Investors should set realistic goals for profit. Industry professionals must pursue higher personal standards and submit to peer organization accountability. Governments need to make the legislation more uniform and reconcile law enforcement with active investigations.