Welcome to the latest edition of Fighting Fraud with Frank. Over the next several issues of Fighting Fraud with Frank, I want to focus on dispelling some of the myths about mortgage fraud and its impacts. Over the years I have had the chance to work with over 60 companies across 4 different industries that have been challenged with fraud management issues. When fraud losses are worsening, I have found that misconceptions, myths and poor information are often at the root of the problem. It isn’t until those myths or misconceptions are dispelled that we can get down to the serious business of solving the problem. So, let’s look at one of those myths regarding mortgage fraud in detail.

One of the most interesting statements I have heard while working in the mortgage industry over the last few years is, “Fraud Performs.” I still hear it today, and it amazes me. With the level of repurchase demands, early payment default and delinquencies increasing (many of which are the result of fraudulent misrepresentations on application files), how could one possibly still believe that fraud performs? Sure we can classify the different motivations for mortgage fraud between fraud for profit (no intent to pay the lender), and fraud for housing (intent to pay the lender), but does that rationalize ignoring fraud just because the borrower intends to pay? The answer is clearly no. Any attempt to try to determine if a borrower will in fact pay when they have all the best intentions to pay is merely guess work. Compound that with the fact that the borrower details have been misrepresented significantly and you are taking a big gamble by letting an application with fraud be funded.

Let’s look at a couple of case examples based on some data studies we recently conducted:

Case Study 1 – When you ignore the fraud investigators’ warnings,
you pay
This case study is on a sample of loans that were originated in 2005. We tracked this sample of loans where fraud investigators had discovered potential misrepresentations in loan files prior to the loan funding and made recommendations for the loan to be declined. Loans that were funded despite the investigators’ warnings subsequently went delinquent at a rate 5 times higher than the average population. The lesson learned – maybe fraud doesn’t really perform.

Case Study 2 – Lending Guidelines and Policies are there for a reason
This second case study also involved loans originated during high-volume years. We tracked loan performance for those loans that had a material exception noted to the lender’s guideline that were later approved (for example, exceed maximum DTI or minimum credit score). When the aggregate performance of those loans was tracked, those loans were 10 times more likely to not perform as compared to the average population. Another lesson learned – trying to second guess underwriting guidelines is often a mistaken path.

Case Study 3 – When a borrower lies about their ability to pay, don’t expect them to be able to pay
Credit scores, debt-to-income ratios, borrower reserves and assets levels are computed by lenders for a reason – they enable a lender to determine if a borrower can afford the loan. One of the most compelling cases to make for the fact that fraud doesn’t perform is examining when key drivers of these formulas are based on misrepresented information. This includes income, bank account or asset manipulations. Reported incomes on applications that are linked to fraud and early payment default are 50% higher than incomes on performing loans. The fact is that when a borrower’s income isn’t reasonable, or what you would expect based on statistical averages for their occupation and/or geography, the loan is more likely not to perform. And borrower’s bank accounts and balances are important too. The amount that a borrower has in reserves plays a critical importance in their ability to repay. When a borrower has little or no money in savings and has misrepresented their balances to help qualify for the loan, they are more likely to default within the first 6 months than borrowers that have true reserves of 4 months or more.

In closing
I think there are plenty of examples that point to the fact that fraud doesn’t perform well. I think the myth was actually born during the mortgage boom when borrowers that lied could merely re-finance their way out of the problem based on escalating home values. As you know, that wallet that we called home equity is empty now in many places, so the capability to refinance out of a prior fraud is all but gone now. For many lenders that means the hard truth is finally realized – Fraud really does not perform. In our next edition, we’ll be debunking another fraud myth. Until then, best wishes to you and your families for a very happy holiday season and New Year!