oversight

First Residential Mortgage Services Corporation, Englewood Cliffs, New Jersey, Did Not Always Comply with HUD/Federal Housing Administration Loan Origination Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-08-14.

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

                                                            Issue Date
                                                                 August 14, 2006
                                                            Audit Report Number
                                                                2006-NY-1009




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


FROM:      Edgar Moore, Regional Inspector General for Audit, 2AGA


SUBJECT:   First Residential Mortgage Services Corporation, Englewood Cliffs, New
           Jersey, Did Not Always Comply With HUD/Federal Housing Administration
           Loan Origination Requirements

                                  HIGHLIGHTS

 What We Audited and Why

            We audited First Residential Mortgage Services Corporation (First Residential), a
            non-supervised lender located in Englewood Cliffs, New Jersey because its
            default rate of 6.73 percent for loans with beginning amortization dates between
            October 1, 2003, and September 30, 2005, was higher than the default rate for the
            State of New Jersey, which was 4.95 percent.

            The audit objectives were to determine whether First Residential (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/FHA requirements.

 What We Found
            First Residential did not always comply with HUD underwriting requirements.
            Seven of 11 loans we reviewed exhibited significant underwriting deficiencies
           such as inadequate credit analysis, inadequate verification of funds to close,
           minimum cash investment not met, and inadequate verification of income and/or
           employment. The remaining four loans contained technical violations. In
           addition, one borrower was charged a $495 ineligible commitment fee. These
           deficiencies occurred because First Residential lacked adequate controls to ensure
           that loans were processed in accordance with HUD requirements.

           First Residential did not ensure that its quality control plan was implemented in
           accordance with both HUD and its own requirements. First Residential did not
           ensure that (1) quality control reviews were conducted for all loans that defaulted
           within six months of closing, (2) at least ten percent of the closed and rejected
           loans were always selected for quality assurance reviews, (3) quality control
           reviews were performed timely, (4) management follow-up was provided for the
           quality control reviews of the loans from the wholesale division, and (5) HUD
           was informed of significant deficiencies that it discovered with one of its loan
           correspondents. This noncompliance occurred because First Residential did not
           establish procedures to ensure that its quality control plan was properly
           implemented. Consequently, the effectiveness of First Residential’s quality
           control plan, which is designed to ensure accuracy, validity, and completeness in
           its loan underwriting process, was lessened.

What We Recommend


           We recommend that the assistant secretary for housing – federal housing
           commissioner require First Residential to: (1) reimburse HUD for the amount of
           claims and associated fees paid on one loan with significant underwriting
           deficiencies, (2) indemnify HUD against future losses on the six loans with
           significant underwriting deficiencies, (3) establish procedures to ensure that
           HUD underwriting requirements are properly implemented and documented, (4)
           implement procedures to ensure compliance with HUD and its own quality
           control requirement, and (5) reimburse the borrower for the $495 ineligible
           commitment fee found in one case.

           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
           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 Residential Mortgage Service Corporation Did Not Always   5
                   Comply with HUD’s Underwriting Requirements

        Finding 2: First Residential Had Weaknesses in the Implementation of Its   10
                   Quality 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                                       36
   D.   Narrative Case Presentations                                               37




                                               3
                      BACKGROUND AND OBJECTIVES


First Residential Mortgage Services Corporation, (First Residential) became an approved U.S.
Department of Housing and Urban Development lender in 1994. The company originates loans,
which it then sells to investors, banks and other mortgage bankers.

The main office of First Residential is located in Englewood Cliffs, New Jersey. There are separate
branch offices located in Weston, Florida; Silver Spring, Maryland; and Whitestone, New York.

Between October 1, 2003 and September 30, 2005 First Residential underwrote 1,203 Federal
Housing Administration-insured mortgages in New Jersey. We selected First Residential for audit
because its 6.73 percent default rate for loans with a beginning amortization date between October
1, 2003, and September 30, 2005 was higher than the average default rate for the State of New
Jersey, which was 4.95 percent.

The objectives of this audit were to determine whether First Residential (1) approved insured loans
in accordance with the 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.




