Issue Date May 26, 2005 Audit Report Number 2005-FW-1010 TO: Frank L. Davis General Deputy Assistant Secretary for Housing, H FROM: Frank E. Baca Regional Inspector General for Audit, 6AGA SUBJECT: Broad Street Mortgage Company, a Subsidiary of Fieldstone Mortgage Company, San Antonio, Texas, Approved Overinsured Loans HIGHLIGHTS What We Audited and Why We audited Broad Street Mortgage Company’s (Broad Street) San Antonio, Texas, branch office because of an unusually high loan default rate and as part of our 2004 Annual Audit Plan. Our objective was to determine whether Broad Street followed U.S. Department of Housing and Urban Development (HUD) loan origination requirements for the 30 loans selected for review. What We Found Broad Street did not follow HUD loan origination requirements for minimum investment in approving 24 of the 26 loans that involved nonprofit gifts. The lender and the sellers used a gift program to circumvent the minimum investment requirements.1 The sellers marked up the sales prices of the homes and increased the sales contracts to cover their contribution to nonprofit downpayment assistance programs. Broad Street then approved the mortgages based on the marked up prices and questionable appraised values. This increased the borrowers’ homeownership costs and risk of default, as well as HUD’s risk of insurance loss. (Finding 1) 1 Title 24, Code of Federal Regulations, 203.19. Broad Street’s quality control plan needed improvement and was not fully implemented. Broad Street stated it was behind in completing quality control reviews of delinquent loans because staff was auditing other loans in addition to those that defaulted in the first 6 months of the loan term. (Finding 2) What We Recommend We recommend that you require Broad Street to indemnify HUD for 24 loans, reimburse the insurance fund for any of the loans reviewed that have been foreclosed, and amend and fully implement its quality control plan. For each recommendation 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. Auditee’s Response We requested a response from the lender on February 28, 2005, and received its written response on April 12, 2005. The lender generally disagreed with our findings. The complete text of the auditee’s response, along with our evaluation of that response, can be found in Appendix C of this report. 2 TABLE OF CONTENTS Background and Objectives 4 Results of Audit Finding 1: Broad Street Originated Overinsured Loans, Putting Borrowers and HUD 5 at Risk Finding 2: The Quality Control Plan Needed Improvement and Was Not Fully 11 Implemented Scope and Methodology 13 Internal Controls 14 Appendixes A. Schedule of Questioned Costs and Funds To Be Put to Better Use 15 B. Schedule of Deficiencies 16 C. Auditee Comments and OIG’s Evaluation 17 D. Criteria 113 3 BACKGROUND AND OBJECTIVES The National Housing Act, Section 203(b)(1), authorizes the U.S. Department of Housing and Urban Development (Department or HUD) to provide mortgage insurance for single-family homes. The Department must approve a mortgage company that originates Federal Housing Administration-insured loans. Participating mortgage companies must follow the National Housing Act and Department instructions when originating Federal Housing Administration- insured loans. Mortgage companies that do not follow the requirements are subject to administrative sanctions. We audited a branch of Broad Street Mortgage Company (Broad Street), approved to originate Federal Housing Administration mortgage loans under the Single-Family Direct Endorsement program. Fieldstone Mortgage Company does business as Broad Street Mortgage Company in San Antonio, TX. The branch, mortgagee identification number 7892800303, was located at 6243 IH 410, Suite 205. The Department approved this branch to originate Federal Housing Administration-insured loans on December 23, 1999. Based on information contained in HUD’s Neighborhood Watch System, Broad Street originated 519 Federal Housing Administration loans between April 1, 2002, and March 31, 2004. Of these 519 loans, 62 (11.9 percent) were in default or claim status as of June 1, 2004. The Department notified Broad Street in August 2004 that the branch’s approval would be terminated due to an unusually high default rate. Broad Street elected to voluntarily close the branch. Our audit objective was to determine whether Broad Street followed the Department’s loan origination requirements for the 30 insured loans reviewed. 4 RESULTS OF AUDIT Finding 1: Broad Street Originated Overinsured Loans, Putting Borrowers and HUD at Risk Broad Street originated 24 of 26 loans involving nonprofit gifts, totaling more than $2.3 million, in violation of HUD’s minimum investment requirements. Broad Street officials disregarded or misinterpreted HUD requirements. Broad Street allowed the sellers to markup the sales prices to cover their contributions to nonprofit downpayment providers. Broad Street approved the loans based on the inflated sales prices. This increased the borrowers’ homeownership costs and default risk, as well as HUD’s risk of insurance loss. Minimum Investment Not Made HUD requires the statutory minimum investment or downpayment of 3 percent of the acquistion cost.2 The maximum loan amount is calculated