oversight

Washington Mutual Bank Did Not Follow HUD Regulations When Underwriting Six Loans

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-09-30.

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

                                                           Issue Date
                                                                    September 30, 2005
                                                           Audit Report Number
                                                                    2005-KC-1009




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

           //signed//
FROM:      Ronald J. Hosking, Regional Inspector General for Audit, 7AGA

SUBJECT: Washington Mutual Bank Did Not Follow HUD Regulations When
         Underwriting Six Loans


                                  HIGHLIGHTS

 What We Audited and Why

            We reviewed 10 Federal Housing Administration loans sponsored by Washington
            Mutual Bank (Washington Mutual) of Seattle, Washington. During an audit of a
            Federal Housing Administration-approved loan correspondent that originated the
            loans, we concluded that eight loans sponsored by Washington Mutual did not
            appear to be properly underwritten according to U.S. Department of Housing and
            Urban Development (HUD) regulations. In addition, Washington Mutual charged
            the borrower fees prohibited by HUD on five loans, three of which were also
            questionable loan originations. Because the sponsor of the loans is ultimately
            responsible for loan processing deficiencies, we addressed these deficiencies to
            Washington Mutual to determine whether it complied with HUD regulations,
            procedures, and instructions when processing the mortgages.

 What We Found
            Washington Mutual did not comply with HUD regulations, procedures, and
            instructions in the underwriting of six Federal Housing Administration-insured
            mortgages. The deficiencies involved unverified property repairs required to
            support the appraised value, unsupported income, improper refund of gift funds to
            the borrower, unsupported assets, and questionable ownership of one subject
            property. Upon further evaluation of the two other loans initially questioned as




                                            1
           improper originations, we concluded that Washington Mutual adequately
           followed HUD regulations and are no longer questioning these loans.

           Washington Mutual charged prohibited fees (totaling $922) on five loans, three of
           which were also identified as improperly underwritten loans.

What We Recommend
           We recommend that the assistant secretary for housing - federal housing
           commissioner take appropriate administrative action against Washington Mutual
           for not complying with HUD underwriting requirements. This action, at a
           minimum, should include requiring indemnification for three actively insured
           loans with original mortgage amounts totaling $223,476, two loans on which
           HUD has incurred losses of $87,639, and one loan that is overinsured by $1,425.

           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


           Washington Mutual agreed with our conclusions and to indemnify HUD for
           potential losses on loans currently insured, and losses already incurred. We
           provided the draft report to Washington Mutual on September 2, 2005 and
           requested a response by September 17, 2005. Washington Mutual provided
           written comments on September 27, 2005.

           The complete text of the auditee’s response can be found in appendix B of this
           report.




                                            2
                            TABLE OF CONTENTS

Background and Objectives                                              4

Results of Audit
      Finding: Washington Mutual Did Not Follow HUD Regulations When   5
                 Underwriting Six Loans

Scope and Methodology                                                  9

Appendixes
   A. Schedule of Questioned Costs and Funds to Be Put to Better Use   10
   B. Auditee Comments                                                 11
   C. Case Studies of Improperly Originated Loans                      14




                                            3
                     BACKGROUND AND OBJECTIVES

Washington Mutual Bank (Washington Mutual) is a supervised lender that began originating
Federal Housing Administration loans in 1979.

During the audit of a loan correspondent, we identified eight Federal Housing Administration
loans sponsored by Washington Mutual that did not appear to be underwritten according to U.S.
Department of Housing and Urban Development (HUD) regulations. We also identified five
loans, three of which were also questionable loan originations, on which Washington Mutual
charged prohibited fees to the borrowers. To resolve these deficiencies, we performed a review
of Washington Mutual’s underwriting of these loans.

Our objective was to determine whether Washington Mutual complied with HUD regulations,
procedures, and instructions when processing these Federal Housing Administration mortgages
that it sponsored for a loan correspondent.




                                               4
                                RESULTS OF AUDIT

Finding: Washington Mutual Did Not Follow HUD Regulations When
         Underwriting Six Loans
Washington Mutual did not comply with HUD regulations, procedures, and instructions in the
underwriting of six Federal Housing Administration-insured single-family mortgages. The loans
contained deficiencies that affected the credit quality (insurability) of the loans. As a result,
HUD insured three improperly underwritten loans with original mortgage amounts totaling
$223,476 and one loan that is overinsured by $1,425, thereby unnecessarily placing the insurance
fund at risk for $224,901. HUD incurred losses of $87,639 on two additional loans when it paid
a claim to the lenders and incurred losses on the sale of the insured properties.


