What Lenders Should Know to Combat Fraud

By James Comtois

Of late, mortgage fraud has risen and is looking to continue rising. With the industry becoming more paperless - therefore more susceptible to identity theft - as well as high home prices and low interest rates, there are many more opportunities and incentives for fraud to take place. In a report released in November 2006 by the Financial Crimes Enforcement Network, there has been a staggering increase in filings of Suspicious Activity Reports to the Federal Bureau of Investigation - by 1,411% - pertaining to suspected mortgage loan fraud between 1997 and 2005.

Since fraud is continuing to grow, mortgage banks need to be more proactive in protecting themselves against mortgage fraud schemes, whether the scheme is from a borrower falsifying an application to a broker engaging in a multi-home flipping scheme.

According to a forensic accountant specializing in analyzing cases of mortgage fraud, in order to fight against this increase in fraud, there are a number of ways mortgage banks need to be more aggressive in examining loan applications for signs of potential fraud.

"With rates relatively low you're able to get a number of buyers that can get into homes that they may not otherwise get into and applicants fudge applications to get borrowers qualified. A lot of that happened in 2006 and I think you'll see more of that in 2007 as interest rates [remain] relatively low and prices [remain] high," said Ivan Garces, a partner in the forensic accounting/litigation consulting division of the accounting firm of Kaufman, Rossin & Co.

The result of this surge in fraud, Mr. Garces added, may be the increased difficulty in borrowers getting loans in 2007. "Banks are taking a step back and tightening their belts and lending isn't quite as aggressive as it once was, so borrowers are going to have a more difficult time getting loans this year," he said.

Mr. Garces has worked as a forensic accounting analyst for more than 10 years, previously serving as the director of forensic services for KPMG LLP before joining Kaufman, Rossin & Co.

Although Mr. Garces explains that forensic accounting is a "reactive analysis," there are still some areas where banks can take proactive measures against mortgage schemes, due diligence being one of them. "They need to do due diligence, not only on the borrower but the broker," he said, adding that banks should "carefully screen apps of borrowers as well."

"People do pretty good jobs doctoring their paychecks. The assets tend to get inflated; they reduce liability and so on, [there are] a lot of places where borrowers tend to fudge the numbers on. Be cognizant of the different types of fraud that's out there, the different ways an application can be fudged."

Banks also need to be aware of the different types of mortgage fraud. In addition to fraud on the origination side, there are also organized mortgage fraud rings where industry insiders come together to engage in appraisal fraud or flip schemes. Mr. Garces believes that education and training is paramount to combat against these different kinds of fraud. "[It's important to] be able to identify these types of 'red flags' that might be present in a closing."

Ultimately, the front line of defense is to train people to identify red flags. The second line of defense is monitoring credit activity (and particularly identifying accounts that deviate from expectations). "Most banks have automated systems that monitor that. Whether it's manual or automatic, it's monitoring account activity on a per-account basis."

Despite the rise in mortgage fraud, Mr. Garces is optimistic about banks keeping a close eye on potential fraud cases, pointing out that the rise in reported cases of fraud - although grim - reveals that banks are becoming more diligent in noticing and reporting such cases.

"The key is being able to immediately identify suspicious activity. Most banks have systems in place that monitor account activity. Banks are doing a good job reporting suspicious activity."