                                                 4
                                         RESULTS OF AUDIT


Finding 1: First Residential Mortgage Service Corporation Did Not
           Always Comply with HUD’s Underwriting Requirements
First Residential Mortgage Services Corporation (First Residential) did not follow prudent
lending practices and HUD regulations in the origination and underwriting of the 11 loans we
reviewed. 1 As a result, loans were approved for potentially ineligible borrowers and these
deficiencies contributed in causing the HUD/Federal Housing Administration (FHA) to assume
an unnecessary insurance risk. Seven loans contained significant underwriting deficiencies such
as inadequate credit analysis, inadequate verification of funds to close, minimum cash
investment not met, and inadequate verification of income/employment. The remaining four
loans contained technical violations. Consequently, the HUD/Federal Housing Administration
Insurance fund paid a claim for one loan totaling of $221,445, and continues to be at risk for
$1,463,394. These deficiencies occurred because First Residential did not have adequate
controls to ensure that loans were processed in accordance with HUD/FHA requirements.


    Significant Underwriting
    Deficiencies

                    Our review of 11 loans with amortization dates between October 01, 2003, and
                    September 30, 2005, disclosed significant underwriting deficiencies in seven
                    loans. These deficiencies occurred because First Residential did not follow
                    prudent lending practices and regulations prescribed by HUD in its origination
                    and underwriting of the seven loans.

                    HUD Handbook 4155.1, REV-5, entitled “ Mortgage Credit Analysis for
                    Mortgage Insurance,” prescribes basic underwriting requirements for Federal
                    Housing Administration-insured single-family mortgage loans. The lender must
                    ensure that the borrower has the ability and willingness to repay the mortgage
                    debt. This assessment must be based on sound underwriting principles in
                    accordance with the guidelines, rules, and regulations described in this handbook
                    and be supported by sufficient documentation. In addition, Chapter 3-1 of the
                    Handbook requires that the application package contain sufficient documentation
                    to support a lender’s decision to approve a mortgage. While this decision involves
                    some subjectivity, our examination of 11 loans approved by First Residential
                    disclosed significant underwriting deficiencies in the approval of seven loans.
                    First Residential did not always (1) sufficiently analyze borrowers’ credit, (2)
                    adequately verify the source of funds to close, (3) ensure that the minimum cash

1
    We originally reviewed 12 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 11 loans for which either a claim was paid or that still represent a risk to the FHA insurance fund.



                                                            5
       investment requriement was met, and (4) properly verify the borrowers’
       employment and/or income.

       The deficiencies are noted in the chart below and in appendix C. The deficiencies
       noted are not independent of one another, as one loan may have contained more
       than one deficiency.

            Areas of deficiencies                   Number of loans
        Inadequate credit analysis                  6 of 7 loans
        Inadequate verification of funds to close   6 of 7 loans
        Minimum cash investment not met             4 of 7 loans
        Inadequate verification of employment       2 of 7 loans
        and/or income

Specific examples of these significant underwriting deficiencies follow:

   •   For FHA case # 352-5230020, the lender did not obtain an adequate explanation
       for the employment gap from August 2002 to March 2003 for the co-borrower.
       HUD Handbook 4155.1, REV-5, section 2-6 requires that the lender must verify
       the borrower’s employment for the most recent two full years. The borrower also
       must explain any gaps in employment spanning one month or more. In addition,
       the borrower made numerous excessive deposits and overdrafts to his bank
       account without explanation. Also, the lender did not (1) conduct an adequate
       credit analysis, and (2) adequately describe the compensating factors used to
       justify mortgage approval.

   •   For FHA case # 352-5213442, the lender did not verify if the borrower had cash
       reserves equivalent to three months’ principal, interest, taxes, and insurance
       (PITI). HUD Handbook, 4155.1, REV-5, section 1-8 C requires that the borrower
       must have reserves equivalent to three months' PITI after closing on the purchase
       transactions for three and four unit properties. Reserves cannot be derived from a
       gift. The Mortgage Credit Analysis Worksheet showed that the cash reserve was
       $79.71, which was less than one month’s (PITI) costs of $2,313. In addition, the
       lender did not adequately (1) conduct a credit analysis and (2) evaluate the
       borrower’s savings pattern.

