oversight

First Magnus's Denver Branch Did Not Follow HUD Requirements in Underwriting 31 Loans

Published by the Department of Housing and Urban Development, Office of Inspector General on 2005-12-20.

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

                                                               Issue Date
                                                                     December 20, 2005
                                                               Audit Report Number
                                                                     2006-DE-1001




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

           //signed//
FROM:      Ronald J. Hosking, Regional Inspector General for Audit, 8AGA

SUBJECT: First Magnus’s Denver Branch Did Not Follow HUD Requirements in
            Underwriting 31 Insured Loans


                                  HIGHLIGHTS

 What We Audited and Why

            We audited the Denver, Colorado, branch of First Magnus Financial Corporation
            (First Magnus) because of its high default rate. Our objective was to determine
            whether the First Magnus Denver branch followed the Department of Housing
            and Urban Development (HUD) requirements in underwriting Federal Housing
            Administration-insured mortgages.

 What We Found
            The branch did not follow HUD requirements in underwriting 31 Federal Housing
            Administration-insured loans. We reviewed 51 loans. Thirty-two of the loans
            required full underwriting, and 19 were streamline refinances. We found
            significant underwriting deficiencies for 12 of the 32 loans that required full
            underwriting. These deficiencies affect the insurability of the loans. We also
            identified overinsured mortgages and unallowable fees in 19 of the loans
            reviewed. The branch office lacked supervision and formal policies to ensure
            compliance with HUD requirements. As a result, First Magnus placed HUD’s
            insurance fund at risk for $1,643,617, overinsured mortgages totaling $10,004,
            and charged unallowable fees totaling $1,611.
What We Recommend
           We recommend that the assistant secretary for housing – federal housing
           commissioner require First Magnus to

               •     Indemnify and/or reimburse HUD for the potential and actual losses on 11
                     loans with significant deficiencies,

               •     Reimburse the appropriate parties for the overinsured and unallowable
                     charges, and

               •     Develop policies and procedures to ensure adequate supervision over its
                     underwriting process.

           For each recommendation without a management decision, please respond and
           provide status reports in accordance with HUD Handbook 2000.06, REV-3.
           Please furnish us copies of any correspondence or directives issued because of the
           audit.

Auditee’s Response
           We provided the draft audit report to First Magnus on November 23, 2005, and
           requested their comments by December 16, 2005. First Magnus provided their
           written response on December 15, 2005. First Magnus agreed with the finding
           and recommendations.

           The complete text of the auditee’s response is in appendix B of this report.




                                             2
                             TABLE OF CONTENTS

Background and Objectives                                                          4

Results of Audit
        Finding 1: Denver Branch Did Not Follow HUD Requirements in Underwriting   5
        31 Insured Loans

Scope and Methodology                                                              10

Internal Controls                                                                  11

Appendixes
   A.   Schedule of Questioned Costs and Funds to Be Put to Better Use             12
   B.   Auditee Comments                                                           13
   C.   Schedules of Deficiencies                                                  17
   D.   Narrative Case Summaries                                                   19




                                              3
                     BACKGROUND AND OBJECTIVES

First Magnus Financial Corporation’s (First Magnus) home office is located in Tucson, Arizona.
The U.S. Department of Housing and Urban Development’s (HUD) Federal Housing
Administration approved First Magnus as a direct endorsement lender in 1996. HUD authorized
the wholesale branch located in Denver, Colorado, to sponsor Federal Housing Administration
loans in December 1999. The branch office only performs underwriting. It does not originate
Federal Housing Administration-insured loans.

The Denver branch underwrote 2,962 Federal Housing Administration-insured loans with
beginning amortization dates between April 01, 2003, and March 31, 2005. The original
mortgage amount of these loans totaled $503,444,719. Two hundred fifty-nine of these loans
(8.74 percent) defaulted within the first two years of closing. The original mortgage amount of
the defaulted loans totaled $44,970,184.

The objective of the audit was to determine whether the Denver branch followed HUD
regulations, procedures, and instructions in the underwriting of Federal Housing Administration-
insured single-family mortgages.




                                                4
                                RESULTS OF AUDIT

Finding 1: Denver Branch Did Not Follow HUD Requirements in
           Underwriting 31 Insured Loans
The Denver branch of First Magnus did not follow HUD requirements in underwriting 31
Federal Housing Administration-insured loans. The branch office lacked supervision and formal
policies to ensure compliance with HUD requirements. As a result, First Magnus placed HUD’s
single-family insurance fund at risk for $1,643,617, overinsured mortgages totaling $10,004, and
charged unallowable fees totaling $1,611.


 HUD Requirements Not
 Followed

              The Denver branch did not follow HUD requirements in underwriting Federal
              Housing Administration-insured loans. We reviewed 51 loans. Thirty-two of
              these loans required full underwriting, and 19 were streamline refinances. We
              found significant underwriting deficiencies for 12 of the 32 loans that required
              full underwriting. Appendix C lists these major deficiencies. Due to the
              seriousness of the deficiencies, HUD should not have insured the loans.

              These deficiencies include

                  •   Excessive ratios without sufficient compensating factors (ten loans)
                  •   Questionable credit history (seven loans)
                  •   Underreported liabilities (four loans)
                  •   Insufficient employment documentation (four loans)
                  •   Outstanding judgments (four loans)
                  •   Overstated income (four loans)
                  •   Unsupported assets (two loans)
                  •   Documents passed through interested third party (two loans)
                  •   Buydown agreement not assessing borrowers’ future ability to pay (two
                      loans)
                  •   Overinsured mortgages and unallowable fees (two loans)

              We also identified overinsured mortgages and unallowable fees in 19 of the loans
              reviewed. Including the two loans identified above, 21 loans contained these
              charges (see appendix C). First Magnus needs to reimburse the appropriate
              parties for the overinsured and unallowable charges.