based on the lessor of the sales price or appraised value. For 24 of 26 loans we reviewed that involved nonprofit gifts, Broad Street violated HUD’s minimum investment requirement. Broad Street requested nonprofit entities that operate downpayment assistance programs to provide down payment gifts to borrowers. The nonprofits required the sellers to reimburse them from the sellers proceeds for the amounts of the gifts plus service fees. Broad Street allowed the sellers to increase their prices to cover their contributions to the nonprofit down payment providers. Broad Street used the increased sales prices to calculate the mortgage amounts. This resulted in the loan amounts involving downpayment assistance being higher than loan amounts not involving downpayment assistance. Broad Steet financed the gift and fee amounts as part of the mortgage. HUD requires that a gift have no expected or implied repayment by the borrower. There were no true gifts in these loan transactions. Broad Street based the mortgage on the sales prices after the “gifts” and fees were added to the prices offered to the general public. As a consequence, the “gifts” and fees were financed and subject to repayment with interest by the borrower. In the transactions we examined, the nonprofits merely transferred funds from the seller to the borrower for a fee. Examples of “gift” transactions Case 495-6704874. To illustrate a typical transaction, the following table compares amounts used to calculate the maximum loan based on the sales prices with and without the gift included. Broad Street calculated the mortgage based on the sales price with the gift included. Broad Street’s practice of calculating the 2 Title 24, Code of Federal Regulations, 203.19. 5 mortgage based on sales prices with gifts included resulted in an overinsured loan, with increased costs and risk to the borrower. In this case, we estimated the borrower’s monthly mortgage payment increased from about $875 to $941 ($66) and the interest cost over the 240-month life of the mortgage increased from $90,328 to $97,108 ($6,780) or by 7.5 percent. Using Original Sales Using Price Broad Street’s Offered to Gift General Program Public Original contract sales price $122,519 $122,519 “Gift” (Ⓐ $8,580 + the fee $500) 9,080 --0-- Contract sales price (HUD-1) (price + gift) $131,599 $122,519 Settlement charges to the borrower HUD-1) 6,477 6,477 Gross due from borrower (HUD-1) $138,076 $128,996 Insured loan (based on acquisition cost) Ⓑ128,752 Ⓒ$119,762 Minimum investment from borrower $ 9,324 $ 9,234 Earnest money 2,200 2,200 “Gift” Ⓐ 8,580 --0-- Funds attributable to borrower $10,780 $ 2,200 Amounts paid on behalf of borrower (HUD-1) $139,532 $121,962 (Due to)/ due from borrower (HUD-1) ($1,456) $7,034 Note: The borrower needed over $9,000 to close but only had about $2,500. The mortgage is overinsured by $8,990 (Ⓑ$128,752 - Ⓒ119,762 = $8,990). In many cases, the sellers had price lists for new homes that showed the prices offered to the general public. Also, in many cases, the original sales prices were shown on the original sales contract, but the sales prices were increased on revised sales contracts which showed the increases were the result of the sellers’ contributions to the “buyer’s fund.” The HUD-1 settlement statements show the amounts of the “gifts” being credited to the buyers and the amounts of the “gifts” plus the fees being deducted from the sellers’ proceeds. 6 Case 495-6609733. This case involved an $8,500 “gift” where the borrowers were aware that the loan was going to be increased by the assistance they received. In our interview, the borrowers told us they first asked the homebuilder for help with the closing costs, and the homebuilder directed them to Broad Street. The Broad Street representative told them funds were available, that the loan would be increased by the amount of the assistance, and they would be repaying the assistance through their mortgage payments. They said they did not know the assistance was supposed to be a gift. They signed the gift letter at closing. No one went over the gift letter. They did not know it said the borrowers were under no obligation to repay the gift or that no portion of the gift came from any person or entity with an interest in the sale of the property, including the seller, real estate agent or broker, builder, loan officer or any entity associated with them. The borrowers said they knew the seller helped with the closing costs. They pointed out that paragraph 9c in the sales contract states, “The seller to pay up to $8,500 towards the Buyers Fund.” The following sections of actual documents from the loan files are representative of the cases we took exception to. The builder/seller’s “option selection sheet” shows the total sales price of $112,495 was made up of the base price of the home ($101,900) with options ($550) and the financed closing costs ($10,045). The gift letter shows a gift amount of $8,187.20. The HUD-1 settlement statement shows an “Ameridream credit to the buyer” of $8,187.20 and a reduction in the seller’s proceeds of $8,512.20 ($8,187.20 plus $325) for “credit plus service fee to Ameridream.” Also, the HUD-1 settlement statement shows an unexplained lender credit of $3,601.11 from Fieldstone Mortgage Company. After only paying the earnest money of $500 to the builder, the borrower received $925.45 back at closing. 