Lender Review Considerations – Mortgage Fraud

Disclaimer: (The following contains general principles of law that cannot be applied to every case and is based on California law. In the event that you encounter issues covered in this outline, you should review the appropriate response with your counsel)

(For more information, including in-house seminars, contact: Spencer Scheer @ [email protected])

THE USUAL SUSPECTS

There are a myriad of ways the mortgage fraud can occur. However, some patterns frequently reoccur. The following are some of the “usual suspects” to consider when examining mortgage fraud claims.

A general description of common mortgage fraud scenarios and a follow up checklist is contained at the end of this document. This can provide an initial framework for Lenders to use when examining their loan files for evidence of fraud.

Broker

If the loan was brokered to a lender under a lender-broker agreement, the broker may be liable for any false statements, misrepresentations or material omissions made during the loan application process, even if the broker was unaware of the fraud. Trust One Mortgage Corp. v. Invest America Mortgage Corp. (2005) 134 Cal. App. 4th 1302 [indemnity agreement in lender-broker contract enforceable]. Whether this is the case depends on the language in the broker agreement between the lender and the broker.

If the broker had knowledge of or participated in the fraud, it will be liable regardless of the language in the broker agreement. Even if the broker becomes insolvent, many have errors and omissions insurance that may cover some of the claims. Note: A defrauded lender may not bring a claim directly against the broker’s insurance company.

In cases of broker fraud or negligence (e.g. failing to adequately verify the representations made in the loan application, properly supervise a salesman etc.), it is important that the lender make a claim against the broker as soon as possible. The errors and omissions insurance commonly held by brokers often covers only those claims made during the policy period. Claims made after the policy period will not be covered even if the fraud or broker’s negligence took place during the policy period.

Borrower

The borrower is responsible false representations (or concealment) in the application and escrow process. Fraud claims may be brought against a borrower even where a deficiency judgment will not normally lie. Note that if a borrower declares bankruptcy and loan fraud is suspected, it is essential that the lender immediately retain counsel to preserve its rights. A debt obtained through fraud may not be discharged in bankruptcy if the creditor acts quickly to assert fraud in the bankruptcy court by filing an adversary proceeding. Using the bankruptcy process to obtain information from the borrower about third parties e.g. broker, appraiser etc is also an important consideration.

Appraiser

Appraisals may be overstated to “make the deal work”. Appraisers normally carry insurance. As is the case with brokers’ insurance, these insurance policies usually cover only those claims made during the policy period even if the appraisal was made during the policy period.

Title and Escrow Companies

Forgeries often occur and provide a basis for a title claim.
Actions taken by title/escrow companies may go beyond their traditional duties and expand the duties owed to a lender in the loan closing transaction. If title/escrow knows there is fraud, fraudulent disbursements, or straw man purchasers, it support claims against the title or escrow company. Sometimes the title or escrow company assists in the fraud by failing to disclose practices associated with the loan closing such as disbursements from seller to buyer, double escrows to hide the identity of the true seller, etc. This will likely depend on the Lender’s instructions to escrow and the extent of the knowledge and participation of escrow/title. On other occasions, an escrow officer may negligently fail to follow the lender’s escrow instructions. These scenarios can provide an independent basis to assert liability.

OTHER CONSIDERATIONS

Sold Out Junior Lienholders

Generally, sold out junior lienholders may sue their borrowers directly on the note only if the loan was not a purchase money loan. In cases where there is no equity in the security given for the loan, it may be prudent to allow the senior lienor to foreclose and pursue a judgment against the borrower as a sold out junior lienor (and for fraud). However, if such a remedy is not available (i.e. purchase-money loan) and there is loan fraud, the lender can still maintain an action for fraud against the borrower.

Foreclosure Considerations

In the event of a non-judicial foreclosure, the lender should underbid if possible. Defendants will assert that a lender’s full credit bid results in full satisfaction of the debt, barring a fraud claim.

COMMON TYPES OF MORTGAGE FRAUD

• Forged verification of income and/or income records such as pay stubs.
• Forged bank statements or bank’s verification of deposits.
• False representation that the borrower is occupying or will occupy the property.
• “Shotgunning”, i.e. closing several loans from different lenders within a short period of time to prevent lenders from learning of the other loans.
• Non-Arms Length Transaction: Broker, appraiser, family, friends, etc. involved in the loan process without disclosure of the relationship.
• Appraisal fraud.

DOCUMENT AND THIRD PARTY SOURCE REVIEW

A. Internal Document Review

• Loan Application.
• Compare statements contained in Loan Application with other sources of information and documents regarding borrower’s assets, income and liabilities. Conduct follow up inquiries i.e. employment and income verification and cross check against loan application.
• Did the borrower claim he or she would reside at the property? Owner-occupancy verification may support fraud claim.
• Appraisal review: Compare initial valuation to current market price (through an appraisal or an online services i.e Zillow.com) for discrepancies or for income properties, appraiser’s income projections against actual or market income.
• Title/Escrow Documents:
• Closing Statements may reveal irregular payments made to borrower or other “insiders” associated with the transaction.
• Title documents and an updated title search may reveal a double escrow or a conveyance from a straw man purchaser shortly before the close, at loan close, or immediately after loan close.

B. Third Party Source Review

• Misrepresentations or omissions on the loan application (for example, omitting a prior bankruptcy).
• Bankruptcy Court records (available on the internet through PACER). Schedules of assets and liabilities filed with the bankruptcy court may reveal inconsistencies with the information provided to lender.
• Websites that provide average salary ranges for a particular position (e.g. Salary.com).
• Database searches may show lawsuits by other defrauded parties providing additional information on the method or operations of the borrower, broker or appraiser.

Investigation of the foregoing may be undertaken by the lender, counsel, a private investigator, or a combination of these parties.