Issue Date
June 19, 2006
Audit Report Number
2006-NY-1007
TO: Brian D. Montgomery, Assistant Secretary for Housing - Federal Housing
Commissioner, H
FROM: Edgar Moore, Regional Inspector General for Audit, 2AGA
SUBJECT: First Suffolk Mortgage Corporation, North Babylon, New York, Did Not Always
Comply with HUD Underwriting Requirements
HIGHLIGHTS
What We Audited and Why
We audited First Suffolk Mortgage Corporation (First Suffolk), a nonsupervised
direct endorsement lender located in North Babylon, New York, because its
default and claim rate for loans with a beginning amortization date between July
1, 2003 and June 30, 2005 was more than twice the New York State average rate.
The audit objectives were to determine whether First Suffolk (1) approved insured
loans in accordance with U.S. Department of Housing and Urban Development
(HUD)/Federal Housing Administration requirements, which include following
prudent lending practices, and (2) developed and implemented a quality control
plan that complied with HUD requirements.
What We Found
First Suffolk did not always comply with HUD underwriting requirements.
Consequently, three of eight loans we reviewed exhibited significant underwriting
deficiencies, such as failure to ensure that the minimum cash investment was
made, and that employment, other assets, and debt were properly verified. The
remaining five loans contained technical violations. As a result, the HUD/Federal
Housing Administration insurance fund paid claims associated with two loans and
continues to assume a risk with the one other loan. These deficiencies occurred
because First Suffolk lacked adequate controls to ensure that loans were
processed in accordance with HUD requirements.
First Suffolk had weaknesses in the implementation of its quality control plan. It
did not always comply with HUD’s and its own quality control requirements to
(1) ensure that all HUD-insured loans that went into default within the first six
payments were reviewed and (2) document that corrective action was taken on all
material findings identified in quality control reviews. This noncompliance
occurred because First Suffolk did not have procedures to obtain default data from
HUD’s Neighborhood Watch system and/or its servicers and to ensure that its
corrective action process addressed all identified deficiencies. Consequently, the
effectiveness of First Suffolk’s quality control plan, which is designed to ensure
accuracy, validity, and completeness in its loan origination process, was lessened.
What We Recommend
We recommend that the assistant secretary for housing - federal housing
commissioner require First Suffolk to (1) reimburse HUD for the amount of
claims and associated fees paid on two loans with significant underwriting
deficiencies, (2) indemnify HUD against future losses on the one loan with
significant underwriting deficiencies, (3) establish procedures to ensure that HUD
underwriting requirements are properly implemented and documented, and (4)
implement procedures to ensure compliance with HUD’s and its own quality
control requirements.
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 a copy of the draft report to the auditee on May 5, 2006, and
discussed the findings with the auditee during the audit and at the exit conference
held on May 19, 2006. The auditee provided written comments on May 31, 2006,
and generally disagreed with our findings.
The complete text of the auditee’s response, along with our evaluation of that
response, can be found in appendix B of this report.
2
TABLE OF CONTENTS
Background and Objectives 4
Results of Audit
Finding 1: First Suffolk Did Not Always Comply with HUD’s 5
Underwriting Requirements
Finding 2: First Suffolk Had Weaknesses in the Implementation of its Quality 10
Control Plan
Scope and Methodology 13
Internal Controls 14
Appendixes
A. Schedule of Questioned Costs and Funds to Be Put to Better Use 16
B. Auditee Comments and OIG’s Evaluation 17
C. Summary of Underwriting Deficiencies 31
D. Case Summary Narratives 32
3
BACKGROUND AND OBJECTIVES
First Suffolk Mortgage Corporation (First Suffolk) was incorporated in the state of New York in
June 1983. First Suffolk is a licensed mortgage banker in New York and Connecticut, a U.S.
Department of Housing and Urban Development (HUD)-approved Title II lender (one to four
family first mortgages), and an approved Federal National Mortgage Association seller/servicer.
First Suffolk originates conventional and Federal Housing Administration mortgages to be sold
in the secondary market. It operates in the New York metropolitan area, with the predominant
portion of its business being conducted on Long Island.
First Suffolk originated 211 HUD-insured loans between July 1, 2003, and June 30, 2005.
During this period, its default and claim rate was 4.74 percent. We selected First Suffolk for
audit because this rate was more than twice the New York State average default and claim rate of
1.82 percent. First Suffolk contracted its quality control function to an independent firm.
The objectives of the audit were to determine whether First Suffolk (1) approved insured loans in
accordance with HUD/Federal Housing Administration requirements, which include following
prudent lending practices, and (2) developed and implemented a quality control plan that
complied with HUD requirements.
4
RESULTS OF AUDIT
Finding 1: First Suffolk Did Not Always Comply with HUD’s
Underwriting Requirements
First Suffolk did not follow prudent lending practices and HUD regulations in the origination and
underwriting of eight 1 loans we reviewed. As a result, three loans exhibited significant
underwriting deficiencies, such as failure to ensure that the minimum cash investment was made
and that employment, other assets, and debt were properly verified. The remaining five loans
contained technical violations. Consequently, the HUD/Federal Housing Administration
insurance fund paid claims totaling $526,944 and continues to be at risk for $256,750. In
addition, three borrowers were charged ineligible fees. These deficiencies occurred because First
Suffolk lacked adequate controls to ensure that loans were processed in accordance with HUD
requirements.
Significant Underwriting
Deficiencies
Paragraph 3-1 of HUD Handbook 4155.1, REV-4, entitled “Mortgage Credit
Analysis for Mortgage Insurance,” requires that the loan application package
contain sufficient documentation to support a lender’s decision to approve a loan.
