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Amid hot housing market, stretched borrowers may be stretching the truth to get loans

Financial Post logo Financial Post 2021-04-26 Geoff Zochodne
a stop sign in front of a building: Rising home prices may require borrowers to take on more debt, and to prove to lenders that they can afford the added burden. © Provided by Financial Post Rising home prices may require borrowers to take on more debt, and to prove to lenders that they can afford the added burden.
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The recent surge in home prices has a federal regulator reminding lenders to stay sharp, but it is also prompting concern that borrowers may be stretching themselves financially and, in some cases, stretching the truth when they apply for a mortgage.

One Canadian mortgage brokerage told the Financial Post it has recently uncovered a rash of suspicious employment letters submitted by individuals trying to obtain loans in the Greater Toronto Area.

“I must say this is the most advanced employment fraud I’ve ever come across,” said Dan Eisner, chief executive of True North Mortgage Inc.

Income letters are provided by prospective borrowers as proof of employment and income, to help show they have the means to pay back a loan.

True North, Eisner said, calls the companies on the job letters prior to funding a mortgage (it also has an exclusive lending arm called THINK Financial). For letters that they now suspect are phony, Eisner said that process was followed and someone answered the phone and confirmed the details of the letter. Other documents, such as purported pay stubs, were provided as well.

However, Eisner said a few weeks back something strange was spotted by a “closer” at the brokerage, who handles documentation. That employee noticed that two letters provided by two would-be borrowers from two supposedly different people at two supposedly different companies had the exact same signature.

True North’s closer alerted the underwriting manager, and six or so other suspicious letters were subsequently discovered. In one case, True North pulled its funding at the last second, but heard nothing back from the client, which led Eisner to suspect fraud.

“Because when we pulled the funding on the deal, the client didn’t complain,” he said in an interview. “And you’ve got to imagine if you’re buying a house, and all of a sudden your bank pulls the funding on the day of closing, you will complain.”

True North checked its files to see if there were other deals that fit the profile, and found a handful of other suspicious letters. They were, Eisner said, from companies the lender had never heard of, that all claimed to be located in the Greater Toronto Area, and that they had websites that had been created recently and contained a fair amount of detail.

“They’re not just coming up with websites, they’re coming up with websites that seem fairly deep,” Eisner said.

The discovery by True North comes amid a red-hot Canadian housing market that is being driven by low interest rates, high levels of household savings and a preference for more space among potential buyers, some of whom may fear missing their chance to own a home. Rising home prices may require borrowers to take on more debt, and to prove to lenders that they can afford the added burden.

Previous bull markets for housing have also caused suspicion about mortgage fraud, which can involve providing false information to a lender. Equifax Canada, for instance, said in January 2017 that its data showed a 52-per-cent increase in suspected fraudulent mortgage applications since 2013.

More recently, a survey by Equifax in February of 1,540 Canadians found that nine per cent hadn’t been totally truthful on a loan application and that that nine per cent said it was acceptable to inflate annual income when applying for a mortgage (which was down from 12 per cent in 2019). Forty per cent of respondents agreed that mortgage fraud is a growing problem.


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Furthermore, one of the trends the credit-reporting agency is seeing recently is a rising level of complexity in manipulating documents, said Carl Davies, head of fraud and identity at Equifax Canada.

“Fraudsters are getting far more sophisticated,” Davies said in an interview. “That’s a problem, not just in the mortgage space, that’s everywhere.”

However, when it comes to mortgages, it also means there is a bit more demand for homes amid an already limited supply.

Some borrowers may be able to afford their mortgage payments in the current low-rate environment, Eisner said, but not at the level they are stress-tested at to ensure they can meet their obligations, which for loans not insured against default is proposed to rise in June to at least 5.25 per cent.

That higher hurdle is in addition to another steadily climbing one for borrowers, which is increasing home prices. The Canadian Real Estate Association reported recently that national home sales set another all-time record in March, and that the actual average sale price rose by 31.6 per cent from a year earlier.

These trends might lead a would-be borrower to try to fudge details on a loan application.

“They’re seeing that their ability to get into a home is only getting further away as home prices increase,” Eisner said. “You can’t save up money fast enough to keep up with the increase of home prices.”

One federal regulator has already warned lenders not to let their guards down amid all the recent housing madness.

That warning came in a letter from the Office of the Superintendent of Financial Institutions earlier this month, which also announced plans to toughen the uninsured mortgage stress test contained in the B-20 guideline for residential mortgage underwriting.

OSFI also said it will be “looking for heightened vigilance” from federally regulated financial institutions in applying B-20’s principles related to collateral management, income verification and debt servicing, among other things.

Superintendent Jeremy Rudin told reporters on April 8 that this was a “proactive measure” motivated by what the watchdog is seeing in the housing market. Conditions such as fast-rising home prices and a high pace of real-estate transactions can tend to undermine sound mortgage underwriting, the head of OSFI said.

Specifically, OSFI said it expects federally regulated financial institutions to “continue applying rigour in the verification of a borrower’s income,” although its concerns seem more aimed at ensuring property values don’t usurp the place of a steady paycheque.

“The most secure mortgages are those to borrowers who have the capacity to repay the loan, and not those that accumulate equity through rapidly rising house prices,” the regulator said in its letter to the lenders. “Consistent with Guideline B-20, FRFI lenders should not rely on collateral values as a substitute for stable and verifiable income.”

The Bank of Canada welcomed OSFI’s proposal in its latest monetary policy report, saying past experiences with surging housing markets show they can lead to “more speculative, extrapolative behaviour,” and can ultimately pose a number of risks.

“High prices could result in stretched borrowing and lending, leaving some households and financial institutions more financially vulnerable to an economic downturn,” the central bank said.

At the moment, though, demand for residential real estate is up, and policymakers have so far avoided any major moves to try to slow things down. The heightened demand is also increasing the amount of due diligence for lenders, and the rush has yet to die down, potentially putting homeownership further out of reach for some would-be buyers, and particularly younger ones.

That can provide a strong incentive for someone to inflate their income on their application to obtain the home they want, Equifax’s Davies said.

“While we continue to see a very hot housing market, that kind of first-party fraud, that misrepresentation that we see, I think we’re going to continue to see that coming through pretty strong in Canada,” he added.

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