   •   For FHA case # 352-5167847, the lender did not conduct an adequate credit
       analysis. HUD Handbook 4155.1, REV-5, section 2-3, provides that major
       indications of derogatory credit require a sufficient written explanation from the
       borrower. The borrower’s credit report indicated 48 instances of late payments
       for one of the creditors, of which numerous late payments were recently incurred.
       The borrower also incurred numerous delinquencies with another creditor. The
       explanations on file did not make sense. Section 2-3C requires that the borrower
       must explain in writing all collections and judgments. The file did not contain a
       written explanation for one judgment incurred for $4,213 and for two other
       judgments. The lender did not obtain any explanations for numerous credit


                                        6
            inquiries. In addition, the lender did not (1) verify the source of the funds for the
            earnest money deposit of $3,500, (2) ensure that the minimum investment
            requirement was met, and (3) obtain verification of deposits.

        •   For FHA case # 352-5217394, the lender did not obtain a credible explanation for
            the source of the funds of $9,000. According to documentation on file, it indicated
            that the borrower’s bank account was opened recently. HUD Handbook 4155.1,
            REV-5, section 2-10B states that if there is a large increase in an account, or the
            account was opened recently, the lender must obtain a credible explanation of the
            source of the funds. The bank account showed one deposit for $9,000 on
            February 9, 2004. The co-borrower had $9,000 in assets available at her private
            savings club. Section 2-10R of the handbook provides that while private savings
            clubs are not supervised banking institutions, at a minimum, the clubs must have
            account ledgers, receipts from the club, verification from the club treasurer, and
            identification of the club so that the lender can re-verify the information provided.
            The underwriter must be able to determine that it was reasonable for the borrower
            to have saved the money claimed, and that there is no evidence that these funds
            were borrowed with an expectation of repayment. The file only contained a
            verification and an affidavit that provided that the borrower started contributing to
            the club in October 2003. The verification indicated that contributions to the
            account are made bi-weekly for $900, while the affidavit that was signed by the
            club treasurer listed the contributions as $900 monthly. Moreover, the co-
            borrower’s credit report indicated that the private savings club treasurer was also
            the co-borrower’s landlord and paid commitment fees on behalf of the borrower
            and co-borrower. In addition, the lender did not (1) adequately verify and/or
            document earnest money, 2) ensure the minimum cash investment requirement
            was met, (3) conduct an adequate credit analysis, and (4) verify costs paid out of
            closing.


Technical Underwriting
Violations

            The remaining four 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.

            These deficiencies are summarized in the chart below.

                Technical Underwriting Violations               Number of loans
            Verification of paid-out-of-closing costs not 1 of 4 loans
            obtained
            Inadequate compensating factors               3 of 4 loans
            Verification of deposits not obtained         3 of 4 loans
            Inadequate credit analysis                    2 of 4 loans
            Inadequate underwriting procedures            1 of 4 loans


                                              7
                   Specific examples of these violations follow:

                   In three loans, First Residential listed compensating factors that were not
                   supported and/or not allowable in accordance with HUD Handbook 4155.1, REV-
                   5, section 2-13G. For instance, income stability, minimum debts and low loan to
                   value ratios were cited as compensating factors, good cash reserves and savings
                   ability were cited without adequate supporting documentation. In three loans,
                   First Residential did not verify the source of funds deposited into borrower’s bank
                   accounts. For example, in FHA case # 352-5235982, First Residential did not
                   obtain the source information of the non-payroll deposits of $2,500 on May 27,
                   2004, $1,778 on April 27, 2004, and seven other non-payroll deposits totaling
                   $2,530 made during the period from April 7, 2004, to May 25, 2004. In two
                   loans, First Residential did not conduct adequate credit analyses for the
                   borrowers. For example, in one case, the borrower’s credit report indicated three
                   late payments on a previous conventional real estate loan within 12 months of the
                   borrower’s application for an FHA loan. The documentation on file stated that
                   the borrower was a co-signer for this loan. However, the HUD-1 settlement
                   statement listed the borrower as a primary seller, and First Residential did not
                   obtain any explanation of the contradictory information from the borrower. In
                   addition, verifications of paid-out-of-closing costs were not obtained for one loan.

    Ineligible Commitment Fees
    Charged to Borrowers


                   First Residential charged a borrower an ineligible commitment fee in one of the
                   11 loans reviewed. Mortgagee Letter 94-7, section IV, provides that a
                   commitment or lock-in fee must be in writing and guarantee the mortgage interest
                   rate and/or discount points for not less than 15 days before the anticipated closing
                   date. First Residential charged an ineligible commitment fee of $495 for one of
                   the 11 loans that we reviewed, even though the supporting documents in the file
                   indicated that borrower did not choose to lock-in the interest rate.

