oversight

Realty Mortgage Corporation, Nonsupervised Lender, Flowood, Mississippi

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-09-12.

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

                                                         Issue Date
                                                                  September 12, 2005
                                                         Audit Report Number
                                                                      2005-FW-1014




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


FROM:      Frank E. Baca
           Regional Inspector General for Audit, 6AGA

SUBJECT: Realty Mortgage Corporation Did Not Follow HUD Requirements When
         Processing a Federal Housing Administration Loan


                                  HIGHLIGHTS

 What We Audited and Why

            We reviewed a Federal Housing Administration loan sponsored by Realty
            Mortgage Corporation (Realty) of Flowood, Mississippi. During an audit of a
            Federal Housing Administration-approved loan correspondent, we identified a
            loan sponsored by Realty that was not properly originated according to U.S.
            Department of Housing and Urban Development (HUD) regulations. Because the
            sponsor of the loan is ultimately responsible for loan processing deficiencies, we
            addressed these deficiencies to Realty to determine whether it complied with
            HUD requirements.

 What We Found


            Realty did not comply with HUD regulations, procedures, and instructions in the
            processing of a Federal Housing Administration-insured single-family mortgage.
            Realty did not ensure the appraisal included an analysis of the subject sales
            contract or list price. It also allowed the loan correspondent to charge $1,277 in
            ineligible fees: a $400 processing fee and $877 in unearned discount points. As a
           result, the risk to HUD’s insurance fund was increased, and the borrower incurred
           excessive costs for the loan.

What We Recommend


           We recommend that the Assistant Secretary for Housing – Federal Housing
           Commissioner take appropriate administrative action against Realty. This action,
           at a minimum, should include requiring reimbursement of the $1,277 in ineligible
           fees to the appropriate parties.

           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


           On September 2, 2005, Realty provided a written response to our report. Realty
           generally agreed with our findings. Its response included corrective action taken
           to ensure appraisals include an analysis of the sales contract. In separate
           correspondence, Realty also agreed to principal reductions for the $400
           processing fee and the $877 in loan discount points. The complete text of
           Realty’s response can be found in Appendix B of this report.




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                           TABLE OF CONTENTS

Background and Objectives                                                   4

Results of Audit
Finding: Realty Mortgage Corporation Did Not Follow HUD Requirements When   5
Processing a Federal Housing Administration Loan

Scope and Methodology                                                       7

Appendixes
   A. Schedule of Questioned Costs                                          8
   B. Auditee Comments and OIG’s Evaluation                                 9
   C. Case Study of Improperly Originated Loan                              13




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                     BACKGROUND AND OBJECTIVES

Realty Mortgage Corporation (Realty) is a nonsupervised lender that began originating Federal
Housing Administration loans in 1989.

During the audit of a loan correspondent, we identified one Federal Housing Administration loan
sponsored by Realty that was not originated according to U.S. Department of Housing and Urban
Development (HUD) requirements. To resolve the deficiencies, we performed a review of
Realty’s underwriting of the loan.

Our objective was to determine whether Realty complied with HUD regulations, procedures, and
instructions when processing the Federal Housing Administration mortgage that it sponsored for
a loan correspondent.




                                               4
                                 RESULTS OF AUDIT

Finding: Realty Mortgage Corporation Did Not Follow HUD
Requirements When Processing a Federal Housing Administration Loan
Realty did not comply with HUD regulations, procedures, and instructions in the processing of a
Federal Housing Administration-insured single-family mortgage. Realty did not ensure the
appraisal included an analysis of the subject sales contract or list price. It also allowed the loan
correspondent to charge $1,277 in ineligible fees: a $400 processing fee and $877 in unearned
discount points. As a result, the risk to HUD’s insurance fund was increased, and the borrower
incurred excessive costs for the loan.



 Realty Did Not Follow HUD
 Requirements


               Realty did not ensure the appraisal met HUD standards. In determining the
               appraised value, the appraiser did not analyze the subject sales contract or list
               price. The sales contract showed the property was under contract for $86,000,
               with the seller agreeing to pay $5,000 in borrower closing costs and other
               expenses. HUD requires the appraiser to analyze all agreements of sale, options,
               or listings in determining the appraised value. According to Realty, the appraiser
               explained that he had not performed the analysis because it was not a requirement
               until HUD issued Mortgagee Letter 2005-02, on January 4, 2005. However, the
               appraiser’s assertion is incorrect. HUD Handbook 4150.2, effective July 1, 1999,
               requires strict compliance with Uniform Standards of Professional Appraisal
               Practice, which require the appraiser to perform the analysis. Since the appraiser
               did not consider the list price or sales contract terms, Realty cannot be certain of
               the accuracy of the appraised value.

               Realty charged a $400 processing fee to the borrower. HUD does not allow
               lenders to charge borrowers processing fees. Realty concurred that the fee should
               not have been charged to the borrower.

