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Loan Fraud: How To Detect and Prevent Against the Next Generation of Lending Fraudsters

Loan fraud is hitting U.S. banks and credit unions hard, both in terms of cost and operational burden. Not only does every $1 of fraud loss cost US financial services $4, but the need for lenders to detect and prevent fraud inevitably adds friction to the application process that can deter genuine end users. All banks and credit unions need to stay ahead of the main types of banking fraud that we’ve explored in a separate article. Here’s how lenders can detect and protect against loan fraud at the point of delivery. 

What Is Loan Fraud? 

The term covers a variety of strategies, but the common factor is a fraudster who is either posing as someone they are not, or misrepresenting their financial status to secure a loan. The loan in question may be a relatively low-value personal loan or credit card application, or a seven-figure mortgage application. It could even be a sophisticated corporate scam worth millions.

The main types of loan fraud include:

  • First-party: the applicant misrepresents financial status or personal details on their form, such as inflating their salary or assets. 
  • Second-party: the applicant borrows the identity of a co-signatory, family member, friend or accomplice, with or without their knowledge. 
  • Third-party: fraudsters use a stolen identity to access credit lines, Social Security and tax details, credit reports and so on. 

Home Loan Fraud

Because of the high stakes, mortgage fraud is a particularly fertile ground for both opportunists and serial criminals. Appraisal fraud, in which the buyer and seller establish an inflated listing price, can be hard to detect, but scammers will also manipulate the foreclosure process or use stolen identities to secure loans. 

Corporate Fraud

The fast turnaround of the Covid relief plan, or Paycheck Protection Program (PPP), provided the opportunity for organized criminals to execute the “biggest fraud in a generation” totalling some $80 billion. By applying for bogus business relief, fraudsters were able to loot federal funds and write themselves a blank check from the U.S. taxpayer. 

Not all loan fraud originates from the applicant. On the lending side, unregulated or fake Payday lenders and other loan sharks will offer fast-track approval (with a fee) for loans that either don’t exist or that come with exorbitant rates.

How Fraudsters Trick the System

It would be easier for banks and credit unions to prevent fraud if they knew what kind of adversary they were looking for. Unfortunately, there is no go-to profile for a scammer. Consider the fact that 91% of mortgage fraud offenders, for example, have no prior criminal history.

With that in mind, financial institutions tend to focus on patterns rather than people. Where a first- or second-party applicant is misrepresenting their current or projected financial status, the bank or credit union can check the facts through the credit report and bank statements. The task is more difficult, however, when an experienced fraudster is using a stolen ID and other documents to “stitch” together a bogus credit file, which may well include a bank account, Social Security account, credit report and more. 

In this scenario, the financial institution will rely on anomalies in end-user behavior to trigger a fraud warning. For example, there appear to be logins from an unknown device or IP address, a significant change in spending habits or recipients or failed attempts to navigate knowledge-based authentication (KBA).

What Financial Institutions Can Do

The U.S. financial system is particularly vulnerable to loan fraud because a simple static ID, such as a Social Security number, still opens too many doors. However, as we shift towards digital banking and multi-factor authentication, there should be less scope for fraudsters to manipulate the process. 

Unfortunately, while it is increasingly difficult for fraudsters to hide their tracks in the digital landscape, it is all-too-easy for committed criminals to steal someone’s identity, to the point where 47% of Americans experienced some sort of financial identity theft in 2020 alone. 

At the forefront of the fight against fraud is a robust, smart system for authenticating online end-user access, starting with the digital onboarding process. Banks and credit unions should enable biometric authentication — such as an iris or fingerprint scan — and deploy artificial intelligence-powered security measures to detect suspicious activity.

Next-Generation Loan Fraud Prevention

Because Lumin Digital’s cloud-native solution integrates fully with your bank or credit union system, rather than sitting on top of your legacy architecture, it allows you to provide a next-generation experience without compromising on security. Thanks to smart onboarding, actionable insights and a full roster of KYC and AML features, you can appeal to the end users you do want, and keep out the fraudsters you don’t. Learn more about the Lumin solution.


Federal Bureau of Investigation (FBI) – Financial Institution/Mortgage Fraud

LexisNexis – Fraud Costs and Volumes Remain Significantly Higher than Pre-Pandemic for Financial Services and Lending Firms, According to New LexisNexis Risk Solutions Report.

Investopedia – Mortgage Fraud: Understanding and Avoiding It