oversight

Fairfield Financial Mortgage Group, Inc., Danbury, Connecticut, Did Not Always Comply with Federal Housing Administration Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-09-26.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 AUDIT REPORT




Fairfield Financial Mortgage Group, Inc., Danbury, Connecticut,
 Did Not Always Comply with Federal Housing Administration
                         Requirements


                        2005-BO-1007


                     September 26, 2005

                  OFFICE OF AUDIT, REGION 1
                          Boston, MA
                                                                  Issue Date
                                                                        September 26, 2005

                                                                  Audit Report Number
                                                                           2005-BO-1007




TO:         Brian D. Montgomery, Assistant Secretary for Housing-Federal Housing
               Commissioner, H


FROM:       For John A. Dvorak, Regional Inspector General for Audit, 1AGA


SUBJECT: Fairfield Financial Mortgage Group, Inc., Danbury, Connecticut, Did Not
            Always Comply with Federal Housing Administration Requirements


                                   HIGHLIGHTS

 What We Audited and Why

             We audited Fairfield Financial Mortgage Group, Inc. (Fairfield Financial), a
             nonsupervised lender approved by the U.S. Department of Housing and Urban
             Development (HUD) to originate Federal Housing Administration-insured single-
             family mortgages. We selected Fairfield Financial for review because of risk
             factors associated with defaulted loans, including higher risk multiunit properties,
             early payment defaults, and income-excessive obligations cited for several
             defaulted loans, which suggested potential problems with the qualifying
             documentation.

             Our objectives were to determine whether Fairfield Financial complied with HUD
             regulations, procedures, and instructions in the origination of Federal Housing
             Administration loans and whether Fairfield Financial’s quality control plan, as
             implemented, met HUD requirements.




                                              1
What We Found


         Fairfield Financial did not always comply with HUD regulations, procedures, and
         instructions in the origination of Federal Housing Administration loans. It
         improperly originated 4 of the 24 loans reviewed. These four loans contained
         deficiencies that affected the insurability of the loans, including unsupported
         income, underreported liabilities, excessive qualifying ratios, and derogatory
         credit information. As a result, HUD insured loans that placed the insurance fund
         at risk for $1,204,981. In addition, Fairfield Financial did not properly disclose to
         borrowers $11,390 for commitment fees in 20 of the 24 loans reviewed.

         Further, Fairfield Financial’s quality control plan, as implemented, did not meet
         HUD requirements. Its written quality control plan lacked required elements, and
         it did not implement procedures to ensure that reviews of early defaulted loans
         took place or that its operations complied with fair lending laws. As a result,
         HUD lacks assurance that Fairfield Financial is able to ensure the accuracy and
         completeness of its loan origination operations.

What We Recommend


         We recommend that the assistant secretary for housing-federal housing
         commissioner require Fairfield Financial to (1) indemnify HUD against future
         losses on the four loans totaling $1,204,981 and (2) revise its procedures to ensure
         that each borrower charged a commitment fee is properly informed, in writing, of
         the fee, the amount of the fee, and the purpose of the fee, and that the actual fee
         charged coincides with the amount disclosed to the borrower. Additionally, HUD
         should require Fairfield Financial to implement controls to ensure that it follows
         HUD’s quality control requirements and verify that it has implemented proper
         controls.

         For each recommendation in the body of the report without a management
         decision, please respond and provide status reports in accordance with HUD
         Handbook 2000.06, REV-3. Please furnish us copies of any correspondence or
         directives issued because of the audit.




                                           2
Auditee’s Response


           We provided Fairfield Financial a draft report on August 24, 2005, and held an
           exit conference with Fairfield Financial officials on August 31, 2005. Fairfield
           Financial provided written comments on September 21, 2005, in which it
           generally expressed disagreement with finding 1 and agreement with finding 2.

           The complete text of the auditee’s response, along with our evaluation of that
           response, is in appendix B of this report.




                                            3
                              TABLE OF CONTENTS

Background and Objectives                                                           5

Results of Audit
        Finding 1: Fairfield Financial Did Not Follow HUD Requirements When         6
        Originating Four Loans
        Finding 2: Fairfield Financial’s Quality Control Plan Did Not Comply with   11
        HUD Requirements

Scope and Methodology                                                               14

Internal Controls                                                                   15

Appendixes
   A.   Schedule of Questioned Costs and Funds to Be Put to Better Use              17
   B.   Auditee Comments and OIG’s Evaluation                                       18
   C.   Narrative of Loan Deficiencies                                              29
   D.   Commitment Fees Charged to Borrowers                                        36
   E.   Audit Criteria                                                              37




                                               4
                      BACKGROUND AND OBJECTIVES

The National Housing Act, as amended, established the Federal Housing Administration, an
organizational unit within the U.S. Department of Housing and Urban Development (HUD). The
Federal Housing Administration provides insurance for lenders against loss on single-family home
mortgages.

HUD approved Fairfield Financial Mortgage Group, Inc. (Fairfield Financial), as a nonsupervised
direct endorsement lender on September 4, 1998. As a HUD-approved direct endorsement lender,
Fairfield Financial can underwrite and close Federal Housing Administration loans without prior
HUD review or approval.

Fairfield Financial originated 423 Federal Housing Administration-insured loans with mortgages
totaling $79.6 million, which had beginning amortization dates (defined as one month before the
first principal and interest payments are due) between January 1, 2003, and December 31, 2004.
According to HUD’s Neighborhood Watch system, 14 of the loans defaulted within the first two
years of origination, equating to an average default rate of roughly 3.3 percent. This default rate
compared favorably to the national average default rate of 4.2 percent during that same two-year
period. As of the latest reporting period ending June 30, 2005, Fairfield Financial’s two-year
average default rate has declined to 3.1 percent, while the national two-year average default rate
has increased to 4.6 percent. Fairfield Financial sells 100 percent of the loans it originates to the
secondary market.

The audit objectives were to determine whether Fairfield Financial complied with HUD
regulations, procedures, and instructions in the origination of Federal Housing Administration
loans and whether Fairfield Financial’s quality control plan, as implemented, met HUD
requirements.




                                                  5
                                 RESULTS OF AUDIT

Finding 1: Fairfield Financial Did Not Follow HUD Requirements
When Originating Four Loans
Fairfield Financial did not follow HUD requirements when originating and approving 4 of the 24
loans reviewed. The loans contained deficiencies that affected the credit quality (insurability) of
the loans. Fairfield Financial approved the loans based on unsupported income, underreported
liabilities, excessive qualifying ratios, and derogatory credit information. The deficiencies
occurred because Fairfield Financial did not exercise due care in originating and underwriting
loans and did not adequately implement its quality control plan. As a result, HUD insured four
loans that placed the Federal Housing Administration insurance fund at risk for $1,204,981. In
addition, Fairfield Financial did not properly disclose to borrowers $11,390 for commitment fees
in 20 of the 24 loans reviewed.




