The coronavirus pandemic has touched nearly every aspect of day-to-day life. What was unimaginable a few months ago is now common. Entire companies working from home? It’s normal. Millions of new unemployment claims? That’s a weekly headline.
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When you combine the dramatic way the world has changed in the past few months with new government programs and verification practices, an increase in fraud in the $1.9 trillion mortgage industry is certain. What should risk managers be thinking about?
Near-Term Risks
High Refinance Volumes: Most lenders are working on high volumes of refinance loans. Heavy workloads and operations disruptions mean staff is more apt to miss red flags. To improve detection, focus on the highest-risk issues. Income and occupancy fraud are the most common for refis. Value inflation could emerge for cash-out refis due to changes in appraisal policy.
Income Instability: Applicants whose income is affected by COVID-19 may attempt to hide that impact from the lender, so income fraud is high risk for all loans. Lenders are checking employment closer to closing, but it is harder to contact the employer and confirm you are reaching a reliable person. Since employment verification can be difficult, checking the recent deposit activity to confirm wages can be helpful.
Gap Risk: Borrowers are more likely to have an income change or request a forbearance shortly after closing. If this happens before the loan is delivered to the investor, it can be a problem. Depending on the terms of the loan sale agreement, the loan may be unsalable or worth less than its face value. Reducing the gap between closing and investor delivery is critical to reduce this risk. If a lender is facing losses from gap risk, they may misrepresent the loan status to sell the loans at a good price.
Liquidity Issues: Gap risk losses or the need to advance funds to cover forbearance puts stress on a lender’s cash flow. This can lead to warehouse fraud, fictitious loans, or the misuse of custodial or trust accounts. Secondary market investors and warehouse lenders should tighten counterparty monitoring, and review for shifts in behavior, cluster analysis, and sequence patterns.
Appraisal Flexibility: Due to social distancing and safety concerns, appraisers cannot physically inspect home interiors. Some programs are using follow-up appraisals after closing. Others are expanding the use of alternate data sources. The risk of appraisal fraud on existing transactions is not high because the purchase process was started before the appraisal restrictions went into effect, so there is less chance of fraud. However, new transactions may be subject to planned manipulation of property values. False alternative information, such as a phony real estate listing, could be created to support a higher value. Lenders should look at multiple sources to support alternative appraisals, such as neighborhood price trends, property history, assessor information, etc. to reduce this risk.
Move to Digital Closings: The move to digital closings is happening faster than planned. Changing settlement providers increases the risk of associated fraud, such as professional identity theft and email compromises. This makes it imperative to increase your vetting and monitoring of settlement providers. Check their identities, licenses, insurance, and wire instructions before entrusting them with sensitive consumer data, documents, and closing funds.
Recording Delays: Delays at recorder’s offices can widen the opportunity for a borrower to obtain loans that exceed a property’s value. Most home equity loans rely on a title search and don’t require title insurance, so the lender bears the loss from this scam. Reviewing the loan application activity of the borrower will help detect the multi-lien fraud.
Servicing: Third-party fraudsters will use new government programs to target consumers who have existing mortgages, trying to intercept payments or personal data. Other scams may push homeowners to use forbearance plans and “invest” the cashflow. Possible scams such as these make it important to provide servicing customers with access to reliable information and links to fraud prevention sites, such as the Consumer Financial Protection Bureau. If your customers have good resources, know how to reach the right people at your company, and know what to expect, they are less likely to become victims.
Future Risk
Longer-term mortgage fraud risk depends on the level of stress in the real estate market. If home prices fall, properties are difficult to sell, or distressed inventory increases, expect to see builder bailout schemes, straw buyers, and illegal flipping. In the next phase of the cycle, fraud may move to loan modifications, short sales, and foreclosure rescue schemes.
Housing finance policy plays a big role in future fraud risk. New programs create new opportunities for fraud and exploitation. Carefully considered policies can anticipate these and control for loopholes. One of the more effective ways to combat this risk is to include suitable disincentives that balance risk and prevent a free-for-all.
What to Watch
The world around us is vastly different than it was even a few months ago. Between new policies, rising unemployment and uncertainty about the future, lenders need to be prepared for a new wave of fraud schemes. To assess the impact of the changing realities of fraud risk, consider:
- Will this make someone more likely to want to commit fraud? Who?
- Will fraud be easier to pull off? How?
- Are there new opportunities to take advantage of? What?
Risk is not static, so make sure your anti-fraud program monitors all types of fraud. Focus targeted quality-control testing on programs that have had major changes. Review changes in fraud risk indicators, such as fraud scores and alert rates. Keep your front-line staff educated on fraud schemes and update them as new schemes emerge, and watch for risk updates from Fannie Mae, Freddie Mac, CFPB, Federal Bureau of Investigation and CoreLogic.
