Most types of financial fraud are relatively straightforward: the fraudster uses creative accounting, inflated numbers, or out-and-out lies to trick their victim into handing over money or valuables they wouldn’t otherwise part with, usually while twirling a villainous mustache. You can probably think of a dozen examples off the top of your head, from Bernie Madoff’s Ponzi scheme to the phone scams that try to convince your Nana her Social Security benefits are in danger. But until allegations were recently brought against Federal Reserve governor Lisa Cook, most people had never heard of mortgage fraud—and for good reason.
This type of fraud is exceedingly rare. In 2021, only 58 mortgage fraud offenders were sentenced in the federal system, and the number of offenders has decreased by nearly 70% since 2017.
Understanding what makes mortgage fraud such an uncommon financial crime can help clarify what’s behind the recent allegations—and can make your own brushes with mortgage underwriting feel less opaque. Here’s what you need to know.
Defining mortgage fraud
The specific type of mortgage fraud that Federal Reserve governor Cook (as well as New York Attorney General Letitia James and California Senator Adam Schiff) have been accused of is intentionally deceiving a mortgage lender or underwriter in order to secure a mortgage loan. There are several types of mortgage fraud that a borrower may engage in, including:
- Income fraud: When a buyer misrepresents their income to the mortgage lender.
- Straw buyer: When a fake buyer acts on behalf of a true borrower to misrepresent the transaction because the real borrower couldn’t qualify for the loan. Typically, the straw buyer transfers the title to the property after the sale is done.
- Illegal property flip: When a buyer purchases a property at below market value and quickly resells it at an artificially inflated price. Although flipping a house for a nice profit is not illegal, if it involves a fraudulent appraisal or misleading the new buyer, it is considered mortgage fraud.
- Occupancy fraud: When the borrower lies about the occupancy status of the property to obtain a better rate, since owner-occupied primary residences receive more favorable terms than second homes or rental properties.
Occupancy fraud is the type of fraud that Cook, James, and Schiff have been accused of, since the allegations against all three center on which of their properties are designated as primary residences. (It’s important to note that Schiff claims he got permission from his lender to consider two homes as primary residences because of his need for a home base in both California and the D.C. area.)
The high bar for mortgage underwriting
Mortgage fraud is not so easy to pull off, as anyone who has been through mortgage underwriting can attest. This process puts the borrower’s credit, income, and financial background under the microscope to determine if they are a good candidate for the loan.
Specifically, mortgage underwriting looks at things like:
- employment records for the previous two years
- W-2 tax records for the past two years
- pay stubs for the past 30 to 60 days
- account information for every type of account you have, including
- checking and savings accounts
- CDs
- investment accounts
- retirement accounts
- that money market account you opened three years ago and forgot about
- additional income, like alimony, child support, bonuses
- a gift letter if friends or family have given you money to help with your down payment
Underwriters have the tenacity of a bloodhound and will halt the process to ask for additional information about unexplained gaps in employment or funds that they consider “unverified.” (The card that Nana sent the $500 birthday check in may not be enough to satisfy your underwriter about the source of that unverified extra five Benjamins. Ask me how I know.)
Depending on the lender, underwriting may also require the borrower to provide an intent to occupy letter as part of the process. This legal document offers proof that the borrower is purchasing the property as a primary residence, and works as a legal protection against occupancy fraud.
Why is mortgage fraud different from all other fraud?
With the exception of illegal property flipping, the most common types of mortgage fraud involve a borrower deceiving a mortgage lender—in order to borrow hundreds of thousands of dollars.
This is not like tricking someone into giving you money and disappearing with it. The mortgage lender literally knows where the borrower lives.
Additionally, if the borrower succeeds in deceiving the lender into a more favorable loan through mortgage fraud, the bank risks losing money if the borrower defaults, but the borrower faces higher risks. If they default, they will ruin their own credit. The lender can easily write off the loss of the money, especially since it still has the property as collateral, while the borrower will be in much worse financial straits after defaulting.
This is not to say that mortgage fraud is some kind of victimless crime that can only hurt the borrower. But a type of fraud where you plan to make monthly payments to your victim is a noticeably different beast from simply illegally transferring money from victim to fraudster.
Fraud or error?
Fed Governor Cook has responded to the allegations that she fraudulently took out mortgages on two primary residences—one in Michigan and another in Georgia—by claiming she made no attempt to deceive anyone and that an unintentional error may be behind the problem.
It is impossible to know for certain what happened in this situation. Mistakes certainly happen in mortgage paperwork. There is no specific definition of “primary residence,” which can vary from one state or county to another, and from one lender to another. And while mortgage records are public, they do not necessarily include all the information shared between borrowers and lenders. There is no way to prove or disprove fraudulent intent on Cook’s part.
Along with the fact that mortgage underwriting is very effective, the difficulty of proving mortgage fraud is why there are so few convictions. Yes, it’s possible that many borrowers are fibbing about their income or where they plan to live. (Donald Trump was famously found liable for fraud by a New York state judge for inflating his net worth in order to secure more favorable loan and insurance terms.) Or they may have an agreement in place with their lenders. Or there may be a clerical error on their mortgage records.
If they are making their mortgage payments on time, no one is paying much attention.
Borrowing with an intent to defraud
Mortgage fraud is a real financial crime where a home buyer deceives a lender in order to get more favorable loan terms. But it’s a difficult fraud to pull off because the mortgage underwriting process requires such attention to the borrower’s financial situation—although falsely claiming that a property will be a primary residence is probably one of the easiest types of mortgage fraud.
While mortgage fraud is not a victimless crime we can simply accept from governors of the Federal Reserve—who need to be above reproach—it’s also unlike most other types of fraud. The “fraudster” is committing to years of monthly payments and faces financial ruin if they default.
Lenders are in an excellent position to protect themselves from mortgage fraud through underwriting. The system appears to be working as intended, considering how difficult it is to identify or prove definitive cases of fraud.
Which raises the question—do we really need to examine the intent behind the borrowing irregularities that are currently in the news cycle?