 Loans Did Not Comply with
 HUD Requirements


               Fairfield Financial originated four loans totaling $1,204,981 that contained
               significant loan origination deficiencies. These loans contained material errors,
               including unsupported income, underreported liabilities, inadequate qualifying
               ratios, and derogatory credit. Fairfield Financial’s quality control process
               contributed to the loan origination deficiencies (see finding 2).

               As of August 31, 2005, HUD’s data systems showed that all four of the loans were
               actively insured with Federal Housing Administration insurance. HUD has not
               incurred any claims associated with these loans. The following table summarizes
               the mortgage amounts and categories of loan deficiencies.

          Case #        Mortgage      Unsupported       Underreported      Excessive     Derogatory
                        amount          income            liabilities      qualifying      credit
                                                                             ratios
       251-3097987       $446,067           X                                  X
       251-2928528         296,656          X                  X
       251-3084029         265,828                                              X             X
       352-5211304         196,430                             X                X             X
          Total         $1,204,981          2                  2                3             2

               All four loans contained more than one deficiency. Descriptions of the
               deficiencies noted are presented below. Appendix C contains detailed narrative
               case presentations for each loan.

                                                 6
Unsupported Income


            Fairfield Financial relied on unsupported income for two loans, case numbers
            251-3097987 and 251-2928528. The anticipated amount of income and the
            likelihood of its continuance must be established to determine a borrower’s
            capacity to repay mortgage debt. Lenders may not use income in evaluating the
            borrower’s loan that it cannot verify, is not stable, or will not continue.
            Overstating income affects the debt-to-income ratios. The use of incorrect
            income information could result in an invalid underwriting decision.

            For example, Fairfield Financial originated case number 251-3097987 using a
            calculated monthly income of $4,687, consisting of $2,542 in base pay and $2,145
            in overtime income. Fairfield Financial calculated the monthly income using only
            one of the pay stubs provided by the borrower, although the borrower provided
            six pay stubs and Internal Revenue Service W-2 forms from the prior two years.
            HUD requires that lenders develop an average of overtime income over the last
            two years or otherwise justify and document the reason for using the income. A
            more accurate estimate of the borrower’s monthly income would have been an
            average of his 2003 earnings and year-to-date earnings. That calculation resulted
            in an average monthly income of $3,916, well below the income Fairfield
            Financial used to qualify the borrower.


Underreported Liabilities


            Fairfield Financial did not consider all relevant liabilities when approving two
            loans, case numbers 352-5211304 and 251-2928528. HUD requires lenders to
            consider all recurring obligations, contingent liabilities, and projected obligations
            that meet HUD’s specific stipulations when evaluating a loan application.
            Underreported liabilities affect the debt-to-income ratios. The use of incorrect
            liability information could result in an invalid underwriting decision.

            For example, for case number 251-2928528, Fairfield Financial omitted liabilities
            for the borrower when evaluating the loan. It requested tax returns to support the
            borrower’s income. However, the borrower was self-employed and had neglected
            to prepare and submit federal tax returns. Although the borrower submitted
            proforma tax returns, Fairfield Financial did not consider more than $32,300 in
            federal taxes and penalties owed by the borrower for the prior two tax years, as
            indicated on the unfiled tax returns. It was Fairfield Financial’s obligation to
            consider this significant liability in evaluating the loan application and its impact
            on the borrower’s capacity to repay mortgage debt.



                                              7
Excessive Qualifying Ratios


            Fairfield Financial allowed excessive qualifying ratios without valid
            compensating factors in three loans, case numbers 251-3084029, 352-5211304,
            and 251-3097987. HUD requires debt-to-income ratios not to exceed 29 and 41
            percent (mortgage payment-to-effective income and total fixed payment-to-
            effective income ratio, respectively). Ratios exceeding 29 and 41 percent may be
            acceptable only if significant compensating factors are present. HUD identifies
            10 compensating factors that may be considered to justify approving mortgage
            loans with qualifying ratios exceeding HUD’s established thresholds. The three
            loans approved by Fairfield Financial did not adequately document any of the 10
            compensating factors recognized by HUD.

            For example, case number 352-5211304 had a mortgage payment-to-income ratio
            of 38.09 percent and a total fixed payment-to-income ratio of 43.50 percent.
            Fairfield Financial should have documented compensating factors to justify the
            excess ratios; especially considering that the borrower’s housing payment was
            increasing 600 percent from $300 per month to just over $2,100 per month.

Derogatory Credit


            Fairfield Financial did not properly evaluate the borrowers’ past credit
            performance and ensure that the borrowers demonstrated financial responsibility
            in two of the four loans, case numbers 251-3084029 and 352-5211304. HUD
            considers past credit performance of the borrowers to be the most useful guide in
            determining the attitude toward credit obligations that will govern the borrowers’
            future actions. If the credit history, despite adequate income to support
            obligations, reflects continuous slow payments, judgments, and delinquent
            accounts, strong compensating factors will be necessary to approve the loan.
            While minor derogatory information occurring two or more years in the past does
            not require explanation, major indications of derogatory credit—including
            judgments, collections, and any other recent credit problems—require sufficient
            written explanation from the borrower.


            For example, the borrower’s credit report for case number 251-3084029 identified
            six different accounts that went into collection. Shortly before the loan
            application, all six of these accounts were brought current, and they all had no
            balances. Derogatory credit, including accounts in collection, requires a sufficient
            written explanation from the borrower. The borrower provided a letter of
            explanation, citing a divorce as the reason for falling behind on payments. The
            letter further indicated that efforts had been made over the last several months to


                                             8
             settle and pay off the debts. The divorce cited by the borrower occurred
             approximately eight years before the loan application, and five of the six accounts
             in collection were opened after the divorce finalization. This does not constitute a
             sufficient written explanation.


$11,390 Charged for
Commitment Fees without
Adequate Disclosure

             Fairfield Financial charged $11,390 for loan commitment fees, without adequate
             disclosure, in 20 of the 24 loans reviewed. Commitment fees are an allowable
             charge if there is a lock-in or commitment agreement, in writing, that guarantees
             the rate or discount points for a period of not less than 15 days before the
             anticipated closing date. Fairfield Financial did not provide adequate disclosure
             of written lock-in or commitment agreements to its borrowers as required. While
             these deficiencies did not affect the overall credit quality (insurability) of the
             individual loans, they do indicate a lack of full commitment to quality
             underwriting. Lenders need to ensure that they follow all facets of HUD
             requirements when originating Federal Housing Administration loans. We
             provided details of these deficiencies to Fairfield Financial during our review.
             Appendix D presents a table summarizing the commitment fees charged to
             borrowers for each of the 20 loans.

