Scotsman Guide - November 2008 Residential Edition

The 1003: Your Legal Shield?
Lenders and brokers have used the uniform loan application to defend against fraud claims
By David L. Hippensteel, council member, Gerson Lehrman Group Councils

The dramatic increase in foreclosures has contributed to a mortgage meltdown. The economic impact has sent ripples — if not waves — throughout the industry, affecting many lives. This has resulted in a near-witch-hunt mentality by some to find and punish those responsible.

Mortgage brokers, loan originators and lenders have been the target of most mortgage-fraud investigations led by Congress and several states. The central argument often is that brokers and lenders should have known that many of their borrowers could not afford the payments that went along with high-risk ARMs when their loans’ rates adjusted. The argument also claims that originators had an ethical or moral duty to do what was best for their clients, particularly when it came to mortgages for which income was not verified and was blatantly overstated on loan applications to satisfy debt-to-income (DTI) ratios.

Within the past several months, many still-solvent mortgage lenders and some brokers have defended themselves in court using a tactic the FBI commonly employs when prosecuting mortgage-fraud cases: Title 18 of the U. S. Code, Section No. 1001, which governs false statements and fraud. They are pointing to Section IX, the ac-knowledgement-and-agreement section of the uniform residential loan application — aka, the 1003 — to defend themselves against many claims.

applying for a mortgage, then shame on them, this defense claims.

Although this defense has worked for many lenders, mortgage brokers who use this strategy face an uphill climb. This is because many lenders take the legal-responsibil-ity defense a step further by turning on the brokers who originated the loans in question.

Many contracts signed between lenders and brokers require that brokers verify the authenticity of all information they submit to the lender prior to underwriting. Lenders argue that the brokers accepted legal responsibility for doing this as part of the mortgage loan-ap-proval process. Adding to the burden of verifying borrower information, many states’ codes of ethics for mortgage brokers and loan originators require licensees to conduct business in their clients’ best interests.

In addition, brokers may not have success with this defense because many state licensing guidelines say brokers, as “licensed professionals,” are responsible for verifying all information on the 1003. Though brokers may claim that they ensured borrowers understood Section IX, states often do not accept the idea that borrowers have the same level of knowledge about mortgages as a broker. Essentially, the states argue, borrowers do not have the underwriting knowledge necessary to take advantage of the system successfully; brokers do.

As such, lenders are finding more success with this defense than brokers.

The defense

Section IX of the 1003 states:

“Each of the undersigned specifically
represents to Lender and to Lender’s ac-
tual or potential agents, brokers, pro-
cessors, attorneys, insurers, servicers,
successors and assigns and agrees and
acknowledges that (1) the information
provided in this application is true and
correct as of the date set forth opposite
my signature and that any intentional or
negligent misrepresentation of this infor-
mation contained in this application may
result in civil liability, including monetary
damages, to any person who may suffer
any loss due to reliance upon any mis- _Spotting _conflictsrepresentation that I have made on this
Mortgage lenders being sued are compil-
application, and/or in criminal penalties
ing substantial databases of conflicting
including, but not limited to, fine or im-
information that borrowers and brokers
prisonment or both under the provisions
submitted in their loan-origination pack-

of Title 18, United States Code, Sec. 1001, _et _seq.” ages. Informational conflicts include:

This section also specifically calls ■■ Job titles on 1003s that do not match out that “the property will be occupied verbal-verification-of-employment as indicated in this application.” This forms; phrase becomes vital for many borrowers _■■_Original _cost _data _on _1003s _that _do _notwho are facing and trying to avoid fore- _match _information _appraisers _obtainedclosure and who face charges of occu- _from _public _records_;pancy fraud.

^■■Mortgage lenders’ and brokers’ defense ^{Primary-residence-occupancy} ^certi-is that even though they may have made ^fications ^that ^do ^not ^match ^borrower-bad financial decisions, the 1003 legally ^provided ^hardship ^letters ^submitted ^asplaces the liability on the borrowers who ^part ^of ^forbearance ^requests;signed it. If the borrowers’ chose to not ^■■Stated incomes that differ greatly from read all the paperwork associated with true incomes;

■■ Real estate owned schedules that de-
liberately omit properties borrowers
recently purchased but that do not yet
appear on their credit reports; and
■■ Declarations under Section VIII of
the 1003 that conflict with credit-report
public records.

The list goes on. These findings are used to illustrate how borrowers deliberately misled brokers and lenders to get a mortgage for which they truly did not qualify. Although these legal arguments do not sit well with state attorneys general, they are holding up in state courts because “legal responsibility” trumps “ethical responsibility” in the eyes of the law.

The most obvious case of borrower deceit has been deliberately elevating job titles on 1003s to support elevated stated incomes. Borrowers who list their current job title as “sanitary engineering foreman,” for instance, have difficulty explaining why their employer verifies their true job title as “garbage collector.”

■■■■■

documentation collected during the loan-approval process that showed the 1003 was purposely flawed. The FBI’s point is clear: Few borrowers forget about what type of debts they have or what their true job title is.

State courts are having trouble disagreeing with the lenders’ defense attorneys because the issue is one of pure legal precedent where morality and ethics take far-back seats. Further, if the FBI has used the strategy to convict mortgage fraudsters successfully, state courts cannot ignore prior federal court rulings just because they let the companies with deep pockets off the hook.

It all comes back to a simple legal rule: Ignorance of the law is no excuse for violating it.

Illustration: Ken Orvidas

Mortgage lenders obtained this legal defense strategy by taking a page from the FBI’s mortgage-fraud investigations. The FBI has successfully used obvious differences in data put on a 1003 and “ verified” by borrower signatures versus other

David L. Hippensteel is a member of the Gerson Lehrman Group Councils, consulting globally in the areas of mortgage fraud, mortgage-investor due-diligence underwriting,

mortgage structuring and consumer-credit management. Hippensteel is an adjunct faculty member of Bryant and Stratton College’s business-development department. Reach him at refimortgages@wi.rr.com or (414) 801-7368.