This article is reproduced with the kind permission of the Editor of The Solicitors Journal. Originally published in the 152/32 edition, 12 August 2008.
Neil Swift explains the different types of mortgage fraud that solicitors are likely to discover and how the regulators are attempting to tackle it
Ten years of cheap and readily available credit coupled with an ever-rising property market have provided fertile ground for those inclined to commit mortgage fraud. Only 12 months ago lenders were falling over themselves to attract new business and the market was full of willing borrowers, anxious to put a foot on or to move up the housing ladder.
Counting the cost
In a time of rising prices, the banks were able to take a commercial view of the risk of honest default and of mortgage fraud, the possibility of financial loss being offset by the ever-increasing value of the security and balanced against profits earned elsewhere. In order to maintain and expand market share the relaxation of lending criteria was within the range of acceptable commercial risk.
However, what was acceptable yesterday is today's unacceptable fraud loss. We are now starting to see how the seeds sown in the days of competitive and easy lending are coming to fruition, with a bumper crop of mortgage fraud, the likes of which has not been seen since the end of the last property boom in the early 1990s. This article aims to provide an overview of the types of fraud that are likely to come to light, what steps can and are being taken to prevent further fraud, and the impact on the mortgage and property market.
Types of fraud
Broadly speaking, mortgage fraud falls into one of two categories: first, the opportunistically dishonest but otherwise genuine homeowner who provides false information during the mortgage application process to secure their loan, and second, that perpetrated by criminal gangs who have seized upon the opportunities for easy gains presented by weaknesses in the conveyancing and mortgage application processes. To an extent one can sympathise with the opportunist. With prices moving further and further beyond the reach of all but a fortunate few first-time buyers, and the price of family homes also increasing as a result of demand far outstripping the supply, many must have been tempted to exaggerate income, or omit previous addresses associated with bad credit.
Nevertheless, particularly with the new offence created by the Fraud Act 2006, those who were' economical with the truth' on their mortgage application forms are technically at risk of prosecution, regardless of the materiality of their mis-statements. Similarly, those who joined the buy-to-let revolution by renting out property purchased with an owner-occupier loan could commit the offence by failing to disclose the true status of the occupiers.
The Fraud Act
The Fraud Act is undoubtedly of wider application than the now repealed Theft Act 1968 and 1978 offences, ditching the effect of the deception on the deceived in favour of the criminal's intentions. While the Fraud Act only applies to offences committed wholly after 15 January 2007, the sting in the tail of mortgage fraud is the inevitability of it being committed again and again: an overstatement of income to secure a loan is likely to resurface when remortgaging, particularly with the post-credit crunch tightening of income multiples and the differential between pre-credit crunch fixed and discounted rates and present standard variable rates.
The second category, mortgage fraud as criminal enterprise, is undoubtedly the most troubling, and that most likely to be dealt with by the criminal courts. More often than not it requires the knowing or negligent assistance of participating solicitors, mortgage brokers or valuers. The possible variations of fraud are limited only by human ingenuity, but examples include:
- mortgages granted over property which was yet to be and indeed
never would be built;
- commercial property claimed to be subject to false leases at
rents which were over market value;
- the preparation and submission of forged certificates of title
in order to deceive a lender on a remortgage;
- the purchase of property at a discount followed very quickly by
remortgaging at the perceived 'value' rather than the
purchase price;
- multiple sales transactions between commonly controlled, often
offshore, corporate structures to ramp up the 'value'
before being mortgaged at that inflated level; and
- back-to-back sale transactions where the first mortgage is not
registered against the property following the first sale and not
redeemed upon completion of the second sale.
Particularly at risk for this type of fraud are new-build blocks, many of which may have been purchased for the purposes of the same dishonest scheme.
It is not difficult for the determined to source false identity documents, establish a credit history and apply for a mortgage to buy a property-or, to make it worthwhile, a portfolio of properties.
Extent of mortgage fraud
The full extent of mortgage fraud arising out of the late 1990s and early 2000s is unlikely to be known for some time. However, it is now apparent that even prior to the credit crunch the incidence of fraud was sharply increasing.
