Research paper on

LOAN & MORTGAGE

FRAUDS

WRITTEN BY:
CA ...................
M. NO.
MOB. NO........
EMAIL ID- ......................
 LOAN AND MORTGAGE FRAUDS

INTRODUCTION:

Any illegal act characterized by deceit, concealment or violation of trust. Theseacts are not
dependent upon application of threat of violence or physical force.Frauds are perpetrated by
individuals and organizations to obtain money, property,or services; to avoid payment or loss of
services; or to secure personal or businessadvantage (ACFE’s definition of fraud)

In law, fraud is deliberatedeception to secure unfair or unlawful gain, or to deprive a victim of a

legal right. Fraud itself can be a civil wrong (i.e., a fraud victim may sue the fraud perpetrator to
avoid the fraud and/or recover monetary compensation), a criminal wrong (i.e., a fraud perpetrator
may be prosecuted and imprisoned by governmental authorities) or it may cause no loss of money,
property or legal right but still be an element of another civil or criminal wrong. (Source: Legal
Dictionary: fraud, Law.com)

There are many types of frauds. Loan and Mortgage Fraud is one of the easiest and most common
types of fraud. We can see thousands of examples of this type of fraud. It is a wilful crime with an
intention to either take loan or mortgage, for which the borrower is not eligible or to take higher
amount than his / her eligibility. Also a loan or mortgage taken for a specific purpose is used for
some other purpose is alsoa Loan or Mortgage Fraud. This fraud can be committed by both
borrowers and lenders.A person intending to buy a property or some machinery etc. can be
inadvertently caught up in a fraud by acting on bad advice from an unscrupulous lender or broker
whom they trust. Another example of fraud by mediator could be in the case of a student intending
to go abroad for higher studies, who may be defrauded by his consultant for getting education
loan.

CATEGORIES OF LOAN AND MORTGAGE FRAUDS: -

There may an endless list of such examples. Briefly we can summarise the loan or mortgage frauds
in following categories: -
1. Fraud by borrower
2. Fraud by lender
3. Fraud by mediator

Let’s discuss each category one by one.

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 1. Fraud by borrower: - The loan or mortgage fraud can be committed by overstating the
value of security against which loan is taken or by manipulating the financial records or by
misleading the lender about the intended use or many other means. Frauds by borrower
can be broadly classified as under:

i. Valuation Fraud: - This fraud occurs when the appraisal or realisable value of
the security is overstated. For example, Mr. X is interested in buying machinery.
The actual price of the machinery is Rs. 50 Lacs. But Mr. X connives with Mr. Y,
the seller of the machinery and get it Invoiced for Rs. 70 Lacs. If the lender; say
ABC Bank was to finance 75% of the value of the machinery, then in this case
ABC Bank will actually finance more than 100% of the actual value of the
machinery.

Invoice Value 70,00,000.00

Less: Margin @25% 17,50,000.00
Bank Finance 52,50,000.00

In fact the value of security of the bank is just Rs. 50 Lac but due to fraud
by the borrower, more money is siphoned off. Such type of frauds are more
common in real estate particularly mortgage loans for buying property.

ii. Cash Back Fraud: - This fraud is committed by a borrower by not disclosing
the discount / rebate / cash back available in the deal to the lender. This may
excess loan or mortgage money can be taken. For example, Mr. X is doing a
business of running buses for the commutation of school students. He wants to
buy a new bus for his business. The price of the bus will cost Rs.12 Lacs and same
can be verified on various websites. He has submitted the Performa invoice for the
bus to his financer. But he has hidden the fact that he will get 10% of the price as
cash back from the seller. Accordingly the actual value of the bus will come to Rs.
10.80 Lacs. So the financer will be financing extra amount.

iii. Intended Purpose fraud: - This fraud occurs when a borrower discloses some
purpose of use of borrowed money but actually uses it for some other purpose. For
example, Mr. X approached ABC Bank for housing loan to purchase plot and then
construct a house there. ABC Bank verifies the property and assures itself about

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 the legal factors as well as map, architect valuation for proposed cost of
construction etc and disburses the loan or mortgage amount. However Mr. X
instead of constructing the house as per map; constructs a commercial complex.
This way he defrauded the bank, because interest rate is higher in case of
commercial construction loans; the local authorities, because construction is not
done as per the approved Map and may defraud the tax authorities also by
claiming tax benefits available to housing loans.

iv. Lender scheme Frauds: - This fraud occurs when a borrower approaches his
lender to borrow funds under specific scheme for which he / she are not eligible.
For example, a borrower Mr. X, who is a businessman, having land in a village
approaches lender say ABC Bank for agriculture loan. He borrows money on the
security of his agriculture land and uses the money for commercial purposes. This
way he will be saving huge interest cost and defrauding both bank as well as
government, who make special schemes for agriculture loans.

v. Income Fraud: - This fraud is committed by a borrower when he manipulates his

financial records to show higher income than he actually have and thus convinces
the lender about his repayment capacity and assures that the money to be landed
will be safe and returned on time. For example, Mr. X approaches ABC bank for
mortgage loan against house. To be eligible, he manipulates and show higher
income in his financial records. On the basis of these documents, ABC bank
finances his house. But since actual income of Mr. X is lower than the disclosed
income, Mr. X will not be in a position to repay the mortgage on time.

