Mortgage Fraud in the Canadian Market: The Hidden Dangers of Collusion

In the Canadian real estate market, the dream of homeownership is a powerful motivator. Owning a home has become more challenging due to high interest rates, stress tests, and a lack of housing supply.

There is tremendous pressure on the various parties in the transaction. Lawyers may be compensated based on doing more transactions and in some cases on the size of the transaction. Mortgage brokers are often paid on commission, and internal sales representatives may be compensated based on sales volume, deal size or a combination of factors.

The Pressure to Close Deals

Most participants in the real-estate process are honest; however, the situation described above can put a significant amount of pressure on buyers, third-party service providers, and even lenders’ employees to defeat controls in order to close deals.
Fraud risk controls are built into the origination through the underwriting process. However, collusion remains a challenge because when two or more parties conspire together, they can defeat the fraud controls and ultimately cause the lender to lose money.

Potential Consequences

As mortgages roll over in Canada, lenders will be taking a hard look at their mortgage portfolios. They may discover that some of their assets may not be as high-quality as they thought. When this happens on a large scale, it can be extremely damaging to the institution and potentially the economy, similar to the sub-prime crisis.

How Collusion Can Defeat Controls

Collusion in mortgage fraud can take various forms but all of it involves parties cooperating in order to defeat controls.

  • Exaggerated Income or Employment History: A borrower might exaggerate their income or employment history with the broker’s assistance. At KeyNorth Group, we have observed cases where a borrower involved in a Ponzi scheme was using real estate as a part of the fraud. This individual submitted three different income declarations on three different mortgage applications in one month where the income rose by over $150,000 between the first application and the third application. The same mortgage broker was involved and did not question the discrepancy.
  • Straw-Buyer/Straw-Borrower Scenario: A mortgage broker may solicit individuals to become borrowers who are unsophisticated, unfamiliar with these types of transactions or unfamiliar with the Canadian mortgage processes. While the straw-buyer/straw-borrower may receive compensation for signing documentation they may not understand the nature of the transaction they are entering into, which is common in certain types of affinity frauds. They may also be a willing participant and are happy to receive compensation for signing their name on the application.
  • Single Points of Failure: Large institutions often have well-resourced operations areas that are completely segregated from the loan origination process; however, smaller institutions may not have those resources and therefore rely more heavily on external counsel or the brokers themselves. Without independent verification, over-reliance can be very high risk.

Frauds can be “chained together.” The main fraud may be a fraudulent loan application; however, those involved may create false identities (synthetic identity fraud), forge documents and prey on members of a specific community (affinity fraud). Institutions have to be aware of all of these issues in addition to the issue of collusion.

Tools and Processes for Detecting and Investigating Collusion

To combat mortgage fraud effectively, a multi-faceted approach that leverages both automated and traditional tools is essential.

  • Automated Tools: AI can be instrumental in detecting anomalous behaviour within the underwriting process. AI can analyze large datasets to identify patterns indicative of fraud, such as inconsistencies in income declarations or unusual relationships between brokers and underwriters (does one broker’s transactions seem to get more approvals than others, for example).
  • Human Intervention: Compliance audits can help uncover fraud that automated systems might miss. When these audits escalate into investigations, they should involve thorough cross-checking of the information provided by borrowers, brokers, and underwriters. Thorough investigations might discover document manipulation, undisclosed relationships between parties and undisclosed compensation arrangements.
  • Income Verification: Many in the mortgage industry have been advocating for income verification through the Canada Revenue Agency (CRA). By directly verifying applicants’ income with the CRA, lenders can significantly reduce the risk of accepting fraudulent income claims on personal loans. This step not only enhances the accuracy of income verification but also deters potential fraudsters who know their claims will be scrutinized.

Securing the Future of the Canadian Real Estate Market

Mortgage fraud, particularly through collusion, poses a significant threat to the integrity of the Canadian real estate market. The pressures faced by buyers, brokers, and lenders create an environment where fraudulent activities can thrive if not rigorously controlled. By understanding how collusion can defeat existing controls and employing a combination of automated and traditional detection tools, stakeholders can better safeguard against fraud.

For decades, KeyNorth Group has worked with financial institutions, regulators, insurance companies, and investors where mortgage fraud is suspected. We have a strong team of resources and external partners that can help.

Contact us if you work for a lender and are concerned about borrower fraud.