Understanding what to look out for will help you recognize the house of cards scenarios fraudulent borrowers may attempt to build.

As a private lender, mortgage fraud is and should be one of your biggest concerns. It’s not just a serious crime, it’s a headache that can cause you to lose money, time, and reputation. Private lenders may be particularly vulnerable to fraud because they often work with borrowers who may not qualify for a more traditional type of investment property loan. Private lenders may have more flexible criteria, which is all the more reason to appropriately vet and document the information you receive, regardless of the source (i.e., a mortgage broker or borrower).

According to the FBI’s Financial Crimes Report, mortgage fraud represented approximately 10% of all reported fraud cases in 2020. Likewise, the Federal Trade Commission (FTC) received 69,595 reports of fraud related to mortgage and other real estate scams, resulting in a total loss of $156.6 million. These are just the ones reported! The Mortgage Bankers Association estimates the mortgage industry experienced $1.9 billion in fraud losses in 2020.

What Is Mortgage Fraud?

Mortgage fraud occurs when someone intentionally deceives or misleads a lender to obtain a mortgage or loan. This can happen at any stage of the mortgage process, from the initial application to the closing. Some common forms of mortgage fraud include:

Asset fraud. Borrowers lie about their assets to qualify for a loan they wouldn’t otherwise qualify for.

Appraisal fraud. The value of the
property is inflated to obtain a higher
loan amount.

Identity theft. Someone steals a borrower’s identity and uses it to apply for a mortgage.

Occupancy fraud. Borrowers claim they will not live in the property as their primary residence, when in fact they intend to use it as a primary. Private lenders are targets for this because of the lighter documentation required compared to a more conventional mortgage loan.

Occupancy fraud in private lending is rampant. Owner-occupied properties have very restrictive compliance guidelines/regulations with oversight by the Consumer Financial Protection Bureau (CFPB). At this time, private lending has not been subject to many compliance regulations, but discovery of a private lender using a business-purpose loan to finance an owner-occupied property could result in significant challenges for the lender, including loss of their lender license, fines, and potential jail time.

Straw buyer fraud. Someone with good credit pretends to be the buyer and applies for a mortgage on behalf of someone with bad credit.

Title fraud. Someone forges or alters documents to transfer ownership of the property to themselves and then takes out a mortgage on the property.

These are just a few examples of the many ways in which mortgage fraud can occur. It’s a complicated crime that requires knowledge and planning. Unfortunately, it happens more often than you might think. In fact, CoreLogic recently reported that about one in every 100 loans involves mortgage fraud. Mortgage fraud can have serious consequences for private lenders. When private lenders lend money for a mortgage, they rely on the information the borrower or mortgage broker provides. If that information is fraudulent, private lenders may end up with a loan that is unlikely to be repaid. In some cases, the property may not even exist or may be worth far less than the loan amount.

When mortgage fraud occurs, it can also damage reputations and relationships with other capital partners. Private lenders want to be known as trustworthy and reliable lenders. Mortgage fraud can undermine that trust.

Fraud Protections

So, what can you do to protect yourself from mortgage fraud? Here are some steps to consider.

Do your due diligence. Don’t take the borrower’s word—verify all the information provided on the application. Research the borrower, the property, and any third parties involved in the transaction. You can do that through third-party data sources like DataTree, local tax authority websites, or even third-party due diligence firms that can perform pre-close or post-fund audits.

Check for other red flags too, including redacted information, change in the fonts of standard documents, comparison of one source document to another in the loan file, etc.

Conduct thorough appraisals. Use qualified and independent appraisers to value the property. Check their credentials and make sure they are not connected to the borrower or the property in any way. In many instances, you may also want to have an in-house process for reviewing valuations received from a third party.

Check occupancy. Ensure the property will be used for income-producing or business purpose. Verifying the borrower will not occupy the property in any form is vital.

Review whether the borrower is a current homeowner. If so, is this new property a potential upgrade? If the borrower is a renter and this is their first investment property, take extra measures to ensure the loan will be a business-purpose loan.

Make sure the note contains strong language about business purpose, including that post-closing, if owner occupancy is discovered, the lender will take action to call the note due to fraud.

Use reputable professionals. Work with experienced and trustworthy professionals (i.e., real estate agents, title agents, appraisers, and attorneys).

In 2021, a former mortgage broker named Robert Morgan was sentenced to 101 months in prison for his role in a multimillion-dollar mortgage fraud scheme that involved obtaining loans for properties that were overvalued or didn’t exist and then selling the loans to investors on the secondary market. Although this particular broker perpetuated fraud across multiple lenders, even something as simple as a pre-close review would have helped lenders discover the red flags much sooner.

There have been numerous reported scandals and scams, but none have been bigger than the one involving Taylor Bean and Whitaker Mortgage Corporation, a large mortgage lender based in Ocala, Florida, that specialized in the origination and sale of FHA-insured mortgages. In 2009, the company was forced to shut down after it was discovered that it had been engaging in a massive fraud scheme that involved the sale of fraudulent mortgage loans.

The scheme involved several layers of deception, including the use of phantom assets, forged documents, and false appraisals to inflate the value of mortgage loans. The company also engaged in a practice known as “double pledging”; that is, it sold the same mortgage loans to multiple investors, creating the appearance of a larger loan portfolio than actually existed.

The fraud scheme was uncovered in August 2009, when the Federal Housing Administration (FHA) suspended Taylor Bean and Whitaker’s ability to issue FHA-insured loans. This led to a chain of events that ultimately resulted in the company’s bankruptcy and the conviction of several of its executives.

In 2011, Lee Farkas, the former chairperson of Taylor Bean and Whitaker, was convicted on multiple counts of fraud, conspiracy, and money laundering, and was sentenced to 30 years in prison. Other executives, including the company’s former president and chief financial officer, were also convicted on charges related to the fraud scheme.

The Taylor Bean and Whitaker case was one of the largest mortgage fraud cases in U.S. history, and it underscored the need for greater oversight and regulation of the mortgage industry. It also served as a warning about the dangers of fraudulent lending practices and the importance of responsible lending standards. Although it is an example in the conventional lending world, the practices this lender used to defraud investors exist in practice for all types of lenders, including private lenders. It has and will continue to have a trickledown effect in forward loan commitment contracts, buy-back language, and overall quality control investors have when buying loans.

In summary, mortgage fraud is a serious crime that can cause significant losses for lenders and investors. As a private lender, it’s important to be aware of the risks and take steps to protect yourself from fraud. Verify all information, conduct thorough appraisals, check occupancy, do your due diligence, and work with reputable professionals. By following these steps, you can reduce the chances of falling victim to mortgage fraud and safeguard your investments. Remember, when it comes to mortgage fraud, prevention—whatever the cost—is always better than the alternative.