7 Case 495-6536800. Two sales contracts were prepared. The borrowers showed us their copy of the first sales contract. The price of the home was $82,900, which was consistent with the homebuilders price list. This contract stipulated that the seller would pay for the title policy if and only if the buyer used the seller’s preferred lender. The other sales contract showed the price of the home to be $88,425 and that the seller was to pay the owner’s title insurance provided the buyer used the seller’s preferred lender and that the seller was to pay up to $7,183 toward the Buyer’s Fund. The borrowers told us they were not aware they were receiving a gift and did not know about the increase in the sales price until after the closing when they looked at the paperwork. They told us they wondered why the price went up from $82,900 to $88,425. First Contract: 3. CONTRACT SALES PRICE: A. Cash portion of Sales Price Payable by Buyer at closing $ 0 B. Sum of all financlng described below (excluding any FHA Mortgage lnsurance Premium [MIP], VA funding fee, or Private Mortgage lnsurance Premium [PMI] $82,900 C. Sales Price (hereinafter Sales Prlce){Sum A Ind B) $82,900 9. SETTLEMENT AND OTHER EXPf;NSI:S: A. The followinq expenses must be paid at, or prior to, closing: (1) Loan appraisal fees must be paid by _____buyer____. Any exceptions to the above: 8 Second Contract: Homebuilder’s Price List: The HUD-1 settlement statement shows a sales price of $88,425, gift equity from Ameridream of $6,858, and the seller’s reimbursement of gift equity to buyers– Ameridream–of $7,183. The borrowers paid an additional $73.05, and the seller neither paid nor received any funds at closing. 204. Gift equitv from Ameridream 6,858.00 1307. Reimbursement of Gift equity to buyers - Ameridream $7,183.00 Case 495-6575118. A Broad Street representative sent the e-mail message below to the builder’s sales agent and provided the new sales price of the home based on the “gift.” The original sales price in this case was $145,900 on the sales contract, 9 dated January 26, 2003. The sales price was $159,000 on the sales contract, dated April 16, 2003. The following message from the lender explains the difference. Recommendation We recommend that the General Deputy Assistant Secretary for Housing: 1A. Require Broad Street to indemnify HUD for the 24 loans (listed in Appendix B) that did not meet Federal Housing Administration minimum investment requirements and reimburse the insurance fund for any of the loans that have been foreclosed. 10 Finding 2: The Quality Control Plan Needed Improvements and Was Not Fully Implemented Broad Street’s quality control plan needed improvements and to be fully implemented. The lender did not require the detection and reporting of serious violations to HUD. The lender had not done reviews of defaulted loans with six or fewer payments. Broad Street did not include sufficient details for appraisal reviews in the plan. Broad Street officials overlooked certain HUD requirements. Without an effective quality control plan, Broad Street allowed violations of HUD requirements to increase HUD’s losses through defaults and foreclosures. Detecting and Reporting Violations Mortgage companies must identify patterns of early loan defaults. Loan defaults involving participants in the process (appraisers, loan officers, processors, underwriters, etc.) who have been associated with problems must be included in review samples. Documents contained in the loan file should be checked for sufficiency and subjected to written verification. Items that must be verified during the quality control review include but are not limited to the mortgagor’s income, deposits, gift letters, alternate credit sources, and other sources of funds. Sources of funds must be acceptable as well as verified. If serious problems are found, the mortgage company must report violations to the Director of the Quality Assurance Division in the HUD Homeownership Center having jurisdiction (determined by the State where the property is located). Broad Street did not meet HUD’s requirements for detecting and reporting serious violations. It did not select loans involving early loan defaults timely. As a result, it lacked assurance that serious violations were detected and reported. Defaulted Loans with Six or Fewer Payments Broad Street’s quality control personnel did not review 11 of 12 loans we reviewed that defaulted early, within the first six payments. A Broad Street official said the lender was behind in completing delinquent loan audits because “it was just a matter of getting everything done.” Appraisal Review The mortgage company’s appraisal review must include a conclusion of the overall quality, including a review of the appraisal data, the validity of the comparables, the value conclusion (“as repaired” to meet safety and soundness), and any changes made by the underwriter. Mortgage companies should select 11 loans for field reviews based on factors found during desk reviews, including excessive distances from comparables to the subject property, inappropriate comparables, unsupportable adjustments, excessive or insufficient repairs required to meet minimum safety and soundness requirements, and an increase in value of the property of more than 20 percent within 12 months of a previous sale. If serious deficiencies or patterns are uncovered, the mortgage company must report these to the Quality Assurance Division in the HUD Homeownership Center having jurisdiction. Broad Street’s plan did not contain sufficient detail on appraisal quality reviews. As a result, Broad Street has no assurance of appraisal quality. Recommendations We recommend that the General Deputy Assistant Secretary for Housing: 2A. Ensure Broad Street’s quality control plan conforms to HUD requirements and is fully implemented. 