Conclusion


             Fairfield Financial did not always exercise due care in originating and
             underwriting loans and did not adequately implement its quality control plan. As
             a result, Fairfield Financial originated four loans containing deficiencies that
             placed the Federal Housing Administration insurance fund at risk for $1,204,981.
             In addition, Fairfield Financial charged $11,390 for loan commitment fees,
             without adequate disclosure, in 20 of the 24 loans reviewed.




                                              9
Recommendations

          We recommend that the assistant secretary for housing-federal housing
          commissioner

          1A.     Require Fairfield Financial to indemnify HUD against future losses on the
                  four loans totaling $1,204,981.

          1B.     Require Fairfield Financial to revise its procedures to ensure that each
                  borrower charged a commitment fee is properly informed, in writing, of
                  the fee, the amount of the fee, and the purpose of the fee, and that the
                  actual fee charged coincides with the amount disclosed to the borrower.




                                           10
Finding 2: Fairfield Financial’s Quality Control Plan Did Not Comply
with HUD Requirements

Fairfield Financial did not establish and implement an adequate quality control process in
accordance with HUD regulations. Fairfield Financial’s quality control plan did not include all
of the HUD-required elements. In addition, its staff did not ensure that loans going into early
payment default were reviewed as part of the quality control process or that its operations
complied with applicable fair lending laws. Further, Fairfield Financial’s quality control plan
lacks specific procedures regarding single-family loan servicing. These deficiencies existed
because of Fairfield Financial’s lack of understanding concerning its responsibility to ensure that
it met HUD requirements when contracting with an outside firm to perform quality control
reviews. As a result, it was unable to ensure the accuracy and completeness of its loan
origination operations, contributing to an increased risk of loss to the Federal Housing
Administration insurance fund.




    Outside Firm Contracted to
    Perform Quality Control
    Reviews


                 HUD provides that a lender may engage outside sources to perform the quality
                 control function. 1 A lender contracting out any part of its quality control function is
                 responsible for ensuring that the outside source meets HUD’s requirements.
                 Fairfield Financial contracted with an outside firm to perform its quality control
                 reviews. It relied on the quality assurance program prepared by the contractor
                 (Fairfield Financial’s quality control plan). However, Fairfield Financial did not
                 ensure that this program contained all HUD-required elements or that it completed
                 quality control reviews in accordance with the plan.


    Written Quality Control Plan
    Did Not Contain Required
    Elements


                 HUD provides that as a condition of HUD-Federal Housing Administration
                 approval, lenders must have and maintain a quality control plan for the origination
                 and servicing of insured mortgages. The quality control plan must be a prescribed
                 function of the lender’s operations and assure that the lender maintains compliance



1
    HUD Handbook 4060.1, REV-1, CHG-1, paragraph 6-3(B)(2).


                                                    11
                 with HUD-Federal Housing Administration requirements and its own policies and
                 procedures. 2

                 Fairfield Financial’s quality control plan was not dated and did not include the
                 following elements:

                     •   Determine whether there are sufficient and documented compensating
                         factors if the debt ratios exceed Federal Housing Administration limits.

                     •   Determine whether all conditions were cleared before closing.

                     •   Determine whether the seller acquired the property at the time of or soon
                         before closing, indicating a possible property “flip.”

                 Additionally, Fairfield Financial’s quality control plan lacked specific procedures
                 regarding single-family loan servicing. We recognize that Fairfield Financial
                 intended to sell 100 percent of the loans it originated. However, from time to time
                 and in varying degrees, it serviced the loans it originated, including Federal Housing
                 Administration-insured loans.


     Early Default and Rejected
     Loans Not Reviewed


                 Fairfield Financial did not fully implement its quality control plan. It did not
                 ensure that quality control reviews were performed on all loans defaulting within
                 six months of closing, as required and as outlined in its own quality control plan.
                 This occurred because Fairfield Financial did not submit the required loan listing
                 of early payment defaults to its quality control contractor. It mistakenly believed
                 that this function was part of the quality control process of the secondary lending
                 market in which it sells its loans. Accordingly, the contractor did not perform the
                 required reviews.

                 Further, Fairfield Financial did not provide a list of rejected loans to its quality
                 control contractor to use in performing quality control reviews. Without these
                 reviews, there was no assurance that Fairfield Financial’s operations complied
                 with applicable fair lending laws. We noted that, with the exception of the four
                 months between January and April 2004, Fairfield Financial did not provide the
                 required rejected loan listing to its quality control contractor. Therefore, the
                 contractor was unable to perform the required fair lending review. Fairfield
                 Financial stated that this was an oversight.




2
    HUD Handbook 4060.1, REV-1, CHG-1, paragraph 6-1.


                                                   12
             Fairfield Financial, along with its quality control contractor, expressed an interest
             in ensuring that its quality control plan meets HUD requirements.


Conclusion



             Fairfield Financial did not establish and implement a quality control process that
             complied with HUD requirements. Its quality control plan lacked required
             elements necessary to conduct proper quality control reviews, and it did not
             ensure that it routinely provided adequate information to its quality control
             contractor to ensure that it conducted reviews in accordance with HUD
             requirements. Without a properly implemented quality control process, Fairfield
             Financial cannot ensure that its loan originations comply with HUD requirements;
             that it is protecting itself and HUD from unacceptable risk; and that it is guarding
             against errors, omissions, and fraud.


 Recommendations



             We recommend that the assistant secretary for housing-federal housing
             commissioner

             2A.    Require Fairfield Financial to establish and implement an adequate quality
                    control process.

             2B.    Verify that Fairfield Financial’s quality control process is fully
                    implemented in accordance with HUD regulations.




                                              13
                      SCOPE AND METHODOLOGY

Fairfield Financial originated 423 Federal Housing Administration-insured loans, which had
beginning amortization dates (defined as one month before the first principal and interest
payments are due) between January 1, 2003, and December 31, 2004. To achieve our objectives,
we chose a nonrepresentative method to select loans for review from that period. This method
allowed us to select Federal Housing Administration-insured loans with certain characteristics,
enabling us to focus our review efforts on Federal Housing Administration-insured loans in
which there was a greater inherent risk to the Federal Housing Administration insurance fund
and/or risk of noncompliance or abuse.

We selected all 14 loans that defaulted within the first two years of loan origination for review
and, based on the high percentage of defaulted loans that were multiunit, we selected an
additional 10 multiunit loans for review. The results of our detailed testing only apply to the 24
loans reviewed and may not be projected to the universe of 423 Federal Housing Administration-
insured loans.

We reviewed HUD’s rules, regulations, and guidance for proper origination and submission of
Federal Housing Administration loans. We interviewed HUD staff to obtain background
information on HUD requirements and on Fairfield Financial, and we reviewed the HUD case
binders for the 24 loans selected.

