The mortgage industry is shifting away from a refinance market back to a purchase market. We asked our experts about a range of topics, including the fraud and quality control trends they’re seeing, the red flags to watch for and pitfalls to avoid, the impact of automation and what best practices to employ in this changing environment.

1. Are underwriters prepared for more complex purchase transactions?

Funds, income documentation and calculations, and the integrity of automated underwriting systems data are all more important than ever. When defects are identified on refinances, they may be considered less concerning because the credit risk is typically lowered via reduced housing payment, the history on the loan, commitment on the property, etc. With a purchase, however, the borrower is generally increasing their credit risk.

Spotting red flags for fraud, and following through on them, is also still very important. The challenge is to ensure that underwriters are well-versed in identifying patterns that might reveal fraud. In a purchase market, underwriters need to be ready to review more eligibility requirements than they may be used to. The purchase market’s increased regulation, lower volumes and compressed margins require diligent fraud protection.

2. What fraud trends are lenders reporting?

Collateral value is where the greatest potential fraud profit is made, and it’s where we need to remain most vigilant in looking for fraud schemes. That said, there are a few notable types of schemes we’re seeing more of these days:

  • Reverse Occupancy. Here’s how it works: To qualify for a mortgage, a borrower buys a home as an investment property. Instead of renting the home, the borrower occupies it as their primary residence. The stated rent proceeds are used in qualifying the borrower, but the actual mortgage payments are made through another means − one that’s undocumented and unknown.
  • Misrepresentation. We’re seeing multiple loans from the same source containing loan-level misrepresentation, with a heavy reliance on gift funds that are questionable. When it comes to income misrepresentation, we sometimes learn that an employer doesn’t even exist. Some fraudsters have gone as far as setting up a bogus Facebook page for a nonexistent business.
  • Falsified Documentation. Documentation is supposed to tell us about the borrower and the value of the property. Many times, documentation − from income, assets, and bank statements to education transcripts − often looks authentic, so falsehoods are often not caught before loan closing. The lesson here is, don’t take every document at face value. If anything seems off, ask for additional corroboration or clarification. Get as much documentation as makes you comfortable.

3. What pitfalls make lenders more vulnerable to fraud schemes?

Oftentimes when we talk about fraud, one of the questions we hear is, how are the loans performing? The biggest fraud schemes we’ve seen in the last year involved loans that were generally performing well. But just because the loan is performing doesn’t mean it meets our standards − or yours.

One of the biggest pitfalls is “check-box underwriting,” where lenders check off that they’ve met requirements. When quality is high, it’s natural to think you don’t have to be as vigilant. But getting too comfortable with who you’re doing business with can get you into trouble.

From a compliance perspective, it’s a great safeguard to ensure you collect the documents as required by our Single-Family Seller/Servicer Guide. But complying with Guide requirements alone won’t guarantee good underwriting. Think of a loan file as a giant puzzle. If the puzzle pieces don’t fit together, it’s a good time to raise your hand.

4. What are some examples of red flags to watch for?

It’s essential to look for red flags when examining documentation and when reviewing how the loan file documents relate to one another. To be clear, a red flag is not proof of fraud or suspicious activity, but it is an indicator that the transaction should be more thoroughly reviewed and that questions should be asked.

For example, consider the red flags that might indicate paystubs are not true and accurate:

  • Deductions are purely required taxes.
  • The borrower is not receiving benefits customary to the represented employment (insurance, vacation, etc.).
  • Paystubs have a “fabricated” feel, meaning they appear to have been generated through common software, such as Excel.

Be on the lookout for anomalies. Red flags can appear anywhere in the loan documents. Does the information make sense? Does everything add up? It’s critical to step back and look at everything in the loan file.

5. What challenges does automation pose for underwriting and fraud assessment?

Because there’s less reliance on human judgment, we tend to expect automation on its own merits to reduce origination time and underwriting errors, while increasing loan quality and reducing fraud.

However, history has taught us that automated processes can be as easy to manipulate as manual processes. As lenders move to automation, they must develop controls and processes to ensure the integrity and accuracy of output.

For our part, we’re constantly staying ahead of potential exploitation of Freddie Mac’s products and technology platforms, and follow a rigid protocol to keep our systems secure.

6. What are the best practices for avoiding fraud while underwriting loans?

Have a well-defined escalation path to determine if a loan is valid or not. Ensure you have a robust pre-funding and post-funding QC process, so you can check information closer to loan origination and identify potential issues before the loan gets funded − and before those issues become problems.

Employ tools and technology in the underwriting process and QC process. Freddie Mac Loan Advisor Suite® includes Quality Control Advisor℠ (see Sidebar for links), our free tool for managing your post-funding QC and remedy process.

You rely on us for guidance, but every lender has its own risk appetite. Knowing your risk appetite plays into the quality of the loans you originate.

Finally, know who you do business with and make sure you continue to monitor them over time. Understand your counterparties.

Don’t Wait for Fraud to Happen

In Fraud and QC at Freddie Mac, we’re very transparent. We let our customers know that we’re using technology and data to be smarter about the loans we observe and how we monitor fraud. We’re always finding ways to keep our customers well informed.

But don’t wait for fraud to happen. Be proactive. And remember, we’re here to partner with you, and are committed to taking steps to protect you.

For More Information

  • Call your Freddie Mac representative