Issue Date
October 4, 2004
Audit Case Number
2005-KC-1001
TO: John C. Weicher, Assistant Secretary for Housing - Federal Housing
Commissioner, and Chairman, Mortgagee Review Board, H
Margarita Maisonet, Director, Departmental Enforcement Center, CV
/signed/
FROM: Ronald J. Hosking, Regional Inspector General for Audit, 7AGA
SUBJECT: Karim Enterprises, DBA Prime Mortgage, Did Not Follow Federal Housing
Administration Requirements
HIGHLIGHTS
What We Audited and Why
We received a complaint alleging that Prime Mortgage, a non-supervised loan
correspondent located in Saint Charles, MO, provided funds to a Federal Housing
Administration borrower to assist with closing costs.
Our audit objective was to determine whether Prime Mortgage complied with the
U.S. Department of Housing and Urban Development’s (HUD) source of funds,
gift documentation, and quality control plan requirements.
What We Found
The owner of Prime Mortgage inappropriately provided funds to two borrowers
just prior to closing their loans. For a third loan, Prime Mortgage did not obtain
adequate documentation of the transfer of gift funds. As a result, HUD has
insured three loans that would not have met the minimum requirements to qualify
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for a Federal Housing Administration loan, placing the HUD insurance fund at
risk for loans totaling $376,102.
Prime Mortgage satisfied one of HUD’s quality control requirements by
developing a written quality control plan, but failed to perform the required
quality control reviews. As a result, HUD lacks assurance that Prime Mortgage is
identifying and correcting potential deficiencies in its loan origination process
before submitting loans for Federal Housing Administration insurance.
What We Recommend
We recommend that the Assistant Secretary for Housing - Federal Housing
Commissioner, and Chairman, Mortgagee Review Board take appropriate
administrative action against Prime Mortgage for its improper actions, and against
the sponsors of the three loans with origination deficiencies.
We recommend that the Acting Director, Departmental Enforcement Center, take
appropriate action against Karim Enterprises, dba Prime Mortgage; such as
debarring the business and principals for providing funds to Federal Housing
Administration borrowers while making it appear that the funds came from
allowable sources, and for providing loans to borrowers to use as funds to close.
If HUD allows Prime Mortgage to maintain its Federal Housing Administration
approval status, we recommend that the Assistant Secretary for Housing – Federal
Housing Commissioner, and Chairman, Mortgagee Review Board require Prime
to implement controls that ensure that it follows HUD’s quality control review
requirements, and verify that Prime has implemented appropriate controls.
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
Prime Mortgage disagreed with our conclusions that it loaned closing funds to
two borrowers, and that it did not adequately document a gift transfer. However,
Prime Mortgage agreed with our conclusion that it did not perform required
quality control reviews. We provided a draft report to Prime Mortgage and
requested a response by September 24, 2004. Prime Mortgage provided its
written comments on September 23, 2004.
The complete text of the auditee’s response, along with our evaluation of that
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 1: Prime Mortgage Did Not Comply with HUD’s Requirements 5
Regarding Funds to Close
Finding 2: Prime Mortgage Failed To Perform Required Quality Control 9
Reviews
Scope and Methodology 11
Internal Controls 12
Appendixes
A. Schedule of Questioned Costs and Funds To Be Put to Better Use 13
B. Auditee Comments and OIG’s Evaluation 14
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BACKGROUND AND OBJECTIVES
Karim Enterprises is the sole owner of Prime Mortgage, a non-supervised loan correspondent
located in Saint Charles, MO. Prime Mortgage began doing business in 1995, and began
performing Federal Housing Administration loan originations in 1998. A loan correspondent is a
mortgagee that has as its principal activity the origination of Federal Housing Administration-
insured loans for sale or transfer to its sponsor(s) for underwriting.
Prime Mortgage originated 69 Federal Housing Administration-insured mortgages from January 1,
2002, through December 31, 2003.
We received an anonymous complaint, stating that the owner of Prime Mortgage had not followed
U.S. Department of Housing and Urban Development (HUD) regulations regarding the use of gift
funds to assist a borrower in obtaining a Federal Housing Administration-insured loan. HUD
regulations state that 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.
During our review, we found evidence to validate the complaint.
Our audit objective was to determine whether Prime Mortgage complied with HUD regulations
for Federal Housing Administration loan origination; specifically, HUD’s requirements for
borrowers’ source of funds and gift documentation related to funds to close and HUD’s
requirements to develop and implement a quality control plan.