 Washington Mutual
 Did Not Follow HUD
 Underwriting Requirements


              Washington Mutual sponsored six loans that contained significant underwriting
              deficiencies. The deficiencies involved unverified property repairs required to
              support the appraised value, unsupported income, improper refund of gift funds to
              the borrower, unsupported assets, and questionable ownership of one subject
              property.

              Case Number 321-3198432
              The appraised value of the property was contingent on required roof repairs, but
              Washington Mutual did not ensure that the roof repairs were completed before the
              loan closing. It cleared all underwriting conditions related to the roof repairs;
              however, the loan file contained no documentation certifying that the roof repair
              was completed and that the appraisal conditions had been met. Washington
              Mutual agreed with our conclusion.

              Case Number 321-2201134
              Washington Mutual gained loan approval from an automated underwriting system
              using an unsupported monthly income amount for the coborrower. Using only the
              supported monthly income, the borrowers’ debt ratio would have increased to
              48.8 percent, well above HUD’s limit of 41 percent. While the loan
              documentation indicated possible compensating factors, these factors were not
              sufficient to overcome the negative factors also present in the loan file.
              Washington Mutual agreed that it had not adequately supported the borrowers’
              income.

              Case Number 581-2396531
              Washington Mutual approved a mortgage amount that was higher than allowed by
              HUD regulations, resulting in an overinsured mortgage. In closing the loan, the


                                               5
borrower received a nonprofit gift of $5,554 and a $765 property tax credit, which
totaled $6,319, but the borrower needed only $4,464 to close the loan. The lender
allowed the refund to the borrower of $1,855 instead of reducing the sales price
used to calculate the maximum mortgage by the amount of the excess funds.

Lenders are allowed to reimburse a borrower for fees paid outside of closing
when other allowable sources of funds become available for the reimbursement.
Therefore, the overage of $1,855 should be offset by the $430 paid by the
borrower outside of closing for hazard insurance, thus reducing the excess funds
paid to the borrower in error to $1,425. As a result, this loan is overinsured by
$1,425. Washington Mutual agreed with our conclusion.

Case Number 161-1980353
Washington Mutual did not adequately verify the assets claimed and required to
close the loan. In obtaining loan approval, the borrowers claimed $3,676 in
available assets (bank accounts and stock options) and needed $3,651 to close the
loan. Verifications of bank accounts obtained just before the loan closed showed
that the borrowers had $2,683 available. However, the average savings account
balance for the previous two months was only $327. Washington Mutual did not
research the large increase in the savings account or obtain the required bank
statements to review for questionable transactions. It also did not confirm
whether the borrowers received funds from the stock options used to qualify for
the loan. Washington Mutual agreed that it had not adequately supported the
borrowers’ claimed assets.

Case Number 161-1979463
Washington Mutual did not verify that the borrower was currently employed, nor
did it support the monthly income claimed because it did not obtain a verification
of employment or a recent pay stub. The borrower claimed $3,045 in monthly
base pay, which included employee and self-employment income. The lender did
not obtain adequate documentation to verify either form of income. Using the
inadequately documented employee monthly income of $2,515 and the self-
employment monthly net profit of $303, the borrower’s monthly income was only
$2,818 per month.

In addition, the borrower’s base monthly income remained steady for the most
recent 2.5 years (i.e., was not increasing) and the current self-employment income
decreased significantly from the two prior years by approximately $250 per
month. Although the $2,818 per month was sufficient to qualify within HUD’s
financial ratio limits, the lender did not adequately verify the validity or stability
of this income. Washington Mutual agreed that it had not adequately supported
the borrower’s employment history and monthly income claimed.

Case Number 161-1975505
The borrowers needed a substantial gift of equity to close the loan, but Washington
Mutual did not obtain adequate documentation to ensure that the gift of equity was
from an allowable source. Only family members may provide equity credit as a gift
on a property being sold to other family members. In some instances, the loan
documentation indicated that the borrower’s grandmother owned the property and


                                  6
             provided the gift of equity. However, the loan files also contained multiple
             discrepancies regarding who actually owned and was selling the property and
             whether the transaction met HUD’s identify-of-interest stipulations. If the seller was
             not a family member, then the loan is overinsured. Washington Mutual agreed that
             it had not adequately verified that the seller of the property was a relative and that
             the gift of equity and other loan elements were appropriate.

