Overview

Mortgage companies must maintain a heightened level of vigilance when it comes to preventing mortgage fraud. The incidence of fraud attempts targeting mortgage companies continues to rise, prompting decisive action against this threat. In a criminal complaint filed on April 23, 2024, in the U.S. District Court for the District of New Jersey, the U.S. Department of Justice (DOJ) leveled charges against two former mortgage loan originators (MLOs) for conspiracy to commit bank fraud, one of who was recognized as a “top producing loan originator” and named Scotsman Guide’s fourth-ranked MLO in America in 2022. While the news of this type of fraud is shocking, it unfortunately is very common.

The Charges, Market Trends

Fraudulent behavior within the financial services arena is not uncommon. According to a recent study published by LexisNexis, businesses in the home lending segment saw an increase of 34.6% in monthly fraud attempts in 2023. Over half of those fraud attempts were successful, costing lenders nearly 4.5 times the lost transaction value, including fines, fees and investigative costs. Notably, mortgage fraud due to fraudulent “scams” was up 51% in 2023.

These statistics and the DOJ’s pending suit should be a wake-up call for businesses in the mortgage space. According to the allegations in the DOJ’s complaint, Christopher Gallo and Mehmet Elmas were employed by an unidentified “financial institution” during the period in question; Elmas served as Gallo’s assistant as well as an MLO. The allegations against Gallo and Elmas include benefiting from mortgage loans with reduced interest rates and fabricating property records. More specifically, the complaint asserts that, from 2018 to 2023, Gallo and Elmas used their positions to conspire and engage in a fraudulent scheme to falsify loan origination documents to obtain mortgage loans based on false and fraudulent pretenses, representations, and promises, and that the two routinely misled mortgage lenders about the intended use of particular properties to fraudulently secure lower mortgage interest rates from mortgage lenders. They frequently submitted loan applications claiming that listed borrowers were primary residents of certain properties when, in reality, the properties were intended for rental or investment purposes. Accordingly, those misrepresentations materially affected the interest rates the mortgage lenders offered on the mortgage loans for those properties and, as a result of the less stringent approval standards, presumably enhanced the defendants’ prospects of earning commissions.

Distinguishing between purchasing a home as a primary residence or an investment property holds significant weight to lenders and buyers on the secondary market. Primary residences typically offer lower rates, require less initial investment, including reserve accounts, and often provide additional incentives for buyers. These incentives stem from the understanding that a primary residence suggests the buyer’s commitment to staying in the property long term, enabling the lending institution to profit from interest payments over time. For instance, a lending institution stands to earn considerably less when a buyer purchases and subsequently “flips” a home on a short-term basis, and thus lenders generally offer lower interest rates and less stringent approval qualifications for primary residences than for investment properties.

Takeaways

The criminal complaint serves as an unwanted reminder that not all fraud threats are external. Vigilant lenders should review existing internal red flags and AML/BSA policies and procedures to ensure robust detection protocols are in place. Moreover, lenders and investors should consider all channels through which bad actors might enter the origination process and review the various operational lines of defense deployed to meet them wherever they are found. Underwriting staff should be trained to detect any inconsistencies in residence type.

We note that the GSEs provide robust guidance on verifying occupancy and identifying related red flags. Every employee, from originators to processors to underwriters, should remain vigilant against deceptive practices, with training designed to enable staff who is most engaged with borrowers to recognize residence-type fraud. And perhaps most importantly, lenders should ensure the sales force is adequately equipped to inform and educate borrowers as to lending options appropriate to the true residency type, with monitoring in place to guard against concerted efforts between external and internal bad actors.

Businesses must treat reports of fraud (whether internal or external) with utmost seriousness, establishing internal protocols for detection, reporting, and investigation to mitigate potential financial losses. Such proactive measures could ultimately save businesses substantial sums of money.

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