While this decision involves some subjectivity, our examination of eight loans
approved by First Suffolk disclosed significant underwriting deficiencies in the
approval of three loans. First Suffolk did not always (1) ensure that the minimum
cash investment was provided, (2) sufficiently analyze borrowers’ credit, (3)
adequately document and/or verify gifts, and (4) properly verify borrowers’
employment. The frequency of these deficiencies is noted in the chart below.
The deficiencies noted are not independent of one another, as one loan may have
contained more than one deficiency.
Deficiency Number of loans
Minimum cash investment not provided 2 of 3 loans
Inadequate credit analysis 2 of 3 loans
Inadequate documentation and/or 2 of 3 loans
verification of gift
Inadequate verification of borrower’s 2 of 3 loans
employment
1
We originally reviewed nine loans; however, one of the loans was paid-in-full and the Federal Housing
Administration insurance was terminated prior to completion of the draft audit report. As a result, we are reporting
on eight loans for which either a claim was paid or that still represent a risk to the FHA insurance fund.
5
Specific examples of these significant underwriting deficiencies follow:
• For loan number 374-4317363, the minimum cash investment was not
met, and a gift letter was not provided. Mortgagee Letter 98-29, dated
October 22, 1998, provides that the National Housing Act requires the
minimum cash investment to be 3 percent of the secretary of HUD’s
estimate of the cost of acquisition. While the minimum cash investment
for this loan was $8,383, the borrower invested $6,888, representing a
shortage of $1,495. In addition, there was no gift letter documented to
support the $8,000 gift listed on the mortgage credit analysis worksheet.
Mortgagee Letter 00-28, dated August 7, 2000, requires that the lender
obtain a gift letter specifying, among other things, the dollar amount given
and that no repayment is required.
• For loan number 374-4297672, the loan was approved with inadequate
analysis and verification of the borrower’s employment and credit. HUD
Handbook 4155.1, REV-4, CHG-1, paragraph 3-1, requires that when
standard documentation does not provide enough information to support a
decision to approve a loan, the lender must provide additional explanatory
statements to clarify or supplement the documentation. First Suffolk did
not resolve a significant discrepancy in the borrower’s reported wages. It
obtained a verification of employment from the borrower’s first employer
reporting year-to-date wages of $24,085, while the borrower’s most recent
pay stub reported year-to-date wages of $13,275 for the same period.
Further, First Suffolk did not resolve an inconsistency in an explanation
for a derogatory account. HUD Handbook 4155.1, REV-4, CHG-1,
paragraph 2-3, requires that major indications of derogatory credit have
sufficient written explanation from the borrower that makes sense and is
consistent with other credit information in the file. The account, opened in
November 2000, was late five times during the period February through
June 2003. The borrower explained that only one payment was late, yet
the creditor kept reporting it late. Documentation in the file indicated the
late designation occurred because the borrower consistently paid less than
the minimum required payment.
Technical Underwriting
Violations
The remaining five loans contained technical underwriting violations that, while
they resulted in noncompliance with HUD requirements, did not cause conditions
serious enough to negatively impact approval of the loans.
6
These violations are summarized in the chart below.
Deficiency Number of loans
Inadequate justification for exceeding HUD’s 3 of 5 loans
benchmarks for debt-to-income ratios
Incorrect debt-to-income ratios 1 of 5 loans
Inadequate verification of alternative
employment documentation 1 of 5 loans
Inadequate analysis of borrowers’ credit 4 of 5 loans
Inadequate verification of faxed 2 of 5 loans
income/employment or asset documentation
Specific examples of these violations follow:
In three loans, First Suffolk listed compensating factors that were inconsistent and/or
were not documented in accordance with HUD Handbook 4155.1, REV-5,
paragraph 2-3. For instance, job stability, job history, and good credit were cited as
compensating factors, and good cash reserves and rental income were cited but were
not supported by adequate documentation. In four loans, the borrowers’ credit was
not adequately analyzed as required by HUD Handbook 4155.1, REV-5, paragraph
2-11. For example, in one case, a $1,005 debt was not included in the debt-to-
income ratio analysis. In the remaining three loans, First Suffolk did not obtain
written explanations for derogatory accounts and/or recent inquiries as required. In
two loans, First Suffolk did not verify the authenticity of faxed asset and
employment documents as required by Mortgagee Letter 2001-01.
Ineligible Fees Charged to
Borrowers
First Suffolk charged borrowers ineligible appraisal and credit report fees. HUD
Handbook 4000.2, REV-2, paragraph 5-3, issued July 30, 1991, allows a lender to
collect customary and reasonable fees for appraisals and credit reports; however,
the fees may not exceed the actual cost to the lender. As shown below, First
Suffolk charged three borrowers fees in excess of actual appraisal and/or credit
report costs.
Loan Ineligible Ineligible Total
number credit report appraisal fee
fee collected collected
374-4337742 $100 $50 $150
374-4360910 $ 50 $ 50
374-4396775 $ 30 $ 30
Total $180 $50 $230
7
Title Issue Unresolved
HUD Handbook 4155.1, REV-4, CHG-1, paragraph 3-12, states the lender is
responsible for resolving all problems regarding title to real estate. First Suffolk
took $2,500 from the seller (loan number 374-4317363) and held it in escrow as
assurance that modifications were made to the property in order that clear title
could be obtained. The loan subsequently went into default and HUD paid a claim
on the loan. However, First Suffolk did not resolve the title issue, and retains the
$2,500 escrow.