             Appendix C contains more detailed analyses of the loans.

Unallowable Fees
Charged to Borrowers

             Washington Mutual charged five borrowers unallowable fees (totaling $922) that
             are prohibited on Federal Housing Administration mortgages.

                Case                                                           Total
               number         Description of unallowable charges        unallowable charges
                           Excessive appraisal fee and
             321-2195941   improper overnight courier fee                     $425
                           Commitment fee without written agreement
             581-2396531   and overcharge on credit report fee                $416
             161-1975505   Overcharge on credit report fee                     $42
             321-2201134   Overnight courier fee on nonrefinance loan          $25
             161-1984269   Overcharge on credit report fee                     $14
                           TOTAL                                              $922

             Washington Mutual agreed with our analysis of the unallowable charges and that
             it owes refunds to the appropriate parties.

Conclusion


             Washington Mutual Bank did not comply with HUD requirements when
             underwriting six Federal Housing Administration loans. The deficiencies
             involved required property repairs that it did not confirm were completed before
             closing the loan, unsupported income, excess gift funds improperly refunded to
             the borrower, unsupported assets, and unverified ownership of one subject
             property. Therefore, HUD is unnecessarily at risk for three loans with original
             mortgage amounts totaling $223,476 and one loan that is overinsured by $1,425.
             In addition, HUD incurred losses of $87,639 when it paid claims on two
             additional loans and incurred losses on the sale of the properties.

             Because the monetary value of the unallowable fees is minimal, and Washington
             Mutual agreed with our analysis and that it owes refunds to the appropriate
             parties, we have made no formal recommendations to HUD in this regard.




                                               7
Recommendation


          We recommend that the assistant secretary for housing - federal housing
          commissioner and chairman, Mortgagee Review Board

          1A.    Take appropriate administrative action against Washington Mutual for not
                 complying with HUD underwriting requirements. This action, at a
                 minimum, should include requiring Washington Mutual to indemnify
                 HUD for three actively insured loans with original mortgage amounts
                 totaling $223,476, two loans on which HUD has incurred losses of
                 $87,639, and one loan that is overinsured by $1,425 (see appendix C).




                                          8
                         SCOPE AND METHODOLOGY

We performed a review of Washington Mutual’s processing of 10 Federal Housing
Administration loans that it sponsored for a Federal Housing Administration-approved loan
correspondent. During our audit of that loan correspondent, we reviewed loans closed from June
1, 2002, through May 31, 2004, that defaulted within the first two years after closing. Of the 10
loans sponsored by Washington Mutual, we identified eight loans that appeared to be improperly
underwritten. We also identified five loans, including three that were also improperly
underwritten, on which Washington Mutual charged unallowable fees to the borrowers. Because
the sponsor of the loans is ultimately responsible for loan processing deficiencies, we addressed
these deficiencies to Washington Mutual.

To accomplish our objective, we prepared case narratives of the loan processing deficiencies
identified and provided the information to Washington Mutual. We allowed Washington Mutual
an opportunity to provide additional information that could affect the initial results of our review
of the loans. Washington Mutual provided a written response, which we evaluated in reaching
our conclusions.

We relied on computer-processed data contained in HUD’s Single Family Data Warehouse
system. During the audit of the loan correspondent, we assessed the reliability of the data,
including relevant general and application controls, which we found to be adequate. We also
performed sufficient tests of the data, and based on the assessments and testing, we concluded
that the data are sufficiently reliable to be used in meeting our objectives.

We did not assess Washington Mutual’s underwriting controls because they were not significant
to our objective of reviewing these 10 loans.

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




                                                 9
                                      APPENDIXES

Appendix A

               SCHEDULE OF QUESTIONED COSTS
              AND FUNDS TO BE PUT TO BETTER USE

                     Recommendation                               Funds to be put
                         number               Ineligible 1/       to better use 2/

                             1A                $     87,639        $      224,901


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/   “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. 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.




                                                10
Appendix B

             AUDITEE COMMENTS




                    11
12
13
Appendix C

    CASE STUDIES OF IMPROPERLY ORIGINATED LOANS


Case number: 321-2198432                        Insured amount: $69,903

Section of Housing Act: 203(b)                  Status upon selection:
                                                   Default status after eight months
Date of loan closing: July 12, 2002

HUD costs incurred:
  $49,120 loss of sale of property


Property Value/Appraised Value Not Supported
The lender did not verify and adequately document that required roof repairs were completed
before the loan closing. The conditional commitment/direct endorsement statement of appraised
value, dated June 3, 2002, clearly stated that the property value assigned was contingent upon an
inspection by a roofing professional and successful completion of any required roof repairs. The
specific commitment conditions required the lender to furnish a certificate stating that required
repairs had been examined and satisfactorily completed.

