Fraud Prevention

Mortgage fraud is a federal crime that costs the industry billions of dollars annually and harms borrowers, lenders, and the housing market. As gatekeepers to the mortgage process, MLOs have both a legal and ethical obligation to detect, prevent, and report fraud.

What Is Mortgage Fraud?

Mortgage fraud is the intentional misrepresentation, misstatement, or omission of information relied upon by an underwriter or lender to fund, purchase, or insure a mortgage loan.

Two Categories of Mortgage Fraud

1. Fraud for Housing - Misrepresentation to qualify for a home the borrower intends to occupy

   • Often committed by borrowers with MLO assistance
   • Example: Overstating income to qualify for a larger loan

2. Fraud for Profit - Complex schemes involving industry insiders

   • Typically involves multiple properties and large losses
   • Example: Property flipping with inflated appraisals

Federal Penalties for Mortgage Fraud

Mortgage fraud violates several federal statutes:

Critical: These are FEDERAL crimes prosecuted by the FBI and DOJ. State penalties for license violations are in addition to federal criminal penalties.

Common Types of Mortgage Fraud

1. Occupancy Fraud

Definition: Misrepresenting the intended use of a property (primary residence, second home, or investment).

Why It Matters:

• Primary residences receive lower interest rates and better terms
• Owner-occupants are considered less risky (less likely to walk away)
• FHA, VA, and conventional loans have occupancy requirements

Red Flags:

• Applicant already owns multiple properties
• Subject property is far from stated employment
• No explanation for selling current primary residence
• Recently purchased another "primary residence"

Example: Borrower claims property will be primary residence but actually intends to rent it out as investment property.

2. Income Fraud

Definition: Misrepresenting income, employment status, or employment history.

Common Methods:

• Inflating income amounts on application
• Creating fictitious employers
• Using fake pay stubs or W-2s
• Omitting debts or liabilities

Red Flags:

• Income inconsistent with profession/title
• Employer phone disconnected or suspicious
• Pay stubs with formatting errors or inconsistencies
• Tax returns that don't match stated income
• Employment verification difficulties

3. Asset Fraud

Definition: Misrepresenting assets, down payment sources, or reserves.

Common Methods:

• Undisclosed loans for down payment
• Fake bank statements
• Temporary "parking" of funds (deposit stacking)
• Borrowed funds misrepresented as savings

Red Flags:

• Large deposits near closing without explanation
• Bank statements with whiteout or alterations
• Down payment sources that don't match application
• Inadequate documentation of gift funds

4. Appraisal Fraud

Definition: Manipulating property valuations to artificially inflate or deflate values.

Common Methods:

• Using inappropriate comparable sales
• Ignoring property defects
• Collusion between appraiser and other parties
• Pressure on appraisers to "hit the number"

Red Flags:

• Appraisal significantly higher than recent sales
• Same appraiser on multiple suspicious transactions
• Comparable sales from distant or dissimilar areas
• MLO or real estate agent selecting appraiser (AIR violation)

Note: The Appraiser Independence Requirements (AIR) prohibit MLOs from selecting, influencing, or coercing appraisers.

5. Identity Fraud/Theft

Definition: Using stolen or synthetic identities to obtain mortgages.

Methods:

• Stolen Social Security numbers
• Synthetic identities (combining real and fake info)
• Deceased person's identity
• Straw buyers

Red Flags:

• ID documents that appear altered
• Inconsistencies between documents
• Applicant unfamiliar with their own history
• Multiple applications with slight variations
• Credit report inconsistencies

6. Straw Buyer Schemes

Definition: Using a person with good credit to obtain a loan for someone who cannot qualify.

How It Works:

1. Actual buyer cannot qualify (bad credit, income issues)
2. "Straw buyer" with good credit applies for loan
3. Straw buyer receives payment for use of their credit
4. Property deeded to actual buyer or straw buyer keeps making payments

Red Flags:

• Buyer has no connection to property area
• Down payment from unknown source
• Buyer shows little interest in transaction details
• Power of attorney used without explanation
• Inconsistencies in signatures

7. Property Flipping Fraud

Definition: Purchasing property, artificially inflating value, and quickly reselling at inflated price.