                                               5
Deficient Loan Examples



           First Magnus approved case number 052-2747876 based on unacceptable credit
           history, understated liabilities, overstated income, insufficient employment
           documentation, unsupported assets, inaccurate and excessive debt-to-income
           ratios, and prohibited involvement by an interested third party. The net loss to
           HUD on the resale was $68,090.

              Unacceptable Credit History and Understated Liabilities
              The borrower’s credit history was unsatisfactory. The documentation for
              some of the borrower’s outstanding debt passed through the real estate agent,
              an interested third party. The underwriter did not adequately verify that the
              borrower paid all of the outstanding debt before closing, including outstanding
              derogatory debt of $2,000.

              Overstated Income and Insufficient Employment Documentation
              The underwriter did not adequately establish the anticipated amount of income
              and the likelihood it would continue. The borrower did not provide Internal
              Revenue Service W-2 forms. The only documentation provided was an
              incomplete pay stub (no year-to-date earnings, deductions, etc.) by an
              interested third party, the realtor. The tax information ordered by First
              Magnus was for only one year, and it showed much less income than was
              reported on the verification of employment.

              Our reverification of employment did not support the income reported in the
              file, and the borrower was not employed after loan closing. The lender did not
              properly verify the borrower’s income and whether that income was to
              continue; therefore, the lender should not have included it in calculating
              borrower’s income ratios. The documentation did not sufficiently support the
              borrower’s ability to repay the mortgage debt.

              Unsupported Assets
              The underwriter did not verify all funds for the borrower’s cash investment.
              The file contained an incomplete and unsigned budget letter.

              Inaccurate and Excessive Debt-to-Income Ratios
              First Magnus approved the loan with high and inaccurate qualifying ratios.
              The underwriter approved the loan at the buydown rate without adequate
              compensating factors. Using the actual note rate, the mortgage payment
              expense ratio was 35 percent, and total fixed payment ratio was 48 percent.
              As discussed above, the file documentation does not support these ratios. Due
              to these factors, it is unlikely the borrower has the ability to repay the
              mortgage debt.

              Prohibited Involvement by Interested Third Party
              The underwriter relied on documentation passed through the real estate agent,
              as an interested third party, to support the borrower’s income, employment,


                                            6
   and payoff of debts. Underwriters must verify that verification documents
   pass directly between the lender and provider without any third-party
   handling.

For case number 052-3146518, First Magnus approved the mortgage based on an
unacceptable credit history, overstated income, understated liabilities, and
inaccurate and excessive debt-to-income ratios. The net loss to HUD on the
resale was $51,314.

   Unacceptable Credit History
   The borrower’s credit history was unsatisfactory. There were no letters of
   explanation in the file for an open collection account of $104 and for a
   recently paid off derogatory account with a high balance of $14,224. The
   lender did not document its analysis of past derogatory accounts, such as the
   borrower’s disregard for financial obligations, an inability to manage debt, or
   factors beyond the borrower’s control.

   Overstated Income
   The underwriter included the borrower’s commissions for effective income;
   however, the underwriter did not obtain a current pay stub to ensure the
   commissions were likely to continue. The underwriter did not properly verify
   the commission income to ensure it was stable and that the borrower had the
   capacity to repay the mortgage debt. Without the commission income, this
   borrower does not qualify for the mortgage.

   Understated Liabilities
   The underwriter understated the recurring expenses by $138 per month. The
   underwriter did not use the most current credit report in the file. The analysis
   did not take into account the new loan taken out by the borrower for the cash
   investment in the property.

   Inaccurate and Excessive Debt-to-Income Ratios
   We recalculated the ratios using the correct gross monthly effective income
   and correct recurring expenses discussed above. The total fixed payment-to-
   income ratio would be 64.28 percent, which exceeds HUD requirements by 23
   percent.

Appendix D lists the case details for the 11 loans (excludes one loan already
resolved with HUD) with significant deficiencies.




                                  7
Lack of Supervision

             The branch manager did not supervise employees to ensure prudent underwriting
             and compliance with HUD requirements. HUD requires lenders to exercise
             control and responsible supervision over their employees. The requirement for
             control and supervision must include regular and ongoing reviews of employee
             performance and of work performed. The branch manager was not involved in
             the day-to-day supervision of employees and did not perform ongoing reviews of
             employee performance.

             When the corporate office identified deficiencies, the branch did not have formal
             procedures to correct them and prevent the problems from reoccurring. The branch
             manager received various deficiency reports from the corporate office. The branch
             manager primarily passed the deficiency information to the responsible employee
             through e-mail correspondence. The employees either e-mailed their response
             directly to the corporate office or indirectly through the branch manager. Several of
             First Magnus’s six-month early payment default reports stated the same problems.

Undue Risk to HUD’s
Insurance Fund

             First Magnus placed HUD’s insurance fund at unnecessary risk by not following
             HUD underwriting requirements. The insurance fund is at risk for the potential
             and actual losses to HUD totaling $1,643,617. The 11 loans with material
             deficiencies had original insured mortgage amounts totaling $2,012,717. Four
             loans are currently active with original insured amounts of $781,777. Three loans
             had claims paid totaling $638,618. Four loans caused losses to HUD on the
             property sales totaling $223,222. Due to the seriousness of the deficiencies
             identified, HUD should not have insured the loans.