The roof inspection, dated June 12, 2002, stated the “rear section of roof will NOT exceed 1 year
without repair,” and a lender note on the inspection states that the roof “MUST BE REPAIRED.”
The loan correspondent’s file contained a note stating the roof was being worked on. An
underwriter condition sheet showed that on June 25, 2002, the lender cleared all underwriting
conditions related to the required roof repairs and inspection. However, the loan file contained
no documentation certifying that the roof repair was completed and that the appraisal conditions
had been met. The lender should not have submitted the loan for insurance endorsement without
verifying and properly supporting that the repairs were completed.

HUD Requirements
The Desktop Underwriter report required the lender to obtain a uniform residential appraisal
report and form HUD 92800-5B, conditional commitment/direct endorsement statement of
appraised value.

HUD Handbook 4000.2, REV-2, chapter 2-19, notes that repair requirements outstanding on the
conditional commitment or the appraisal report must be satisfied before the mortgage is
submitted for endorsement. Generally, satisfaction of repair requirements is indicated on a
HUD-92051, compliance inspection report, prepared by an appraiser or inspector.




                                               14
Case number: 321-2201134                         Insured amount: $125,530

Section of Housing Act: 203(b)                   Status upon selection:
                                                    Default status after five months
Date of loan closing: June 21, 2002

HUD costs incurred:
  $38,519 loss on sale of property


Unsupported Income
The lender did not adequately support income claimed to qualify the borrowers for the loan. The
Fannie Mae Loan Prospector report showed monthly base employment income of $1,638
claimed for the coborrower. However, the coborrower’s recent pay stub showed year-to-date
income through April 20, 2002, of only $1,458 per month ($5,271/110 days = $47.92 per day x
365 days = $17,491 per year/12 months = $1,458 per month). The verification of employment
for this same job also supported the lower amount of monthly income. The coborrower listed
other employment on the loan application, but the loan file contained no pay stubs from the
second employer, and the verification of employment sent to the second employer was returned
with a note stating: “No record of employment.” Therefore, the lender gained approval from
Loan Prospector using an unsupported monthly income amount for the coborrower.

Using only the supported monthly income, the borrowers’ debt ratio would have increased to
48.8 percent, well above HUD’s limit of 41 percent. While the loan documentation indicated
possible compensating factors, these factors were not sufficient to overcome the negative factors
also shown in the loan file.

For example, the lender indicated that it had not included possible ancillary income (bonuses,
commissions, and overtime) in the monthly income used to qualify the borrowers. However,
ancillary income would not have materially affected the borrowers’ financial ratios. Although
the borrower earns ancillary income, her total monthly income averaged only $2,780 over the
28.25 months before the loan closed and only $2,896 for the previous 16.25 months. Both
monthly averages are below the current base monthly income claimed ($2,942) to approve the
loan. Further, for the 8.5 months that the coborrower had been in his current job, he had earned
an average of only $35 per month in overtime, which would not have materially affected the
ratios.

While the loan documentation showed that the borrowers had acceptable credit scores and
potential reserves (a retirement account), the loan file also contained negative factors, including

   o Housing costs increased from $200 per month to $1,124 per month.

   o Borrowers had liquid assets of only $866, and $580 of this amount was needed for
     closing, leaving liquid reserves of less than one monthly housing payment.

   o Borrowers needed a substantial gift ($3,825) from a nonprofit for downpayment
     assistance to close the loan.


                                                 15
HUD Requirements
Mortgagee Letter 98-14 says that the Federal Housing Administration has approved Freddie
Mac’s Loan Prospector for use on Federal Housing Administration-insured mortgages, effective
March 2, 1998. The lender remains accountable for compliance with Federal Housing
Administration guidelines and those credit, capacity, and documentation aspects not addressed in
the Loan Prospector Users Guide.

Freddie Mac’s Loan Prospector Automated Underwriting Service Training and Users Guide,
section 2, states that the data the user inputs into Loan Prospector must match the application,
underwriting documentation, and delivery information at the time the data is entered and that the
user is responsible for data integrity.