2B. Require Broad Street to establish controls to ensure timely reviews of loans that default with six or fewer payments. 12 SCOPE AND METHODOLOGY We divided the objective into mortgage credit analysis areas to determine whether the borrower had available assets to close the loan, was credit worthy, and had adequate and stable effective income. We also determined, with the help of an Office of Inspector General (OIG) appraiser, that our initial sample was fairly valued. We initially selected 16 loans from a list of 62 of Broad Street’s defaulted in HUD’s Neighborhood Watch System3 from April 1, 2002, through March 31, 2004. We selected another 26 defaulted loans because they involved nonprofit “gifts.” The records center sent us two more loan files we did not request, and we added them to our sample to consider for review, for a total of 44 loans. Due to time constraints, we reviewed 30 of the 44 loans, including all 26 of the loans that involved nonprofit gifts. We reviewed relevant Federal regulations, HUD handbooks, Broad Street’s quality control plan, and Federal Housing Administration and the mortgage company’s loan origination files. Our review of the loan origination files included: • Collecting certain data to determine whether a pattern of defaults existed; • Comparing the quality control plan to HUD requirements; • Examining loan documents for inconsistent and derogatory information; • Comparing the final application with the preliminary application, verifications of deposit and employment, credit reports, and any other relevant documentation available for inconsistency; • Examining the appraisal and comparing the subject property and details with the comparable properties and Bexar County Appraisal District information and values for inconsistency; • Verifying the deposit and employment information; • Interviewing the borrowers; and • Reviewing the title company closings. We interviewed HUD Quality Assurance Division staff and held an entrance conference with Broad Street’s executives on May 26, 2004. We performed our fieldwork at the Broad Street office and HUD’s office in San Antonio, Texas, from May 26, 2004, to January 11, 2005. We performed our review in accordance with generally accepted government auditing standards. 3 We did not perform procedures to assess the data contained in HUD’s Neighborhood Watch System. The audit did not include any other computer-generated data. 13 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: • Requirements for loan originations and • The lender’s quality control plan. 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 Significant Weaknesses Based on our review, we believe the following are significant weaknesses: • Broad Street originated overinsured loans, putting borrowers and HUD at risk (Finding 1) and • The lender’s quality control plan needed improvements and was not fully implemented (Finding 2). 14 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS AND FUNDS TO BE PUT TO BETTER USE Recommendation Funds To Be Put Number to Better Use 1 1A $2,324,196 1/ “Funds to be put to better use” are quantifiable savings that are anticipated to occur if an 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. 15 Appendix B Broad Street Mortgage Company Schedule of Loans that Did Not Meet Minimum Investment Requirements Sales Price Mortgagee Mortgage Sales Price to Under Gift Case Number Number Amount the Public Program Difference 495-6425888 7329013162 $69,101 $64,900 $74,000 $8,100 495-6609733 7329014162 105,915 $101,900 $112,495 $10,045 495-6704874 7329014746 128,752 $122,519 $131,599 $9,080 495-6623192 7329014128 75,810 $71,000 $77,000 $6,000 495-6563001 7329013958 60,845 $57,000 $61,800 $4,800 495-6153000 7329011974 78,561 $78,800 $86,000 $7,200 495-6536800 7329012954 85,260 $82,900 $88,425 $5,525 495-6530294 7329013528 126,012 $121,900 $128,000 $6,100 495-6333860 7329012704 107,184 $106,185 $113,585 $7,400 495-6735938 7329014647 125,894 $120,563 $130,563 $10,000 495-6575118 7329013536 153,315 $145,900 $159,000 $13,100 495-6387750 7329012948 134,436 $129,581 $136,581 $7,000 493-7270669 7329012990 99,799 $104,995 $109,261 $4,266 495-6136162 7329011827 82,925 $82,000 $86,000 $4,000 495-6144826 7329011947 96,425 $93,400 $99,400 $6,000 495-6147629 7329013967 77,698 $72,600 $85,100 $12,500 495-6158507 7329011704 84,651 $80,005 $86,000 $5,995 495-6192256 7329012144 125,098 $120,249 $129,749 $9.500 495-6244162 7329012335 84,042 $82,000 $92,000 $10,000 495-6289869 7329012326 81,925 $78,500 $86,500 $8,000 495-6321261 7329012696 93,024 $93,000 $98,000 $5,000 