12 common red flags in loan underwriting for application fraud

Loan application fraud poses a significant threat to lenders, jeopardizing financial stability and customer trust in the mortgage loan process.

Mortgage fraud is a serious issue within the broader category of financial crimes, and understanding the important factors in the mortgage approval process, such as credit history, is crucial for lenders.

And as the financial landscape evolves, so do the tactics of fraudsters. Not only did 80% of risk and ops leaders say they saw a YOY increase in fraud attempts during 2023, but we uncovered some alarming statistics for lenders: Over 60% of fraudulent personal loan application documents, and 46% of fraudulent SMB loan application documents match the pattern of first-party fraud. These individuals are inflating their salaries or hiding evidence of risky revenue practices and present a much higher risk of delinquency. (Learn more in our 2024 Document Fraud Report.)

Mortgage fraud refers to the intentional misrepresentation or omission of crucial information during the mortgage process.

Lenders must remain vigilant and equipped to identify suspicious activity early on. In this blog post, we’ll discuss 12 common red flags for loan application fraud and offer insights into how lenders can stay one step ahead.

Introduction to loan application fraud

Loan application fraud is a type of mortgage fraud that involves intentionally misrepresenting information on a loan application to obtain a mortgage. This can include providing false or altered credit reports, inflating income or employment history, or misrepresenting property value or condition.

Loan application fraud can be committed by individuals, mortgage brokers, or other parties involved in the mortgage process. Financial institutions and mortgage lenders must be vigilant in detecting and preventing loan application fraud to avoid significant financial losses.

How Inscribe detects mortgage loan application fraud

Inscribe leverages advanced AI to detect fraudulent activity in mortgage loan applications with precision and scale. Watch the quick video below to see how Inscribe detects mortgage loan application fraud: 

By analyzing documents like bank statements, pay stubs, tax forms, utility bills, and more, Inscribe identifies signs of tampering, forgery, or misrepresentation that may not be visible to the human eye.

Our fraud detection engine examines metadata, embedded text anomalies, document structure inconsistencies, and cross-document discrepancies to flag suspicious files in real time. Combined with machine learning models trained on millions of real and fraudulent documents, Inscribe empowers underwriters and risk teams to uncover hidden risks, reduce false positives, and streamline the verification process—ultimately protecting lenders from financial loss and reputational damage.

The role of the mortgage underwriter

The mortgage underwriter plays a pivotal role in evaluating loan applications to determine whether a borrower qualifies for a mortgage. Their primary objective is to assess risk—ensuring the lender is making a sound financial decision and the borrower can reasonably manage repayment.

Credit Evaluation: Underwriters review an applicant’s credit history by examining credit reports from major bureaus. This includes assessing payment history, credit utilization, the age of accounts, recent inquiries, and public records. These elements contribute to the credit score, which heavily influences loan approval and terms. A strong credit profile can improve approval chances and reduce interest rates, while a poor one may lead to higher costs or loan denial.

Cash Flow Underwriting: For applicants with limited or non-traditional credit histories, underwriters also assess cash flow. This involves analyzing bank statements and transaction histories to evaluate consistent income deposits, recurring financial obligations, and overall spending patterns. Cash flow analysis helps verify reported income, detect inconsistencies or potential fraud, and offer a more complete picture of the applicant’s financial health.

Debt Evaluation: Underwriters evaluate existing debt obligations by analyzing metrics like the debt-to-income (DTI) ratio, credit utilization, and outstanding loans such as credit cards or car payments. This ensures borrowers are not over-leveraged and can handle new mortgage payments. The outcome helps determine loan eligibility, interest rates, and repayment terms.

Types of loan application fraud

There are several types of loan application fraud, including income fraud, appraisal fraud, and occupancy fraud.

• Income Fraud: Misstating employment or income levels.
• Appraisal Fraud: Inflating property values to justify larger loans.
• Occupancy Fraud: Claiming a property will be a primary residence when it’s intended for rental.
• Liability Fraud: Hiding debts or obligations to appear more creditworthy.
• Identity Theft: Using stolen or fabricated identities to secure loans.

Mortgage lenders must be aware of these types of loan application fraud and take steps to prevent them. They must often request additional documentation to verify the accuracy of the information provided and to prevent these types of fraud.