Many a times, this fraud is committed along with valuation fraud. The borrower
manages to get amount more than what he would have got by selling the house in
the open market.

vi. Hiding liabilities: - This fraud is committed when a borrower lies about his
personal and existing liabilities to his lender. One of the most frequent criterions
used by lenders is the debt-to-income ratio, i.e., how much money a borrower
already owes versus how much he or she makes a year. In order to dupe lenders,
borrowers may lie about debts they owe on other mortgages, credit cards, cars, etc.
Thus getting further loan. For example, Mr. X approaches ABC Bank for sanction
of loan against his property. He did not inform the bank about the loan already
taken by him from a private financer for his personal purposes. When ABC Bank,

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 calculated his eligibility on the basis of his papers, they found him eligible, which
he otherwise was not, had his personal liability been disclosed to bank.

vii. Shotgunning: - This fraud occurs when multiple loans for the same property are
obtained simultaneously for a total amount greatly in excess of the actual value of
the property. These schemes leave lenders exposed to large losses because the
subsequent mortgages are junior to the first mortgage to be recorded and the
property value is insufficient for the subsequent lenders to collect against the
property in foreclosure. The result of this fraud is that lenders often litigate which
has first priority to the property. For example, Mr. X borrows money against his
property from ABC Bank. He has submitted original title deeds of his property to
the bank. At the same time, he got a colored Xerox of the original title deed and
used it to borrow funds from another bank.

viii. Working the gap: - This fraud is committed by using the time gap available
though legal channels. For example, XYZ Co. Pvt. Ltd. approaches ABC Bank for
loan for buying machinery. The security in this case is machinery only. All the
necessary financials were duly submitted and on that basis ABC Bank financed
the machine. Since there is 30 days available to register charge against the assets
of company, XYZ Co. Pvt. Ltd. in the mean time approached another MNO Bank
and got the same machinery financed by them also. As a result both the banks
financed same asset and they will have problem as the amount financed is much
higher than the actual value of the security.

ix. Identity Frauds: - This fraud occurs when a person assumes the identity of
other and uses that identity to take loan or mortgage without the knowledge or
consent of the victim. For example, Mr. Surinder Kumar was aware that his next
door neighborMr.Surinder Sharma is having good income. He falsified himself
with the bank as SurinderShrama and on the basis of documents of Mr. Surinder
Sharma fraudulently obtained by him, borrowed money from Bank in the name of
Mr. SurinderShrama, without the knowledge of the later.

This list may go on without any end because with passage of each single day a new fraud is
being committed by the lenders in one way or the other. Sometimes the two or three frauds
mentioned above are performed together to get more money.

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 2. Fraud by Lenders: - Lenders can commit fraud with the borrower by misleading him or
by hiding some important facts of the loan. Fraud by the lenders can be broadly
exemplified as under:

i. Interest rate Fraud: - This fraud is committed by a lender when the interest
rate informed to borrower is different than the interest rate charged. For example:
Mr. X has borrowed Rs. 10 Lac from ABC Finance Co for one year. It was
informed to him that the interest will be charged @ 10% per annum. However, the
EMI told to him has been calculated @ 11% per annum, without his knowledge.
The EMI @10% will beRs. 91,670/- per month whereas the EMI told to him is Rs.
92,500/- per month.

ii. Fixed v Floating Fraud: - This fraud is also another form of interest rate fraud,
where interest rate is mentioned as either fixed or floating and charged otherwise
to the borrower. In case of fixed rate of interest, interest rate is not changed with
the change of rate in the market. On the other hand in case of floating rate of
interest, interest rate is changed with the change of rate in the market. Sometime,
lender defraud the borrower by changing fixed rate to floating and vice versa as
per the market conditions beneficial to them. For Example, Mr. X borrowed Rs.
10 Lac from ABC Finance Co for one year @ 10% per annum fixed. However the
market rate increased to 11%, so the lender changed his interest to 11% stating
that rate will be changed with change in market rate, but at the same time refused
to reduce it below 10% when later market rate got reduced to 9%, stating that
minimum rate of interest will be 10%. This way Mr. X had to pay the excess
interest.