             Because the underwriters did not follow proper underwriting guidelines,
             borrowers’ mortgages were overinsured and borrowers were charged unallowable
             fees. The overinsured mortgages totaled $10,004, and the unallowable charges
             totaled $1,611. First Magnus needs to reimburse the appropriate parties for these
             amounts.

Conclusion


             The branch did not follow HUD requirements in underwriting the insured loans.
             At the branch level, there is a lack of supervision and formal policies to ensure
             compliance with HUD requirements. The insurance fund is at risk for the
             potential and actual losses to HUD.




                                               8
Recommendations



          We recommend that the assistant secretary for housing – federal housing
          commissioner require First Magnus to

               1a. Indemnify four actively insured loans originated at $781,777, which it
                   issued contrary to HUD’s requirements.
               1b. Indemnify HUD for future losses on three loans with claims paid
                   totaling $ 638,618, which it issued contrary to HUD’s requirements.
               1c. Reimburse HUD for claims paid and losses incurred on four loans
                   totaling $ 223,222, which it issued contrary to HUD’s requirements.
               1d. Pay down the principal balance of the 10 overinsured loans totaling
                   $10,004. For loans with claims already paid, remit the payment to
                   HUD.
               1e. Reimburse the appropriate parties for the unallowable fees totaling
                   $1,611. For loans with claims already paid, remit the payment to HUD.
               1f. Develop and implement policies/procedures to supervise its
                   underwriting process.




                                          9
                         SCOPE AND METHODOLOGY

The Denver branch underwrote 2,962 Federal Housing Administration-insured loans with
beginning amortization dates between April 01, 2003, and March 31, 2005. Two hundred fifty-
nine of these loans defaulted within the first two years of closing. We reviewed 51 of these
defaulted loans. We selected the loans that posed the highest risk to the insurance fund. The risk
factors we considered were the number of payments before default and claims paid. The results
of our review only apply to the loans we reviewed.

To accomplish the audit objective, we
   •   Reviewed regulations and reference materials related to single-family requirements.
   •   Reviewed Federal Housing Administration case binders for compliance with regulations.
   •   Reviewed First Magnus’s electronically scanned loan case files.
   •   Interviewed Denver branch officials and staff.
   •   Obtained the Denver branch’s policies and procedures.
   •   Reviewed the Denver branch’s quality control plan and quality control reviews, including
       the early payment default reports. We did not evaluate First Magnus’s organizationwide
       implementation of the quality control process. Its corporate office performs this function.
       Another region is performing an audit of First Magnus’s quality control process at the
       corporate level. We only reviewed the quality control procedures as they relate to the
       underwriting function at the branch level.
   •   Interviewed and discussed findings with the Denver HUD Quality Assurance Division
       office.

We used data maintained by HUD in the Single Family Data Warehouse and Neighborhood
Watch systems for background information and in selecting our sample of loans. We did not
rely on the data to base our conclusions. Therefore, we did not assess the reliability of the data.

We performed the audit work from May to October 2005 and conducted the audit in accordance
with generally accepted government auditing standards.




                                                 10
                             INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides
reasonable assurance that it meets the following objectives:

   •   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:

              •       Underwriting policies and procedures – Policies and procedures established
                      by management to ensure Federal Housing Administration-insured loans are
                      underwritten in accordance with HUD requirements and

              •       Quality control process – Policies and procedures established by
                      management to ensure implementation of the quality control plan and
                      performance of related reviews in accordance with HUD requirements.

              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:

              •       First Magnus does not have an adequate underwriting process to ensure
                      compliance with HUD requirements.




                                               11
                                      APPENDIXES

Appendix A

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

                 Recommendation             Ineligible 1/    Unsupported 2/      Funds to be put
                        number                                                    to better use 3/
                                 1a                                                    $ 781,777
                                 1b                                $ 638,618
                                 1c           $ 223,222
                                 1d           $ 10,004
                                 1e           $ 1,611



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/   “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.




                                              12
Appendix B

             AUDITEE COMMENTS




                    13
14
15
16
       Appendix C

                                                                                               SCHEDULES OF DEFICIENCIES


                                                                                                                               SIGNIFICANT DEFICIENCIES



                                                                                               Excessive ratios insufficient




                                                                                                                                                                                                                                                              Buydown affects pay ability
                Questionable credit history




                                                                                                                                                                              Prohibited involvement by




                                                                                                                                                                                                                                  Significantly overinsured
                                                                   Underreported liabilities




                                                                                                                                                   Insufficient employment




                                                                                                                                                                                                          Outstanding judgments
                                                                                               compensating factors




                                                                                                                                                                              interested third party
                                              Unsupported assets




                                                                                                                               Overstated income


                                                                                                                                                   documentation
                                                                                                                                                                                                                                                                                              Original
                                                                                                                                                                                                                                                                                              mortgage    Claim paid    Loss on
 Case number                                                                                                                                                                                                                                                                                 amount (1)       (2)       sale (3)
052-3146518      X                                                  X                                   X                       X                                                                                                                                                                                      $ 51,314
052-2747876      X                            X                     X                                   X                       X                        X                           X                                                                                                                                 $ 68,090
052-2817280                                                         X                                   X                       X                        X                           X                                                                                                                                 $ 59,218