HUD Handbook 4155.1, REV-4, CHG-1, chapter 2-12-B, states that if the total mortgage
payment and all recurring charges do not exceed 41 percent of gross effective income, the
relationship of total obligations to income is considered acceptable. A ratio exceeding 41
percent may be acceptable if significant compensating factors are presented.

Unallowable Charges
The HUD-1 settlement statement showed that the borrower was charged a $25 overnight courier
fee. This was not a refinance loan.

HUD Requirement
HUD Homeownership Center Reference Guide, chapter 2, “Mortgage Credit Guidelines,” pages
2-15, “Closing Costs and Other Fees,” states that all closing items associated with a HUD-
insured loan, including paid outside of closing items, must be itemized on the HUD-1 settlement
statement for Real Estate Settlement Procedures Act compliance. Overnight courier fees are
allowable only on refinance loans and under certain conditions.




                                               16
Case number: 581-2396531                        Insured amount: $94,141

Section of Housing Act: 203(b)                  Status upon selection:
                                                   Default status after 21 months
Date of loan closing: July 31, 2002

HUD costs incurred:
  $625 in loss mitigation


Overinsured Loan
Washington Mutual approved a mortgage amount that was higher than allowed by HUD
regulations because it improperly allowed the borrower to receive a substantial refund of gift
funds at closing instead of reducing the sales price used to calculate the maximum mortgage by
the amount of the excess funds. As a result, HUD overinsured the loan by $1,425.

The mortgage credit analysis worksheet showed that the borrower needed $5,901 to close the
loan. However, the HUD-1 settlement statement showed that settlement charges to the borrower
totaled only $3,605. The HUD-1 settlement statement also showed that a $5,554 nonprofit gift
and a $765 property tax credit were applied to the funds paid on behalf of the borrower. We
were unable to determine how the nonprofit determined its gift amount, but it was likely derived
from the required downpayment, estimated closing costs, and prepaid expenses. It appears that a
portion of the excess gift funds was derived from the underwriter overestimating closing costs
and prepaid expenses when estimating the cash needed to close at $5,901.

The nonprofit gift and property tax credit totaled $6,319, but the borrower needed only $4,464 to
close the loan. The lender allowed the borrower to receive the $1,855 in excess funds instead of
considering the funds as expenses paid on the borrower’s behalf that should have been
considered inducements to purchase. The lender should have reduced the sales price and,
therefore, the amount of the insured mortgage by the amount of the inducement.

Lenders are allowed to reimburse a borrower for fees paid outside of closing when other
allowable sources of funds are available for the reimbursement. Therefore, the overage of
$1,855 should be offset by the $430 paid by the borrower outside of closing for hazard insurance,
thus reducing the excess funds paid to the borrower in error to $1,425. As a result, this loan is
overinsured by $1,425.

HUD Requirements
HUD Handbook 4155.1, REV-4, CHG-1, chapter 1-7, says that HUD expects the estimate of
closing costs used to calculate the mortgage amount during processing and underwriting to be a
reasonable reflection of actual closing costs at the time of settlement. If the estimated closing
costs used to calculate the mortgage exceed the actual charges by more than $250, the mortgage
amount must be recalculated and reduced before settlement. It is the lender’s responsibility to
assure that its loans close in compliance with this requirement.

Chapter 1-7-B says that certain other expenses (beyond those described in chapter 1-7-A) paid on
behalf of the borrower and other inducements to purchase result in a dollar-for-dollar reduction


                                                17
to the sales price before applying the appropriate loan-to-value ratio. The expenses described in
chapter 1-7-A are the seller contributions to the buyer’s expenses. HUD permits sellers to
contribute up to 6 percent of the property’s sales price toward the buyers actual closing costs,
prepaid expenses, discount points, and other financing concessions. Closing costs normally paid
by the borrower are considered contributions if paid by the seller.

Unallowable Charges
The HUD-1 settlement statement showed that the borrower paid a $406 commitment fee, but the
loan file did not contain a lock-in or commitment agreement which guaranteed the interest rate or
discount points, as required. The borrower was also charged a $55 fee for credit reports. The actual
cost of the credit reports was $45 ($34 and $11), an overcharge of $10. Therefore, the borrower
paid $416 in unallowable fees.