    Conclusions

                   First Residential did not always follow HUD regulations in the approval of loans.
                   As a result, it approved seven loans for which HUD paid a claim on one loan
                   totaling $221,445 2 and remains at risk for $1,463,394 2 in potential claims for the
                   other six loans. The final loss that HUD incurs on the loan for which a claim was

2
    Based upon HUD’s current 29 percent default loss experience, the amount of unsupported costs for one loan for
    which a claim was paid is estimated at $64,219 (29 percent of $221,445). The amount of cost savings or funds to
    be put to better use on the loan for which indemnification is recommended is estimated at $424,384 (29 percent of
    $1,463,394).



                                                           8
          paid depends upon what HUD realizes when it disposes of the property. HUD’s
          most recent data disclosed that its loss rate is 29 percent. 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 Residential also approved four other loans with technical
          underwriting deficiencies and charged an ineligible commitment fee to one loan.

          Appendix C of the report provides a summary of the underwriting deficiencies
          noted in the seven cases. Appendix D of this report provides a more detailed
          description of the deficiencies.

Recommendations

          We recommend that the assistant secretary for housing - federal housing
          commissioner require First Residential to:

          1A.     Reimburse HUD for losses on the one loan that had significant
                  underwriting deficiencies for which claims and associated fees were paid.

          1B.     Indemnify HUD against future losses on six loans with significant
                  underwriting deficiencies.

          1C.     Establish procedures to ensure that all HUD underwriting requirements are
                  properly implemented and documented.

          1D.     Reimburse the borrower for the $495 ineligible commitment fee.




                                            9
Finding 2: First Residential Had Weaknesses in the Implementation of
           Its Quality Control Plan
Our review disclosed that First Residential had weaknesses in the implementation of its quality
control plan. It did not always comply with both HUD and its own quality control requirements
to ensure that (1) all HUD-insured loans that defaulted within the first six payments were
reviewed; (2) ten percent or more of the closed and rejected loans were reviewed; (3) quality
control reviews were performed in a timely manner; (4) management follow-ups were provided
for the quality control findings of the wholesale loans; and (5) HUD was immediately informed
of the significant deficiencies that it discovered with one of its loan correspondents. This
noncompliance occurred because First Residential did not establish procedures to ensure that its
quality control plan was properly implemented. Consequently, the effectiveness of First
Residential’s quality control plan, which is designed to ensure accuracy, validity, and
completeness in its loan underwriting 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 HUD Handbook 4060.1, REV-1, CHG-1, paragraph
              6-6 D, and First Residential’s quality control plan. We found that quality control
              reviews were not performed on eight out of the 47 early defaulted loans. First
              Residential overlooked one loan it originated. The other seven loans were
              originated by one of its loan correspondents. First Residential officials decided
              that it was unnecessary to review these seven early defaulted loans since it went
              into litigation against that loan correspondent regarding its misconduct in loan
              originations. Quality control reviews of the early defaulted loans can provide
              valuable information about the causes of default that may indicate inadequate
              underwriting. First Residential officials acknowledged this weakness and advised
              that review of these defaulted loans will be enforced.


 Insufficient Sampling for
 Closed and Rejected Loans

               HUD Handbook 4060.1 REV-1, CHG-1, paragraph 6-6C states that a mortgagee
               originating 7,000 or fewer Federal Housing Administration loans per year must
               review 10 percent of the Federal Housing Administration loans it originates.
               Paragraph 6-8A(1) states that a minimum of 10 percent or a statistical random
               sample that provides a 95 percent confidence level with 2 percent precision must
               be reviewed for the total loans rejected. Our testing disclosed that First
               Residential did not always follow the requirements. Less than ten percent of the
               closed and rejected loans received quality control reviews for serveral months


                                               10
           during our audit period. First Residential officials acknolwledged this weakness
           and advised that review of these loans will be reinforced.

