UNDERSTANDING THE BASICS OF MORTGAGE

UNDERSTANDING THE BASICS OF

TABLE OF CONTENTS

INTRODUCTION Learning Objectives ...... 1 A Short History Lesson ...... 1 Evolution to Today ...... 1 Reform from the Great Depression...... 1 Secondary Market Influence ...... 2 Loan Market Offerings ...... 3 The Evolution of Mortgage Lenders ...... 4 The Evolution of Mortgage Brokers ...... 5 Regulations and Regulators in the Mortgage Industry ...... 5 Factors Affecting Mortgage Fraud Today ...... 6 The Business of Commission ...... 6 Lender Competition ...... 6 Alt-A Loans ...... 8 Loan Volume ...... 8 Subprime Market Implosion ...... 8 Predatory Lending ...... 10 Technological Advances ...... 11 Criminal Statutes ...... 11 The Mortgage Fraud Problem Today ...... 11 Suspicious Activity Reports ...... 12 Geographical Hot Spots ...... 12 Other Reports ...... 12 Hot Spots ...... 13 Actual Loss Due to Mortgage Fraud ...... 14 Related Costs ...... 14 Industry Reaction to Mortgage Fraud ...... 15 Federal Legislation ...... 15 State Legislation ...... 15 Federal and State Regulators ...... 16 Secondary Market Investor Reaction ...... 17 Industry Partner Actions ...... 18 Mortgage Fraud in the Future ...... 18 A Stabilizing or Decreasing Market...... 18 Adjustable-Rate Mortgages and Non-Traditional Loan Resets ...... 19 Are on the Rise ...... 19 A Shrinking Secondary Market ...... 19 Conditions are Ripe for Future Mortgage Fraud ...... 20 Chapter Summary ...... 20 Review Questions ...... 21

THE LIFE CYCLE OF A Learning Objectives ...... 23 Introduction ...... 23 Seller ...... 23

Mortgage Fraud -i- UNDERSTANDING THE BASICS OF MORTGAGE FRAUD

THE LIFE CYCLE OF A MORTGAGE LOAN (CONT.) Individual Home Owner ...... 24 Builder or Developer ...... 24 Manufactured Housing Dealer...... 24 Real Estate Investor ...... 24 Bank-Owned Real Estate ...... 25 Expectations of a Property Seller ...... 25 Fraud Trends – Property Sellers ...... 25 Real Estate Listing Agent ...... 26 Licensing and Regulation ...... 26 Expectations of a Real Estate Listing Agent ...... 27 Fraud Trends – Real Estate Listing Agents ...... 27 Borrower ...... 27 Straw Borrower ...... 28 Identity Fraud Victim ...... 29 Accomplice ...... 29 Expectations of a Borrower ...... 29 Fraud Trends – Borrowers ...... 30 Real Estate Buyer’s Agent ...... 30 Fraud Trends – Real Estate Buyer’s Agents ...... 30 Lender ...... 30 Correspondent Lender ...... 30 Warehouse Line of Credit ...... 31 Loan Officer ...... 31 Retail Loan Officer ...... 31 Third-Party Originator ...... 31 Expectations of a Loan Officer ...... 32 The Three Cs of Underwriting ...... 32 Loan Processor ...... 34 Fraud Trends – Loan Processors ...... 35 Appraiser...... 35 Licensing Requirements ...... 36 Uniform Standards of Professional Appraisal Practice ...... 37 Appraisal Report ...... 37 Expectations of an Appraiser ...... 37 Fraud Trends – Appraisers ...... 38 Underwriter ...... 38 Underwriting Outcomes ...... 38 Expectations of an Underwriter ...... 39 Fraud Trends – Underwriters ...... 39 Mortgage Service Provider ...... 39 Title Insurer/Escrow Agent ...... 40 Types of Closings ...... 40 Duties of an Escrow Agent ...... 41 Fraud Trends – Escrow Agents ...... 44 Notary ...... 45 Fraud Trends – Notaries...... 46 Secondary Market ...... 46

-ii- Mortgage Fraud UNDERSTANDING THE BASICS OF MORTGAGE FRAUD

THE LIFE CYCLE OF A MORTGAGE LOAN (CONT.) Double Selling ...... 46 Servicing ...... 46 Payment Services and Remittance to Investor ...... 46 Collections of Past-Due Loans/Workouts ...... 47 Foreclosure ...... 48 Fraud Trends – Servicing ...... 48 Loan Resolution ...... 48 Fraud Trends – Resolution ...... 49 Chapter Summary ...... 49 Review Questions ...... 50