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RESULTS OF AUDIT
Finding 1: Prime Mortgage Did Not Comply with HUD’s Requirements
Regarding Funds to Close
The owner of Prime Mortgage violated HUD’s funds to close requirements by providing funds to
two borrowers before their loan closings. As a party to these transactions, Prime Mortgage is not
allowed to provide funds to Federal Housing Administration borrowers. Prime Mortgage
management chose to ignore HUD regulations regarding funds needed to close loans. As a
result, HUD has insured two loans that would not have met the minimum requirements to qualify
for a Federal Housing Administration loan, placing the HUD insurance fund at risk for loans
totaling $252,049. In addition, Prime Mortgage did not obtain adequate documentation of the
transfer of gift funds for a third loan with an original mortgage amount of $124,053. As a result,
HUD cannot be certain that the borrower used funds from an allowable source to close the loan.
Prime Mortgage Owner Loaned
Funds to Borrowers
The owner of Prime Mortgage loaned funds to two borrowers before their loan
closings. According to 24 Code of Federal Regulations 202.5, a mortgagee may
not pay anything of value, directly or indirectly, in connection with any insured
mortgage transaction. HUD Handbook 4155.1, chapter 2, paragraph 2-10, “Funds
to Close,” says that gift funds may not be derived in any manner from a party to
the sales transaction. Mortgagee Letter 00-28 says that in cases in which gift
irregularities occur as a result of a lender not complying with HUD’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.
Prime Mortgage originated 69 Federal Housing Administration loans from
January 1, 2002, through December 31, 2003. Of those 69 loans, we reviewed 30
loans that required gift funds to close, or that Prime Mortgage had written checks
to, or on behalf of, the borrower. We concluded that Prime Mortgage violated
HUD regulations when originating 3 of the 30 loans reviewed.
Specifically, Prime Mortgage loaned gift funds to one borrower by supplying the
funds to an allowable donor, who deposited the funds into their own bank
account, and later forwarded the money to the borrower. The borrower and gift
donor told us that Prime Mortgage instructed the borrower to obtain a blank check
from the donor, after which Prime Mortgage gave the borrower a $3,000 check to
be deposited in the donor’s bank account. The borrower then negotiated the
check provided by the donor for the $3,000 gift amount, creating the appearance
of properly transferred gift funds. The donor provided evidence of the transaction
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by supplying a copy of the deposited check written by the owner of Prime
Mortgage.
Because Prime Mortgage instructed the borrower to obtain a blank check from the
donor, and wrote a check to the donor to then provide the funds to the borrower, it
is clear that Prime Mortgage management was aware that HUD rules prohibit a
mortgagee from providing funds to a Federal Housing Administration borrower.
Therefore, we believe that Prime Mortgage management chose to ignore these
regulations. The owner of Prime Mortgage told us that he had loaned the funds to
the borrower’s relative (the donor) because he had a personal relationship with the
relative, and that the relative later repaid the loan. The owner also told us that the
relative was trying to help the borrower acquire a home and did not have the
funds to donate to the borrower at that time, but would have the funds by the time
the loan closed.
Prime Mortgage’s owner also directly loaned $2,456 to a second borrower before
the borrower’s loan closing, which appears to have been used as funds to close the
loan. The Prime Mortgage check, made payable to the borrower within two
weeks of closing, showed “loan” on the memo line. The borrower deposited the
$2,456 check from Prime Mortgage on March 22, 2002, and closed the Federal
Housing Administration loan on April 4, 2002.
We reviewed case #292-4167405 to determine if the borrower would have had
sufficient funds to close the loan despite the funds provided by Prime Mortgage.
The borrower provided bank statements for two bank accounts. The bank
statements showed that as of March 21, 2002, the day before depositing the Prime
Mortgage check, the borrower had $364 in one account and $675 in the second
account, for a total of $1,039. The borrower’s HUD-1 Settlement Statement
showed that the borrower needed $4,115 to close the loan on April 4, 2002.
Therefore, the borrower did not have the funds to close the loan just two weeks
prior to closing, which we believe shows that Prime Mortgage provided the funds
to assist the borrower with closing costs.
The owner of Prime Mortgage told us that the borrower had the funds to close
from the sale of another residence. However, the St. Louis County Government’s
website showed that the borrower’s previous residence sold on May 1, 2002, one
month after the borrower closed the Federal Housing Administration loan.
