The law of supply and demand determines the price of goods. In other words, the higher the demand, the higher the price. While this can promote economic growth, could it also be used to measure the likelihood of fraud scams? A strong market tends to ease underwriting practices and loosen lending controls. Results? More possibility of fraud.
So what drives this risk and what can lenders do to protect themselves? Multiple factors play into the risks associated with runaway markets, including:
- Massive underwriting backlogs
- Looser lending standards (i.e. fast money)
- Government stimulus
- Desperate borrowers
- Cheap fraud services
How Lenders Respond to a Competitive Market
According to Auto Finance News, in Q2 2021 banks eased credit standards in order to keep up with consumer demand (Auto Finance News). The market was highly competitive. So being able to underwrite and fund a loan quickly meant the difference between a booked loan and a lost customer.
To keep up with demand, auto and mortgage lenders often allow more exceptions than usual. So consumers enjoy easier loan approval and faster cash. As sharks are drawn to blood in the water, so, too,are fraudsters drawn to fast money. This fast money environment is favorable to both first-party (individuals who misrepresent fact to obtain approval) and third-party fraudsters (criminals running a money-making scam). In both cases, default is inevitable.
Fraud Scams in the Booming Auto Market
According to the Bureau of Labor and Statistics, used car prices are up by 30% in the last year. Manheim, the largest used car auction in the US, puts that number closer to 48%. A domino effect of circumstances contributed to the increase:
- Consumers emerged from pandemic lockdowns
- Historically low interest rates on new vehicles
- Chip shortages reduced the supply of new vehicles
- High demand for use cars that now sold for more than their value
- Fake pay stubs became cheap and easy to find
- Price increases dramatically outpaced wages
This created the Fraud Triangle, a framework that explains the three contributors to an individual’s decision to create fraud: Circumstances, Opportunity, and Justification.
Fraud Scams in the Hot Mortgage Industry
Lately, the price of real estate seems to come up in every conversation. Homes routinely sell in minutes for 10-20%, even 50%, over asking price. The mortgage industry has never seen such an influx of applications for both home purchases and refinances. Borrowers compete over limited property inventories. Existing homeowners refinance to take advantage of continuing low rates or cash out some of their equity.
This leads to an important fraud driver: Higher prices makes it harder and harder for some borrowers to qualify for a purchase or refinance.
Along with the “fast money” of escalating property values comes tighter qualifying ratios, leading to the rise of certain fraud types. Income fraud, for example, is linked to the drive to qualify for mortgages. Sometimes the borrowers initiate this fraud by themselves. Other times, intermediaries (brokers) coach borrowers on how to falsify incomes to qualify for the mortgage.
Consider the Unemployed Cash Out Refinance. An unemployed homeowner wants to refinance his home and take out cash. But without a job, he won’t be approved. For $100, a local credit repair business falsifies his employment. He intends to pay his mortgage. But when the fast money is gone, mortgage payments stop.
The Problem with Government Stimulus
For a time, the influx of government stimulus does stem the tide of total economic collapse for individuals. Additional unemployment benefits, periodic stimulus checks, and eviction moratoriums helped keep families afloat and the market moving. But as they come to an end, so will some people’s monthly payments.
A recent Point Predictive survey indicated that 70% of lenders saw stable or even decreased lending risk last year. This is worrisome because, during that same time period, we’ve seen a dramatic increase in misrepresentation. This means the impacts of fraud have not been realized yet. Temporary increases in cash through stimulus checks, and higher prices of vehicles and homes, can only keep losses low for a time. The lifting of eviction moratoriums will create a ripple effect throughout the rest of the market, resulting in a new wave of bankruptcies.
Recommendations to Lenders
As lenders further automate their originations workflows, lending becomes faster and fraud becomes easier. The solution is not to accept backlogs and settle for laborious underwriting that increases friction for only the riskiest population. The solution is to implement proper fraud scam controls. The move toward automation is necessary, but lenders should take care not to rely heavily on performance data or risk benchmarks from pandemic-era information. While seeking to reduce underwriting scrutiny and automated decisioning, lenders must leverage alternative data sources to limit risk to their portfolios.
Keep an eye on fraud drivers, whether they’re inflated prices that increase profits and decrease net loss, or government assistance giving borrowers an affordability buffer. The faster lenders become, the faster they become targets. Fast money = Fast fraud scams.
Point Predictive’s consortium approach allows lenders to work together to identify fraud scams and ensure stability in the market. The ability to quickly identify fraud trends can help lenders streamline their low-risk populations and focus their time on the riskiest loans.