Unlike conventional mortgage lenders, home equity lenders face a unique set of fraud risks.
Financial Insights announced the results of its report, Combating Fraud in Home Equity Lending: The Enemy of My Enemy Is My Friend, which examined the results of new research into emerging fraud within home equity loan portfolios.
Home equity accounts are reportedly among the best performing of all consumer loans, boasting low delinquency and charge-off rates, and have grown considerably over conventional mortgages. Currently, there are 37.7 million home equity loans — 80 percent above the number in 2000, compared to 56.5 million mortgage accounts — 7 percent more than five years earlier.
“It stands to reason then that fraud in home equity lending would look very much like fraud in mortgage lending,” author Christine Pratt said in the report. “In most cases that is true, but what isn’t true is that home equity lenders are not always mortgage lenders, or that they know how to defend against fraud risk.”
The number of mortgage fraud cases and related losses jumped to about 23,000 and $1 billion in 2005 from about 3,000 and less than $0.2 billion five years earlier, according to the report, which also noted that 2003 U.S. Census information indicated that the most vulnerable people, homeowners with a person of 65 years or older in the household, live in the areas most likely to have fraud: the South and Midwest.
“This will become even more important for lenders to consider as reverse mortgages — a home equity product targeted at elderly homeowners — become increasingly popular with aging baby boomers and eager lenders,” the author wrote. “Additionally, rising interest rates, subprime delinquencies, and foreclosures are all indicators of increasing fraud risk in real estate portfolios.
“There is not shortage of fraud schemes within the real estate industry designed to relieve defaulting homeowners of their property but not their debt.”
The report highlighted three documented incidents of home equity fraud that demonstrate the industry’s potential exposure.
One involved a large U.S. bank that was defrauded of $1.2 million by a person who submitted three applications, two on the same day and the other six months later, for HELs on three different properties — none of which he owned and one of which was in a different state. The person used his father’s social security number in addition to submitting bogus employment information and tax returns.
Such theft is reportedly referred to as “loan or lien stacking” in which an individual applies to multiple institutions with a few days for a loan on the same property.
Another incident involved a branch manager/loan officer of one of the largest U.S. finance companies, who embezzled $45,000 from 13 elderly borrowers. The originator routinely used false loan applications to qualify borrowers for home equity loans and then diverted portions of the loans to her own accounts in a nearby credit union, where her sister helped launder proceeds.
The third cited incident consisted of a fraud ring in Massachusetts and Rhode Island that orchestrated an investment pyramid scheme, in which about 400 victims were encouraged to get HELs and use the money to invest in bogus companies with the promise of high returns. The average loan was $26,000.
Fraud for profit is more pervasive and extensible to home equity, than fraud for property, and is usually committed for personal gain, concealing a customer’s or portfolio’s deteriorating condition and protecting an employee’s job. Of these three most oft-cited reasons for fraud for profit, the latter two have direct applicability to home equity portfolios and the lending environment, but, still, “there are no good statistics on home equity fraud, most likely because is early in the product life cycle relative to mortgage” and other types of financing, the report said.
A uniquely home equity issue, however, is “low line utilization,” — there is nearly $500 billion in unused home equity commitments at insured lenders, which represents nearly half the actual $1.3 trillion balance of home equity portfolios, according to the report.
To increase utilization, lenders often embark on risky marketing campaigns that leave them vulnerable to fraud, the report states. Offering rewards or incentives to loan officers for funds withdrawn from accounts within six months of the origination is one of the most common campaigns, and the other is encouraging credit card use to draw on the line, but having no capability to monitor for transaction fraud. Also, many marketing programs drive customers online to apply for or accept offers without having appropriate security infrastructure.
“Combine that with demographic vulnerability, readily accessible information, and large dollars involved in home equity transactions, and the risk of significant losses grows,” Pratt stated.
Additionally, risk escalates through home equity line-of-credit checking accounts because of the large dollar amounts available to home equity borrowers and because people often ignore their account statements until they use their accounts, making suspicious activity go unnoticed, the report indicated.
“Solutions to prevent or resolve fraud in the home equity portfolio already exist (for the most part) in the form of analytics to authenticate, prevent account takeover, and monitor transaction activity, all developed to support either mortgage or credit card processing,” the report said. “Going forward, new predictive analytics will be needed (and existing ones will need to be adapted) to support unique portfolio characteristics.”
Institutions intent on growing home equity portfolios must believe there is fraud in the portfolios already, understand that lessons learned by mortgage and credit card lenders are not product centric, and evaluate new marketing programs and constantly review processes and procedures for potential fraud risk. Additionally, if the plan is to actively market reverse mortgages, institutions should take extra care in developing policies and procedures because these loans targets a growing elderly population.