052-2922722      X                                                                                      X                                                                                                                           X                                                                                  $   44,600
                                                                                                                                                                                                                                                                                                                         HUD
052-2844762                                                                                             X                                                                                                                                                                                                              Resolved.
052-2924979      X                                                                                                                                                                                         X                                                                                              $ 209,110
052-2999800                                                         X                                   X                         X                                                                                                                                                          $ 197,214
052-3163306                                                                                             X                                                X                                                                                                     X                             $ 236,572
052-3426597      X                                                                                                                                                                                         X                                                                                              $ 220,809
052-3427869      X                            X                                                      X                                                                                                     X                                                                                 $ 202,492
052-3522232                                                                                          X                                                                                                                                                             X                         $ 145,499
052-3549973      X                                                                                   X                                                   X                                                 X                                                                                              $ 208,699
        Count    7                              2                    4                               10                          4                       4                            2                    4                         1                          2                                4            3            4

                                                                                                                                                                                                                                  Totals $                                                    781,777     $ 638,618    $ 223,222

                                                                                                                                                                             Combined totals =                                                                                              $ 1,643,617

          (1) Loans actively insured as of September 30, 2005.
          (2) HUD paid a claim for these loans and acquired the property. As of September 30, 2005,
              HUD has not sold the properties.
          (3) HUD incurred a loss after the sale of these properties.




                                                                                                                                                                                                     17
                      Unallowable Fees and Overinsured Loans


                                                                       Overinsured loan
 Case number              Type of loan          Unallowable fees (1)         (2)
 052-2890195         Streamline refinance       $       40.00
 052-2921727         Streamline refinance                              $     1,184.28
 052-2922722         Conventional refinance     $        50.00          See above chart.
 052-3147261         Streamline refinance                              $       674.58
 052-2693666         Conventional refinance     $        20.00
 052-3366730         Streamline refinance       $        40.00
 052-2812701         Streamline refinance       $        16.00         $     1,662.96
 052-3380210         Purchase                   $        25.00
 052-2822222         Streamline refinance                              $        99.85
 052-2826020         Streamline refinance       $       50.00          $     1,449.87
 052-2830439         Streamline refinance       $       40.00
 052-2963995         Streamline refinance       $       40.00
 052-2974532         Streamline refinance       $       40.00          $     1,776.70
 052-2999800         Purchase                   $      515.00
 052-3138251         Streamline refinance       $       40.00
 052-3449450         Streamline refinance       $       45.00          $       349.00
 052-3170619         Cash-out refinance         $      515.00
 052-3179840         Purchase                   $       15.00
 052-3232401         Streamline refinance       $       40.00          $       410.00
 052-3291054         Streamline refinance       $       40.00          $     1,557.19
 052-3327714         Cash-out refinance         $       40.00          $       839.75
                                      Count             18                    10

                     Totals                               $1,611.00           $10,004.18


(1)   First Magnus charged unallowable administration fees as the lender underwriting these
      loans. It also charged borrowers unallowable courier fees. Courier fees were
      unallowable because either the loans were not refinances or the borrowers did not agree
      to pay for the courier service in writing before loan closing. (HUD Handbook 4000.2,
      REV-2, paragraph 5-3; HUD Handbook 4000.2, REV-3, paragraph 5-2 )

(2)   First Magnus did not correctly calculate the allowable mortgage amount for these
      refinanced loans. (HUD Handbook 4155.1 REV-4, CHG-1, paragraphs 1-11 and 1-12;
      Mortgagee Letter 2001-12; HUD Handbook 4155.1 REV-5, paragraphs 1-11 and 1-12)




                                           18
Appendix D

                         NARRATIVE CASE SUMARIES

(This section contains the narrative case summaries for the loans identified with significant
deficiencies.)

HUD case number:       052-3146518                   Status:         Net loss to HUD on resale
Loan amount:           $128,504                      Loss on resale: $51,314
Closing date:          September 26, 2003

First Magnus underwrote and approved the mortgage based on an unacceptable credit history,
overstated income, understated liabilities, and inaccurate and excessive debt-to-income ratios.
Therefore, HUD insured the loan based on First Magnus’s inaccurate representation that the
borrower met HUD qualifying guidelines.

Unacceptable Credit History
HUD Handbook 4155.1, REV-4, CHG-1, paragraphs 2-3 and 2-5; 24 CFR [Code of Federal
Regulations] 203.5(c)
The borrower’s credit history was unsatisfactory. There were no letters of explanation in the file
for an open collection account of $104 and for a recently paid off derogatory account with a high
balance of $14,224. The lender did not document its analysis of past derogatory accounts, such
as the borrower’s disregard for financial obligations, an inability to manage debt, or factors
beyond the borrower’s control.

Overstated Income
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 2
The underwriter included the borrower’s commissions for effective income; however, the
underwriter did not obtain a current pay stub to ensure the commissions were likely to continue.
The underwriter did not properly verify the commission income to ensure the stability of the
income and the borrower’s capacity to repay the mortgage debt. Without the commission
income, this borrower does not qualify for the mortgage.

Understated Liabilities
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 4
The underwriter understated the recurring expenses by $138 per month. The underwriter did not
use the most current credit report in the file. The analysis did not take into account the new loan
taken out by the borrower for the cash investment in the property.