Conclusion
First Suffolk did not always follow HUD regulations in the approval of loans. As a
result, it approved three loans for which HUD paid claims totaling $526,944 and
remains at risk for $256,750 in potential claims. The final loss that HUD incurs on
loans for which a claim was paid depends upon what HUD realizes when it disposes
of the property. HUD’s most recent data discloses that its loss rate is 29 percent.2
Net sales proceeds after considering carrying and sales expenses may mitigate the
amount of the claim paid. Loans for which HUD remains at risk can be mitigated by
requesting that the lender indemnify HUD. In this case, the lender reimburses HUD
for any insurance claim, taxes, interest and other expenses connected with the
disposition of the property, reduced by any amount recouped by HUD via sale or
other disposition. First Suffolk also approved five other loans with technical
underwriting deficiencies and charged borrowers ineligible appraisal and credit
report fees.
Appendix C provides a summary of the significant underwriting deficiencies,
while appendix D provides the detailed case narratives.
Recommendations
We recommend that the assistant secretary for housing - federal housing
commissioner require First Suffolk to
2
Based upon HUD’s current 29 percent defaulted loss experience, the amount of unsupported costs for the two loans
for which a claim was paid is estimated at $152,814 (29 percent of $526,944). The amount of cost savings or funds
to be put to better use on the loan for which indemnification is recommended is estimated at $74,458 (29 percent of
$256,750).
8
1A. Reimburse HUD for losses on the two loans that had significant
underwriting deficiencies for which claims and associated fees were paid.
1B. Indemnify HUD against future losses on the one loan with significant
underwriting deficiencies.
1C. Establish procedures to ensure that all HUD underwriting requirements are
properly implemented and documented.
1D. Confirm that clear title can be conveyed on the loan for which a claim was
paid, and then determine who should receive the $2,500 held in escrow.
1E. Reimburse borrowers charged $230 in ineligible fees.
1F. Develop procedures to ensure that charges to borrowers do not exceed
actual costs.
9
Finding 2: First Suffolk Had Weaknesses in the Implementation of Its
Quality Control Plan
Our review disclosed that First Suffolk had weaknesses in the implementation of its quality
control plan. It did not always comply with both HUD’s and its own quality control
requirements to (1) ensure that all HUD-insured loans that went into default within the first six
payments were reviewed and (2) document that corrective action was taken on all material
findings identified in quality control reviews. This noncompliance occurred because First
Suffolk did not have procedures to obtain default data on HUD-insured loans from HUD’s
Neighborhood Watch system and/or its servicers and its corrective action process did not address
all identified deficiencies. Consequently, the effectiveness of First Suffolk’s quality control
plan, which is designed to ensure accuracy, validity, and completeness in its loan origination
process, was lessened.
Loans Defaulting within Six
Payments Not Reviewed
Loans that defaulted within the first six payments (early payment defaults) were
not reviewed as required by paragraph 6-6 D of HUD Handbook 4060.1, REV-1,
CHG-1, and First Suffolk’s quality control plan. We found that quality control
reviews were not performed on 7 of the 12 early payment default loans. Three of
these loans were reviewed after our request for copies of the reviews, which did
not comply with the required timeframe for review. Further, while two other
loans were reviewed, the reviews were performed as random routine reviews and
not because of early default.
An official of the quality control contractor stated that First Suffolk did not have
an established policy for conducting reviews of early defaulted loans. First
Suffolk did not implement procedures to obtain early payment default data from
Neighborhood Watch and/or its servicer(s). First Suffolk’s president stated that
privacy rules prohibit servicers from providing First Suffolk with information on
defaulted loans once they are sold. However, Mortgagee Letter 00-20, dated June
2, 2000, announced the availability of Neighborhood Watch to allow all Federal
Housing Administration-approved lenders to analyze their early default loans and
claims. Therefore, First Suffolk should have used Neighborhood Watch to obtain
data on the early default loans. An official of the quality control contractor stated
that First Suffolk established a policy in November 2005 in which the contractor
would notify First Suffolk each month to check Neighborhood Watch so that First
Suffolk could obtain a list of early defaulted loans, which the contractor would
then review.
10
Corrective Action Not
Documented
Our testing of 16 Federal Housing Administration loans selected for random review
under First Suffolk’s quality control plan disclosed that First Suffolk’s quality control
reviews were generally adequate, were performed in a timely manner, and included a
method for followup and resolution of deficiencies noted. However, First Suffolk did
not always document that corrective action was taken to address all material findings
identified in the quality control reviews of the loans we reviewed.
Paragraph 6-3 I of HUD Handbook 4060.1, REV-1, CHG-1, requires management to
take prompt action to deal appropriately with any material findings and document in the
final report or addendum the actions being taken, the timetable for their completion, and
any planned followup activities. While we found that the quality control reports
identified the deficiencies to be addressed, management’s corrective action reports did
not document the specific action to be taken for all material deficiencies, the timeframe
for the action, or the followup measures taken. For example, two quality control
reviews conducted in the second quarter of 2004 identified the following material
deficiencies: (1) credit documents faxed by a third party and (2) misrepresentation of
income based upon pay stubs, W-2 forms, and tax returns. These material
deficiencies were not addressed by management in its corrective action memorandum
reports for the second quarter. As a result, we cannot determine the corrective action
taken, if any; the timetable for the completion of the corrective action; or if there
were any planned followup activities for these deficiencies.
Conclusion
First Suffolk had weaknesses in the implementation of its quality control plan because
it did not review all HUD-insured loans that went into default within the first six
payments and did not document that corrective action was taken on all material
findings identified in quality control reviews. As a result, the effectiveness of First
Suffolk’s quality control process was lessened.
Recommendations
We recommend that the assistant secretary for housing - federal housing
commissioner require First Suffolk to
2A. Establish procedures to ensure that data pertaining to HUD-insured
defaulted loans are obtained from Neighborhood Watch and/or the loan
servicer(s) and properly reviewed.
