Schemes, Mechanisms, and Red Flag Indicators

The following is an excerpt from Chapter 3 of Volume II of The Mortgage Professional's Handbook:


by Constance “Connie” Wilson, CMB, AMP, CFE

Schemes, Mechanisms, and Red Flag Indicators  

When we talk about mortgage fraud in the larger sense, there is a lexicon or vocabulary that goes along with the discussion.  It is imperative to break that down from the perspective of someone whose main goal is to detect and prevent fraud.  We encourage those in the fight to be cautious about fraud scheme naming conventions.  The name of a particular scheme does not necessarily tell an underwriter what to be wary of, or give any clue as to how an investigator can proceed to document the fraud.  It may be derived from what a victimized lender’s experience was or how it was perceived by media.  It is far more instructive to be cognizant of the individual mechanisms of fraud; also because so many terms are used interchangeably, it is beneficial to speak the same language. 

The nomenclature around fraud schemes refers to the general process of the fraud that was perpetrated.  There is quite a bit of variability in what schemes are called depending upon who is reviewing it, and what the perspective may have been at that time.  For the purposes of fraud prevention, the term used to describe a scheme is far less important than fraud mechanisms and red flag indicators that are present.  Listed below are some typical scheme names used in the years leading up to the mortgage crisis and beyond, along with a brief description:

         Straw Borrower or Nominee Loans – A technique to misrepresent the credit and identity of a borrower to the lender by using a stand-in “straw” borrower, who may be paid or unpaid by the scheme orchestrator.  Almost always entails falsified income, employment, assets, and occupancy.[1] 

·         Builder Bailout / Air Loans – If a builder is plagued with unsold inventory, they may concoct a scheme to unload properties to free up cash.  Usually involve hidden seller financing or incentives, down payment assistance, gifts, and unauthorized payouts on the HUD-1 Settlement statement. If no willing borrowers can be found, they may fabricate a borrower from synthetic identity, employ a straw borrower or create one from whole cloth.  An “Air Loan” works the same way except that the borrower is real, but the property inventory does not exist.[2]

·         Chunking – A scheme that preys upon unsophisticated borrowers (in some cases paid straws) who are dealing with an orchestrator like a loan officer.  Multiple applications are submitted to numerous lenders on a single property with the orchestrator acting as power of attorney (POA) for the borrower.  Perhaps the loan officer is also the seller making the transaction non-arm’s length as well.  Often entails identity theft and elder abuse. 

·         Shotgunning – This is a variation on chunking, but with HELOC loans.  Numerous applications are submitted to multiple lenders on a single property in rapid succession.  Generally “rate shopping” is the rationale used to explain away the large number of credit inquiries.  May be conducted as a bust out scam by foreign nationals that exit the country immediately upon consummation of the fraud.  This is a favorite technique of international criminal enterprises and offshore money launderers.[3]

·         Churning – In this scam, the loan officer advises borrowers to refinance within a short time frame several times.  Each time the loan officer would split the yield spread premium with the borrower, and the borrower would avoid paying the mortgage during the interim periods.  Typically the loan officer would do this with multiple borrowers hitting multiple lenders to avoid detection.[4] 

·         Identity Fraud and Theft – Simply put, it is the misrepresentation of identity, either your own or someone else’s.  Given the number of borrower profiles and loans that can cross an insider’s desk, there is nearly a limitless number of identities that may be compromised.  Ultimately identity theft is itself a mechanism that shows up in a great number of other schemes.   A further perfection of this scheme is professional identity theft, where the credentials of a licensed or certified person are stolen and then used to create falsified documentation.  An example of this would be stealing the license and signature of an appraiser and then create a falsified appraisal. 

·         Market Creation – Through multiple falsified appraisals in a particular area, a false market can be created that is then used to support other falsified values.  Works in both an appreciating and depreciating market depending upon the goal of the scheme.  May be a mechanism in a larger short sale or flipping scheme.

·         Property Flipping – Buying low and selling high, and in certain cases it is not illegal.  However, illegal flipping involves unsubstantiated changes in value due to phantom renovations and rapid changes in ownership in a compressed timeframe. Often times this was used as part of investment club schemes.    There are numerous examples where properties appreciated many thousands of dollars in the same day.  Because real estate is a “relationship” business, the participants needed to carry this out would be the loan officer or real estate agent, appraiser, and settlement agent.[5] 

·         Foreclosure Rescue – As the foreclosures and delinquencies mounted, unscrupulous loan officers and real estate agents would re-brand themselves as a foreclosure rescue company assisting home owners in avoiding foreclosure on their properties.  This entailed misdirected mortgage payments, high fees, equity stripping and leasebacks.  Often times this scam was committed by the very same loan officers who placed borrowers in properties that they could not afford in the first place.[6]

·         Short Sale – Lenders have the option of taking a property back through the foreclosure process and then having to dispose of the property.  Since most lenders do not want to be landlords, they are amenable to approving a sale by the delinquent borrower for less than the total payoff amount of the loan.[7]  As the collapse gained momentum and origination staff were re-tasked to collections and loss mitigation, obvious instances of collusion were created where the staff responsible for negotiating a short sale on behalf of the lender may be acquainted with the borrower or with a real estate professional who is arranging the sale.  In some cases the sale was to a relative allowing the borrower to stay in the home, or it may be that the real estate professional arranged a short sale at one particular price, but then has an undisclosed cash offer pending for the property of which the lender is unaware.  Appraisal fraud may be used to deflate the value initially, using a falsified BPO along with an unmotivated listing in the MLS.  Another way to artificially devalue property was using one of the 3Ms (Mold, Murder, or Meth) as a way to falsify the value.  Lab reports showing the presence of mold or methamphetamines lowering the market value are easily falsified.  Violent crime may also be used to influence value unduly.

Read the rest of this chapter in The Mortgage Professional's Handbook!

Constance “Connie” Wilson, CMB, AMP, CFE is widely recognized as one of the nation’s leading authorities on mortgage fraud. She has authored and published an extensive fraud-training program nationwide to financial institutions, as well as state and federal law enforcement agencies. She often serves as an expert witness in legal cases to convict fraudsters, and is a frequent commentator and contributing author on mortgage fraud trends for media and at industry events.

Connie’s broad experience in mortgage banking and lending services spans over 30 years in the areas of first and second mortgages and sub-prime products, as well as underwriting, quality assurance, due diligence, claims and fraud management. Career highlights include executive leadership of Interthinx (now First American), where she was instrumental in the initial design of the company’s quality control program and fraud-tracking database for all mortgage loan types. Prior to the formation of Interthinx, Connie was executive vice president for AppIntelligence, one of the two entities merged to form the company in 2005. Her early pioneering efforts involved the design of cutting edge applications to detect fraud that included an automated data integrity scoring system, automated desktop appraisal review program and a property value verifier and automated valuation model.

[1] Association of Certified Fraud Examiners, Understanding the Basics of Mortgage Fraud, 2010 p. 81

[2] Freddie Mac, Fraud Mitigation Best Practices, Jan 2015, p 15

[3] Association of Certified Fraud Examiners, Understanding the Basics of Mortgage Fraud, 2010 p. 67

[4] Association of Certified Fraud Examiners, Understanding the Basics of Mortgage Fraud, 2010 p. 70

[5] Association of Certified Fraud Examiners, Understanding the Basics of Mortgage Fraud, 2010 p. 56

[6] Freddie Mac, Fraud Mitigation Best Practices, Jan 2015, p 21

[7] Freddie Mac, Fraud Mitigation Best Practices, Jan 2015, p 23