12 red flags for loan application fraud 

While not all of these are definitive proof of loan application fraud, they are risk signals that should be noted and warrant a closer review of applicants.

1. Forged or Altered Documents: If the submitted documentation, such as pay stubs, bank statements, or tax documents, appears to be forged or altered, it’s a clear indication of potential document fraud. Look for inconsistencies in fonts, signatures, formatting, and any visible signs of tampering, as well as any fraud signals in the metadata or embedded text (with the help of an AI document fraud detection solution).

2. Incomplete or Blank Sections: Loan application forms with sections left intentionally incomplete or left entirely blank might suggest that the applicant is trying to hide certain information. Fraudsters may do this to prevent detection of false claims or to evade close scrutiny of their financial situation.

3. Inconsistent Information: When information provided by an applicant contradicts itself or is inconsistent across documents, it’s a clear sign of potential fraud. Lenders should closely examine discrepancies in addresses, employment history, income details, and more. High asset applicant’s investments that are not diversified can also be a red flag.

4. Lack of Documentation: Applicants who provide insufficient documentation or avoid providing requested information could be hiding critical details about their financial situation, potentially indicating fraudulent intent.

5. Unusually High Income: Applicants claiming excessively high incomes that seem out of proportion to their occupation or industry might be inflating their earnings to secure a larger loan. Verification of income sources is essential to detect such fraud.

6. Sudden and Unexplained Changes: Rapid changes in financial behavior, such as a sudden surge in credit inquiries, opening multiple new accounts, or large deposits with no clear source, can indicate that an applicant is attempting to manipulate their credit profile. Suspicious transactions should be closely monitored. Unusual cash flow patterns, such as large deposits or withdrawals that do not align with the applicant's reported income, can also be a red flag for potential fraud.

7. Frequent Changes in Address: Applicants who provide multiple addresses in a short period or who frequently change residences might be attempting to obscure their true identity or financial history. Large down payments can also be a red flag for potential occupancy fraud.

8. Unusual Loan Purpose: If the stated purpose of the loan doesn’t align with the applicant’s financial situation or history, it’s worth investigating further. Be wary of requests for loans that seem unrelated to the applicant’s needs or goals. Irregularities related to earnest money deposits can signal potential fraudulent activities.

9. Borrower’s History of Default: A history of frequent loan defaults, bankruptcies, or late payments raises concerns about an applicant’s ability and intention to repay a new loan. Discrepancies in the sales contract can also indicate potential fraud.

10. Falsified Employment Information: False or exaggerated employment information, such as claiming to work at a non-existent company, can be a red flag for potential fraud. Verify employment details through official channels. A suspicious activity report should be filed if fraudulent activity is suspected.

11. Unusual Collateral or Guarantors: If an applicant offers collateral or guarantors that seem unusual or unrelated to the loan, it could be an attempt to secure a loan they have no intention of repaying. Discrepancies in the applicant’s credit history can also be a red flag.

12. Pressure to Rush the Process: Applicants who exhibit impatience or pressure to expedite the loan approval process might be trying to preempt close scrutiny of their application and true financial situation. Discrepancies found in the credit report can serve as red flags for potential mortgage fraud.

Beyond the 12 common red flags, there are deeper and more nuanced indicators that mortgage lenders should watch for. These patterns often emerge from document analysis, transaction structures, and unusual applicant behaviors:

Employment and income fraud

• Improperly formatted Employer Identification Numbers (EINs) may suggest the applicant fabricated or manipulated employment data.
• Discrepancies between income and employment details, such as high earnings paired with entry-level roles, should trigger further review.
• Underwriters should also review tax returns to verify the reported income and ensure it aligns with the applicant's employment details.
• Loan applications that are altered or fabricated, either digitally or on paper, are a common vehicle for income fraud.
• Inflated rental income claims, especially if not supported by leases or deposit records, can indicate fraud related to investment properties.

Credit report and profile manipulation

• Authorized user accounts with better payment histories than the applicant may be used to artificially boost credit scores.
• Unusually high balances in checking accounts, particularly if inconsistent with reported income, can point to asset fraud.
• Applicants avoiding traditional banking systems, such as using prepaid cards or cash-only documentation, may be masking illicit financial behavior.
• Underwriters should also examine the number of open accounts to assess the applicant's credit utilization and overall financial behavior.