11
2B. Implement controls and procedures to ensure that all loans that go into
default within the first six payments are reviewed in accordance with
HUD’s requirements and its own quality control plan.
2C. Document in its reports the action being taken, timetable for completion,
and any planned followup activities in response to any material findings
resulting from quality control reviews.
12
SCOPE AND METHODOLOGY
To accomplish our audit objectives, we reviewed applicable laws, regulations, HUD handbooks,
mortgagee letters, and reports from HUD’s Quality Assurance Division. We reviewed
independent audit reports from First Suffolk’s independent auditor, and we interviewed First
Suffolk’s staff and quality control contractor to obtain an understanding of the auditee’s internal
controls.
We selected a nonstatistical sample of 10 defaulted loans from Neighborhood Watch that were
originated by First Suffolk with a beginning amortization date between June 1, 2003, and July
31, 2005. The 10 loans in our sample were HUD-insured loans that totaled more than $2.6
million. We used the following criteria to select the loans: (1) currently in default with a first
default report with 12 or fewer payments, (2) a claim paid, and (3) not reviewed by HUD or
subject to an indemnification agreement. Three of the loans were terminated after our selection.
Therefore, we sampled an additional three loans that were currently in default with a first default
report with six or fewer payments. These three loans had a beginning amortization date between
December 21, 2002, and October 31, 2005, and totaled $806,450. One of these loans was also
terminated. Therefore, our detailed testing was performed on nine loans, and the results of our
detailed testing only apply to the nine 3 loans tested and cannot be projected.
We performed detailed testing and review of the underwriting procedures performed for the nine
loans. We reviewed documentation from both HUD’s Homeownership Center loan
endorsement files and loan files provided by the auditee. Our detailed testing and review
included (a) analyses of borrowers’ income, assets, and liabilities; (b) verification of selected
data on the settlement statements; and (c) confirmation of employment, gifts, and rental history.
We discussed issues with HUD and First Suffolk staff.
We reviewed First Suffolk’s quality control plan as well as documentation provided to us by the
quality control contractor. We selected two samples, consisting of 16 loans, to test First
Suffolk’s quality control plan and to determine compliance with HUD requirements.
We performed audit fieldwork from November 2005 through March 2006.
The audit was conducted in accordance with generally accepted government auditing standards.
3
One of the nine loans was paid-in-full and the Federal Housing Administration insurance was terminated prior to
completion of the draft audit report. As a result, we are reporting on eight loans for which either a claim was paid
or that still represent a risk to the FHA insurance fund.
13
INTERNAL CONTROLS
Internal controls are an integral component of an organization’s management that provides
reasonable assurance that the following objectives are being achieved:
• Effectiveness and efficiency of operations,
• Reliability of financial reporting, and
• Compliance with applicable laws and regulations.
Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals, and objectives. Internal controls include the processes and procedures for
planning, organizing, directing, and controlling program operations. They include the systems
for measuring, reporting, and monitoring program performance.
Relevant Internal Controls
We determined the following internal controls were relevant to our audit objectives:
• Program operations - Policies and procedures that management has
implemented to reasonably ensure that a program meets its objectives.
• Compliance with laws and regulations - Policies and procedures that
management has implemented to reasonably ensure that resource use is
consistent with laws and regulations.
• Safeguarding resources - Policies and procedures that management has
implemented to reasonably ensure that resources are safeguarded against
waste, loss, and misuse.
• Validity and reliability of data - Policies and procedures that management
has implemented to reasonably ensure that valid and reliable data are
obtained, maintained, and fairly disclosed in reports.
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.
14
Significant Weaknesses
Based on our review, we believe the following items are significant weaknesses:
• First Suffolk did not ensure that certain loans were processed in accordance
with all applicable HUD underwriting requirements (see finding 1).
• First Suffolk did not always comply with HUD’s and its own quality control
requirements (see finding 2).
15
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 $152,814
1B $74,458
1D $ 2,500
1E $ 230
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 estimates of amounts that could be used more
efficiently if an Office of Inspector General (OIG) recommendation is implemented.
This includes reductions in outlays, deobligation of funds, withdrawal of interest
subsidy costs, costs not incurred by implementing recommended improvements,
avoidance of unnecessary expenditures noted in preaward reviews, and any other
savings which are specifically identified. Implementation of our recommendation to
indemnify loans that were not originated in accordance with FHA requirements will
reduce FHA’s risk of loss to the insurance fund. The amount above reflects that,
upon sale of the mortgaged property, FHA’s average loss experience is about 29
percent of the claim amount, based upon statistics provided by HUD.
16
Appendix B
AUDITEE COMMENTS AND OIG’S EVALUATION
Ref to OIG Evaluation Auditee Comments
Comment 1
OIG Evaluation of Auditee Comments
Evaluate each comment (as concisely as possible) referenced in the first part of
this appendix where the comments are presented.
17
Ref to OIG Evaluation Auditee Comments
Comment 2
Comment 3
Comment 4
OIG Evaluation of Auditee Comments
Comment 3 Evaluate each comment (as concisely as possible) referenced in the first part of
this appendix where the comments are presented.
18
Ref to OIG Evaluation Auditee Comments
Comment 5
Comment 6
Comment 7
OIG Evaluation of Auditee Comments
Evaluate each comment (as concisely as possible) referenced in the first part of
this appendix where the comments are presented.
19
Ref to OIG Evaluation Auditee Comments
Comment 8
Comment 9
Comment 10
Comment 11
OIG Evaluation of Auditee Comments
Evaluate each comment (as concisely as possible) referenced in the first part of
this appendix where the comments are presented.