Inaccurate and Excessive Debt-to-Income Ratios
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 5; Mortgagee Letter 97-26
We recalculated the ratios using the correct gross monthly effective income and correct recurring
expenses discussed above. The total fixed payment-to-income ratio would be 64.28 percent,
which exceeds HUD requirements by 23 percent.




                                                19
HUD case number:      052-2747876                    Status:         Net loss to HUD on resale
Loan amount:          $134,883                       Loss on resale: $68,090
Closing date:         March 31, 2003

First Magnus underwrote and approved the mortgage based on an unacceptable credit history,
understated liabilities, overstated income, insufficient employment documentation, unsupported
assets, inaccurate and excessive debt-to-income ratios, and prohibited involvement by an
interested third party. Therefore, HUD insured the loan based on First Magnus’s inaccurate
representation that the borrower met HUD qualifying guidelines.

Unacceptable Credit History and Understated Liabilities
HUD Handbook 4155.1, REV-4, CHG-1, paragraphs 2-3, 2-5, and 2-11; 24 CFR [Code of
Federal Regulations] 203.5(c)
The borrower’s credit history was unsatisfactory. The borrower did not pay an outstanding
derogatory debt of $2,000 before closing. The underwriter did not adequately verify that the
borrower paid all of the outstanding debt before closing. The documentation for some of the
borrower’s outstanding debt passed through the real estate agent.

Overstated Income and Insufficient Employment Documentation
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 2, and chapter 3, paragraph 3-1
The underwriter did not adequately establish the anticipated amount of income and the likelihood
of its continuance. The documentation did not sufficiently support the borrower’s ability to
repay the mortgage debt. The file did not contain the most recent year-to-date pay stub,
documenting one full month’s earnings. An incomplete pay stub was provided (no year-to-date
earnings, deductions, etc.) by an interested third party, the realtor. The borrower did not provide
Internal Revenue Service W-2 forms. The tax information ordered by First Magnus was for only
one year, and it showed much less income than was reported on the verification of employment.

Our reverification of employment did not support the income reported in the file. The loan
closed at the end of March 2003; however, the employer terminated the borrower’s employment
after March 2003. The lender did not properly verify the borrower’s income and whether that
income was to continue; therefore, it could not be included in calculating borrower’s income
ratios.

Unsupported Assets
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 3
The underwriter did not verify all funds for the borrower’s cash investment. The borrower
appeared to have completed but did not sign the budget letter noted in the file.

Inaccurate and Excessive Debt-to-Income Ratios
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 5; Mortgagee Letter 97-26
First Magnus approved the loan with high and inaccurate qualifying ratios. The underwriter
approved the loan at the buydown rate without adequate compensating factors. Using the actual
note rate, the mortgage payment expense ratio was 35 percent and total fixed payment ratio was
48 percent. As discussed above, the file documentation does not support these ratios. Due to
these factors, it is unlikely the borrower has the ability to pay the mortgage.




                                                20
Prohibited Involvement by Interested Third Party
HUD Handbook 4155.1, REV-4, CHG 1, chapter 3, section 1
The underwriter relied on documentation passed through the real estate agent, as an interested
third party, to support the borrower’s income, employment, and payoff of debts. Underwriters
must verify that verification documents pass directly between the lender and provider without
any third-party handling.




                                               21
HUD case number:      052-2817280                    Status:         Net loss to HUD on resale
Loan amount:          $162,450                       Loss on resale: $59,218
Closing date:         April 29, 2003

First Magnus underwrote and approved the mortgage based on unacceptable overstated income,
insufficient employment documentation, understated liabilities, inaccurate and excessive debt-to-
income ratios, and prohibited involvement by an interested third party. Therefore, HUD insured
the loan based on First Magnus’s inaccurate representation that the borrower met HUD
qualifying guidelines.

Overstated Income and Insufficient Employment Documentation
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 2, and chapter 3, paragraph 3-1
The underwriter did not adequately establish the anticipated amount of income and the likelihood
of its continuance. The documentation did not sufficiently support the borrower’s ability to
repay the mortgage debt. The file did not contain the most recent year-to-date pay stub
documenting one full month’s earnings. An incomplete pay stub was provided (no year-to-date
earnings, deductions, etc.) by an interested third party, the realtor. The borrower did not provide
Internal Revenue Service W-2 forms.

Our reverification of employment did not support the income reported in the file. The loan
closed at the end of April 2003; however, the employer terminated the borrower in March 2003.
The lender did not verify the borrower’s income and whether it was to continue; therefore, it
could not be included in calculating borrower’s income ratios.

Understated Liabilities
HUD Handbook 4155.1, REV-4, CHG-1, paragraphs 2-3 and 2-11
There was no verification of rental history as required. The credit report shows one small
derogatory item and two liabilities with monthly payments of $47 that were not on the loan
application and mortgage credit analysis worksheet. The underwriter should have considered the
additional debt in the calculation of recurring expenses.

Inaccurate and Excessive Debt-to-Income Ratios
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 5; Mortgagee Letter 97-26
First Magnus approved the loan with high and inaccurate qualifying ratios. The underwriter used
inaccurate compensating factors. The underwriter did not determine how the borrower would
handle the payment shock. The borrower had no verifiable assets or investment in the property.
As discussed above, the lack of employment does not support the ratios. It is unlikely the
borrower has the ability to repay the mortgage debt.

Prohibited Involvement by Interested Third Party
HUD Handbook 4155.1, REV-4, CHG 1, chapter 3, section 1
The underwriter relied on documentation passed through the real estate agent, as an interested
third party, to support the borrower’s income and employment. Underwriters must verify that
verification documents pass directly between the lender and provider without any third-party
handling.