Untimely Quality Control
Reviews

           HUD Handbook 4060.1, REV-1, CHG-1, paragraph 6-3D, states that the review
           of a specific mortgage should be completed within 90 days of closing. Reviews
           of different aspects of servicing will vary in frequency; delinquent servicing and
           loss mitigation activities should be reviewed monthly. First Residential did not
           always perform the quality control reviews in a timely manner. Quality control
           reviews for 16 out of the 47 early defaulted loans were significantly delayed. In
           addition, due to the lack of an audit date on the quality control reports, we cannot
           determine the timeless of quality control reviews in another nine out of 47 early
           defaulted loans. Also, the quality control reviews for the loans closed or rejected
           in June and July 2004 were not performed within 90 days after closing.

Inadequate Management
Response to Wholesale Loans

           HUD Handbook 4060.1, REV-1, CHG-1, paragraph 6-3I, 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 follow-up activities. We noted that First Residential
           provided timely management follow-ups for the material deficiencies identified at
           quality control reviews of the loans originated by itself. However, no management
           follow-up was provided to the loans from its wholesale division for the quality
           control reviews conducted in 2003 and 2004. In addition, material deficiences
           identified in quality control reviews were not addressed by management for
           several early defaulted loans origianted by its loan correspondents.

Failure to Inform HUD of
Significant Deficiencies

           HUD Handbook 4060.1, REV-1, paragraph 6-3J states that findings of fraud or
           other serious violations must be referred, in writing (along with the supporting
           documentation) to the Director of the Quality Assurance Division in the HUD
           Homeownership Center having jurisdiction (determined by the State where the
           property is located) within 60 days after initial discovery. In 2004 First
           Residential discovered serious violations or deficiencies by one of its loan
           correspondents, in the origination of FHA-insured loans. These deficiencies
           included invalid Social Security numbers, corrupted credit documentation, and/or
           fraudulent document and false information to induce the approval of the loans.
           First Residential requested the loan correspondent to purchase two loans back,
           and went into litigaion when the loan correspondent refused to purchase the loans.



                                            11
              However, the issue was not completely resolved by the time this audit started.
              First Residential officials did not report these serious deficiencies or fraud to the
              Homeownserhip Center (HOC) because they did not believe that they had
              sufficient facts to complete a substantiated report against the loan correspondent.


Conclusions

              First Residential had weaknesses in the implementation of its quality control plan
              because it did not: review all HUD-insured loans that went into default within six
              payments, select sufficient samples for the reviews of closed and rejected loans,
              always conduct quality control reviews in a timely manner, provide adequate
              management follow-ups to wholesale loans, and inform HUD of significant
              deficiencies detected with one of its loan correspondents. As such, its quality
              control plan was lessened. However, correcting these deficiencies will strengthen
              the quality control system.

Recommendations

              We recommend that the assistant secretary for housing - federal housing
              commissioner require First Residential to

              2A.    Establish procedures to ensure that (1) all HUD-insured loans that default
                     within the first six payments are properly reviewed; (2) ten percent or
                     more of the closed and rejected loans are reviewed; (3) quality control
                     reviews are performed in a timely manner; and (4) adequate management
                     follow-up is provided for any material findings resulting from quality
                     control reviews.

              2B.    Implement the controls and procedures to ensure that HUD will be
                     informed within 60 days if any significant deficiencies are identified with
                     any loan correspondents.




                                                12
                         SCOPE AND METHODOLOGY


To achieve our objectives, we reviewed applicable laws, regulations, HUD handbooks,
mortgagee letters, and reports from the HUD’s Quality Assurance Division. We reviewed
independent audit reports from First Residential’s independent auditor, and interviewed First
Residential’s managers and quality control staff to obtain an understanding of the auditee’s
internal controls.

We reviewed 11 defaulted loan files that were underwritten by First Residential with beginning
amortization dates between October 1, 2003, and September 30, 2005. The 11 loans were
selected from Neighborhood Watch. Sample selections included loans underwritten for First
Residential’s wholesale and retail divisions. Loan selection criteria also included factors such as
loans that (1) defaulted within 12 payments, (2) were not indemnified by HUD, (3) were not
reviewed by the Homeownership Center (HOC) in Philadelphia, and (4) were not a streamline
refinance. The results of our detailed testing only apply to the 11 loans tested and cannot be
projected.

We performed detailed testing and review of the underwriting procedures for the 11 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 include (1) analysis of
borrowers’ income, assets, and liabilities; (2) review of the borrowers’ savings ability and credit
history; (3) verification of selected data on the underwriting worksheet and settlement
statements; and (4) confirmation of employment and gifts. We discussed issues with HUD and
First Residential officials.