Typical Scheme:

1. Purchase distressed property at low price
2. Make minimal or no improvements
3. Obtain inflated appraisal (often through collusion)
4. Sell to unsuspecting buyer or nominee at inflated price
5. Profit the difference

Red Flags:

• Rapid appreciation with no clear reason
• Multiple sales in short period
• Renovation costs inconsistent with scope of work
• Same parties appearing in multiple transactions

Red Flags Summary

MLOs must be alert to these warning signs:

MLO Reporting Obligations

Suspicious Activity Reports (SARs)

MLOs and their employers must file SARs when they detect suspicious activity:

Filing Requirements:

• File within 30 days of detecting suspicious activity
• If no suspect identified, file within 60 days
• FinCEN Form 111 (SAR) filed electronically
• Keep SAR records for 5 years

What Must Be Reported:

• Potential money laundering
• Suspected mortgage fraud
• Suspicious wire transfers
• Identity theft indicators
• Any activity that may involve a crime

Consequences of Failure to Report

Warning: It is a federal crime to notify ("tip off") any person that a SAR has been or will be filed.

Protecting Yourself

As an MLO, protect yourself from fraud allegations:

1. Document everything - Keep detailed notes on all transactions
2. Verify independently - Don't rely solely on broker/agent representations
3. Question inconsistencies - Follow up on anything that doesn't make sense
4. Refuse to participate - Walk away from suspicious transactions
5. Report concerns - File SARs and notify compliance
6. Get training - Complete anti-fraud training regularly
7. Know your parties - Verify identities and relationships

Real-World Mortgage Fraud Enforcement

FBI Operation Stolen Dreams (2010)

The Largest Mortgage Fraud Takedown in History:

• Scope: 1,215 criminal defendants charged across the United States
• Duration: 3.5-month coordinated law enforcement operation
• Financial Impact: Over $2.3 billion in estimated losses
• Convictions: Resulted in hundreds of convictions with prison sentences ranging from 1-30 years

Types of Schemes Prosecuted:

• Property flipping with inflated appraisals
• Straw buyer rings
• Builder bailout schemes
• Short sale fraud
• Loan modification scams
• Equity skimming operations

Notable Case from Operation Stolen Dreams: A Florida-based fraud ring used straw buyers and inflated appraisals to obtain $36 million in fraudulent mortgages. The ringleader received 30 years in federal prison.

Typical Sentences for Mortgage Fraud

Recent Mortgage Fraud Prosecutions

Case Study 1: The Loan Processor (2023) A California loan processor was sentenced to 6 years in federal prison for creating fake pay stubs, W-2s, and bank statements for over 100 loan applications. Losses exceeded $8 million.

Case Study 2: The Appraisal Fraud Ring (2022) Three appraisers and two MLOs in Texas were convicted for systematically inflating property values. Combined sentences: 47 years. Losses: $14 million.

Case Study 3: The Occupancy Fraud Scheme (2024) An MLO was sentenced to 42 months for helping 23 investors claim properties as primary residences. The MLO coached borrowers on what to say during verification calls.

FBI Mortgage Fraud Statistics

Financial Crimes Enforcement Network (FinCEN) SAR Data

Annual mortgage-related Suspicious Activity Reports:

• 2024: 96,000+ mortgage loan fraud SARs filed
• Top fraud types reported: Income/employment fraud (42%), occupancy fraud (23%), appraisal fraud (18%)
• States with most SARs: California, Florida, Texas, New York, Illinois

MLO Warning: The FBI considers mortgage fraud a "target-rich environment" and prioritizes these investigations. Industry insiders who participate in fraud face the harshest sentences because they violate positions of trust.