20
Ref to OIG Evaluation Auditee Comments
Comment 12
Comment 2
Comment 13
OIG Evaluation of Auditee Comments
Evaluate each comment (as concisely as possible) referenced in the first part of
this appendix where the comments are presented.
21
Ref to OIG Evaluation Auditee Comments
Comment 14
OIG Evaluation of Auditee Comments
Evaluate each comment (as concisely as possible) referenced in the first part of
this appendix where the comments are presented.
22
Ref to OIG Evaluation Auditee Comments
Comment 15
Comment 16
OIG Evaluation of Auditee Comments
Evaluate each comment (as concisely as possible) referenced in the first part of
this appendix where the comments are presented.
23
Ref to OIG Evaluation Auditee Comments
Comment 17
Comment 18 Evaluate each comment (as concisely as possible) referenced in the first part of
OIG Evaluation of Auditee Comments
24
Ref to OIG Evaluation Auditee Comments
Comment 19
Comment 20
Comment 21
OIG Evaluation of Auditee Comments
Evaluate each comment (as concisely as possible) referenced in the first part of
this appendix where the comments are presented.
25
Ref to OIG Evaluation Auditee Comments
Comment 22
Comment 3
OIG Evaluation of Auditee Comments
26
Appendix B
AUDITEE COMMENTS AND OIG’S EVALUATION
Comment 1 First Suffolk concurs that three borrowers were charged $230 in ineligible fees
and agrees to reimburse the borrowers.
Comment 2 First Suffolk concurs that the $2,500 escrow should be released. HUD Handbook
4155.1, REV-4, CHG-1, paragraph 3-12, states the lender is responsible for
resolving all problems regarding title to real estate. First Suffolk remains in
possession of a $2,500 escrow deposit provided by the seller at closing. The
seller agreed to deposit the $2,500 in escrow until the Certificate of Occupancy
for the two sheds and a deck listed on the title report was obtained.
Comment 3 Our review of the auditee files and discussion with the Quality Control contractor
disclosed that during our audit period loans were not specifically selected for
review based upon their early default status as required by HUD regulations. We
acknowledged in the report that First Suffolk had established such a policy after
the start of our review.
Comment 4 First Suffolk maintains that the Comply Eye Bulletin is a corrective action
memorandum. This Bulletin, which was not provided to us during our audit,
states that it provides information that may be helpful to processors and
underwriters, and does not support that correction action was taken to address all
material findings identified in the quality control reviews of the loans we
reviewed. Further, alternative documentation to support that corrective action
was taken was not provided during the audit.
Comment 5 First Suffolk maintains that the $8,406 ($7,314 earnest money deposit, $450
appraisal fee and $642 hazard insurance) exceeded the 3 percent minimum
required investment of $7,314. However, when this loan was originated, hazard
insurance was not considered as part of the minimum cash investment as per
HUD-FHA Single Family Housing Homeownership Center Reference Guide,
Chapter 2-15. Further, the HUD-1 reported $1,019 cash back to the borrower;
therefore, the borrower’s total investment consisted of $7,764 ($7,314 earnest
money deposit and $450 cash deposit) minus $1,019 cash back to the borrower,
resulting in a total investment of $6,745 ($7,764 less $1,019). As a result, the
minimum required investment was short $615 ($7,360 less $6,745).
Comment 6 First Suffolk provided additional information to show that, while the borrower
attempted to bring the debt current by making additional payments, the creditor
applied the payments to principal, rather than reducing the late payments. As a
result, the credit report continued to show the borrower delinquent and finance
charges continued to accrue monthly. The payment history provided by First
Suffolk reported that the borrower paid $68 monthly, even though the minimum
payment was $204. Therefore, First Suffolk did not obtain a sufficient explanation
27
from the borrower to explain why the borrower was paying $68 instead of the
minimum required payment of $204.
Comment 7 There was no evidence in the loan file that First Suffolk attempted to resolve the
inconsistent employment data prior to closing the loan.
Comment 8 First Suffolk deposited the borrower’s $450 cash deposit into its petty cash
account to be used for the mortgagee's general operating purposes, which is
prohibited by HUD Handbook 4330.1, REV-5, Chapter 2-4.
Comment 9 First Suffolk concurs that the minimum cash investment was not made per the
HUD-1, and attributes it to an error by the settlement agent.
Comment 10 Neither the FHA case binder nor the lender's file contained an actual gift letter to
support the gift from the borrower's fiancée as required by Mortgagee Letter 00-
28.
Comment 11 First Suffolk obtained a Verification of Employment and faxed copies of the
borrower's two most recent paychecks, but did not verify the authenticity of the
faxed copies as required by Mortgagee Letter 2001-01. Further, First Suffolk
maintains that the debt to income ratio calculated was supported by the paystubs
in the file. This is incorrect because the employer provided itemization of pay
and deductions reported $321 child support, which was not included in First
Suffolk’s debt to income ratio. While including this increases the back ratio to
40.8 percent, which is within FHA guidelines to not require compensating factors,
First Suffolk did not include the $321 for child support in underwriting the loan as
required.
Comment 12 The loan file noted compensating factors on the MCAW of (1) stability of income
established due to profession, applicant at time of underwriting was a driver and a
warehouse supervisor, (2) stability of employment established due to 24 years on
the job, (3) applicant able to devote more of his income for housing expenses
since there were no other recurring monthly debts or obligations, and (4) applicant
able to devote more income to housing due to a small family. However, three of
these are not valid compensating factors per HUD Handbook 4155.1 REV-4
Chapter 2-13 to justify approving this loan with a front ratio that exceeds HUD
established benchmark. Further, the compensating factor that the applicant is able
to devote more income for housing expenses since there were no other recurring
monthly debts or obligations, is not supported because the borrower did have a
recurring debt of $321 for child support.