495-6604430 7329013162 68,327 $65,000 $69,400 $4,400 495-6363427 7329012875 90,639 $86,500 $94,000 $7,500 495-6173527 7329013340 88,558 $88,950 $96,950 $8,000 Total for Indemnification $2,324,196 16 APPENDIX C AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments 17 Comment 1 Comment 1 18 Comment 1 Comment 1 Comment 1 19 Comment 1 Comment 1 Comment 1 20 Comment 1 21 Comment 1 Comment 2 22 Comment 2 Comment 2 23 Comment 2 Comment 2 24 Comment 2 25 Comment 2 26 Comment 2 27 Comment 2 28 29 Comment 1 Comment 2 30 Comment 1 31 Comment 2 32 Comment 1 33 34 Comment 2 35 Comment 2 36 Comment 2 37 Comment 2 38 Comment 2 39 Comment 1 40 41 Comment 2 42 Comment 1 43 44 45 46 47 Comment 1 48 Comment 2 49 Comment 1 50 51 52 Comment 2 53 Comment 1 54 Comment 2 55 Comment 1 56 Comment 2 57 Comment 1 58 59 Comment 2 60 Comment 1 61 62 Comment 2 63 Comment 1 64 Comment 2 65 Comment 1 66 67 Comment 2 68 Comment 2 69 70 Comment 2 71 Comment 2 72 73 74 Comment 2 Comment 2 75 Comment 1 76 77 78 Comment 2 Comment 2 79 Comment 2 80 Comment 2 81 Comment 1 82 Comment 2 83 Comment 1 84 85 Comment 2 Comment 2 86 Comment 1 87 Comment 2 88 Comment 2 89 90 91 Comment 2 92 Comment 2 93 Comment 4 94 Comment 2 95 Comment 2 96 Comment 2 97 Comment 2 98 Comment 2 99 100 101 Comment 2 102 Comment 2 103 104 Comment 2 105 Comment 2 106 107 Comment 3 Comment 3 108 Comment 3 109 Comment 3 110 111 OIG Evaluation of Auditee Comments Comment 1 Minimum Investment Not Made. The essence of our finding is that the nonprofits are not providing a true gift to the buyer. The buyer has to repay the “gift,” including interest; the “gift” is simply being added to the price of the house. Other buyers that do not participate in the nonprofit program are being charged a lower price for the same house. Contrary to Broad Street’s assertions, HUD has never approved the practice of raising the price of a house to cover downpayment assistance. The April 7, 1998 Office of General Counsel opinion dealt with the issue of sellers making contributions to nonprofit providers, and concluded that Nehemiah’s practice complies with HUD guidelines because the seller’s payment could not be identified as the direct source of the buyer’s downpayment. The same opinion quotes the HUD requirement that “No repayment of the gift may be expected or implied.” Our finding provides documentary evidence to show that buyers are in fact having to repay the “gift” through an increase in the price of the house. As such, there is no bona fide gift involved in these transactions, and the statutory minimum investment requirement is being circumvented. Broad Street states that “In some instances” the sellers increased the sales price to cover the fee and/or contribution that they paid to the nonprofit organization. However, our review found that this practice was the rule rather than the exception, occurring in 24 of 26 cases involving gifts from nonprofit entities. Broad Street’s comment that the appraisal supports the value of the property skirts the issue of the gift requirement. The sales price is not being raised because of any appraisal, but rather to cover the cost of the seller’s contribution to the nonprofit. Further, HUD requires that the maximum loan amount be calculated based on the lesser of the sales price or appraised value. Comment 2 We concluded that the appraisal and credit borrower issues were secondary to the primary issue regarding gifts and minimum investment, and therefore revised the report to exclude these issues. For privacy act purposes, we redacted borrower names. Comment 3 We revised our draft recommendations regarding finding 2. We acknowledge Broad Street’s statement that it has now reviewed the early payment defaults in our sample, it is current with such reviews through March 31, 2005, and that it has always been committed to quality control and strict compliance with HUD-FHA compliance. However, we believe the plan needs to contain provisions for reporting to HUD serious problems, if any, discovered during the quality control reviews, and more detail as to procedures for the quality control review of appraisals. In addition, better controls need to be in place to assure timely reviews of loans that default within 6 payments. 112 Appendix D CRITERIA Minimum Investment, Title 24, Code of Federal Regulations, 203.19 (a) At the time the mortgage is insured, the mortgagor shall have paid in cash or its equivalent the following minimum amount: (1) In all cases (except those involving a veteran meeting the requirements of Sec. 203.18(b) or a disaster victim meeting the requirements of Sec. 203.18(e)), the minimum investment shall be at least 3 percent of the Commissioner’s estimate of the cost of acquisition (excluding the amount of any one-time mortgage insurance premium payable in accordance with Sec. 203.280) or such other larger amount as the Commissioner may determine. Due Diligence, Title 24, Code of Federal Regulations, 203.5(c) (c) Underwriter due diligence. A Direct Endorsement mortgagee shall exercise the same level of care that it would exercise in obtaining and verifying information for a loan in which the mortgagee would be entirely dependent on the property as security to protect its investment. Mortgagee procedures that evidence such