oversight

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)

                                                                         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




                     15

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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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