EMERGING SCHEMES Learning Objectives ...... 52 Types of Mortgage Fraud ...... 52 Mortgage Fraud for Housing ...... 52 Mortgage Fraud for Profit ...... 53 Mortgage Fraud for Criminal Enterprise ...... 54 Emerging Trends in Mortgage Fraud ...... 54 Emerging Schemes ...... 55 Property ...... 55 The One-Transaction Flip ...... 57 Builder Bailout ...... 59 Air Loans ...... 60 Foreclosure Rescue Scams ...... 61 Short Sales ...... 63 Chunking and Shotgunning ...... 64 Identity Fraud Schemes ...... 65 Schemes ...... 66 Churning (Loan Flipping) ...... 67 Common Misrepresentations in Mortgage Fraud Schemes ...... 67 Common Misrepresentations ...... 68 Chapter Summary ...... 68 Review Questions ...... 69

CREDIT Learning Objectives ...... 71 Credit Reports ...... 71 Permissible Purposes of Credit Reports ...... 72 How a Credit Report is Accessed and Created ...... 73 FICO Score ...... 73 How Credit Drives Fraud Schemes ...... 74 Legitimate Borrowers with High FICO Scores ...... 74 Legitimate Borrowers with Marginal Credit ...... 75 Legitimate Borrowers with No ...... 76 Straw Borrowers ...... 77 Identity Fraud ...... 79 Credit Red Flags ...... 79

Mortgage Fraud -iii- UNDERSTANDING THE BASICS OF MORTGAGE FRAUD

CREDIT (CONT.) Credit Report Red Flags ...... 80 Straw Borrower Red Flags ...... 80 Identity Fraud Red Flags...... 81 Chapter Summary ...... 82 Review Questions ...... 83

COLLATERAL Learning Objectives ...... 85 Assessing the Collateral Risk ...... 85 Legal Ownership to Convey Title ...... 86 First Lien Position ...... 86 Legal Ownership and First Lien Position Red Flags ...... 86 Type of Property ...... 86 Property Type Red Flags ...... 87 Use of Property – Occupancy ...... 87 Kiddie Condos ...... 88 Common Misrepresentations of Occupancy ...... 88 Occupancy Red Flags ...... 89 Loan-to-Value Ratio ...... 90 The Cash-Out Refinance ...... 90 Equity Contribution in a Purchase Transaction ...... 90 Value ...... 98 Appraisal Process ...... 98 Adjustments ...... 101 Limits on Adjustments ...... 102 Prior Sales of Comparables ...... 102 Ways to Push Up a Value ...... 102 Phantom Renovations ...... 103 Comparable Shopping ...... 103 Wrong or Excessive Adjustments ...... 104 Misrepresentation of the Subject ...... 105 Misrepresentation of Ownership and Prior Sales ...... 106 Altered Appraisals/Theft of Appraiser’s Signature ...... 106 Inflated Value Red Flags ...... 106 Chapter Summary ...... 107 Appraisal Report Checklist ...... 107 Review Questions ...... 110

CAPACITY Learning Objectives ...... 112 Capacity ...... 112 Debt Ratios ...... 112 Top Debt Ratio ...... 113 Bottom Debt Ratio ...... 113 How Capacity Drives Fraud Schemes ...... 114 Altered or Fabricated Documentation ...... 115 Employment ...... 115

-iv- Mortgage Fraud UNDERSTANDING THE BASICS OF MORTGAGE FRAUD

CAPACITY (CONT.) Common Ways to Misrepresent Employment ...... 115 Income ...... 119 Common Ways to Misrepresent Income ...... 119 Stated Income Loans ...... 122 Debts ...... 123 Common Ways to Misrepresent Debts ...... 124 Debt Misrepresentation Red Flags ...... 124 Assets ...... 125 Common Ways to Misrepresent Assets ...... 126 Asset Misrepresentation Red Flags ...... 127 Chapter Summary ...... 128 Review Questions ...... 129