The following table provides details on the two loans described above:
Loan Mortgage Closing Prime Mortgage Check
Number Amount Date Check Date Amount
292-4417214 $123,068 9/16/03 9/11/03 $3,000
292-4167405 $128,981 4/4/02 3/22/02 $2,456
For a third loan, case #292-4257704, Prime Mortgage did not properly document
the transfer of $7,000 in gift funds from the donor to the borrower. Prime
Mortgage received a verification of deposit from the donor’s bank that stated that
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the donor had a sufficient balance in their account to provide the $7,000 gift. A
deposit slip showed that the donor transferred $8,000 into the account from which
the donor wrote the $7,000 check to the borrower. However, Prime Mortgage did
not obtain documentation that the borrower deposited, or otherwise used, the
$7,000 gift check as funds to close the loan. Therefore, Prime Mortgage did not
obtain the proper documentation to ensure that the funds used to close the loan
were from an allowable source on the $124,053 loan.
HUD Handbook 4155.1 requires a lender to document the transfer of gift funds
from the donor to the borrower when gift funds are required to qualify a borrower
for a Federal Housing Administration-insured loan. HUD requires:
• A gift letter specifying the dollar amount, signed by the donor and the
borrower, stating that no repayment is required and showing the donor’s
name, address, telephone number, and relationship to the borrower; and
• Documentation, such as bank statements of both the borrower and the
donor, withdrawals slips, and canceled checks, showing the transfer of the
funds from the donor to the borrower, to provide assurance that the funds
were not derived from a party to the transaction.
We reviewed the case file to determine if the borrower would have had sufficient
funds to close the loan without the gift funds. On the loan application, the
borrower disclosed no other assets other than $1,000 in earnest funds already
paid, and the $7,000 in expected gift funds. The borrower provided bank
statements for a two-month period. The bank statements showed that as of
September 16, 2002, just two weeks before the loan closed, the borrower had only
$176. The borrower’s HUD-1 Settlement Statement showed that the borrower
needed $6,279 to close the loan. Therefore, the borrower did not have the funds
to close the loan just two weeks prior to closing. Therefore, HUD can not be
assured that the funds used to close the loan were provided by the allowable
donor, or were from some other source.
Conclusion
Prime Mortgage did not comply with HUD requirements for funds to close two
insured mortgages because the owner loaned funds to the borrowers before
closing. Prime Mortgage also did not obtain proper documentation to show the
transfer of gift funds from the donor to the borrower on a third loan. As a result,
HUD’s insurance fund has been placed at risk by insuring loans of borrowers that
without the loans from Prime Mortgage, may not have qualified for a Federal
Housing Administration loan. Also, without proper documentation showing the
transfer of gift funds, HUD lacks assurance that the gift funds were provided by
an allowable donor and not by a party to the transaction as an inducement to
purchase. HUD’s systems showed that as of July 30, 2004, all three of these loans
were actively insured.
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Recommendations
We recommend that the Assistant Secretary for Housing - Federal Housing
Commissioner, and Chairman, Mortgagee Review Board
1A. Take appropriate administrative action against Prime Mortgage, such as
imposing civil money penalties and withdrawing Prime Mortgage’s Federal
Housing Administration approval status.
1B. Take appropriate administrative action against the Federal Housing
Administration sponsor for the three improperly originated loans, such as
requiring indemnification from the applicable sponsor(s) for the two loans
(totaling $252,049) with improper sources of funds, and the additional loan
(totaling $124,053) without proper documentation of the transfer of gift
funds.
We recommend that the Acting Director, Departmental Enforcement Center
1C. Take appropriate action against Karim Enterprises, dba Prime Mortgage,
such as debarring the business and principals, for providing funds to Federal
Housing Administration borrowers prior to closing.
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Finding 2: Prime Mortgage Failed To Perform Required Quality
Control Reviews
Prime Mortgage has not performed quality control reviews, as required by HUD, because it
mistakenly believed that any requirements of the quality control plan were being met by its
certified public accountant. As a result, HUD lacks assurance that Prime Mortgage is identifying
and correcting potential deficiencies in its loan origination process before submitting loans for
Federal Housing Administration insurance.
Quality Control Plan
A quality control plan is a HUD-required process that all mortgagees, including
loan correspondents, must implement to assist in the assurance of the accuracy,
validity, and completeness of its loan origination operations. The quality control
plan must be a prescribed function of the mortgagee’s operations and assure that
the mortgagee maintains compliance with HUD/Federal Housing Administration
requirements and its own policies and procedures.