HUD Requirement
HUD Homeownership Center Reference Guide, chapter 2, “Mortgage Credit Guidelines,” pages
2-15, “Closing Costs and Other Fees,” states that all closing items associated with a HUD-
insured loan, including paid-outside-closing items, must be itemized on the HUD-1 settlement
statement for Real Estate Settlement Procedures Act compliance. Commitment fees are only
allowable if the lock-in or commitment agreement for which a fee is charged is in writing and
guarantees the rate and/or discount points for a period of not less than 15 days before the
anticipated closing date. Credit reports are to be charged at actual cost.




                                                18
Case number: 161-1980353                        Insured amount: $93,024

Section of Housing Act: 203(b)                  Status upon selection:
                                                   Default status after 18 months
Date of loan closing: July 19, 2002

HUD costs incurred:
  None identified


Unsupported Assets
The lender did not obtain bank statements to support the borrowers’ assets claimed. According
to the mortgage credit analysis worksheet, the borrowers had $3,676 in available assets ($1,276
in liquid assets + $2,400 in stock options) and needed $3,651 to close the loan, leaving $25 in
reserves after closing.

Based on the July 11, 2002, verifications of deposit (one week before the loan closed), the
borrowers had $2,683 in available liquid assets [$1,362 available in checking accounts ($247 +
$1,115) and $1,321 available in savings accounts ($1,311 + $11)]. However, the average savings
account balance for the previous two months was only $327 ($316 + $11). The loan file did not
contain an explanation for the large increase in the savings account or the required bank
statements to review for questionable transactions. According to the HUD-1 settlement
statement, the borrowers paid a $200 earnest deposit and $2,817 in cash at closing.

The lender also did not obtain adequate documentation to support receipt of funds from stock
options. While the loan file contained a July 15, 2002, stock options summary, there was no
evidence that the borrower received the funds to use for the loan closing.

HUD Requirements
HUD Handbook 4155.1, REV-4, CHG-1, paragraph 3-1-F states that mortgage credit analysis
requires documentation of assets by verification of deposit and most recent bank statements (i.e.,
most recent at time of application and provided the document is not more than 120 days old
when the loan closes). As an alternative to obtaining a verification of deposit, the lender may
choose to obtain original bank statements covering the most recent three-month period or the two
most recent consecutive statements, provided the bank statements show the previous month’s
balance.

HUD Handbook 4155.1, REV-4, CHG-1, chapter 2-10-L, notes that when the borrower claims
assets through the sale of stocks and bonds, the value of these securities must be verified from
the stockbroker or by photocopies of the stock certificates, along with a dated newspaper stock
price list. Actual receipt of funds must be verified.




                                                19
Case number: 161-1979463                        Insured amount: $79,748

Section of Housing Act: 203(b)                  Status upon selection:
                                                   Default status after 13 months
Date of loan closing: July 29, 2002

HUD costs incurred:
  None identified


Unsupported Income
The lender did not verify that the borrower was currently employed, nor did the lender support
the monthly income claimed because it did not obtain a verification of employment or a recent
pay stub. Further, the lender included the borrower’s self-employment income in the base
income amount without proper support.

According to the mortgage credit analysis worksheet, the borrower’s monthly income included
$3,045 in base pay from insurance sales. However, the lender did not adequately verify the
income claimed.

   o For 2002 employee income, the borrower provided an employee earnings summary,
     which showed only the period from April 1 through May 16, 2002, and that the borrower
     earned $2,515 per month ($3,773 / 1.5 months). The earnings summary activity report
     did not contain the Social Security number or year-to-date earnings of the borrower.

   o For 2002 self-employment income, the borrower provided an informal profit and loss
     statement for January 1 through July 15, 2002, that showed an average of $508 per month
     in gross receipts ($3,300 / 6.5 months) but only $303 per month in net profit ($1,971 / 6.5
     months). Although required to support self-employment income, the lender did not
     obtain a year-to-date balance sheet for 2002.

   o For the prior years of income, the lender obtained Internal Revenue Service Form W-2
     for 2001 but did not obtain the 2001 federal tax return. The lender obtained only the
     unsigned schedules related to self-employment income. For 2000, the lender obtained an
     Internal Revenue Service Form W-2 and an incomplete, unsigned federal tax return.

Using the inadequately documented employee monthly income of $2,515 and the self-
employment monthly net profit of $303, the borrower’s monthly income was only $2,818 per
month. In addition, the borrower’s base income remained the same for the two and one-half
years (i.e., was not increasing), and the self-employment monthly income decreased from the
two prior years to the year-to-date in 2002 by approximately $250 per month. Although the
$2,818 per month was sufficient to qualify within HUD’s financial ratio limits, the lender did not
adequately verify the validity or stability of this income.