               Realty allowed the loan correspondent to charge $877 in loan discount points
               without reducing the borrower’s interest rate. Instead, the loan correspondent
               charged the borrower an above-market interest rate. Realty compensated the loan
               correspondent for the higher interest rate through the payment of a yield spread
               premium. HUD believes yield spread premiums can be a legitimate tool to reduce
               borrowers’ closing costs through a higher interest rate. However, the loan
               correspondent could not provide documentation to show that the borrower
               received anything of value for the discount points charged. The Real Estate



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           Settlement Procedures Act prohibits giving or accepting any part of a charge for
           services not performed. Realty does not believe that the unearned fees were
           improper since the seller, not the borrower, paid them. However, the Real Estate
           Settlement Procedures Act does not limit the prohibition of unearned fees to fees
           paid by the borrower. Since the loan correspondent charged loan discount points
           without reducing the interest rate, the discount points were unearned fees in
           violation of the Real Estate Settlement Procedures Act.

           The underwriting deficiencies on this loan unnecessarily increased the risk to the
           insurance fund. Further, the ineligible fees unfairly increased the cost of the loan
           to the borrower. Realty should take steps to ensure its controls over appraisals are
           adequate and repay the appropriate parties for the $1,277 in ineligible fees.


Recommendations


           We recommend the Assistant Secretary for Housing – Federal Housing
           Commissioner and Chairman, Mortgage Review Board:

           1A. Require Realty to reimburse the appropriate parties for the $400 processing
               fee improperly charged.

           1B. Require Realty to reimburse the appropriate parties for the $877 in unearned
               fees.

           1C. Ensure Realty’s controls over appraisals are adequate to provide reasonable
               assurance that its appraisals include an analysis of the subject sales contract.




                                            6
                        SCOPE AND METHODOLOGY

We reviewed Realty’s processing of one Federal Housing Administration loan that it sponsored
for a Federal Housing Administration-approved loan correspondent. During our audit of that
loan correspondent, we reviewed loans closed from July 1, 2002, through June 30, 2004, that
defaulted within the first three years of closing. We identified a loan, sponsored by Realty,
which appeared to be improperly underwritten. Because the sponsor of the loan is ultimately
responsible for loan processing deficiencies, we addressed the deficiencies to Realty.

To accomplish our objective, we prepared a case narrative of the loan processing deficiencies
identified and provided the information to Realty. We allowed Realty an opportunity to provide
additional information that could resolve the deficiencies identified. Realty provided a written
response. We evaluated the response when reaching our conclusions.

In conducting our audit, we used computer-processed data contained in HUD’s Neighborhood
Watch system. However, we did not rely on the data to accomplish our audit objective.
Accordingly, we did not assess the reliability of the data in the system.

We did not assess Realty’s underwriting controls because they were not significant to our
objective of reviewing the loan.

We performed the work from May through August 2005. The audit was conducted in
accordance with generally accepted government auditing standards.




                                               7
                                    APPENDIXES

Appendix A

                SCHEDULE OF QUESTIONED COSTS




                             Recommendation
                                 number     Ineligible 1/

                                     1A                    $400
                                     1B                    $877




1/   Ineligible costs are costs charged to a HUD-financed or HUD-insured program or
     activity that the auditor believes are not allowable by law, contract, or federal, state, or
     local policies or regulations.




                                               8
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




                          9
10
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                         OIG Evaluation of Auditee Comments

Comment 1   Realty agreed that the appraisal should have included an analysis of the sales
            contract. In separate correspondence, Realty also agreed to principal reductions
            for the $400 processing fee and the $877 in loan discount points.




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Appendix C

            CASE STUDY OF IMPROPERLY ORIGINATED LOAN
Case number: 491-8298201

Mortgage amount: $84,733

Gift amount: $5,126

Date of loan closing: February 2, 2004

Status as of March 31, 2005: Foreclosure started (October 1, 2004)

Payments before first default reported: 1

Summary:

Appraisal Did Not Include an Analysis of the Subject Sales Contract or List Price

The appraiser did not analyze the subject sales contract or property listing. The appraiser notes
that the property was under contract for $86,000. The sales contract, dated before the date of the
appraisal, showed the property was under contract for $84,000. It also showed the seller agreed
to pay $5,000 in borrower closing costs and other expenses. HUD Handbook 4150.2, paragraph
4.0, requires strict compliance with Uniform Standards of Professional Appraisal Practice.
Standards rule 1-5(a) requires the appraiser to analyze all agreements of sale, options, or listings
of the subject property in determining a property’s appraised value. Standards rule 2-2(a)(ix)
states that if the information is unobtainable, the appraiser must provide a statement on efforts
made to obtain the information.

Ineligible Closing Costs Charged to Borrower

Realty allowed the loan correspondent to charge a $400 processing fee to the borrower. HUD
Homeownership Center Reference Guide, page 2-15, does not allow processing fees to be
charged to the borrower.

Realty allowed the loan correspondent to charge $877 in loan discount points without reducing
the borrower’s interest rate. Instead, it charged the borrower an above-market interest rate,
resulting in a yield spread premium of $2,755. The loan correspondent did not provide
documentation to show the borrower received anything of value for the discount points charged.
HUD allows lenders who originate Federal Housing Administration-insured loans to charge
borrowers a 1 percent loan origination fee and eligible closing and prepaid costs; however,
additional fees should be for specific services performed beyond the normal loan processing and
underwriting. Section 8 of the Real Estate Settlement Procedures Act prohibits giving or
accepting any part of a charge for services not performed. Since the loan correspondent charged



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loan discount points without reducing the interest rate, the discount points were unearned fees in
violation of the Real Estate Settlement Procedures Act.




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