CLOSING Learning Objectives ...... 131 Steps in the Process ...... 131 Pre-Closing ...... 131 Closing ...... 132 Post-Closing ...... 132 Title Commitment ...... 133 Property Seller on a Purchase Transaction Not in Title ...... 134 Borrower on a Refinance Transaction Not in Title ...... 135 Liens Not Properly Listed on the Title Commitment ...... 136 Identification of the Borrower and Seller ...... 138 Fabricated Driver’s Licenses ...... 138 Copies of Driver’s Licenses ...... 138 Power of Attorney ...... 139 Mail-Away Closings ...... 139 Lender’s Closing Instructions ...... 140 Identifying Red Flags in Closing Instructions ...... 140 Closing Condition Red Flags ...... 142 HUD-1 Statement ...... 142 Purchase Transaction ...... 142 Refinance Transaction ...... 145 Reviewing the HUD-1 ...... 146 Chapter Summary ...... 150 Review Questions ...... 151

IDENTIFYING AND RESOLVING RED FLAGS Learning Objectives ...... 153 Loan File Documentation ...... 153 Lender’s or Investor’s Credit Loan File...... 154 Mortgage Broker File ...... 155 Lender’s or Investor’s Quality Control File ...... 155 Servicing Records ...... 156 Servicer’s REO Department ...... 157 Lender’s Database ...... 158

Mortgage Fraud -v- UNDERSTANDING THE BASICS OF MORTGAGE FRAUD

IDENTIFYING AND RESOLVING RED FLAGS (CONT.) Private Mortgage Insurer File ...... 158 Borrower’s Documentation ...... 158 Property Seller’s Documentation ...... 159 ’s Documentation ...... 159 Appraiser Work File ...... 159 Title Company’s File...... 160 Investigative Techniques ...... 161 Publicly Available Resources and the Internet ...... 161 Subscription or Fee-Based Resources ...... 168 Borrower (or Loan Party) Authorization or Waiver ...... 172 Telephone Inquiries ...... 173 Chapter Summary ...... 175 Review Questions ...... 176

LEGAL ASPECTS AND REMEDIES Learning Objectives ...... 178 Legal Remedies of a Mortgage Fraud Investigation ...... 178 Insurance Claim ...... 178 Repurchase ...... 179 Administrative Hearing – License Revocation ...... 179 Termination of a Business Relationship ...... 179 Civil Litigation ...... 179 Criminal Prosecution ...... 180 Preparing a Mortgage Fraud Case for Prosecution or Litigation ...... 183 Other Remedies ...... 184 Working with Law Enforcement ...... 185 Loan Losses ...... 185 Facilitating Prosecution ...... 186 Chapter Summary ...... 186 Review Questions ...... 188

APPENDIX – RED FLAGS One-Transaction Flip Red Flags ...... 189 Builder Bailout or Air Loan Scheme Red Flags ...... 189 Foreclosure Rescue Scam Red Flags ...... 190 Deceptive Short Sale Red Flags ...... 190 Identity Fraud Red Flags...... 190 Identity Theft Red Flags ...... 190 Churning Red Flags ...... 191 Credit Red Flags ...... 191 Loan Application Red Flags ...... 191 Credit Report Red Flags ...... 191 Straw Borrower Red Flags ...... 192 Identity Fraud Red Flags...... 192 Collateral Red Flags...... 193 Legal Ownership and First Lien Position Red Flags ...... 193 Property Type Red Flags ...... 193

-vi- Mortgage Fraud UNDERSTANDING THE BASICS OF MORTGAGE FRAUD

APPENDIX – RED FLAGS (CONT.) Occupancy Red Flags ...... 193 Equity Contribution Red Flags ...... 194 Purchase Transaction Disguised as Refinance – Red Flags ...... 195 Capacity Red Flags ...... 195 Altered Document Red Flags ...... 195 Employment Red Flags on the Loan Application ...... 195 Verification of Employment Red Flags ...... 197 Self-Employment Red Flags ...... 197 Pay Stub and W-2 Red Flags ...... 198 Tax Return Red Flags – Self-Employment and Income (Including Rental Income) ...... 199 Agreement Red Flags ...... 199 Stated Income Program Red Flags ...... 200 Debt Misrepresentation Red Flags ...... 200 Loan Application Red Flags ...... 201 VOD Red Flags ...... 201 Bank Statement/Investment Fund Account Statement Red Flags ...... 202 Closing Red Flags ...... 202 Vested Owner Misrepresentation Red Flags ...... 202 Suspicious Lien and Disbursement Red Flags ...... 203 Borrower Identification Red Flags ...... 203 Closing Condition Red Flags ...... 204 HUD-1 Red Flags ...... 204 Disbursement Summary and Canceled Check Red Flags ...... 205 GLOSSARY OF ACRONYMS ...... 206 ANSWERS TO REVIEW QUESTIONS ...... 209 FINAL EXAMINATION ...... E-1

Mortgage Fraud -vii-