                                               20
HUD Requirements
HUD Handbook 4155.1, REV-4, CHG-1, chapter 3-1-E, states that a verification of employment
and the most recent pay stub must be used to support employment income. As an alterative to
obtaining a verification of employment, the lender may choose to obtain from the borrower
original pay stub(s) covering the most recent 30-day period, along with original copies of the
previous two years’ Internal Revenue Service Form W-2s. The pay stub(s) must show the
borrower’s name, Social Security number, and year-to-date earnings. The lender must also
verify by telephone all current employers. The loan file must include a certification from the
lender that original documents were examined and the name, title, and telephone number of the
person with whom employment was verified.

HUD Handbook 4155.1, REV-4, CHG-1, chapter 2-9-B, states that HUD requires the following
documents to support self-employment income:
   1) Signed and dated individual tax returns, plus all applicable schedules, for the most recent
      two years;
   2) Signed copies of federal business income tax returns for the last two years, with all
      applicable schedules, if the business is a corporation, an S corporation, or a partnership;
   3) A year-to-date profit and loss statement and balance sheet; and
   4) A business credit report on corporations and S corporations.




                                               21
Case number: 161-1975505                           Insured amount: $50,704

Section of Housing Act: 203(b)                     Status upon selection:
                                                      Default status after 14 months
Date of loan closing: July 15, 2002

HUD costs incurred:
  None identified


Seller/Owner Inconsistencies, Questionable Gift of Equity, and Overinsured Loan
The lender did not obtain adequate documentation to ensure that the gift of equity needed to close
the loan was from an allowable source. Only family members may provide equity credit as a gift on
a property being sold to other family members. In some instances, the loan documentation
indicated that the borrower’s grandmother owned the home and provided the gift of equity.
However, the loan documentation also contained multiple discrepancies regarding who actually
owned and was selling the property. These discrepancies call into question the validity of the gift of
equity and may be indications of fraudulent activity.

If the grandmother was not the seller, the actual seller contributed significantly more than 6 percent
of the sales price allowed by HUD regulations and paid the borrowers’ $1,882 court judgment in
violation of HUD rules. With a sales price of $51,500, an unrelated seller would be limited to
contributions of $3,090. An unrelated seller would have caused the loan to be overinsured because
the 6 percent limit was exceeded (seller contributions included a $4,600 gift of equity, and the seller
settlement charges included at least $2,300 in closing costs normally attributed to the borrower,
excluding the court judgment).

Further, if the grandmother was the actual seller, the various documents call into question whether
the grandmother was living in the subject property, and if not, the identity-of-interest limitation of
85 percent presents additional questions regarding the legitimacy of the transaction. The lender
noted on the mortgage credit analysis worksheet that the identity-of-interest exclusion was met and
that the borrowers were long-term tenants of the subject property. The credit report showed that at
least one of the borrowers lived at the subject property as early as 1993, but the loan files contained
no evidence that the borrowers rented the property, other than the borrowers’ application, which
states that they have rented the property for 10 years. The property was appraised at $53,000, and
loan was insured for $50,704.

The loan file contained two purchase agreements, each for $51,500.

    o The first (dated May 11, 2002) was between the borrowers and an individual other than
      the grandmother (hereafter referred to as “person A”). This purchase agreement said that
      the seller would pay up to $3,000 in borrower prepaids and closing costs by providing a
      $2,000 gift of equity and paying off the borrowers’ judgment to Hawkeye Inc.

    o The second (dated June 14, 2002) was between the borrowers and the grandmother and
      indicated that the seller would pay up to $3,500 in borrower prepaids and closing costs by



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       providing a $2,700 gift of equity and paying off the borrowers’ judgment to Hawkeye
       Inc.

The appraisal (dated May 29, 2002) listed person A as the seller/owner; however, the title
insurance documents (dated June 21, 2002) indicated that another party owned the property
(hereafter referred to as “person B”). The title insurance also showed that multiple real estate
documents had to be filed to clear the title to the property, including

   o Record a release of real estate contract made by person B to the grandmother in the
     amount of $28,500, dated October 15, 1987, and filed October 16, 1987. Interest in the
     real estate contract was transferred to person A by a quit claim deed, filed on June 25,
     1990.

The loan file also contained a June 28, 2002, gift of equity letter for $4,600 from the grandmother,
but the letter did not identify the borrowers and was not signed by the borrowers.