We reviewed First Residential’s quality control plan and the quality assurance reports provided
by its own quality control personnel as well as its out-sourcing company. We selected a sample
of 15 loans to test the implementation of First Residential’s quality control plan and to determine
compliance with HUD requirements.

We performed the audit fieldwork from February 2006 through May 2006. We conducted our
audit in accordance with generally accepted government auditing standards.




                                                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 Residential did not ensure that certain loans were processed in
                  accordance with all applicable HUD requirements (see Finding 1).

           •      First Residential did not adequately implement its quality control plan to
                  ensure compliance with HUD 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                             $64,219
                       1B                                                $424,384
                       1D           $495


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 efficient
     if an Office of Inspector General (OIG) recommendation is implemented. This includes
     reduction 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 mortgage 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




                         17
18
Comment 1




Comment 2




Comment 3




            19
Comment 2




Comment 4




Comment 2




Comment 5




            20
Comment 6




Comment 7




Comment 8




Comment 2




            21
Comment 9




Comment 2



Comment 10




Comment 11




             22
Comment 12




    “

    “

    “



Comment 13




Comment 14




             23
Comment 15




    “



Comment 16




Comment 17




             24
 Comment 18




Comment 19




              25
Comment 20




Comment 21




Comment 22




             26
Comment 23




             27
Comment 24




             28
29
30
                      OIG Evaluation of Auditee Comments

Comment 1   First Residential concurs that there was no explanation provided concerning
            the non-payroll deposits of $1,000 and $1,300 on December 26, 2003 and
            January 12, 2004, respectively into a bank account. However, First
            Residential implies that since there was no large increase in the account after
            these deposits were made, the lender did not have to obtain credible
            explanation of the source of these funds. HUD Handbook 4155.1, REV-5,
            section 2-10B, states that if there is a large increase in a bank account, the
            lender must obtain a credible explanation of the source of the funds. HUD
            regulations do not specifically state that it is not necessary to obtain a credible
            explanation of the source of the funds, when there is no significant difference
            between beginning balance and ending balance.

Comment 2   First Residential concurs with our determinations.

Comment 3   The hazard insurance policy declaration page dated April 23, 2004, reflects a
            billing period from November 04, 2003 to November 04, 2004. However, we
            were not provided with an explanation on why the borrower was billed for
            hazard insurance from November 04, 2003, when the closing of the FHA loan
            did not take place until April 28, 2004. Further, although the invoice provided
            by First Residential indicated that the borrower had paid $924.62 towards the
            $1,128 hazard insurance premium, and the remaining $203.38 was not due
            until May 24, 2004; no copies of cancelled checks were on file. In addition,
            the bank statements for two bank accounts did not provide any evidence that
            the $924.62 was paid from the borrower’s bank account. Therefore as
            explained for this case, the borrower did not have adequate funds to close.

Comment 4   First Residential officials concur that there is a history of derogatory credit.
            However, with the exception of the car loans they maintain that it was not
            necessary to verify the other derogatory items because they were not recent. We
            noted that some collections occurred in March 2004, which was during the time
            the borrowers applied for the loan. In addition, several credit delinquencies that
            lead to a court judgment happened within a year of the closing date. As such,
            the borrower must explain in writing all collections and judgments and the
            lender must consider this per HUD Handbook 4155.1, section 2-3C.

Comment 5   There was no specific support for the past two-year history of the overtime
            income and its continuance. From the documentation provided there was no
            verification that the amount of compensation (as shown on Form W2s) that
            was in excess of the base pay was all overtime pay or that it is likely to
            continue. In addition, overtime income is required to be averaged for the past
            two years. If it varies significantly from year to year, a period of more than
            two years must be used in calculating the average income.




                                          31
Comment 6   First Residential subsequently provided a copy of a verification of
            employment for the co-borrower’s previous job held with Home Depot from
            March 2000 to August 2002. Based on this supporting document, we agreed
            to modify this deficiency. We still consider the co-borrower’s explanation
            about the employment gap to be inadequate. The co-borrower stated that she
            started collecting unemployment benefits and was baby sitting for two
            individuals from September 2002 to April 2003; each individual paid her $100
            a week. These two jobs were not listed on the FHA loan application. The
            verbal verification provided by First Residential for these two jobs did not
            disclose income information.