We interviewed Fairfield Financial’s management and staff to obtain information regarding its
policies, procedures, and management controls. We reviewed Fairfield Financial’s written
policies and procedures to gain an understanding of how its processes are designed to function.
We also reviewed Fairfield Financial’s quality control plan, as well as the quality assurance
program of its quality control provider, and available quality control reports. Additionally, we
reviewed Fairfield Financial’s origination binders for the 24 loans selected for review.

We relied upon computer-processed data contained in HUD’s Single Family Data Warehouse
system. We assessed the reliability of these data, including relevant general and application
controls, and found them to be adequate for the data obtained. We also performed sufficient tests
of the data, and based on the assessments and testing, we concluded that the data are sufficiently
reliable to be used in meeting our objectives.

The audit generally covered the period from January 1, 2003, through December 31, 2004. We
expanded this period, when applicable, to include the most current data through August 31, 2005,
while performing the audit. We performed our fieldwork from January through July 2005.

We performed our review in accordance with generally accepted government auditing standards.




                                               14
                             INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides
reasonable assurance that the following objectives are being achieved:

   •   Effectiveness and efficiency of operations,
   •   Reliability of financial reporting, and
   •   Compliance with applicable laws and regulations.

Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals, and objectives. Internal controls include the processes and procedures for
planning, organizing, directing, and controlling program operations. They include the systems
for measuring, reporting, and monitoring program performance.



 Relevant Internal Controls
              We determined the following internal controls were relevant to our audit objectives:

              •       Program operations. Policies and procedures that management has
                      implemented to reasonably ensure that the loan origination process
                      complies with HUD/Federal Housing Administration requirements and
                      that the objectives of the program are met.

              •       Validity and reliability of data. Policies and procedures that management
                      has implemented to reasonably ensure valid and reliable data are obtained,
                      maintained, and fairly disclosed in reports.

              •       Compliance with laws and regulations. Policies and procedures that
                      management has implemented to reasonably ensure that resource use is
                      consistent with laws and regulations.

              •       Safeguarding of resources. Policies and procedures that management has
                      implemented to reasonably ensure that resources are safeguarded against
                      waste, loss, and misuse.

              We assessed the relevant controls identified above.

              A significant weakness exists if management controls do not provide reasonable
              assurance that the process for planning, organizing, directing, and controlling
              program operations will meet the organization’s objectives.




                                               15
Significant Weaknesses


           Based on our review, we believe the following items are significant weaknesses:

           •      Compliance with laws and regulations. Fairfield Financial did not follow
                  HUD requirements when originating four Federal Housing Administration-
                  insured loans (see finding 1).

           •      Compliance with laws and regulations. Fairfield Financial has not
                  implemented its quality control plan in accordance with HUD requirements
                  (see finding 2).




                                           16
Appendix A

     SCHEDULE OF FUNDS TO BE PUT TO BETTER USE

                  Recommendation        Funds to be put
                         number          to better use 1/
                                 1A          $1,204,981


1/    ”Funds to be put to better use” are quantifiable savings that are anticipated to
      occur if an Office of Inspector General (OIG) recommendation is implemented,
      resulting in reduced expenditures at a later time for the activities in question. This
      includes costs not incurred, deobligation of funds, withdrawal of interest,
      reductions in outlays, avoidance of unnecessary expenditures, loans and
      guarantees not made, and other savings.




                                           17
Appendix B

     AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation    Auditee Comments




Comment 1




                        18
Comment 2




Comment 3



Comment 4




Comment 5




Comment 6




            19
Comment 7



Comment 8




Comment 9




Comment 10



Comment 11




             20
Comment 12




Comment 13




Comment 14




             21
Comment 15




Comment 16




Comment 17




Comment 18




Comment 19




             22
23
                     OIG Evaluation of Auditee Comments

Comment 1   Fairfield Financial agreed to make the recommended changes, but noted
            that their Quality Control Plan (QCP) was not deficient. As detailed in
            this report, Fairfield Financial’s QCP is deficient, as it lacks HUD-
            required elements and procedures regarding single-family loan servicing.

Comment 2   Fairfield Financial disagreed that the borrower’s income was incorrectly
            calculated. We agree that the loan file contained six pay stubs. The loan
            file also contained Internal Revenue Service W-2 forms for 2002 and
            2003. Fairfield Financial, however, only used one of those pay stubs and
            none of the W-2 forms to calculate the borrower’s base income, as well as
            the borrower’s overtime income. This is not adequate and does not meet
            HUD/FHA requirements. Fairfield Financial stated that, an average of the
            borrower’s earnings prior to his elevated position, with its increased
            overtime demands, would have been inappropriate in the underwriters
            opinion. We agree, and that’s why we indicate in the report that a more
            accurate estimate of the borrower’s monthly income would have been an
            average of his 2003 earnings (the year of his promotion) and his year-to-
            date earnings; not a single a pay stub.

Comment 3   We did not present this issue in the audit report. Fairfield Financial is
            referring to comments we made in an earlier OIG letter, dated June 9,
            2005, in which we detailed our preliminary concerns and provided
            Fairfield Financial an opportunity to respond. Fairfield Financial did not
            revise its comments prepared in response to that letter to reflect only the
            issues presented in the audit report. As we did not carry this issue forward
            to the audit report, we offer no response.

Comment 4   We agree that the loan closed in May 2004, and that it was completely
            acceptable to qualify the borrower at the first year bought-down rate.
            Regardless of whether the loan closed prior to, or subsequent to May
            2004, Fairfield Financial was required to establish that the eventual
            increase in mortgage payments would not adversely affect the borrower
            and lead to default. Fairfield Financial did not establish, or document as
            required, that the eventual increase would not adversely affect the
            borrower.

Comment 5   Fairfield Financial disagrees that the borrower’s income was not
            sufficiently established. Prior to his mortgage application, the borrower
            failed to prepare Federal tax returns for the prior two years and, most
            likely, for prior years as well. The Federal tax returns included in the loan
            file indicated that they were prepared by a “paid preparer” on March 26,
            2003, but did not include the paid preparer’s signature. Further, the
            borrower did not sign and date the tax returns until the day of his loan
            closing. There is no indication that those returns were ever filed or


                                         24
              accurately reflect the borrower’s self-employment income. Our main
              concern lies with the $32,000 plus owed for taxes and penalties reflected
              on the 2001 and 2002 tax returns and not considered by Fairfield Financial
              during the underwriting process (see comment 10).

Comment 6     The loan file does contain a conflicting Social Security number for the
              borrower. The loan file contains two separate certificates from the City of
              Brockton; one from 1998 and one from 2002. Both certificates include the
              borrower’s printed name and signature, but reflect two different Social
              Security numbers. There is nothing in the loan file indicating that the
              conflicting Social Security number is that of the borrower’s business
              partner.