The HUD-1 settlement statement (dated July 15, 2002) was signed by person A as the seller of
the property and showed a $4,600 gift of equity; however, person A was not the grandmother and
was not the indicated donor or a relative of the borrowers. The HUD-1 settlement statement also
showed multiple borrower charges paid for by the seller, including a payoff of a first mortgage to
person B.

HUD Requirements
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2-10-A, states that only family members may
provide equity credit as a gift on a property being sold to other family members.

Chapter 1-7-A states that sellers are permitted to contribute up to 6 percent of the property’s
sales price toward the buyer’s actual closing costs, prepaid expenses, discount points, and other
financing concessions. Each dollar exceeding the Federal Housing Administration’s 6 percent
limit must be subtracted from the property’s sales price before applying the appropriate loan-to-
value ratio.

Chapter 1-7-B states that certain other expenses (beyond those described in chapter 1-7-A) paid
on behalf of the borrower and other inducements to purchase result in a dollar-for-dollar
reduction to the sales price before applying the loan-to-value ratio.

Chapter 1-8-A states that identity-of-interest transactions on principal residences are usually
restricted to a maximum loan-to-value ratio of 85 percent. “Identity-of-interest” is defined as a
transaction between family members, business partners, or other business affiliates. Maximum
financing above an 85 percent loan-to-value ratio is permissible under the certain circumstances,
including when one family member is purchasing another family member’s
    1) principal residence or
    2) property that he or she has rented for at least six months predating the sales contract. A
         lease or other written evidence must be submitted verifying occupancy.

Unallowable Charges
The HUD-1 settlement statement showed that the borrower was charged a $55 credit report fee.
Mortgage Express ordered a three repository merged credit report on February 15, 2002, for $14
and a full residential mortgage credit report on July 2, 2002, for $14. Because the residential


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mortgage credit report was ordered after the merged credit report, the borrowers should have been
charged only for the residential mortgage credit report. Therefore, the borrowers were overcharged
$42.

HUD Requirement
HUD Homeownership Center Reference Guide, chapter 2, “Mortgage Credit Guidelines,” pages
2-15, “Closing Costs and Other Fees,” states that all closing items associated with a HUD-
insured loan, including paid-outside-closing items, must be itemized on the HUD-1 settlement
statement for Real Estate Settlement Procedures Act compliance. Credit reports are to be
charged at actual cost. If the lender orders a three repository merged credit report and then
orders a full residential mortgage credit report, the borrower may only be charged for the
residential mortgage credit report.




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Case number: 321-2195941                        Insured amount: $63,995

Section of Housing Act: 203(b)                  Status upon selection:
                                                   Default status after 16 months
Date of loan closing: June 5, 2002


Unallowable Charges
The HUD-1 settlement statement showed that the borrower was charged $850 for the property
appraisal. The customary appraisal fee for this area was $450; therefore, the borrower was
overcharged $400. The HUD-1 settlement statement also showed that the borrower was charged
a $25 overnight courier fee, payable to a title company. This was not a refinance loan. In total,
the borrower was overcharged $425 to close this loan.

HUD Requirement
HUD Homeownership Center Reference Guide, chapter 2, “Mortgage Credit Guidelines,” pages 2-
15, “Closing Costs and Other Fees,” states that all closing costs associated with a HUD-insured
loan, including paid-outside-closing items, must be itemized on the HUD-1 settlement statement for
Real Estate Settlement Procedures Act compliance. Allowable appraisal fees for non-HUD-owned
properties are the customary charge for the area. Overnight courier fees are only allowable on
refinance loans.




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Case number: 161-1984269                       Insured amount: $49,227

Section of Housing Act: 203(b)                 Status upon selection:
                                                  Default status after seven months
Date of loan closing: July 30, 2002


Unallowable Charges
The HUD-1 settlement statement showed that the borrower was charged a $44 credit report fee.
The actual cost of the three credit reports totaled $30 (June 19, 2002 - $3.00; June 21, 2002 -
$14; July 3, 2002 - $14). Therefore, the borrower was overcharged $13.

HUD Requirements
HUD Homeownership Center Reference Guide, chapter 2, “Mortgage Credit Guidelines,” pages
2-15, “Closing Costs and Other Fees,” states that all closing costs associated with a HUD-insured
loan, including paid-outside-closing items, must be itemized on the HUD-1 settlement statement
for Real Estate Settlement Procedures Act compliance. Credit reports are to be charged at actual
cost.




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