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Borrower fraud declines on FHA-backed mortgages

A study by quality control and assurance company Quality Mortgage Services shows that the percentage of misrepresentation on loans backed by the Federal Housing Administration declined 40% in 2011 from the prior year.

But recent changes to the FHA streamlined refinance process could reverse that trend, analysts warn.

Through a verification process and a series of audits, the Brentwood, Tenn.-based company searched for instances of borrower misrepresentation on mortgages. According to a QMS random sampling of 10% of FHA quality control audits, 1.96% of FHA-backed loans contained material misrepresentation in 2011, down from 3.26% in 2010.

QMS President Tommy A. Duncan attributes the decline to a “discovery of stronger compliance in 2010, with the industry starting to crack down on quality control programs,” he said. “We saw the results in 2011, and I think we’ll see even stronger results in 2012.”

“In 2011, there was more direct prefunding, tighter underwriting requirements and lender templates were a little stronger than FHA requirements, so it was harder to get a loan,” Duncan added. “Much more documentation to support the data in the underwriting decision, along with a number of prefunding fraud prevention tools.”

Changes to the FHA streamlined refinance process is expected to benefit homeowners with a mortgage originated before June 2009. But an analyst at the Royal Bank of Scotland warned in March that the Department of Housing and Urban Development will likely increase its indemnification demands for lenders that, it feels, wrongfully wrote the new mortgage.

“We expect HUD to be more active in seeking claims for fraud,” said mortgage securities analyst Jeana Curro in an email to clients, “while HUD has always had indemnification rules in place, it has made few claims in the past.”

The fall of suspicious activity reports is indicative of a slowing rate of mortgage fraud. Potential fraud declined 31% in the first quarter of 2012 to 17,651 from 25,485 in the year-ago quarter, according to a report from the Financial Crimes Enforcement Network.

FinCEN reported an “unusual spike” in filings from the first to third quarters of 2011, due largely to mortgage repurchase demands on banks. Those demands prompted a review of mortgage loan origination and refinancing documents, where fraud was often discovered and then reported on SARs.

Duncan places fault with both lenders and borrowers when it comes to fraud.

“The borrower may be omitting information and perhaps the lender is not doing a good enough job to document or allowing known omissions to not be disclosed,” he says. “It can be shared.”

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