Eliminating Stated-Income Programs and the Golden Goose
By Frank McKenna of National Mortgage News 

January 16, 2008

I felt this article by Frank McKenna, linked above was very worthy of displaying.  His topic and explanation of Stated Income loans that many call "liars" loans is very educational and informative.  It was this specific type of loan that has been blamed for the sub prime meltdown as well as contributing to much of the mortgage fraud that has occurred.  Larry Rubinoff

Please link to the article and move around this issue of National Mortgage News for more good information.

A long time ago, a man came upon a goose, which laid a golden egg every day. The man took the goose home and soon began to stockpile his riches. After a while, he began to think he was not getting rich fast enough and, imagining that the goose had insides made of gold, decided to kill it to immediately get all of the gold. When he cut it open he found that it was just like any other goose.

He didn’t get rich quickly, as he had hoped, and since he killed the goose, he no longer received the daily goldeneggs he once had.

Eliminating stated-income mortgage programs is a lot like killing the golden goose. When you kill the stated-income programs, you don’t really get the fraud-free world you thought you were going to find. In fact, instead of the benefit of having easy-to-spot stated-income fraud, the lender ends up trying to find more well-hidden limited and full-documented loan fraud schemes.

I want to focus on dispelling some of the myths about mortgage fraud and its impacts on the industry. One myth that exists in the industry involves what I call easy fixes, such as eliminating high-risk programs and the expectation that this would solve the problem of mortgage fraud.

Here is one such myth I want to address:

Myth: Eliminating stated-income programs will eliminate most income fraud.

Reality: Some income fraud will go away, most will migrate to full and limited document loans.

I don’t think it’s far-fetched to draw the conclusion that eliminating stated income programs will eliminate most income fraud, I just think it’s unrealistic given what we know about fraud. Fraud is an ever-changing and adapting beast. Solving the problem of income fraud will not be achieved with an easy fix like turning off stated-income programs. I don’t think income fraud is going away — rather, I think it’s going to change.

Let me give you some reasons why I believe this.

1. Full and limited document income fraud has historically represented risk.

BasePoint analyzed historical fraud rates on full-, limited- and stated-income document programs from 2001-2006.  Surprisingly the highest fraud risk levels occurred on limited document programs and not on stated-income programs.

In some cases, the risk rate on limited document programs was almost twice that of stated programs. Since limited document programs will still be available, these programs will certainly bear even higher fraud rates in the future.

2. Full document is a misnomer.

People tend to think of full income document loans as containing either pay stubs and W2s for wage earners or 1040s for self-employed borrowers. These are referred to as documents of reliance, since the lenders use them to validate that a borrower’s reported income on the 1003 can be relied upon as truthful. It is important to remember,

 however, that full document programs will often defer to a written verification of employment in place of paystubs and W2s.

Yes, this is in fact a widely accepted practice.

A written VOE (the easiest to fabricate document in a loan file) can actually be considered full income documentation.Simply put, full document fraud is not that hard to perpetrate at all. Filling out a handwritten and non-computer-generated form is so easy that, no offense, even a caveman could do it.

3. Gaming the system has always been and will continue to be a factor.

Cheating the system has been around since the beginning of time. It is basic human nature to push the limits of the system for a person’s own self interest. “Gaming” the system or manipulating underlying loan factors to get an approved loan with the fewest conditions is a form of mortgage fraud. Consider a common technique used by some in the industry to see how far they can push the limits of “reasonable” income.

An unscrupulous loan officer electronically submits a loan for an unemployed 21-year-old borrower for $15,000 a month, knowing the income is false. The lender returns a conditional approval but requires full income documentation from the broker. The loan officer then re-submits the loan for $8,000 a month and gets a conditional approval with little or no income documentation required.

In this case, the lender has unknowingly allowed a loan officer to “game” their system of fraud controls. The lender may consider their fraud risk to be minimal on this loan since the loan falls into what was once a historically low-risk population. In reality, this fraud has just flown under their radar.

Fraud can be managed, but it will not come from a simple fix.

While there is no easy fix, I think the industry should be applauded for taking drastic actions to reduce fraud.  Eliminating stated-income programs demonstrates that individuals are taking significant measures to stop fraud. This is a great thing.

I believe that there are other methods that, while harder, will provide lenders with more security against fraud.  Fraud risk must always be evaluated at the loan level. A borrower’s income is either reasonable or unreasonable but that reasonability cannot be determined at an aggregate level, it must be determined on a case-by-case basis.

The absolute level of income risk is a product of the layers of risk on the application itself: the borrower, the property being purchased, the level of risk of the broker, the appraiser, and everyone else involved in the transaction. Finding income fraud, regardless of the supporting documentation type, comes from peeling back each of these layers of risk and just asking the question, does this loan make sense?

Frank McKenna is co-founder and chief fraud strategist for BasePoint Analytics. For more information, visit http://www.basepointanalytics.com/FFwF01-08.html.