Comment 7     We do not dispute that the borrower appears to be self-employed.

Comment 8     We agree that the loan file does not contain any other Social Security
              discrepancies and that the credit report did not contain a warning.

Comment 9     We disagree that Fairfield Financial was unaware that the borrower had
              not filed previous tax returns or that he had not paid any tax liability to the
              Internal Revenue Service. The tax returns for 2001 and 2002 are both
              dated by the “paid preparer” on March 26, 2003, providing evidence that
              they were prepared at the time of the borrower’s application for a
              mortgage loan. The tax returns clearly indicate the tax liability and
              penalties of over $32,000 and there is no indication in the loan file that
              Fairfield Financial considered this, as required. Fairfield Financial
              correctly pointed out that the borrower would be eligible if the delinquent
              account was brought current, paid, or otherwise satisfied or a satisfactory
              repayment plan was made between the borrower and the Federal agency
              owed and verified in writing. There is no indication that Fairfield
              Financial made any effort to determine if this occurred. Further, our
              concern did not lie with the closing stipulations or instructions, but with
              the timeliness of the returns and the significant liability owed by the
              borrower that was not addressed by Fairfield Financial.

Comment 10 Fairfield Financial did not consider the borrower’s significant liability in
           evaluating the loan application and its impact on the borrower’s capacity
           to repay mortgage debt, as required. Neither the loan file nor the HUD
           case binder provided any justification for moving forward with this loan or
           any evidence that the borrower brought current, paid, or otherwise
           satisfied the delinquent account. Further, Fairfield Financial presumes to
           know what the borrower’s liability with the Internal Revenue Service
           would be. In the absence of a repayment agreement, the borrower’s
           liability is unknown. The tax returns in question represent only two years
           and the borrower was self-employed prior to that. Therefore, it is likely



                                            25
              that the borrower’s liability to the Internal Revenue Service may far
              exceed the $32,000 owed for the 2001 and 2002 tax years.

Comment 11 We agree with Fairfield Financial that, as of August 31, 2005, the loan
           does not appear in the early warning default section of HUD’s
           Neighborhood Watch system. This does not excuse Fairfield Financial
           from adhering to HUD/FHA regulations in the origination and
           underwriting of FHA-insured loans.

Comment 12 Again, Fairfield Financial is referring to comments we made in an earlier
           OIG letter, dated June 9, 2005, in which we detailed our preliminary
           concerns and provided Fairfield Financial an opportunity to respond.
           Fairfield Financial did not revise its comments prepared in response to that
           letter to reflect only the issues presented in the audit report. We agree that
           the borrower had three months of reserves, as reflected in the audit report.
           The borrower’s fixed payment to effective income ratio, however, was
           49.90, well above the HUD/FHA threshold.

Comment 13 Fairfield Financial presented the argument that an additional compensating
           factor was present. The loan file, however, only included two
           compensating factors on the Mortgage Credit Analysis Worksheet
           (MCAW); “3-months reserves” and “job longevity.” We agree that the
           borrower had three months of reserves. Job longevity, though, is not
           recognized as a compensating factor. The loan file does not contain any
           other information or documentation regarding compensating factors
           present. If Fairfield Financial felt other compensating factors were
           relevant, they should have documented those factors on the MCAW as
           required.

Comment 14 Fairfield Financial stated that five of the six accounts actually went into
           collection within 12-24 months of the borrower’s divorce. This is
           incorrect. In fact, four of the six accounts were not opened by the
           borrower until October 1999 or later, over three years after the divorce.
           Only one of the accounts was open prior to the divorce. This is why the
           borrower’s explanation that the divorce caused her to fall behind on
           payments was inadequate, as five of the six accounts were opened
           subsequent to the divorce. It was not until the borrower applied for a
           mortgage loan that she made an effort to clear her delinquent accounts.

Comment 15 Fairfield Financial stated that the borrower sold the subject property on
           August 31, 2005 and that it would be inappropriate to indemnify the loan.
           A check of HUD’s Neighborhood Watch system, as of August 31, 2005,
           showed that foreclosure was started on the subject property. If the
           property was in fact sold, we would still recommend that Fairfield
           Financial indemnify HUD from paying any claims or costs associated with
           this loan.


                                           26
Comment 16 Fairfield Financial stated they no longer employ the underwriter or the
           originator of this loan. Fairfield Financial believes that the file reflects the
           two properties, but concedes that the file documentation should be
           improved and that the analysis should have been contained in the file
           documentation. We did not find that the loan file reflected both
           properties. The initial application included both properties, whereas, the
           final application reflected only the FHA-insured property. There was no
           explanation regarding the discrepancy between the initial and final
           application, as required. The borrower stated that the originator was well
           aware of his intent to purchase both properties, but he could not recall why
           the final application did not reflect this.

Comment 17 Fairfield Financial stated that the $190 debt was an installment loan with a
           balance of $520, based on a March 9, 2004, credit report. Fairfield
           Financial further stated that the loan would have been paid off prior to the
           first mortgage payment due August 1, 2004. This is incorrect. The credit
           report was ordered on March 9, 2004, but was revised as of June 7, 2004
           and still reflected the $520 balance. We stand by our conclusion that the
           $190 monthly payment would have adversely affected the borrower’s
           ability to make his mortgage payment in consideration that his monthly
           housing payment was increasing 600 percent.

Comment 18 Fairfield Financial stated that the property purchased was a three family
           dwelling and that, when the potential rental income is considered as an
           offset to the housing payment, the net increase to the borrower’s monthly
           housing expense is significantly less than the 600 percent cited in the
           report. We disagree. As Fairfield Financial correctly stated, the
           borrower’s previous monthly housing payment was $300. The new
           monthly housing payment was $2,120. This equates to over a 600 percent
           increase. Fairfield Financial is quick to point out that the potential rental
           income would reduce the burden on the borrower of meeting this increase,
           but neglects to mention the second property purchased by the borrower
           that also required a monthly housing payment. The fact remains that the
           borrower’s monthly housing payment was increasing from $300 a month
           to over $2,100 a month, regardless of any other potential income sources.

Comment 19 Fairfield Financial provided twelve commitment letters evidencing that
           they locked in each borrower for a minimum of 15 days. For the
           remaining eight loans in question, Fairfield Financial provided copies of
           their investor locks showing the borrowers were locked in prior to or on
           the day of the issuance of their commitment letters. Fairfield Financial
           contends that the borrowers were properly informed of their lock in
           protection.