                                                22
HUD case number:      052-2922722                   Status:        Preforeclosure sale
Loan amount:          $195,668                                     completed
Closing date:         June 12, 2003                 Claim Paid:    $44,600

First Magnus underwrote and approved the mortgage based on a questionable credit history and
inaccurate and excessive debt-to-income ratios and significantly overinsured loan. Therefore,
HUD insured the loan based on First Magnus’s inaccurate representation that the borrower met
HUD qualifying guidelines.

Unacceptable Credit History
HUD Handbook 4155.1, REV-4, CHG-1, paragraphs 2-3 and 2-5; 24 CFR [Code of Federal
Regulations] 203.5(c)
The borrower’s credit history was unsatisfactory. The borrower had several derogatory credit
items shown on the credit report, which shows a poor attitude toward credit obligations. The
underwriter did not obtain a written explanation or document compensating factors for approving
the loan. The lender did not document its analysis as to whether past derogatory accounts were
due to the borrower’s disregard for financial obligations, an inability to manage debt, or factors
beyond the control of the borrower.

Inaccurate and Excessive Debt-to-Income Ratios
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 5; Mortgagee Letter 97-26
The mortgage payment expense ratio exceeds the guidelines. The underwriter did not list any
compensating factors on the mortgage credit analysis worksheet as required. The documentation
did not sufficiently support the borrower’s ability to repay the mortgage debt.

Significantly Overinsured Loan
HUD Handbook 4155.1, REV-4, CHG-1, chapter 1, section 4
The loan was a cash-out refinance for the purposes of consolidating the first mortgage and a
debt. Cash-out refinances are limited to 85 percent of the appraised value. The appraised value
is $205,000; therefore, the loan amount should not have exceeded $174,250. The loan amount
was actually $195,688, or $21,438 over the allowable insured amount.




                                               23
HUD case number:      052-2924979                   Status:      Property conveyed to insurer
Loan amount:          $193,956                      Claims Paid: $209,110
Closing date:         June 27, 2003

First Magnus underwrote and approved the mortgage based on questionable credit history and
outstanding judgments. Therefore, HUD insured the loan based on First Magnus’s inaccurate
representation that the borrower met HUD qualifying guidelines.

Questionable Credit History and Outstanding Judgments
HUD Handbook 4155.1, REV-4, CHG-1, paragraphs2-3 and 2-5
The borrower’s credit report showed 59 collection accounts and 2 civil judgments. It does not
appear the borrower had a good attitude toward credit obligations, although the borrower
provided some letters of explanation for the collection accounts. The borrower did not pay two
of the judgments totaling $220 before closing. The borrower is required to pay off judgments
before loan approval. The underwriter must consider the judgments, as well as the numerous
collections, in the analysis of credit worthiness because they indicate the borrower’s disregard
for credit obligations.

Despite adequate income to support the obligations, the borrower did not have a good attitude
toward credit obligations. The borrower did not invest any of his own funds in the property. The
borrower deposited $500 as earnest money but received $500 back at closing. The borrower
received gift funds as the cash requirement. The borrower only made two payments before
defaulting and only made three payments during the approximately one and one-half years of the
loan.




                                               24
HUD case number:      052-2999800                    Status:          Reinstated by mortgagor
Loan amount:          $197,214                       Indemnification: $197,214
Closing date:         July 21, 2003

First Magnus underwrote and approved the mortgage based on overstated income, understated
liabilities, and inaccurate and excessive debt-to-income ratios. Therefore, HUD insured the loan
based on First Magnus’s inaccurate representation that the borrower met HUD qualifying
guidelines.

Overstated Income
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 2
The mortgage credit analysis worksheet overstates the coborrower’s monthly income of $497.
The underwriter used a 17.8-month average to compute the monthly income for the coborrower.
The two pay-stubs and two Internal Revenue Service W-2 forms in the file do not support the
higher income amount.

Understated Liabilities
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 4
The mortgage credit analysis worksheet understated the recurring liabilities by $353. The
monthly car payment of $353 was not included in the recurring expenses because there were
fewer than 10 monthly payments remaining. However, HUD requirements state that lenders
must count debts with fewer than 10 months remaining if the amount of the debt affects the
borrower’s ability to make the mortgage payment, especially if there are limited cash assets after
closing. The borrower’s cash reserves are less than one month’s reserve. The limited cash
reserve, along with the overstated income above, affects the borrower’s ability to make the
mortgage payment. The car payment should have been included in the recurring expenses.

Inaccurate and Excessive Debt-to-Income Ratios
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 5; Mortgagee Letter 97-26
The underwriter approved the loan with a high qualifying ratio. The total fixed payment-to-
income ratio was 53.70 percent, which exceeds the HUD requirement by 12.7 percent. We
recalculated the qualifying ratios using the correct gross monthly income and correct recurring
expenses discussed above. The recalculated mortgage payment-to-income ratio of 32.11 percent
exceeds the HUD requirement by approximately 3 percent. The total fixed payment-to-income
ratio of 68.91 percent exceeds the HUD requirements by almost 28 percent.




