CASES OF MORTGAGE FRAUD—THE act of intentionally misleading a lender into overextending credit—are rising, a panel of industry experts told the House Financial Services Subcommittee on Housing and Community Opportunity in October. “Based on various industry reports and FBI analysis, mortgage fraud is pervasive and growing,” Chris Swecker, assistant director of the FBI's Criminal Investigations Division, told the subcommittee.

Mortgage fraud takes one of two forms: fraud for property, committed by buyers, and fraud for profit, which is usually committed by such industry insiders as appraisers, mortgage brokers, and loan originators. For-profit schemes comprise 80 percent of fraud cases, according to Swecker. The amount of fraud may be underestimated because it's usually only found when a borrower defaults on the loan, leading the lender to review it.

The cases come with big price tags for lenders, who end up footing the costs associated with the fraud. When secondary market investors—who buy mortgages—discover a fraud case, they require the bank that originated the loan to repurchase it. The original lender usually forecloses on the house and tries to resell it to recover some of the cost but almost always loses money on the deal, says Steve O'Connor, vice president of government affairs for the Mortgage Bankers Association.

Government agencies and lenders have stepped up their fraud prevention, detection, and enforcement activities. Many vendors have begun marketing fraud detection information systems to lenders, while some banks have designed their own applications to identify suspicious loan applications.

The Federal Housing Administration (FHA) has combined policy changes and technological innovations to weed out fraud. It has implemented Appraiser Watch, a risk-based monitoring of appraisers, and Credit Watch, which tracks default rates for the 25,000 lender offices that originate FHA loans.

Under Credit Watch the FHA terminates lenders with early default rates exceeding twice the local market rate. John Weicher, assistant secretary for housing and federal housing commissioner, reported in his Congressional testimony that 261 lender branches have been terminated since May 1999. Appraiser Watch also is effective: The FHA removed 325 appraisers from its roster from 2002 through 2004's third quarter. “We have gotten the attention of both lenders and appraisers,” Weicher says.