Comment 7   First Residential concurs that no explanation was obtained for seven deposits
            totaling $13,174. However, First Residential implied that the lender did not
            have to obtain a credible source of the funds since the beginning balance and
            ending balance did not reflect significant difference on the bank statements for
            the period of December 16, 2003 to February 26, 2004. However, the
            difference between the beginning and ending balance was significant since the
            ending balance was positive whereas the beginning balance was negative.
            Accordingly, a credible explanation of the source of the funds should have
            been obtained per HUD Handbook 4155.1, REV-5, section 2-10B. HUD
            regulations do not state that it is not necessary to obtain credible explanation
            of the source of the funds, when there is no significant difference between
            beginning balance and ending balance.

Comment 8   The borrower had eight non-sufficient fund charges in one month, during the
            period of December 16, 2003, to January 16, 2004. As such, First
            Residential’s explanation that the borrower had a period of mismanaging his
            account is not adequate. Chapter 3 of the HUD Handbook, 4155.1, REV-5,
            provides that the lender is responsible for asking sufficient questions to elicit a
            complete picture of the borrower's financial situation, source of funds for the
            transaction, and the intended use of the property. All information must be
            verified and documented. First Residential also stated that the source of funds
            to close and significant reserves after closing came from the co-borrower’s
            own funds as reflected in the savings account. However, funds from gifts from
            any source are not to be included as cash reserves as defined in HUD
            Handbook 4155.1, REV-5, section 2-13. If we exclude the gift of equity in
            calculating cash reserves, then the borrower would have had negative cash
            reserves of $10,926.

Comment 9   First Residential explained that a 10% down payment is considered as a
            compensating factor. However, the Mortgage Credit Analysis Worksheet
            (MCAW) did not list the 10% down payment as a compensating factor; it only
            listed (1) low loan-to-value (LTV) ratio and (2) strong reserves after closing,
            as compensating factors. Low LTV ratio is not an allowable compensating
            factor, and funds from gifts from any source are not to be included as cash
            reserves as defined in HUD Handbook 4155.1, REV-5, section 2-13. If we



                                          32
              exclude the gift of equity in calculating cash reserves, then the borrower
              would have had negative cash reserves of $10,926. Further, First Residential
              stated that at the time of closing, the borrower had strong cash reserves as
              documented by the savings account statement showing total assets of
              $18,501.67. Our review of a copy of the savings account passbook disclosed
              that the co-borrower had $18,501.67 as of February 20, 2004, which was
              approximately three months prior to the closing date of May 13, 2004. In
              addition, there is no evidence of what the savings balance was after the
              closing.

Comment 10 HUD Handbook, 4155.1, REV-5, Section 2-3, states that major indications of
           derogatory credit require sufficient written explanation from the borrower.
           The borrower’s explanation that these late payments were due to the creditor’s
           computer errors or that the bills were sent to the neighbor’s house is
           inadequate.

Comment 11 HUD Handbook, 4155.1, REV-5, Section 2-10B states that if there is a large
           increase in a bank account, the lender must obtain credible explanation of the
           source of those funds. First Residential officials state the verification of
           deposit shows an average balance of $1,517.76 in the last two months.
           However, the bank statement for the period of August 10, 2004, to September
           03, 2004, shows that the ending bank balance was $353.63.

              Our review of the Mortgage Credit Analysis Worksheet disclosed that the
              assets available totaling $39,035 included a relocation benefit received by the
              borrower amounting to $38,672; therefore, the borrower only had $363 in a
              bank account. There was no other asset documentation in the file, thus the
              borrower did not demonstrate savings ability.

Comment 12 A total of 48 consecutive late payments and numerous other delinquencies are
           significant. First Residential should have conducted further credit analysis
           regarding the borrower’s credit and inadequate explanations. However, First
           Residential did concur with our determinations on the judgement and
           additional credit inquiries.

Comment 13 HUD Handbook 4155.1 requires the lender to verify the source of the earnest
           deposit when it appears excessive based on the borrower’s history of
           accumulating savings. Monthly income is not a qualified source document for
           the earnest deposit. Without the $3,500 earnest deposit, the borrowers would
           have had a negative cash reserve at closing.