iii. Reducing v Flat: - This fraud occurs when the lender charges interest at flat
basis rather than reducing basis. When a person borrows money and pays EMI,
then out of every EMI some principal amount is also repaid in addition to interest.
Thus principal keeping on coming down and accordingly interest cost also keep on
coming down. But lender by defrauding borrower charges interest at Flat rate
rather than reducing rate. For example,Mr. X borrowed Rs. 10 Lac from ABC
Finance Co for two years @ 10% per annum. In case of reducing system EMI
would be Rs. 46,045/- whereas in case of flat system the EMI would be Rs.
50,000/-. The interest to be paid by Mr. X in reducing system over the period of 2
years will be Rs. 1,05,080/- whereas the same in case of flat system will be Rs.
2,00,000/-, almost double.

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 iv. Annual Reducing v Monthly Reducing : - This fraud is committed by the
lender by changing the reducing system. If out of EMI, principal amount will be
reduced every month then the compounding effect of interest will be lower rather
than annual reducing or quarterly reducing or six monthly reducing. For example,
Mr. X borrowed Rs. 10 Lac from ABC Finance Co for two year @ 10% per
annum reducing. In case of Annual reducing, the EMI will be Rs. 48,016/-,
whereas in case of monthly reducing the EMIwould be Rs. 46,045/-. The interest
to be paid by Mr. X in monthly reducing system over the period of 2 years will be
Rs. 1,05,080/- whereas the same in case of annual reducing system will be Rs.
1,52,384/-, almost one and half time.

v. Advance EMI: - This fraud is committed by the lender hen advance EMIs are
taken to adjust the interest without informing the effect to the borrower. For
example, Mr. X borrowed Rs. 10 Lac from ABC Finance Co for two year @ 10%
per annum monthly reducing. Now the EMI will be Rs. 46,045/-. However the
lender has taken two advance EMI on the date of disbursement of loan. It was
informed to Mr. X that now he has to pay the balance 22 instalments. But Mr. X
has been defrauded as the actual amount lent to him is not Rs. 10 Lacs but Rs.
9,07,910/- as he has returned two EMI amounting to Rs. 92,090/- (46045 * 2) at
the same time. So his interest cost would be higher. This mechanism is commonly
used by lender to misguide the borrower with the amount of EMI when there is
competition in the market.

vi. Pre payment charges: - Sometimes lenders do not inform the borrower about the
terms of loan or mortgage in detail. Pre payment charges are charged to borrower
in case he ant to repay some extra amount in addition to his regular EMI. For
example, Mr. X borrowed Rs. 10 Lac from ABC Finance Co for two year @ 10%
per annum monthly reducing.The EMI is Rs. 46,045/-. However Mr. X got some
extra funds. So in addition to Rs. 46,045/- he repaid a lump sum amount of Rs. 1
Lac to the lender. But lender charged Rs. 2,500/- as pre payment charges without
informing Mr. X. At the end when, Mr. X went to lender to close his loan, this
amount was shown payable by him.

All these types of frauds are committed normally to earn extra interest.
3. Fraud by mediator: - Normally people approach some mediators to get their loan or
mortgage approved from financial institutions. Also mediators like direct marketing agents

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 of private financial institutions approach public and industrial organisation with offer to
get them finance. These types of mediators can commit fraud to both lenders as well as
borrowers. Mediators normally commit frauds to earn extra commission or make extra
financial gain. Frauds that can be committed by such mediators can be exemplified as
under:

i. Upfront fees fraud: - Sometimes the mediator asks for cash payment from the
borrower as upfront fees for loan processing. Normally in such cases, the mediator
never turns up again and defrauds the borrower with the money. For example, Mr.
A, a mediator approached Mr. X a proposed borrower. Mr. A promised Mr. X that
he will get him housing loan for Rs. 50 Lacs. But he will have to pay Mr. A an
upfront fees of 2% i.e. Rs. Rs. 1 Lac in cash. Mr. X being lured by his offer paid
him Rs. 1 Lac cash without verifying his credential etc. Then Mr. A never turned
up and Mr. X realised that he has been defrauded.

ii. Identity Frauds: - This fraud occurs when a proposed borrower give his
personal documents to the mediator without verifying his credentials. Then the
mediator is at liberty either to use these documents or misuse them for the loan
purpose of any other person.For example, Mr. A, a mediator approached Mr. X a
proposed borrower. Mr. A promised Mr. X that he will get him housing loan for
Rs. 50 Lacs. But Mr. X have to give Mr. A his ID proofs and financial documents
for verification and loan eligibility calculation by Bank. Mr. X being lured by his
offer handed over him all the requisite documents without verifying his credential
etc. Then Mr. A never turned up and suddenly after 3 months Mr. X got a letter
from bank that he is not repaying the loan taken. When Mr. X approached bank
that he has never borrowed any money from them, he found that all his documents
and ID proofs are there in the bank and loan has been taken in his name then he
realised that he has been defrauded.