To satisfy the basic elements of a quality control plan, the mortgagee must have a
written quality control plan and perform the required quality control reviews. The
following types of reviews are required:
• A review of 10 percent of all Federal Housing Administration-insured loans,
• A review of all loans defaulting within six months, and
• A review of 10 percent of all rejected loans.
Prime Mortgage’s Quality
Control Plan
Prime Mortgage is a non-supervised loan correspondent that performs only the
origination process for Federal Housing Administration-insured loans. Prime
Mortgage’s written quality control plan contained all of the HUD requirements
for loan origination, but Prime Mortgage had not properly implemented the plan
because it had not performed the required quality control reviews. Without a
properly implemented quality control plan, the mortgagee cannot ensure that its
loan originations comply with HUD/Federal Housing Administration
requirements; that it is protecting itself and HUD from unacceptable risk; and that
it is guarding against errors, omissions, and fraud.
Prime Mortgage did not have in-house staff to perform the quality control
reviews. HUD regulations allow a mortgagee to outsource its quality control
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function if adequate staff is not available in house, but Prime Mortgage did not
outsource the quality control function. The owner of Prime Mortagage initially
told us that the company’s certified public accountant performs the required
reviews, but the accountant told us that he does not perform these types of
reviews. Subsequently, Prime Mortgage’s owner told us that he had confirmed
that the accountant does not perform the required quality control reviews, and that
Prime Mortgage was preparing a quality control process that would meet HUD’s
requirements.
The owner of Prime Mortgage also told us that he and another staff member
review the files and know what actions are being taken on loans. However, a
cursory review of a loan file does not show that Prime Mortgage meets HUD’s
specific requirements for a quality control plan and process.
Conclusion
Prime Mortgage did not meet HUD’s quality control requirements because it did
not perform the required quality control reviews. As a result, Prime Mortgage did
not evaluate the accuracy, validity, and completeness of its loan origination
operations. Therefore, HUD lacks assurance that Prime Mortgage is identifying
and correcting potential deficiencies in its loan origination process before
submitting loans for Federal Housing Administration insurance.
Recommendations
If HUD determines that Prime Mortgage can maintain its Federal Housing
Administration approval status, we recommend that the Assistant Secretary for
Housing - Federal Housing Commissioner, and Chairman, Mortgagee Review
Board
2A. Require Prime Mortgage to implement controls to ensure that it completes
quality control reviews according to HUD regulations.
2B. Verify that Prime Mortgage has implemented effective controls that prevent
Prime from submitting loans for Federal Housing Administration insurance
endorsement that do not meet HUD requirements.
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SCOPE AND METHODOLOGY
Prime Mortgage originated 69 Federal Housing Administration-insured loans during our audit
period of January 1, 2002, through December 31, 2003. To achieve our objectives, we reviewed
the Federal Housing Administration case binders for the 13 loans that required gift funds for
closing. We reviewed the documents related to the transfer of gift funds, including bank
statements of the borrowers and donors, canceled checks, gift letters, and HUD-1 Settlement
Statements.
Further, we reviewed Prime Mortgage’s bank statements and canceled checks for the same audit
period to identify any checks written to, or on behalf of, Federal Housing Administration
borrowers or gift donors. We identified an additional 17 loans for review. In addition to Prime
Mortgage’s bank statements and canceled checks, we reviewed borrowers’ checks written to
Prime Mortgage for prepaid closing costs, deposit slips showing that Prime Mortgage deposited
the borrowers’ funds, and HUD-1 Settlement Statements.
We interviewed Prime Mortgage’s management and staff to obtain information regarding its
policies, procedures, and management controls. We also interviewed borrowers and donors to
obtain information regarding their experiences with Prime Mortgage.
We performed audit work from March through June 2004. The audit was conducted in
accordance with generally accepted government auditing standards.
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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:
• Controls over Federal Housing Administration loan originations
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 items are significant weaknesses:
• Prime Mortgage has not properly implemented its quality control plan.
(see Finding 2).
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APPENDIXES
Appendix A
SCHEDULE OF QUESTIONED COSTS
AND FUNDS TO BE PUT TO BETTER USE
Recommendation Ineligible 1/ Unsupported Unreasonable or Funds To Be Put
Number 2/ Unnecessary 3/ to Better Use 4/
1B $376,102
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
polices or regulations.
