Part II of III in a series

Based on my discussions with industry participants over the years, it’s safe to say most people believe that discovering fraud is mainly an origination workflow event. However, the truth is fraud can be discovered at a number of events in the life of a loan. Here’s a quick summary of where and when fraud can occur within your current workflow.

1. Prior to loan closing in the origination workflow – Verification processes, up-front fraud tools, underwriting, and pre-funding quality control are all great tools to identify fraud before it’s on the books. However, few lenders have installed strong tracking mechanisms to determine how much fraud is being averted, which loans or loan types, and which method accounted for the detection. This could be a valuable dataset to focus operational controls and to understand trends vs. treating fraud as a one-off.

2. Standard post-funding lender QC reviews– Fraud can easily go undetected in a QC review because it is not a fraud-specific review. QC sampling usually looks at about 10% or less of loan production. QC reviews are completed within the first 2-3 months after closing and usually re-verify credit reports, income and assets. Fraud found in these reviews are most likely to be undisclosed liabilities or job loss that happened prior to closing. Credit reports will consistently uncover most new debts, but asset reverifications may not be returned and may just show the current asset picture versus what it was at the time of the original asset document. Similarly, income verifications may not be returned, or, if part of a collusive scheme, be returned with false information again. Unfortunately, organized schemes are usually sophisticated enough to pass through this type of review.

3. Investor QC – Investors typically perform some level of QC due diligence in the first few months after acquiring the loan. Again, as noted above, fraud is not the primary focus of these reviews and are most likely to find issues like undisclosed liabilities and job loss prior to closing. Investors usually have options for Indemnifications or repurchase requests.

4. Early Payment Default (EPD) reviews – Loans that become 60 to 90 days delinquent in their first 6 to 12 months are often routed to a special QC review queue. Given the nature of EPDs, fraud found in these reviews will represent a much higher percentage of the reviewed population. Unsophisticated fraud schemes (such as a one-off straw buyer flip) that defaulted immediately are often detected in this type of review. Indemnification or repurchase requests are likely if the loan was sold with reps and warrants in the contract.

5. Severe loss reviews – Many investors will perform QC or root cause analysis on loans with large losses, even those with a vintage over one year. Egregious frauds and schemes may be detected here, and recourse will be sought from the originator.

6. Fraud investigations – These take place at any time over the life of the loan, and are usually triggered by a tip about a particular loan, loan officer, appraiser or a particular fraud scheme. As the investigation continues, the sample will broaden as related loans are identified. This is where most fraud schemes are fully identified. Again, recourse from the originator will be an outcome if it was purchased with reps and warrants in the contract.

As noted, mortgage origination fraud may have long discovery delays, and different types of fraud are more likely to emerge at different times in the life of a loan. For these reasons by the time a problem has been identified, it may have become very large. To prevent this, predictive analytics are the key to identifying potential fraud earlier in the process either to target prevention efforts, or to measure risk levels and trend changes.

For more information about the predictive analytics efforts of CoreLogic and its consortium-based population of millions of loan applications, and thousands of examples of loans with fraud, visit: http://www.corelogic.com/products/loansafe-fraud-manager.aspx

Next: The Delay in Mortgage Fraud Discovery and What You Can Do About it.

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