                                            27
The commitment letters provided, in most cases, were not included in the
loan files or the HUD case binders at the time of our review. We
recognize that the borrowers received a rate lock for the commitment fees
paid. We disagree, however, that the borrowers were properly informed.
Of the twelve commitment letters, only seven included the correct
commitment fee amount charged to the borrower. Furthermore, of the
twelve commitment letters: two were not dated by the borrower; one was
not signed or dated by the borrower; and the remaining nine were all
signed on the date of the closing. We have no way of knowing whether
the borrowers received any notification for the eight loans where Fairfield
Financial was unable to provide commitment letters. Accordingly, we
disagree that the borrowers were properly informed considering the
inconsistent amounts listed on the commitment letters to what was actually
charged and that the borrowers, in most cases, did not sign the
commitment letters until the day of closing.

As this was the first review of Fairfield Financial, and it appears that the
borrowers received a rate lock for the commitment fees paid, we revised
our recommendation. We revised the recommendation from requesting
repayment of the $11,390 charged, to require Fairfield Financial to ensure
it properly discloses the fee to each borrower.




                             28
Appendix C

               NARRATIVE OF LOAN DEFICIENCIES


Case number:                                    251-3097987

Mortgage amount:                                $446,067

Date of loan closing:                           May 28, 2004

Current status                                  Current
 (as of August 31, 2005):
Cause of default:                               Not applicable

Number of payments before                       Not applicable
 first default reported:
Unpaid principal balance                        $439,634
 (as of August 31, 2005):

Summary:

Unsupported Income

The application indicated the borrower’s total monthly employment income was $4,687,
which consisted of $2,542 in base income and $2,145 in overtime income. Fairfield
Financial computed the income during its verification process by using one of the
borrower’s pay stubs. While the year-to-date earnings reflected on the pay stub were
sufficient to establish the borrower’s base income, considering a recent raise, they were not
sufficient to establish the overtime income of the borrower. HUD allows overtime income
in qualifying a borrower so long as the borrower has earned overtime income for
approximately two years. Otherwise, the lender must adequately justify and document its
reasons for using the income.

The borrower’s historical income data revealed that the borrower averaged only $3,153 per
month in 2002, the year of his last promotion. In 2003, the borrower averaged $3,626 per
month. A more accurate estimate of the borrower’s monthly income would have been an
average of his 2003 earnings and year-to-date earnings. That calculation resulted in an
average monthly income of $3,916, including overtime, well below the $4,687 monthly
income Fairfield Financial used to qualify the borrower. Using that income, the mortgage
payment-to-effective income ratio increased from 39.10 to 43.78 percent, and the total fixed
payment-to-effective income ratio increased from 44.00 to 49.20 percent.
Excessive Qualifying Ratios



                                              29
Fairfield Financial exceeded HUD’s allowable limits without compensating factors. The
mortgage credit analysis worksheet showed the borrower’s mortgage payment-to-
effective income ratio as 39.10 percent and total fixed payment-to-effective income ratio
as 44.00 percent. The worksheet indicated “credit an isolated situation” and “job
longevity” as compensating factors. These are not included in the 10 compensating
factors recognized by HUD. Also, as pointed out above, we calculated the debt ratios to
be 43.78 percent and 49.20 percent based on the revised income calculation, further
illustrating the need for compensating factors.

Other Deficiencies
Contrary to HUD requirements, Fairfield Financial approved a buydown interest rate loan
without establishing and documenting that the eventual increase in mortgage payment
would not adversely affect the borrower’s ability to make higher mortgage payments in
the future. As noted above, Fairfield Financial improperly calculated the borrower’s
monthly income, resulting in lower debt-to-income ratios. The debt-to-income ratios
were actually much higher, which would have an adverse impact on the borrower’s
ability to make higher mortgage payments in the future.




                                           30
Case number:                                  251-2928528

Mortgage amount:                              $296,656

Date of loan closing:                         April 18, 2003

Current status                                Reinstated by borrower who retains
(as of August 31, 2005):                      ownership; December 1, 2003
Cause of default:                             Other

Number of payments before                     Two
 first default reported:
Unpaid principal balance                      $288,571
 (as of August 31, 2005):

Summary:

Unsupported Income

The application indicated the borrower was self-employed with total monthly
employment income of $4,167. To support this income, Fairfield Financial requested
federal tax returns for the past two years and learned that the borrower had not prepared
the required tax returns. Fairfield Financial allowed the borrower to have the federal tax
returns prepared. Although the borrower signed and dated the prepared tax returns, the
preparer did not sign the tax returns, and there is no indication that the borrower ever
filed the tax returns with the Internal Revenue Service. Further, the loan file contains a
conflicting Social Security number for the borrower, as reported on the certificate he
signed as the owner of the business. Fairfield Financial did not address this conflicting
Social Security number and did not sufficiently establish the borrower’s reported self-
employment income.

Underreported Liabilities

In addition, Fairfield Financial omitted liabilities for the borrower when evaluating the
loan. As noted above, Fairfield Financial requested tax returns to support the borrower’s
income. However, the borrower was self-employed and had neglected to prepare and
submit federal tax returns. Although the borrower submitted proforma tax returns,
Fairfield Financial did not consider more than $32,300 in federal taxes and penalties
owed by the borrower for the prior two tax years, as indicated on the unfiled tax returns.




                                            31
When a borrower is delinquent on any federal debt, HUD declares that the borrower is
not eligible until the delinquent account is brought current, paid, or otherwise satisfied or
a satisfactory repayment plan is made between the borrower and the federal agency owed
and verified in writing. It was Fairfield Financial’s obligation to consider this significant
liability in evaluating the loan application and its impact on the borrower’s capacity to
repay mortgage debt. As there is no repayment agreement in place for the borrower’s tax
liability, we were unable to calculate the effect on the debt-to-income ratios.




                                             32
Case number:                                   251-3084029

Mortgage amount:                               $265,828

Date of loan closing:                          April 1, 2004

Current status                                 Foreclosure started; August 1, 2005
 (as of August 31, 2005):
Cause of default:                              Inability to rent property

Number of payments before                      Four
 first default reported:
Unpaid principal balance                       $261,357
 (as of August 31, 2005):

Summary:

Excessive Qualifying Ratios

Fairfield Financial exceeded HUD’s allowable limits without compensating factors. The
mortgage credit analysis worksheet showed the borrower’s mortgage payment-to-
effective income ratio as 42.94 percent and total fixed payment-to-effective income ratio
as 49.90 percent. The worksheet indicated “job longevity” and “3-months reserves” as
compensating factors. HUD does not recognize job longevity as a compensating factor.
Although the borrower did have three months of reserves, HUD requires that the lender
judge the overall merits of the loan application when determining to what extent the
ratios may be exceeded. Considering the excessive ratios and the derogatory credit
detailed below, the one compensating factor cited by Fairfield Financial was not
sufficient to qualify the borrower.