due diligence shall be incorporated as part of the quality control plan required under Sec. 202.5(h) of this chapter. The Secretary shall publish guidelines for Direct Endorsement underwriting procedures in a handbook, which shall be provided to all mortgagees approved for the Direct Endorsement procedure. Compliance with these guidelines is deemed to be the minimum standard of due diligence in underwriting mortgages. Mortgage Calculation, Mortgagee Letter 98-29 …the property’s sales price (or appraised value, if less) exclusive of any borrower-paid closing costs will be multiplied by a percentage that is determined by both the sales price (or value, if less) and the average closing cost for that State. This determines the maximum mortgage amount that FHA will insure if the mortgagor makes a cash investment of at least three percent into the property, which may include closing costs. Maximum Mortgage, HUD Handbook 4155.1, “Mortgage Credit Analysis,” Chapter 1, paragraph 1-7A and B A. The seller (or other interested third parties such as real estate agents, builders, developers, etc., or a combination of parties) may contribute up to six percent of the property’s sales price toward the buyer’s actual closing costs, prepaid expenses, discount points, and other financing concessions. Contributions exceeding six percent of the sales price or exceeding the actual cost of prepaid expenses, discounts points, and other financing concessions will be treated as inducements to purchase, thereby reducing the amount of the mortgage. Closing costs normally paid by the borrower are considered contributions if paid by the seller. Inducements to purchase are described in paragraph B, below. 113 The six percent limitation also includes seller payment for permanent and temporary interest rate buydowns and other payment supplements, payments of mortgage interest for fixed rate mortgages and GPMs [graduated payment mortgages] only (but not principal), mortgage payment protection insurance, and payment of UFMIP [Up Front Mortgage Insurance Premium]. Fees typically paid by the seller under local or state law, or local custom, such as real estate commissions, charges for pest inspections, fees paid for trustees to release a deed of trust, etc., are not considered contributions. The dollar limit for seller contributions is calculated by using Attachment A on the HUD-92900-PUR /HUD-92900WS forms. Each dollar exceeding FHA’s [Federal Housing Administration] six percent limit must be subtracted from the property’s sales price before applying the appropriate LTV [loan-to-value] ratio. B. Certain expenses (beyond those described above) paid on behalf of the borrower, as well as other inducements to purchase, result in a dollar-for-dollar reduction to the sales price before applying the appropriate LTV ratio. These inducements include decorating allowances, repair allowances, moving costs, and other costs as determined by the appropriate HOC [Home Ownership Center]. We also require dollar-for-dollar reductions to the sales price for excess rent credit (see 2-10 N), as well as for gift funds not meeting the requirements stated in Chapter 2. Personal property items such as cars, boats, riding lawn mowers, furniture, televisions, etc., given by the seller to consummate the sale result in a reduction to the mortgage. The value of the item(s) must be deducted from the sales price and the appraised value of the property (if not already done so by the appraiser) before applying the LTV ratio. However, certain items, depending upon local custom or law, may be considered as part of the real estate transaction with no adjustment to the sales price or appraised value necessary. These items include ranges, refrigerators, dishwashers, washers, dryers, carpeting, window treatments, and other items as determined by the jurisdictional HOC. That office determines if these items affect value and are considered customary. Replacement of existing equipment or other realty items by the seller before closing, such as carpeting or air conditioners, does not require a value adjustment provided no cash allowance is given to the borrower. In addition, if the seller or builder of the property agrees to pay any portion of the borrower’s sales commission on the sale of the borrower’s present residence, the amount paid by the seller or builder is an inducement to purchase and must be subtracted dollar for dollar from the sales price before the LTV ratio is applied. Similarly, a borrower not paying real estate commission on the sale of a present home constitutes a sales concession, if the real estate broker or agent is involved in both transactions and the seller of the property purchased by the borrower pays a real estate commission exceeding that typical for the area. In these situations, the amount paid by the seller above the normal real estate commission is considered an inducement to purchase and must be subtracted from the sales price of the property being purchased before applying the LTV ratio. Mortgage Amount limitations when the Downpayment Assistance Provider is Also the Seller of the Property, Mortgagee Letter 2002-22, Section D. In accordance with Section 528 of the National Housing Act, the combined loan-to-value (CLTV) or indebtedness may