Comment 13 First Suffolk provided information for development of a credit history for the
borrower and co-borrower. However, there was no explanation for two of four
inquiries on the co-borrower’s credit report within the last 90 days, one from
another mortgage lender and one from an unknown source. Consequently, First
Suffolk did not obtain a written explanation as required by HUD Handbook
4155.1, REV-5, Chapter 2-3. In addition, First Suffolk maintains that it did not
clarify the co-borrower’s rent verification indicating monthly rental expenses of
28
$1,700 and reported monthly wages of $1,213 because the co-borrower is married
to someone other than the primary borrower. However, the loan application
reports that the co-borrower is unmarried and the rental verification listed only
one tenant.
Comment 14 The donor’s bank statement disclosed that $3,900, the amount of the gift, was
deposited on the same day that the gift was made. Prior to that deposit, the donor
had an account balance of $706. Consequently, there was no conclusive evidence
that the funds given to the borrower came from the donor’s own funds as required
by Mortgagee Letter 00-28.
Comment 15 Based upon the auditee’s comments, we removed this issue.
Comment 16 First Suffolk presented support for a compensating factor of not being a heavy
credit user; therefore, we have deleted reference to a deficiency related to the
adequacy of compensating factors.
Comment 17 Mortgagee Letter 98-29, dated October 22, 1998, requires a borrower to provide
minimum cash investment of three percent of the estimated cost of acquisition.
The HUD-1 documents that the borrower paid an earnest money deposit of
$2,000, a $450 cash deposit outside of closing, and $7,340 at closing, for a total
investment of $9,790. Therefore, the borrower was short $73 ($9,790 less
$9,863). However, the FHA insurance on this loan was terminated on February
24, 2006; therefore, we have removed this case from the audit report.
Comment 18 HUD Handbook 4155.1, REV-5, Chapter 2-3 requires a written explanation from
the borrower explaining all inquiries shown on the credit report in the last 90
days. First Suffolk demonstrated that one of three recent inquiries was from a
company used by First Suffolk for the pre-qualification of the co-borrower;
consequently, we agree that First Suffolk would not need a written explanation
from the borrower for this inquiry. However, First Suffolk should have obtained
a written explanation from the borrower for the remaining two inquiries shown on
the credit report. Nevertheless, the FHA insurance on this loan was terminated on
February 24, 2006; therefore, we have removed this case from the audit report.
Comment 19 First Suffolk did not obtain conclusive evidence from the donor that the gift funds
were indeed the donor’s own funds as required by Mortgagee Letter 00-28. The
donor’s bank statement for the period March 5, 2005 through April 6, 2005
showed a negative balance on March 5, 2005. Then on April 4, 2005, the same
day the gift was given, a $4,000 deposit was made. However, since the FHA
insurance on this loan was terminated on February 24, 2006, we have
removed this case from the audit report.
Comment 20 The HUD-1 showed cash from borrower of $7,340, however, the loan file
disclosed that First Suffolk documented $6,105; the additional $1,235 needed to
close was not documented. However, the FHA insurance on this loan was
terminated on February 24, 2006; therefore, we have removed this case from the
audit report.
29
Comment 21 First Suffolk computed front and back ratios of 42.95% and 43.23%, respectively,
and noted the following compensating factors on the MCAW: (1) one credit card
is used, (2) no late payments, (3) good job stability, and (4) good comment on
how he works. However, these items are not valid compensating factors per HUD
Handbook 4155.1 REV-4 Chapter 2-13. Nevertheless, since the FHA insurance
on this loan was terminated on February 24, 2006; we have removed this case
from the audit report.
Comment 22 The technical underwriting deficiencies we found, such as failure to consider a
debt, inadequate credit analysis, and inadequate documentation of, and erroneous,
compensating factors were not serious enough to negatively impact the decision
to approve a loan. Nevertheless, reporting of these deficiencies is warranted so
that First Suffolk can improve its underwriting procedures to ensure full
compliance with all HUD requirements.
30
Appendix C
SUMMARY OF UNDERWRITING DEFICIENCIES
Inadequate
Minimum Inadequate
Inadequate documentation
Case cash verification of Other Appendix
credit and/or
number investment borrower’s deficiencies reference
analysis verification of
not provided employment
gift
374-4297672 X X X X D-1
374-4317363 X X X X D-2
374-4337742 X X D-3
Total 2 2 2 2 2
31
Appendix D
CASE SUMMARY NARRATIVES
Appendix D-1
Page 1 of 2
Case number: 374-4297672
Loan amount: $240,000
Settlement date: October 1, 2003
Status: Claim paid
Claim amount: $254,787
Pertinent Details
A. Minimum Cash Investment Not Provided
Mortgagee Letter 98-29, dated October 22, 1998, provides that the National Housing Act
requires a borrower to provide minimum cash investment of 3 percent of the estimated cost of
acquisition. HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-10, requires that the cash
investment in the property equal the difference between the amount of the insured mortgage,
excluding any upfront mortgage insurance premium, and the total cost to acquire the property,
including prepaid expenses. The borrower did not make the minimum cash investment of
$7,360. The borrower made a cash deposit of $450 and an earnest money deposit of $7,314 for a
total cash investment of $7,764. However, the HUD-1 settlement statement reported cash to the
borrower of $1,019, resulting in a cash investment of $6,745, or $615 less than the required
investment.