Derogatory Credit

The borrower’s credit report identified six different accounts that went into collection.
Derogatory credit, including accounts in collection, requires a sufficient written
explanation from the borrower. The borrower provided a letter of explanation, citing a
divorce as the reason for falling behind on payments. The letter further indicated that
efforts had been made over the last several months to settle and pay off the debts. The
divorce cited by the borrower occurred approximately eight years before the loan
application, and five of the six accounts in collection were opened after the divorce
finalization. This did not constitute a sufficient written explanation.




                                            33
Case number:                                  352-5211304

Mortgage amount:                              $196,430

Date of loan closing:                         June 14, 2004

Current status                                Reinstated by mortgagor who retains
(as of August 31, 2005):                      ownership; December 31, 2004
Cause of default:                             Curtailment of borrower income

Number of payments before                     One
 first default reported:
Unpaid principal balance                      $194,304
 (as of August 31, 2005):

Summary:

Underreported Liabilities

The borrower’s initial loan application indicated rental income from a single-family
residence suggesting that he owned another residence. The final loan application did not
include the rental income from this single-family residence and further indicated that the
borrower did not own any other real estate. HUD requires a satisfactory letter of
explanation from the borrower addressing any significant variances between the initial
application and final application. Fairfield Financial did not document how this
discrepancy was resolved and should have asked the borrower about this potential other
property so that it could consider the asset and corresponding liability in the qualifying
process.

We learned that the borrower purchased two properties from the same seller, including
the Federal Housing Administration property. The borrower closed on the other single-
family property in the month before closing on the Federal Housing Administration
property. The borrower stated that Fairfield Financial was aware of his intent to purchase
both properties, but he was supposed to close on the Federal Housing Administration
property first. Regardless of the order of closings on the properties, Fairfield Financial
was obligated to include this liability in its analysis.

Additionally, the borrower’s credit report included a $190 monthly payment to one
creditor. Fairfield Financial excluded the debt because there were fewer than 10 monthly
payments left on the obligation. HUD requires that lenders include debts lasting less than
10 months if the amount of the debt will affect the borrower’s ability to make the
mortgage payment during the months immediately after loan closing. In this instance, the
borrower’s monthly housing payment was increasing from $300 per month to more than
$2,100 per month, a 600 percent increase. The borrower also owned another property on
which he was making mortgage payments. Considering this substantial increase and the


                                            34
borrower’s obligations to his other property, the additional $190 monthly payment would
adversely affect the borrower’s ability to make his mortgage payments.

Excessive Qualifying Ratios

Fairfield Financial exceeded HUD’s allowable limits without compensating factors. The
mortgage credit analysis worksheet showed the borrower’s mortgage payment-to-
effective income ratio as 38.10 percent, requiring compensating factors, and total fixed
payment-to-effective income ratio as 40.10 percent. Including the $190 monthly
payment excluded by Fairfield Financial (detailed above), we calculated the total fixed
payment-to-effective income ratio at 43.50 percent, also requiring compensating factors.
Fairfield Financial did not document compensating factors. We were unable to determine
what effect the borrower’s other property would have on the debt-to-income ratios.

Derogatory Credit

The borrower’s credit report identified a past judgment, various late payments, and six
different accounts that went into collection. Derogatory credit, including accounts in
collection, requires a sufficient written explanation from the borrower. The borrower
provided a letter of explanation citing that the derogatory credit items were due to address
changes and extended vacations and that he was a victim of identity theft. Address
changes and extended vacations were not sufficient explanations, and there was nothing
in the loan file or otherwise documented by Fairfield Financial substantiating that the
borrower was a victim of identity theft.

Other Deficiencies

Fairfield Financial did not ensure the loan complied with HUD’s self-sufficiency
requirements, as required. As a result, the monthly mortgage payment exceeded the
property’s monthly net rental income, resulting in an over-insured loan.




                                            35
Appendix D

  COMMITMENT FEES CHARGED TO BORROWERS


       Case #            Description of fee               Fee charged
    061-2594624   Commitment fee; inadequate disclosure            $180
    251-2948755   Commitment fee; inadequate disclosure             500
    061-2662310   Commitment fee; inadequate disclosure             595
    061-2672274   Commitment fee; inadequate disclosure             595
    251-2877993   Commitment fee; inadequate disclosure             595
    251-2928528   Commitment fee; inadequate disclosure             595
    251-2978060   Commitment fee; inadequate disclosure             595
    251-2987969   Commitment fee; inadequate disclosure             595
    251-2992447   Commitment fee; inadequate disclosure             595
    251-3040714   Commitment fee; inadequate disclosure             595
    251-3041749   Commitment fee; inadequate disclosure             595
    251-3059409   Commitment fee; inadequate disclosure             595
    251-3066191   Commitment fee; inadequate disclosure             595
    251-3084029   Commitment fee; inadequate disclosure             595
    251-3097987   Commitment fee; inadequate disclosure             595
    251-3099102   Commitment fee; inadequate disclosure             595
    352-5211304   Commitment fee; inadequate disclosure             595
    352-5303820   Commitment fee; inadequate disclosure             595
    374-4333229   Commitment fee; inadequate disclosure             595
    374-4399067   Commitment fee; inadequate disclosure             595
   Total                                                        $11,390




                                 36
Appendix E

                               AUDIT CRITERIA


HUD Handbook 4060.1, REV-1, CHG-1, “Mortgagee Approval Handbook,” Chapter 6,
“Quality Control Plan,” provides guidelines and requirements to be implemented by all
lenders.

Paragraph 6-1 requires all Federal Housing Administration-approved lenders, including
loan correspondents, to implement and continuously have in place a quality control plan
for the origination and/or servicing of insured mortgages as a condition for receiving and
maintaining Federal Housing Administration approval. The quality control plan must be
a prescribed and routine function of the lender’s operations and assure that the lender
maintains compliance with HUD-Federal Housing Administration requirements and its
own policies and procedures.

Paragraph 6-3 contains the basic elements that are required in all quality control
programs. The lender must properly train its staff involved in quality control and provide
them with access to current guidelines relating to the operations that they review. It is
not necessary for lenders to maintain these guidelines in hard copy format if they are
accessible in an electronic format. Many of the statutes, regulations, HUD handbooks,
and mortgagee letters that establish the requirements for Federal Housing Administration
programs may be accessed through HUD’s home page on the World Wide Web.

Paragraph 6-6C, “Sample Size and Loan Selection,” states that a lender originating 7,000
or fewer Federal Housing Administration loans per year must review 10 percent of the
Federal Housing Administration loans it originates.

Paragraph 6-6D, “Early Payment Defaults,” provides that in addition to the loans selected
for routine quality control reviews, lenders must review all loans going into default
within the first six payments. Early payment defaults are loans that become 60 days past
due.