                                                25
HUD case number:      052-3163306                   Status:                Delinquent
Loan amount:          $236,572                      Indemnification:       $236,572
Closing date:         September 29, 2003

First Magnus underwrote and approved the mortgage based on insufficient employment
documentation, insufficient verification of rent payment history, inaccurate and excessive debt-
to-income ratios, and inappropriate use of a buydown to qualify. Therefore, HUD insured the
loan based on First Magnus’s inaccurate representation that the borrower met HUD qualifying
guidelines.

Insufficient Employment Documentation
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 2, and chapter 3, paragraph 3-1
The underwriter did not adequately verify and document the borrower’s income. The
underwriter cannot use the income to approve the loan if it is not sufficiently verified and
documented. The file did not contain the most recent year-to-date pay stub or Internal Revenue
Service W-2 forms to support the income.

Insufficient Verification of Rent Payment History
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 1, and chapter 3, paragraph 3-1
The underwriter did not verify previous rental payment for the most recent 12 months. The
mortgage credit analysis worksheet shows the new total mortgage payment to be $1,582. This is
more than a $700 increase in the housing payment. Without verification of the previous rent
payment and without considering the buydown interest rate (below), the underwriter did not
support that the borrower had the capacity to qualify the loan.

Excessive Debt-to-Income Ratios
HUD Handbook 4155.1, REV-4, CHG-1, chapter 2, section 5
First Magnus approved the loan with a high mortgage payment-to-income ratio. The mortgage
payment-to-income ratio was 35.72, which exceeds the HUD requirement by almost 7 percent.
The files did not contain documentation or support for the compensating factors. The
underwriter should not have used the buydown to approve the loan. The underwriter should have
only used it as a compensating factor.

The mortgage payment-to-income ratio increases to 42.42, and the total fixed payment-to-
income ratio increases from 37.98 to 44.68, using the actual note mortgage payment. The file
contains no evidence the underwriter considered this increase to determine whether the borrower
had the capacity to handle the higher payment. These excessive ratios and the lack of
compensating factors do not support approving the loan. It is unlikely the borrower has the
ability to repay the mortgage debt.

Inappropriate Use of Buydown to Qualify
HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-14; Mortgagee Letter 97-26
First Magnus qualified the borrower using the buydown interest rate but failed to show that the
scheduled mortgage payment increase would not adversely affect the borrower and likely lead to
default. To use the buydown interest rate to qualify, the underwriter must document the
borrower’s ability to handle the scheduled mortgage payment increase. It is unlikely the
borrower has the ability to repay the mortgage debt.



                                               26
HUD case number:      052-3426597                    Status:      Property conveyed to insurer
Loan amount:          $213,647                       Claims Paid: $220,809
Closing date:         May 28, 2004

First Magnus underwrote and approved the mortgage based on questionable credit history and
outstanding judgments. Therefore, HUD insured the loan based on First Magnus’s inaccurate
representation that the borrower met HUD qualifying guidelines.

Questionable Credit History and Outstanding Judgments
HUD Handbook 4155.1, REV-5, paragraphs 2-3 and 2-5
The borrower’s credit report shows one judgment, two bankruptcies, an account more than 90
days old, 10 seriously delinquent accounts, and 12 closed/paid off accounts. Although the file
contained some explanation letters and some of the items were older, it does not appear the
borrower had a good attitude toward credit obligations. The borrower did not pay a judgment for
$300 before closing, which the borrower is required to pay as a condition of loan approval. The
borrower did not explain two derogatory debts. The borrower must explain in writing all
collections and judgments. The underwriter must consider the judgments, as well as the overall
pattern of credit behavior, in the analysis of credit worthiness because they indicate the
borrower’s disregard for credit obligations.

The underwriter did not verify rent, and the file did not contain documentation for verification of
rental history. The new total mortgage payment is $1,622. Based on the unverified
documentation in the file, this is at least a $400 increase in the housing payment. With the
borrower’s credit history, we question whether the borrower has the capacity to qualify for this
high a mortgage amount.




                                                27
HUD case number:      052-3427869                    Status:               Delinquent
Loan amount:          $202,492                       Indemnification:      $202,492
Closing date:         May 24, 2004

First Magnus underwrote and approved the mortgage based on a questionable credit history and
outstanding judgment, inadequately supported assets, and inaccurate and excessive debt-to-
income ratios. Therefore, HUD insured the loan based on First Magnus’s inaccurate
representation that the borrower met HUD qualifying guidelines.

Questionable Credit History and Outstanding Judgment
HUD Handbook 4155.1, REV-5, chapter 2, section 1
The borrower’s credit report shows 5 judgment and 15 collection accounts. Although the file
contained some explanation letters and some of the items were older, it shows a serious disregard
for credit obligations, and it does not appear the borrower had a good attitude toward credit
obligations. The borrower did not pay a judgment for $700 before closing, which the borrower is
required to pay as a condition of loan approval. The borrower must explain in writing all
judgments and collections. The borrower paid the collection accounts as a condition for loan
approval; however, this decreased the borrower’s cash reserves (see below). The underwriter
must consider the judgments, as well as the overall pattern of credit behavior, in the analysis of
credit worthiness because they indicate the borrower’s disregard for credit obligations.

Unsupported Assets
HUD Handbook 4155.1, REV-5, chapter 2, section 3
The underwriter did not adequately verify and document funds for the borrower’s cash
investment. The file only contained a summary bank statement showing the balance of the bank
account. The statement showed a balance of more than $20,000 but did not show the detailed
monthly activity. Due to the credit history of the borrower, this is a rather large amount of
money and requires the lender to obtain a creditable explanation of the source of funds.

