Stated-income loans vulnerable to fraud

Martha Aikens was on the verge of losing her home in early 2004. The culprit: a "stated-income" loan that she had been induced to take out a year and a half earlier but was never able to make a single payment on.

Aikens, a widow in her 70s, sought to refinance the mortgage on her home in Evanston, Ill., in May 2002. But to qualify her for a higher-rate loan and get the commission, the mortgage broker grossly inflated her income and falsified her employment information to make the overstated income look plausible, according to a complaint filed against the broker.

Her application then went through as a stated-income loan — one that discloses income but doesn't require verification.

The case points to a growing concern among consumer advocates and regulators over the home-lending industry's increasing reliance on reduced documentation, particularly unverified income, to speed up the loan-approval process amid the ever-intensifying competition.

"It's just too easy to cheat," says Tom Miller, Iowa's attorney general.

Fraud related to stated-income loans often is initiated by lenders and brokers in pursuit of profits, Miller says, leaving consumers in the dark.

Multistate probe

In a recent multistate investigation led by Iowa, Ameriquest Mortgage was accused of engaging in a variety of improper lending practices, including encouraging borrowers to exaggerate their income to qualify for loans. The subprime lender, a unit of closely held ACC Capital Holdings in Orange, Calif., settled those charges in January by agreeing to pay $325 million and making sweeping changes to its lending practices.

Loans requiring no income check have been around for many years, with the initial intention of offering convenience, time savings and financial privacy to self-employed borrowers with high credit scores and large down payments. A qualifying borrower may need to submit only his or her business license, a signed letter from his or her accountant confirming a two-year history of the business, and an IRS form verifying the income source but not the amount.

"The industry is trading risk for convenience," says Larry Goldstone, president and chief operating officer at Thornburg Mortgage in Santa Fe, N.M. "That may be mistaken at some point in the future."

Industry experts say loans with reduced documentation now account for about 40 percent of the entire mortgage pool.

The vulnerability of stated-income loans to fraud is illustrated in a recent report by the Mortgage Asset Research Institute to the Mortgage Bankers Association: After reviewing a sample of 100 stated-income loans and the accompanying IRS forms, an undisclosed lender recently discovered that almost 60 percent of the stated incomes were inflated by more than 50 percent, while 90 percent of the stated amounts were exaggerated by 5 percent or more.

Industry leader Countrywide Financial and subprime lenders like Long Beach Mortgage, a unit of Washington Mutual, maintain that they have proper controls and safeguards in place to adequately manage risks of loans with reduced documentation. For instance, the lenders say, they always attempt to gauge the validity of the stated income based on the applicant's occupation and assets including savings and investments.

More safeguards urged

Still, consumer-advocacy groups are urging regulators to install more safeguards to protect consumers.

In a letter to the Federal Reserve Board, more than 50 organizations in California, including California Reinvestment Coalition and Housing and Economic Rights Advocates, voiced support for the creation of "a suitability standard for home loans" similar to the one that governs how stockbrokers should sell stocks, bonds or other investment products to investors.

In borrower Aikens' case, when she went to the broker, 1st Metropolitan Mortgage, to refinance her home so she could get money for her granddaughter, she had a monthly income of about $1,400 — $800 from Social Security and $600 from working part time as a housekeeper.

However, her loan application, prepared by the broker, said she made $7,225 a month as a housekeeping supervisor for a large institutional employer, according to the complaint filed on May 16, 2005, against the broker in the Circuit Court of Cook County, Ill.

A month later, through the broker, Aikens received a loan of $149,000 with a monthly tab of roughly $1,029 — almost three-quarters of her entire monthly income. She was never able to make a single payment, says Daniel Lindsey, a supervisory attorney with the Legal Assistance Foundation of Metropolitan Chicago that represented Aikens. Her lender, Countrywide, filed a foreclosure action against her in January 2004.

Earlier this year, a settlement was reached that Lindsey says "saved her a substantial amount of debt, defeated the foreclosure action and kept her in the home."

First Metropolitan Mortgage was dissolved in August 2003. Its two principals named in the complaint couldn't be reached for comment. Countrywide wouldn't comment.