iii. Income fraud: - Sometimes mediators assure a borrower that they will get him
loan of higher amount. In such cases they defraud the lender by fabricating the
documents of proposed borrower. They fabricate the Income proofs and other
financials to convince the lender that the proposed borrower has higher income
and the loan or mortgage proposed to be financed is safe. This way they defraud
the lender. For example, Mr. A, a mediator approached Mr. X a proposed
borrower. Mr. A promised Mr. X that he will get him housing loan for Rs. 50
Lacs. Mr. X handed over him all the requisite documents. Mr. A found that on the

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 basis of these financial documents Mr. X is not eligible for Rs. 50 Lacs loan. Then
in connivance with Mr. X, Mr. A altered the financial of Mr. X and got the loan
sanctioned and disbursed from a financial institution. When Mr. X was not able to
repay the instalments on time, due to his lesser income, financial institution came
to know about the fraud.

iv. Valuation Fraud: - Sometimes in order to get the maximum finance for his
customer, a mediator defrauds the lender by inflating the value of security. For
example, Mr. A, a mediator approached Mr. X a proposed borrower. Mr. A
promised Mr. X that he will get him housing loan for Rs. 50 Lacs. Mr. X handed
over him all the requisite documents. Mr. A found that on the basis of these
property documents Mr. X is not eligible for Rs. 50 Lacs loan. Then in connivance
with Mr. X, Mr. A got inflated valuation from a valuer for the property of Mr. X
and got the loan sanctioned and disbursed from a Bank. Later when Mr. X did not
repay the instalments and loan account become NPA, bank tried to sell the
security only then they came to know about the fraud.

v. Shotgunning: -This fraud is committed by the mediator and the borrower

jointly. They obtain multiple loans for the same property simultaneously for a total
amount greatly in excess of the actual value of the property. Thus leaving all the
lenders in a situation where they can only litigate with each other over the
security.

Also sometimes frauds are committed by all the three i.e. borrower, lender and mediator
collectively on the financial institution. This happens normally when the employee of the
financial institution is authorised as lender. Borrower commits frauds to get extra money
as loan, mediator commits fraud to earn extra commission as well as extra kickback and
the lender commits fraud for the extra kickback. In all the frauds, if ultimately the loan
goes bad or coverts to non performing asset (NPA) then it adversely effects the overall
economic position and financial stability of the financial institution, which may in turn
effect the economic position of the country as a whole, depending upon the quantum of
loan or mortgage.

PREVENTION FROM LOAN AND MORTGAGE FRAUDS: -

The basic tips to avoid becoming a victim of loan or mortgage frauds are provided underneath:

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 i. Before hiring any mediator, a borrower should check all the credentials of mediator
like his experience, his existing customers, his success rate, his overall reputation etc.

ii. A borrower should not ever handover cash to anybody for loan proposal as most of the
financial institutions deduct processing or upfront fees from the loan amount. Even if
some financial institutions take it separately they take it in the form of cheque etc.

iii. A borrower should never ever sign any blank documents.

iv. A borrower should read all the documents carefully particularly the terms and
conditions of financing, interest rate etc.

v. A lender should get verified the documents submitted by a borrower. Due diligence
should be applied.

vi. In case verification of documents need expert guidance, the lender should resort to
experts whether it is valuation of property or legal opinion about the property papers
or opinion about the financial documents etc.

vii. In case of loan proposal through mediator, lender should be extra cautious when the
existing loan case of that mediator is not in good health.

viii. Financial institutions should give training to their employees on dealing with loan
proposals as per their roles and levels.

ix. A regular check and change of role should be there in a financial institution. No
person should continue to work on the same place for too long.

x. Financial Institutions should put sound and appropriate fraud detection, prevention,
investigation, resolution, and reporting policies and procedures in place and
communicate them to employees.

xi. Now a day’s CIBIL is very important tool to curb the menace of loan and mortgage
frauds. Employees of the financial institutions should be trained in reading the
information available on CIBIL.

CONCLUSION: -

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 Loan or mortgage frauds are getting common day by day. Both lenders and borrowers have to be
very cautious. They have to take extra care while moving any step. It is a hard fact that borrowers
cannot go without lenders and at the same time lenders cannot do business without borrowers.
Both have to go hand in hand otherwise it will be loss to both of them.

However considering the tendency of fraud now a day’s both should take preventive measures in
advance to avoid loss of any kind.

It is very well said by John Grant, an English crime writer that:

“FRAUD IS THE DAUGHTER OF GREED”

Till the time greed does not come to an end, fraud and fraudulent people also can not end.

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