Excessive Debt-to-Income Ratios
HUD Handbook 4155.1, REV-5, chapter 2, section 5
First Magnus approved the loan with excessive qualifying ratios without adequate compensating
factors. The mortgage and fixed payment-to-income ratios were 47.89 percent, which exceeds
the HUD requirement by almost 19 percent for the mortgage payment ratio and by almost 7
percent for the total fixed payment ratio. There was not support in the files for the compensating
factors listed on the mortgage credit analysis worksheet.

The actual cash reserves after closing were almost zero because cash reserves listed in the file
paid for collection accounts and the large amount of funds required for closing and should have
paid for the outstanding judgments. The underwriter considered that the borrower had a low loan
amount compared to the value of the property. However, the loan was for 96 percent of the
value of the property, which is not low and is an unsupported compensating factor. The credit
history, low cash reserves, and high ratios causes doubt as to whether the borrower can
reasonably be expected to meet the expenses involved in homeownership.




                                                28
HUD case number:      052-3522232                  Status:          First legal action to
Loan amount:          $145,499                                      commence foreclosure
Settlement date:      August 31, 2004              Indemnification: $145,499

First Magnus underwrote and approved the mortgage based on inaccurate and excessive debt-to-
income ratios and inappropriate use of a buydown to qualify. Therefore, HUD insured the loan
based on First Magnus’s inaccurate representation that the borrower met HUD qualifying
guidelines.

Excessive Debt-to-Income Ratios
HUD Handbook 4155.1, REV-5, chapter 2, section 5
First Magnus approved the loan with high qualifying ratios. The total mortgage payment-to-
income and the total fixed payment-to-income ratios were 44.80 percent, which exceeds the
HUD requirement by almost 16 percent for the mortgage payment ratio and by almost 4 percent
for the total fixed payment ratio. The compensating factors were minimal and were not
significant factors as required for approving a buydown loan. The underwriter should have used
the buydown as a compensating factor, and she should not have used it to approve the loan.

Using the actual note mortgage payment, the mortgage payment expense and total fixed payment
ratios were 53.49 percent. We considered an average of the borrower’s overtime income and the
cash reserves of the borrower, which were compensating factors. The compensating factors were
minimal and not significant enough to support the borrower’s ability to pay the mortgage. These
excessive ratios and the minimal compensating factors do not support approving the loan, and it
is unlikely the borrower has the ability to repay the mortgage debt.

Inappropriate Use of Buydown to Qualify
HUD Handbook 4155.1, REV-5, paragraph 2-14
First Magnus qualified the borrower using the buydown interest rate but failed to show that the
scheduled mortgage payment increase would not adversely affect the borrower and likely lead to
default. To use the buydown interest rate to qualify, the underwriter must document the
borrower’s ability to handle the scheduled mortgage payment increase. It is unlikely the
borrower has the ability to repay the mortgage debt.




                                              29
HUD case number:      052-3549973                   Status:      Accelerated claim disposition
Loan amount:          $201,832                      Claims Paid: $208,699
Closing date:         October 01, 2004

First Magnus underwrote and approved the mortgage based on an unacceptable credit history,
understated liabilities, and inaccurate and excessive debt-to-income ratios. Therefore, HUD
insured the loan based on First Magnus’s inaccurate representation that the borrower met HUD
qualifying guidelines.

Unacceptable Credit History
HUD Handbook 4155.1, REV-5, paragraph 2-3
The borrower’s credit history was unsatisfactory. The credit report listed a judgment for $525.
HUD requires that court-ordered judgments be paid off before the mortgage loan is eligible for
insurance endorsement. The file did not contain documentation that showed the borrower paid
off the judgment before closing or endorsement. According to the underwriter, she mistakenly
overlooked this judgment.

Understated Liabilities
HUD Handbook 4155.1, REV-5, paragraphs 2-3 and 2-11
The mortgage credit analysis worksheet understates the borrower’s recurring liabilities by $602.
There is no documentation in the file to show the borrower paid off the five accounts as stated on
the application. Four of the five accounts were in collection for bad debts. The balances of these
four accounts total $173.

The fifth account not paid off was with Countrywide Home Loans for $92,377 at $602 per
month. A condition of the loan approval was the sale of the house mortgaged with Countrywide
Home Loans with anticipated sale proceeds expecting to total $9,000. The borrower did not sell
the property before loan closing. Since borrower did not pay off the loan before closing, the
recurring expenses increased from $469 to $1,071.

Inaccurate/Excessive Debt-to-Income Rratios
HUD Handbook 4155.1, REV-5, chapter 2, section 5
The underwriter approved the loan with high qualifying ratios without adequate compensating
factors. The mortgage payment-to-income ratio was 33.70 percent, which exceeds the HUD
requirement by almost 5 percent. The total fixed payment-to-income ratio was 44.96 percent,
which exceeds the HUD requirement by almost 4 percent. We recalculated the qualifying ratios
using the correct recurring expenses discussed above. With the increase of $602 to the recurring
expenses, the total fixed payment-to-income ratio increased to 51 percent. This exceeds the
HUD requirement by 10 percent.

Compensating factors listed on the mortgage credit analysis worksheet were inadequate, and the
file did not contain any support for the exceeding ratios. The file contained no support for the
compensating factor of two months’ reserves.

The housing expense more than doubled. It increased by more than $800 dollars. This increase,
along with the high ratios, causes doubt as to the borrower’s ability to meet the expenses
involved in homeownership.




                                               30