The March 2008 intelligence report circulated by the Association of Chief Police Officers to financial institutions and police forces estimated that somewhere in the region of £700m of lending in 2007 was fraudulently obtained. The bottom line cost to a lender in each case of fraud was estimated at £45,000.
According to KPMG's Forensic Fraud Barometer for 2008, which examines cases which are going through the courts, there were nine cases of mortgage fraud in the first half of 2008 worth a total of £20m. This compares with just 10 cases in the whole of 2007, with a value of only £3.7m. But there is an inevitable delay between fraud being committed and being dealt with by the courts, and the 2008 cases largely predate the credit crunch. Commentators agree that the full impact is unlikely to be felt for some time.
Market response
Many lenders have in place dedicated application vetting teams that systematically examine flagged applications for possible fraud. Some have started to take further steps to reduce their potential exposure to fraud, such as withdrawing from the new build market, reducing their maximum loan to value ratios, and appointing in-house valuers, as part of a general tightening up of procedures. Many lenders also participate in various discussion and information exchange forums, such as the Public-Private Forum on Identity Management, established by HM Treasury.
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SJ takeaway
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Professional bodies, associations and the Financial Services Authority (FSA) have recently taken steps to raise awareness and tighten up regulation of those working in the market who deliberately or inadvertently might find themselves involved in mortgage fraud. The time for 'light touch' regulation is most definitely gone.
Warning signs
The Law Society reissued its Fraud Practice Note in March 2008, aimed at reminding conveyancing solicitors about the potential pitfalls. The note sets out several of the well-known warning signs, but given that the proportion of complaints to the Solicitors Regulatory Authority about solicitors involved in mortgage fraud is rising, and now exceeds 25 per cent, the warning was perhaps too late.
Following its assumption of responsibility for mortgage products in 2004 the FSA has been active, and in April 2006 launched a reporting system enabling the collation of information provided by lenders about suspected or proven mortgage fraud involving mortgage brokers. As a result of this initiative 17 brokers have been banned by the FSA in the past 12 months, and in one case a heavy financial penalty was imposed. Generally their offending behaviour involved assisting applicants to submit applications with false income and employment details, but the one subjected to the financial penalty submitted numerous applications in her own name supported by over-inflation of her earnings. Arguably the latter was fortunate not to face criminal prosecution, although no doubt the costs she incurred, the £129,000 fine and the effective loss of her livelihood has the potential to deter others.
Further, the FSA announced in July 2008 that it planned to visit 200 financial intermediaries to assess their financial crime systems and controls. It also plans to gather more information about suspect applications from lenders. However, as Philip Robinson, director of financial crime and intelligence at the FSA recently said: "Lenders must also have in place systems and controls to identify and reduce fraud and continue to provide us with the intelligence which is key to success in this area".
The Council of Mortgage Lenders has been working in conjunction with the FSA and supports this, CML Director General Michael Coogan commenting that: "The FSA rightly identifies that the best way to tackle mortgage fraud is for lenders and the regulator to work together, along with law enforcement agencies, to root out fraudsters ... We welcome the FSA's focus and practical approach in this area, and we expect that even more lenders will now participate in the voluntary initiative designed to identify and investigate broker fraud."
Consequences for the market
Although when compared to the volume of mortgage business in the UK the proportion believed to be fraudulent is comparatively small, it is still significant. It will have implications beyond the direct losses borne by the financial sector and will be felt throughout the market. Properties which have been purchased and remortgaged solely for fraudulent purposes will, when repossessed and resold, be worth very much less than the market thought they were and will exert further downwards pressure on prices.
That said, it is difficult to pinpoint precisely which features of today's mortgage market are as a direct result of fraud and which are in response to the 'credit crunch' and its underlying causes. Lenders already wary of their exposure in these difficult times have tightened up their lending criteria, although one would hope that measures designed specifically to combat fraud do not impinge upon genuine borrowers.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