B. Inadequate Credit Analysis
HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-3, requires that sufficient written
explanation from the borrower, that makes sense and is consistent with other credit information
in the file, be obtained for major indications of derogatory credit, including judgments,
collections, and any other recent credit problems. The borrower’s credit report listed one
derogatory account, for which First Suffolk did not obtain sufficient explanation. The account,
which was opened in November 2000, was late five times during the period February 2003
through June 2003. While the borrower provided a written explanation, it was inconsistent with
the basis for the derogatory credit. The borrower explained that only one late payment was
made; yet the creditor kept reporting it late. The documentation in the file indicated that the
creditor reported it late because the borrower was paying an amount less than the minimum
required payment. First Suffolk did not address this inconsistency.
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Appendix D-1
Page 2 of 2
C. Inadequate Employment Verification
HUD Handbook 4155.1, REV-4, CHG-1, paragraph 3-1, requires that when standard
documentation does not provide enough information to support the lender’s decision to approve
the mortgage, the lender must provide additional explanatory statements, consistent with other
information in the application, to clarify or supplement the documentation submitted by the
borrower. First Suffolk did not adequately follow up on inconsistent data regarding employment
income. A verification of employment from the borrower’s first employer reported year-to-date
wages of $24,085 as of August 13, 2003. However, First Suffolk also obtained the borrower’s
most recent pay stub, which reported year-to-date wages of $13,275 for the pay period ending
August 13, 2003. The file contained no evidence of action to resolve this discrepancy. Further,
a verification of employment, which we sent to the employer, confirmed that the correct wages
were as stated on the pay stub. Consequently, the wages used to approve this loan were
overstated. As a result, we determined that the mortgage payment-to-effective income ratio and
total fixed payment-to-income ratio of 36.9 and 38.1 percent calculated by First Suffolk would
increase to 45.2 and 46.6 percent, respectively. Such ratios would have required First Suffolk to
document compensating factors to justify loan approval.
D. Inadequate Bank Account Documentation
HUD Handbook 4155.1, REV-4, CHG-1, paragraph 3-1F, provides that as an alternative to
obtaining a verification of deposit, the lender may obtain from the borrower original bank
statement(s) covering the most recent three-month period. First Suffolk chose the alternative but
only obtained one month’s bank statement.
E. Excessive Ratio without Compensating Factors
HUD Handbook 4155.1, REV 4, CHG-1, paragraphs 2-12 and 2-13, require that compensating
factors justify approval of loans in which the mortgage payment-to-effective income ratio and
total fixed payment-to-income ratio exceed 29 and 41 percent, respectively. Mortgagee Letter
2005-16, dated April 13, 2005, raised the qualifying front and back ratios to 31 and 43 percent,
respectively; however, the lender must describe the compensating factors if either or both ratios
exceed the guidelines on a manually underwritten mortgage. First Suffolk calculated the front
ratio as 36.9 percent without documenting significant compensating factors.
F. Improper Escrow of Borrower’s Funds
HUD Handbook 4330.1, REV-5, paragraph 2-4, prohibits commingling (even temporarily) of
escrow funds with funds used for the lender’s general operating purposes. First Suffolk received
$450 in cash from the borrower to pay for the appraisal report and placed this cash into its petty
cash account; therefore, it improperly escrowed funds received from the borrower.
33
Appendix D-2
Page 1 of 2
Case number: 374-4317363
Loan amount: $259,800
Settlement date: November 10, 2003
Status: Claim paid
Claim amount: $272,157
Pertinent Details
A. Minimum Cash Investment Not Provided
Mortgagee Letter 98-29, dated October 22, 1998, provides that the National Housing Act
requires a borrower to provide minimum cash investment of 3 percent of the estimated cost of
acquisition. HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-10, requires that the cash
investment in the property equal the difference between the amount of the insured mortgage,
excluding any upfront mortgage insurance premium, and the total cost to acquire the property,
including prepaid expenses. The borrower did not make the required cash investment of $8,383.
The borrower invested $6,888, consisting of a cash deposit of $450, an earnest money deposit of
$5,000, and $1,438 paid at closing according to the HUD-1 settlement statement. Therefore, the
borrower was short $1,495.
B. Inadequate Gift Documentation
Mortgagee Letter 00-28, dated August 7, 2000, requires the lender to document any gift funds
with a gift letter that specifies the dollar amount of the gift and the donor’s name, address,
telephone number, and relationship to the borrower, is signed by the donor and the borrower, and
states that no repayment is required. The mortgage credit analysis worksheet listed a gift of
$8,000 from the borrower’s fiancée; however, neither the case binder nor the lender’s file
contained a gift letter as required.
C. Inadequate Employment Verification
HUD Handbook 4155.1, REV-4, CHG-1, paragraph 3-1, provides that when standard
documentation does not give enough information to support a decision, the lender must provide
additional explanatory statements, consistent with other information in the application, to clarify
or supplement the documentation submitted by the borrower. Mortgagee Letter 2001-01
provides that if income/employment or asset documents are faxed to the lender, the documents
must clearly identify the employer or depository/investment firm’s name and source of
information, and the lender must determine the authenticity of the document by examining,
among other things, the information included at the top or banner portion of the fax received by
the lender. First Suffolk obtained a verification of employment and faxed copies of the
borrower’s two most recent computerized paychecks without verifying the authenticity of the
faxed paychecks. A confirmation that we sent to the borrower’s employer indicated that the
34
Appendix D-2
Page 2 of 2
wages on the verification of employment were incorrect. The verification of employment
reported earnings of $78,000 for 2001 and 2002 and $57,000 through September 26, 2003,
whereas the confirmation showed earnings of $29,294 for 2001, $29,484 for 2002, and $23,698
through September 26, 2003.