2/ Unsupported costs are those costs charged to a HUD-financed or HUD-insured program
or activity when we cannot determine eligibility at the time of audit. Unsupported costs
require a decision by HUD program officials. This decision, in addition to obtaining
supporting documentation, might involve a legal interpretation or clarification of
departmental policies and procedures.
3/ Unreasonable/unnecessary costs are those costs not generally recognized as ordinary,
prudent, relevant, and/or necessary within established practices. Unreasonable costs
exceed the costs that would be incurred by a prudent person in conducting a competitive
business.
4/ “Funds to be put to better use” are quantifiable savings that are anticipated to occur if an
Office of Inspector General (OIG) recommendation is implemented, resulting in reduced
expenditures at a later time for the activities in question. For this review, the funds to be
put to better use consist of loans and guarantees not made because of indemnification.
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Appendix B
AUDITEE COMMENTS AND OIG’s EVALUATION
Ref to OIG Evaluation Auditee Comments
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Comment 1
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Comment 2
Comment 3
Comment 4
Comment 5
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OIG Evaluation of Auditee Comments
Comment 1 We clarified the report to state that the owner of Prime Mortgage told us that he
had provided the funds to a relative of the borrower, not directly to the borrower.
We also included information that the owner told us that the relative (the donor)
was trying to help the borrower acquire a home and did not have the funds to give
to the borrower at that time, but would have the funds by the time the loan closed.
Prime Mortgage’s position is not consistent with the information provided by the
donor and the borrower. Prime Mortgage says that the owner did not provide the
funds to the borrower, but to the borrower’s father. Our review determined that
the donor was actually the borrower’s brother, not the father. In addition, the
donor and borrower told us that the owner of Prime Mortgage knew that the funds
were for the loan closing because the owner had told them both that he could not
give funds to the borrower directly, but that he could give the funds to the donor,
who could in turn provide the funds to the borrower. Also, the borrower told us
that she repaid the owner of Prime Mortgage directly, not through the relative.
The owner told us that the relative had repaid the loan.
We maintain that Prime Mortgage indirectly provided closing funds to the
borrower, by using a relative in the transfer of funds that the owner provided.
This transaction violates HUD’s requirements, and HUD should take appropriate
action.
Comment 2 We believe, based on the chronology of events and the documents in the loan file,
that Prime Mortgage provided closing funds to the borrower. Prime Mortgage’s
position is that the funds to close could have come from cash on hand, or from a
payroll check that had not yet been deposited. HUD requires that a borrower be
able to show that the borrower has the wherewithal to close a loan. HUD
Handbook 4155.1 requires that all funds for the borrower’s investment in the
property be verified. Specifically, in order to include cash on hand as funds
available to close, the money must be verified, whether deposited in a financial
institution or held by the escrow / title company. The borrower must also provide
satisfactory evidence of the ability to accumulate such savings. The loan file does
not support that the borrower had funds available to close the loan, other than the
use of the funds loaned by Prime Mortgage just two weeks prior to closing.
In addition, Prime Mortgage’s owner says that he has no memory of the
transaction, and does not believe that the funds were needed to close the
transaction. This statement is inconsistent with what the owner told us at the
conclusion of the audit. The owner had previously told us that he recalled the
transaction, and that the borrower would have the funds to close from the sale of
another residence. However, as noted in the report, we confirmed that the sale of
the borrower’s previous residence did not take place until one month after the
closing of the Federal Housing Administration loan.
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Comment 3 Prime Mortgage’s position is that it complied, in every respect, with the lender’s
underwriting requirements. However, HUD places the same requirements on loan
correspondents, such as Prime Mortgage, as it does on lenders / sponsors. As a
result, Prime Mortgage was required to properly document the transfer of gift
funds from the donor to the borrower, but it did not.
Comment 4 We commend Prime Mortgage for its efforts to correct the quality control review
deficiency. If Prime Mortgage immediately begins to conduct reviews of its files
in accordance with its written plan, this should resolve our concerns in this area.
Comment 5 Given that the owner of Prime Mortgage signed the checks written to the two
borrowers that we concluded used the Prime Mortgage funds to close their
Federal Housing Administration loans, we maintain that our recommendations are
warranted, and that sanctions imposed should reflect the seriousness of the
situations.
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Karim Enterprises, DBA Prime Mortgage, Did Not Follow Federal Housing Administration Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2004-10-04.
Below is a raw (and likely hideous) rendition of the original report. (PDF)