be affected when the downpayment assistance provider is also the seller. All sellers are permitted to pay the homebuyer’s closing costs, prepaid expenses, and discount points up to an amount equaling six percent of the sales price; any amount above this 114 threshold results in a dollar-for dollar reduction to the loan amount. Similarly, if a governmental unit or nonprofit is providing a gift of equity from the sale of the property, there must be a dollar- for-dollar reduction to the sales price. Gifts, HUD Handbook 4155.1, “Mortgage Credit Analysis,” Chapter 2, section 3, paragraph 2- 10C An outright gift of the cash investment is acceptable if the donor is the borrower’s relative, the borrower’s employer or labor union, a charitable organization, a governmental agency or public entity that has a program to provide homeownership assistance to low- and moderate-income families or first-time homebuyers, or a close friend with a clearly defined and documented interest in the borrower. The gift donor may not be a person or entity with an interest in the sale of the property, such as the seller, real estate agent or broker, builder, or any entity associated with them. Gifts from these sources are considered inducements to purchase and must be subtracted from the sales price. No repayment of the gift may be expected or implied. (As a rule, we are not concerned with how the donor obtains the gift funds provided they are not derived in any manner from a party to the sales transaction. Donors may borrow gift funds from any other acceptable source provided the mortgage borrowers are not obligors to any note to secure money borrowed to give the gift.) This rule also applies to properties of which the seller is a government agency selling foreclosed properties, such as the Veterans Administration or Rural Housing Services. Only family members may provide equity credit as a gift on a property being sold to other family members. These restrictions on gifts and equity credit may be waived by the jurisdictional HOC provided that the seller is contributing to or operating an acceptable affordable housing program. The lender must document the gift funds by obtaining a gift letter, signed by the donor and borrower, that specifies the dollar amount of the gift, states that no repayment is required, shows the donor’s name, address, telephone number, and states the nature of the donor’s relationship to the borrower. In addition, the lender must document the transfer of funds from the donor to the borrower, as follows: If the gift funds are in the homebuyer’s bank account, the lender must document the transfer of the funds from the donor to the homebuyer by obtaining a copy of the canceled check or other withdrawal document showing that the withdrawal is from the donor’s account. The homebuyer’s deposit slip and bank statement that shows the deposit is also required. If the gift funds are to be provided at closing: a. If the transfer of the gift funds is by certified check made on the donor’s account, the lender must obtain a bank statement showing the withdrawal from the donor’s account, as well as a copy of the certified check. b. If the donor purchased a cashier’s check, money order, official check, or any other type of bank check as a means of transferring the gift funds, the donor must provide a withdrawal document or canceled check for the amount of the gift, showing that the funds came from the donor’s personal account. If the donor borrowed the gift funds and cannot provide documentation from the bank or other savings account, the donor must provide written evidence that those funds were borrowed from an acceptable source, i.e., not from a party to 115 the transaction, including the lender. “Cash on hand” is not an acceptable source of the donor’s gift funds. Regardless of when the gift funds are made available to the homebuyer, the lender must be able to determine that the gift funds ultimately were not provided from an unacceptable source and were indeed the donor’s own funds. When the transfer occurs at closing, the lender remains responsible for obtaining verification that the closing agent received funds from the donor for the amount of the purported gift and that those funds came from an acceptable source. NOTE: FHA (Federal Housing Administration) does not “approve” down payment assistance programs in the form of gifts administered by charitable organizations (i.e., nonprofits). Mortgage lenders are responsible for assuring that the gift to the homebuyer from the charitable organization meets the appropriate FHA requirements and the transfer of funds is properly documented. In addition, FHA does not allow nonprofit entities to provide gifts to homebuyers for the purpose of paying off installment loans, credit cards, collections, judgments, and similar debts. Gifts, MORTGAGEE LETTER 00-28 As part of HUD’s recently announced initiatives to address predatory lending practices targeted at FHA borrowers, it has revised its procedures for verifying the transfer of gift funds from private individual donors to homebuyers, as well as the required contents of the gift letter itself. These reforms are intended to ensure to the greatest extent possible that the gift funds were in fact the donor’s own and are not