D. Incorrectly Calculated Ratios and Excessive Qualifying Ratios without Adequate
Compensating Factors
HUD Handbook 4155.1, REV-4, CHG-1, paragraphs 2-12 and 2-13, provide that if the
borrower’s mortgage payment-to-effective income ratio and total fixed payment-to-income ratio
exceed 29 and 41 percent, respectively, the underwriter must present significant compensating
factors supported by documentation to justify mortgage approval. Mortgagee Letter 2005-16,
dated April 13, 2005, raised the qualifying ratios to 31 and 43 percent, respectively; however, the
lender must describe the compensating factors if either or both ratios exceed the guidelines on a
manually underwritten mortgage. First Suffolk computed the ratios to be 35.87 and 35.87
percent, respectively, and noted the following compensating factors: (1) stability of income was
established due to profession at the time of underwriting (the applicant was a driver and a
warehouse supervisor), (2) stability of employment was established due to 24 years on the job,
(3) the applicant was able to devote more of his income for housing expenses since there were no
other recurring monthly debts or obligations, and (4) the applicant was able to devote more
income to housing due to a small family. However, these items were not valid compensating
factors according to HUD requirements, nor were they supported by adequate documentation. In
addition, the lender did not include a $321 monthly child support payment in its calculation,
which would have raised the total fixed payment-to-income ratio to 40.80 percent.
E. Unresolved Title Issues
HUD Handbook 4155.1, REV-4, CHG-1, paragraph 3-12, states the lender is responsible for
resolving all problems regarding title to real estate. First Suffolk is holding $2,500 in escrow
provided by the seller at closing to be held in escrow until issues with the title of the property
were resolved. The title report identified two sheds and a deck that did not have the proper
Certificate of Occupancy and an escrow agreement indicated that the seller agreed to deposit
$2,500 in escrow and obtain the Certificate of Occupancy. HUD paid a claim on this loan and
First Suffolk is still holding the $2,500 in escrow and the title issues are unresolved.
35
Appendix D-3
Page 1 of 2
Case number: 374-4337742
Loan amount: $256,750
Settlement date: March 11, 2004
Status: Current - Reinstated by borrower who retains ownership
Pertinent Details
A. Inadequate Credit Analysis
HUD Handbook 4155.1, REV-5, paragraph 2-3, requires that if borrowers have not established a
credit history or used traditional credit, the lender must develop a credit history from utility
payment records, rental payments, automobile insurance payments, or other means of direct
access from the credit provider. Paragraph 2-3 further states that documents confirming the
existence of a nontraditional credit provider may include a public record from state, county, or
city records or other means providing a similar level of objective confirmation. First Suffolk did
not follow these HUD requirements in developing credit histories for the borrower and
coborrower. The credit reports obtained by the lender reported no activity for either the
borrower or the coborrower. Therefore, First Suffolk developed credit histories by obtaining a
verification of rent and a letter from an insurance agency for the borrower and a verification of
rent and a letter from a travel agency for the coborrower. There was no documentation
indicating that First Suffolk confirmed the existence of the credit providers (insurance agency
and travel agency) as required. Additionally, the verification of rent for the coborrower does not
appear to be reasonable because the monthly rent indicated is $1,700 and the coborrower’s
monthly wages are $1,213. HUD Handbook 4155.1, REV-5, paragraph 3-1, states that when
standard documentation does not provide enough information to support a decision, the lender
must provide additional explanatory statements, consistent with other information in the
application, to clarify or to supplement the documentation submitted by the borrower. Since the
coborrower’s documented monthly wages were only $1,213 and the documented monthly rent
was $1,700, First Suffolk should have obtained an explanatory statement from the coborrower.
Also, the coborrower’s credit report showed a recent inquiry, from a mortgage lender, for which
there was no written explanation from the coborrower as required by HUD Handbook 4155.1,
REV-5, paragraph 2-3B.
B. Inadequate Documentation and Verification of Gift
Mortgagee Letter 00-28, dated August 7, 2000, requires the lender to document the transfer of
any gift funds from the donor to the homebuyer by obtaining a copy of the canceled check or
other withdrawal document showing the withdrawal is from the donor’s personal account, along
with the homebuyer’s deposit slip or bank statement showing the deposit. Further, regardless of
when the gift funds are made available to the homebuyer, the lender must be able to determine
that the gift funds were not ultimately provided from an unacceptable source and were the
donor’s own funds. First Suffolk documented the gift with a customer’s copy of an official bank
check in the amount of $3,900, dated January 25, 2004, a copy of the donor’s bank
36
Appendix D-3
Page 2 of 2
statement, and a copy of the borrower’s bank statement. However, the customer’s copy of the
official check did not contain the bank routing number, which should be on both the official
check and the customer’s copy. Therefore, this customer copy of an official bank check is not
adequate supporting documentation for the $3,900 gift. Additionally, the copy of the donor’s
bank statement shows check number 131 for $3,900 clearing the bank account on January 26,
2004, with a handwritten note stating “gift out.” The lender did not obtain a copy of check
number 131 to document the gift as required. The donor’s January 28, 2004, bank statement
showed a zero beginning balance and deposits of $103, $604 and $3,900 on December 29, 2003,
January 20, 2004, and January 26, 2004, respectively. However, the lender did not obtain
conclusive evidence to support the source of the $3,900 deposit. While First Suffolk obtained a
bank printout for the borrower’s bank account showing a $4,000 deposit on January 26, 2004, the
lender did not document the transfer of funds from the donor to the homebuyer and did not
obtain conclusive evidence that the $3,900 was indeed the donor’s own funds as required.
37
First Suffolk Mortgage Corporation, North Babylon, Did Not Always Comply with HUD Underwriting Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-06-19.
Below is a raw (and likely hideous) rendition of the original report. (PDF)