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Local Firm Fights Rising Tide of Mortgage Fraud

Three former employees of HNC Software, a San Diego company that made credit card fraud detection software, are now taking aim at a rise in fraud occurring in the mortgage lending industry.

Two years ago, the trio launched BasePoint Analytics, a firm that produces software that helps lenders identify mortgage fraud, an activity that usually involves multiple criminals, and can be far more costly than credit card fraud because the cash transactions are much larger.

In the last three years, mortgage fraud has increased 140 percent and has cost lenders between $1 billion and $3 billion annually, according to a BasePoint Analytics study that used data from banks and the Federal Bureau of Investigation.

“We found that losses stemming from mortgage fraud is costing lenders between 7 to 20 basis points (or 0.07 to 0.2 percent) of their total loans. For an average lender that is making about $10 billion in mortgages, that comes out to losses of about $7 million,” said Tim Grace, the president and chief operating officer of BasePoint.

Company officials say their product, named FraudMark, helps pinpoint where fraud could be hiding, allowing lenders to take steps to prevent the loan from being made, which saves money for both the lenders and legitimate customers who won’t have to pay additional costs when they borrow to purchase a home.

Among more than a dozen customers to FraudMark is New Century Financial Corp., an Irvine-based mortgage bank that did more than $56 billion in loans last year.

Terry Theologides, New Century Financial’s general counsel, said because fraud adds costs to any operation, the bank has taken some aggressive steps to curb such activity, including contracting with BasePoint for its software.

“BasePoint assists us in monitoring our brokers and appraisers to help us make sure they are adhering to our ethical standards. With BasePoint in place, we’re able to predict fraud with amazing accuracy and eliminate much more of it before it happens,” Theologides said.


Several People Involved

Grace said unlike credit card fraud , a crime that usually involves a single person , mortgage fraud often is a crime done by several people working in concert.

“There are often multiple parties who can be brokers, appraisers and borrowers,” Grace said.

Some of the more common methods used to defraud lenders are inflating property values through false appraisals, providing falsified paycheck stubs and personal income tax statements to deceive loan underwriters, and setting up false or straw buyers for the loan.

As an example, BasePoint provided several news accounts of mortgage fraud illustrating the activity. In October, one mortgage fraud ring cracked by a combined force of the FBI and the Michigan state police entailed the arrest of 20 people, including a mortgage broker, according to an Oct. 19 report in the Detroit News.

According to the FBI, the ring used straw buyers, people with good credit but not good income, to buy properties well above the fair market value. An appraiser, in collusion with the seller of the house, would then inflate the house’s value. After the loan was approved, the seller would kick back the excess funds to participants.

Daniel Roberts, the FBI agent in charge of the case, said, “Mortgage fraud generally requires insider involvement.”


Pattern Recognition

Grace said FraudMark uses pattern recognition techniques that analyze patterns and trends from past legitimate transactions, and compares that to the data provided by applicants. The software also collects histories on particular loan officers and others engaged in the lending process to ascertain whether a potential fraudulent transaction is occurring.

“We’re the only provider of pattern recognition anomaly detection models in the lending industry,” Grace said.

While FraudMark may have distinct programming elements that make it unique, there are other software programs available to lenders targeting mortgage fraud, said Rick Howe, a spokesman for Accredited Home Lenders Corp., a San Diego-based mortgage bank that makes loans to sub-prime borrowers.

Accredited uses a different fraud detection system, and several other firms have contracted the company to counter an increase in mortgage fraud nationally, Howe said.

Howe declined to reveal the amount Accredited has lost due to mortgage fraud, but said it is an issue that the company is keenly aware of, and addressing.

“It’s something that you have to be constantly vigilant about,” he said. “Once these guys glom onto a particular lender who may have some gaps in their system, they just hammer them.”

BasePoint, with an office in Carlsbad, has been growing fast as it picks up new customers , primarily in the mortgage lending and financial services industry, said Grace, who declined to reveal his business’s financial data.

“We started with four people at the outset in July 2004, and we now have 23 employees. By the end of this year, we should be at about 40 people,” he said.

The two main jobs being created by the business are analytic scientists and fraud experts. Of the latter group, Grace said he’s recruited some of the top talent in the field, including former workers of some of the largest financial institutions in the nation.

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