Property and transaction schemes

• Non-arm’s length transactions, where buyers and sellers have a pre-existing relationship, can be manipulated for personal gain.
• Fraudsters acquiring mortgages on properties they don’t own, often using straw buyers or falsified ownership documents, are part of sophisticated schemes. A thorough title search is essential to confirm the legitimacy of property ownership and to uncover any potential liens or legal issues.
• Borrowers misrepresenting their intentions for investment properties, such as claiming they are primary residences, can impact loan terms and risks.
• The absence of a real estate agent involved in the transaction removes a key verification layer and can be a red flag.

Documentation and sales agreement red flags

• Purchase agreements with discrepancies or earnest money checks issued by someone other than the buyer indicate possible fraud. Discrepancies between the appraised value and the purchase price can also indicate potential fraud and should be carefully reviewed.
• Real estate fraud, including altered title documents or forged sales contracts, can significantly undermine transaction legitimacy.
• Multiple red flags in a single loan file (e.g., forged documents, high asset anomalies, and inconsistent employment) should be treated as high-risk.

Systemic or collusive fraud

• Industry professionals—mortgage brokers, loan officers, or underwriters—collaborating to manipulate data can undermine institutional controls.
• Mortgage brokers manipulating documents or submitting inflated valuations, particularly in property flipping schemes, can expose lenders to significant losses.
• Loan originators misusing their expertise, for example by fast-tracking questionable loans, may be exploiting system loopholes for personal gain.
• The increase in Suspicious Activity Reports (SARs) underscores the rising scale of mortgage fraud that often goes unaddressed.

Tips for preventing loan application fraud 

Preventing loan application fraud through effective document review is crucial for maintaining the integrity of the lending process within any financial institution. To effectively combat loan application fraud, lenders should implement a multi-faceted approach:

• Educate and empower frontline fraud fighters: Train underwriters to recognize these red flags and promote a culture of vigilance across the organization. Encourage open communication among underwriting teams to share insights and concerns about potentially fraudulent applications. Loan officers play a critical role in fraud prevention by ensuring the accuracy and authenticity of borrower information.

• Utilize advanced analytics solutions: Leverage data analytics and AI-powered solutions to detect patterns and anomalies that could signify fraudulent behavior. Mortgage brokers can also be instrumental in fraud detection by scrutinizing documentation and collaborating with loan officers to identify inconsistencies.

• Establish clear documentation requirements: Clearly communicate to applicants the specific documents and information they need to provide as part of their loan application. Having comprehensive documentation requirements sets expectations and helps ensure that you receive accurate and complete information. The involvement of a real estate agent can add an extra layer of oversight, ensuring transparency and legitimacy in transactions.

• Look for patterns and anomalies: Pay attention to patterns and anomalies within documents and across multiple applications. Unusual formatting, missing information, or repeated use of the same document across different applications could indicate fraudulent activity. Artificial intelligence and machine learning solutions can help you do this at scale.

• Utilize advanced detection and processing technology: Leverage document fraud detection technologies and tools to identify altered, forged, or counterfeit documents. Document processing software and other advanced solutions can help detect inconsistencies and anomalies. Loan originators are also crucial in preventing fraud by adhering to strict documentation standards and ethical practices.

• Securely retain borrower documentation: Maintain organized and secure records of all applicant documents, communication, and decision-making processes. These records can serve as valuable evidence in case of audits or investigations.

Additional institutional insights

• Maintaining a fraud loss database can help lenders identify repeat offenders and evolving fraud techniques over time.
• Training underwriters and loan officers remains crucial; they are on the front lines of identifying irregularities in loan files.
• Greed and opportunity often drive mortgage fraud, whether to gain housing or secure financial advantage.
• Discrepancies in credit reports, deposit histories, or property documents demand systemic prevention measures such as AI fraud detection and layered compliance checks.

In the battle against loan application fraud, vigilance is key. By remaining attentive to these common red flags and adopting a proactive approach to fraud prevention, lenders can protect themselves, their customers, and the integrity of the lending industry as a whole.

Inscribe helps business and consuming lending companies reduce fraud and credit losses by detecting application fraud in bank statements, utility bills, tax documents, and others — while also helping you assess borrower creditworthiness. Want to learn more about how you can prevent application fraud with the help of AI? Check out an interactive tour of Inscribe, or reach out to speak with a member of our team.