derived from an unacceptable source. The donor must be able to furnish conclusive evidence that the funds given to the homebuyer came from the donor’s own funds and thus, were not provided directly or indirectly by the seller, real estate agent, builder, or any other entity with an interest in the sales transaction. The gift letter, as always, must specify the dollar amount given, be signed by the donor and the borrower, state that no repayment is required, and show the donor’s name, address, telephone number, and relationship to the borrower. It now must also contain language asserting that the funds given to the homebuyer were not made available to the donor from any person or entity with an interest in the sale of the property including the seller, real estate agent or broker, builder, loan officer, or any entity associated with them. In addition to the existing instructions regarding gift funds outlined in the mortgage credit analysis handbook (HUD 4155.1, REV-4, CHG 1), the verification process described below must be met. If the gift funds are in the homebuyer’s account: • The lender must document the transfer of the funds from the donor to the homebuyer by obtaining a copy of the canceled check or other withdrawal document showing the withdrawal is from the donor’s personal account, along with the homebuyer’s deposit slip or bank statement that shows the deposit. 116 If the gift funds are to be provided at closing: • If the transfer of the gift funds is by certified check made on the donor’s account, the lender must obtain a bank statement showing the withdrawal from the donor’s personal account as well as a copy of the certified check. • If the donor purchased a cashier’s check, money order, official check, or any other type of bank check as a means of transferring the gift funds, then the donor must provide a withdrawal document or canceled check for the amount of the gift showing the funds came from the donor’s personal account. If the donor borrowed the gift funds and thus, cannot provide the documentation from his or her bank or other savings account, the donor must provide evidence that those funds were borrowed from an acceptable source, i.e., not from a party to the transaction including the mortgage lender. “Cash on hand” is not an acceptable source of the donor’s gift funds. Regardless of when the gift funds are made available to the homebuyer, the lender must be able to determine that the gift funds were not ultimately provided from an unacceptable source and were indeed the donor’s own funds. When the transfer occurs at closing, the lender remains responsible for obtaining verification the closing agent received funds from the donor for the amount of the purported gift. When FHA reviews the performance of a lender on loans where gift funds were provided for the downpayment, it must be able to trace the gift funds from the donor to the homebuyer. In cases in which irregularities occurred with respect to the gift as a result of a lender not complying with the Department’s requirements, there may be grounds for administrative action and the lender may be referred to the Mortgagee Review Board for the imposition of administrative sanctions or civil money penalties. Quality Control Plan – HUD Handbook 4060-1 GHG-1 Paragraph 6-2 – Mortgagees must design programs that meet these basic goals: • Assure compliance with HUD’s and the mortgagee’s own origination or servicing requirements throughout its operations. • Protect the mortgagee and HUD from unacceptable risk. • Guard against errors, omissions, and fraud. • Assure swift and appropriate corrective action. Failure to comply with specific Quality Control requirements may result in sanctions and the imposition of Civil Money Penalties by the Mortgagee review Board (MRB). Paragraph 6-6. Basic Requirements for Quality Control of Single Family Production D. Early Payment Defaults. In addition to the loans selected for routine quality control reviews, mortgagees must review all loans going into default within the first six payments. As defined here, early payment defaults are loans that become 60 days past due. 117 E. 2. Credit Documentation Reverification. Documents contained in the loan file should be checked for sufficiency and subjected to written reverification. Examples of items that must be reverified include but are not limited to, the mortgagor’s employment or other income, deposits, gift letters, alternate credit sources, and other sources of funds. Sources of funds must be acceptable as well as verified. E.3. Appraisals. A desk review of the property appraisal must be performed on all loans chosen for a Quality Control Review except streamline refinances and HUD Real Estate Owned (REO) sales. The desk review must include a review of the appraisal data, the validity of the comparables, the value conclusion, any changes made by the underwriter and the overall quality of the appraisal. Mortgagees are expected to perform field reviews on 10 percent of the loans selected during the sampling process…. 118
Broad Street Mortgage Company, A Subsidiary of Fieldstone Mortgage Company San Antonio, TX
Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-05-26.
Below is a raw (and likely hideous) rendition of the original report. (PDF)