Paragraph 6-7 prescribes minimum elements for the production portion of a quality
control program. The lender must address the following elements, among others:

   •   Determine whether there are sufficient and documented compensating factors if
       the debt ratios exceed Federal Housing Administration limits (paragraph 6-7J).

   •   Determine whether all conditions were cleared before closing (paragraph 6-7 L).

   •   Determine whether the seller acquired the property at the time of or soon before
       closing, indicating a possible property “flip” (paragraph 6-7P).


                                            37
HUD Handbook 4000.4, REV-1, CHG-2, “Single Family Direct Endorsement Program,”
paragraph 2-1, states that a lender must conduct its business operations in accordance
with accepted sound mortgage lending practices, ethics, and standards.

Paragraph 2-4C states that lenders are expected to exercise due diligence in the
underwriting of loans to be insured by the Federal Housing Administration.
HUD Handbook 4155.1, REV-4, CHG-1 (September 1995) and HUD Handbook 4155.1,
REV-5 (October 2003), “Mortgage Credit Analysis for Mortgage Insurance on One- to
Four-Family Properties,” requires lenders to determine the borrowers’ ability and
willingness to repay the mortgage debt and, thus, limit the probability of default or
collection difficulties. Lenders should evaluate the stability and adequacy of income,
funds to close, credit history, qualifying ratios, and compensating factors. Lenders must
ensure the application package contains sufficient documentation to support their
decision to approve the mortgage loan.

Paragraph 1-8C imposes self-sufficiency requirements on three- and four-unit properties
as follows:

   “THREE- AND FOUR-UNIT PROPERTIES, regardless of occupancy status, must
   be self-sufficient, i.e., the maximum mortgage is limited so that the ratio of the
   monthly mortgage payment divided by the monthly net rental income does not exceed
   100 percent.”

Paragraph 2-3 states that while minor derogatory information occurring two or more
years in the past does not require explanation, major indications of derogatory credit,
including judgments and collections, and any other recent credit problems require
sufficient written explanation from the borrower. The borrower’s explanation must make
sense and be consistent with other information in the file.

Paragraph 2-5B states if the borrower, as revealed by public records, credit information,
or HUD’s Credit Alert Interactive Voice Response System, is presently delinquent on any
federal debt (e.g., U.S. Department of Veterans Affairs-guaranteed mortgage, Title I loan,
federal student loan, Small Business Administration loan, delinquent federal taxes) or has
a lien, including taxes, placed against his or her property for a debt owed to the United
States, the borrower is not eligible until the delinquent account is brought current, paid,
or otherwise satisfied or a satisfactory repayment plan is made between the borrower and
the federal agency owed and verified in writing. Tax liens may remain unpaid provided
the lien holder subordinates the tax lien to the Federal Housing Administration-insured
mortgage. If any regular payments are to be made, they must be included in the
qualifying ratios.

Section 2 and paragraph 2-7 require the lender to establish the anticipated amount of
income and the likelihood of its continuance to determine a borrower’s capacity to repay
the mortgage debt.




                                            38
Paragraph 2-7A states that overtime may be used to qualify if the borrower has received
such income for approximately two years and the employment verification must not state
categorically that such income is not likely to continue. Periods of less than two years
may be acceptable provided the underwriter adequately justifies and documents his or her
reasons for using the income.

Paragraph 2-9B prescribes documentation requirements for self-employed borrowers as
follows:

   1. Signed and dated individual tax returns, plus all applicable schedules, for the most
      recent two years;
   2. Signed copies of federal business income tax returns for the last two years with all
      applicable schedules if the business is a corporation, an “S” corporation, or a
      partnership;
   3. A year-to-date profit-and-loss statement and balance sheet; and
   4. A business credit report on corporations and “S” corporations.

Paragraph 2-11A indicates the borrower’s liabilities include all installment loans,
revolving charge accounts, real estate loans, alimony, child support, and all other
continuing obligations. In computing the debt-to-income ratios, the lender must include
the monthly housing expense and all additional recurring charges extending 10 months or
more, including payments on installment accounts, child support, or separate
maintenance payments, revolving accounts and alimony, etc. Debts lasting less than 10
months must be counted if the amount of the debt affects the borrower’s ability to make
the mortgage payment during the months immediately after loan closing.

Paragraph 2-11C states if a debt payment, such as a student loan, is scheduled to begin
within 12 months of the mortgage loan closing, the lender must include the anticipated
monthly obligation in the underwriting analysis unless the borrower provides written
evidence that the debt will be deferred to a period outside this timeframe.

Section 5, “Borrower Qualifying,” states that HUD does not set an arbitrary percentage
that ratios may never exceed. However, it is left up to the lender to judge the overall
merits of the loan application and determine what compensating factors apply and to
what extent the ratios may be exceeded. Establishing that a loan transaction meets
minimal standards does not necessarily constitute prudent underwriting.

Paragraph 2-12 states that debt-to-income ratios are used to determine whether the
borrower can reasonably be expected to meet the expenses involved in homeownership
and otherwise provide for the family. The lender must compute two ratios: (1) mortgage
payment expense-to-effective income, which is considered acceptable if it does not
exceed 29 percent of gross effective income, and (2) total fixed payment-to-effective
income, which is considered acceptable if it does not exceed 41 percent of gross effective
income. However, these ratios may be exceeded if significant compensating factors are
presented.



                                           39
Paragraph 2-13 establishes the 10 compensating factors that may be used in justifying
approval of the loan with ratios exceeding HUD benchmark guidelines. Underwriters
must state on the “remarks” section of the mortgage credit analysis worksheet the
compensating factors used to support loan approval.

Paragraph 2-14 permits lenders to provide borrowers with interest rate buydowns.
Interest rate buydowns are designed to reduce the borrower’s monthly payment during
the early years of the mortgage. It also requires the lender to establish that the eventual
increase in mortgage payments will not adversely affect the borrower and likely lead to
default. The underwriter must document which of four criteria the borrower meets.

   1. The borrower has a potential for increased income that would offset the scheduled
      payment increases, as indicated by job training or education in the borrower’s
      profession or by a history of advancement in the borrower’s career with attendant
      increases in earnings.

   2. The borrower has a demonstrated ability to manage financial obligations in such a
      way that a greater portion of income may be devoted to housing expenses. This
      criterion also may include borrowers whose long-term debt, if any, will not extend
      beyond the term of the buydown agreement.

   3. The borrower has substantial assets available to cushion the effect of the increased
      payments.

   4. The cash investment made by the borrower substantially exceeds the minimum
      required.

Paragraph 3-6 requires a satisfactory letter of explanation from the borrower addressing
any significant variances between the initial application and final application.




                                             40