oversight

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)

                                                               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