Comment 14 First Residential did not address the missing supporting documents for the
           $848.23 deposit on 12/12/03 in its comments. First Residential maintains that
           the borrower’s explanation for the $2,414.96 deposit on 11/05/03 was
           reasonable based on the assumption that the borrower may deposit the payroll
           income via means other than direct deposit. However, we noted one of the



                                           33
               three payroll checks the borrower quoted in her explanation was not supported
               by documents such as payroll statements or canceled checks. The borrower
               did not even mention from which employer that paycheck was from. As a
               result, the borrower’s explanation was inadequate.

Comment 15 First Residential considers that it is not necessary to verify the source of funds
           because the beginning and ending balance in the account did not change
           greatly and bank statements show a steady history of accumulated savings.
           However, this is not a valid justification for a lender to avoid underwriting
           procedures that are required by the regulations. The large increases or
           deposits to the acccont of $2,798, $1,000 and $4,107 should have been
           explained per HUD Handbook 4155.1, section 2-10. In addition, the
           assumption of additional income based on the borrower’s position as a police
           officer is not a qualified explanation for the the significant deposits.

Comment 16 HUD Handbook 4155.1, section 2-3C states that collections indicate a
           borrower’s disregard for credit obligations and must be considered in the
           analysis of creditworthiness with the lender documenting its reasons for
           approving a mortgage where the borrower has record of accounts in
           collection. In addition, First Residential should have obtained explanations
           for the late payments with the other creditors because several of these late
           payments were recently incurred.

Comment 17 An explanation is required because seven overdrafts within a month of the
           closing date brought a significant drawback to the borrower’s credit worthiness.
           First Residential should have asked sufficient questions regarding the large
           deposits, overdrafts, collections and late payments to elicit a complete picture of
           the borrower’s financial situation and source of funds for the transaction as
           required by HUD Handbook 4155.1, section 3.

Comment 18 HUD Handbook 4155.1, REV-5, section 2-10B states that if there is large
           increase in an account, or the account was opened recently, the lender must
           obtain a credible explanation of the source of the funds. Contrary to HUD
           regulation, First Residential did not obtain an explanation of the source of the
           funds. The file only contained a verbal verification of the account and an
           affidavit from the club treasurer. HUD Handbook 4155.1, REV-5, section 2-
           10R requires that at a minimum, the clubs must have account ledgers, receipts
           from the club, verification from the club treasurer, and identification of the
           club so that the lender can re-verify the information provided.

               Further, since our review disclosed that the treasurer of the private savings
               club paid a commitment fee for this FHA loan and was the co-borrowers
               landlord, it should have been evident that there is an appearance of a possible
               conflict of interest. Thus, First Residential should have asked sufficient
               questions to elicit a complete picture of the borrower's financial situation, the




                                             34
              source of funds for the transaction, and the intended use of the property as
              stated in the Chapter 3 of the HUD Handbook, 4155.1, REV-5.

Comment 19 HUD Handbook, 4155.1, REV-5, section 2-10A provides that if the amount of
           the earnest money deposit exceeds 2 percent of the sales price or appears
           excessive based on the borrower’s history of accumulating savings, the lender
           must verify with documentation the deposit amount and the source of the
           funds. The file contained a copy of an escrow letter from realtor
           acknowledging the receipt of $6,450, which exceeded 2 percent of the sales
           price of $215,000. According to the bank statement on file, the source of the
           earnest money deposit was the inadequately verified $9,000 from the private
           savings club as explained previously, thus the borrower did not have sufficient
           funds to cover the earnest money deposit and the documentation in the file for
           the earnest money deposit was inadequate. First Residential should have
           verified the source of the $6,450 earnest money deposit, and the $1,000 initial
           deposit.

Comment 20 HUD Handbook 4155.1, REV-5, section 2-10 requires that all funds for the
           borrower’s investment in the property be verified and documented. First
           Residential should have verified the source of the $6,450 earnest money
           deposit, and the $1,000 initial deposit. Therefore, we conclude that due to
           unsupported paid outside of closing costs of $475, and the unverified earnest
           money deposit of $6,450, the borrower could not meet the cash requirement at
           closing. The HUD-1 settlement statement indicates the cash due from the
           borrower was $2,756 and if we add back $475 and $6,450, then the borrower
           would have been required to pay $9,681.

Comment 21 First Residential agreed that no satisfactory explanation was obtained for the
           co-borrower’s derogatory account, due to an oversight by the underwriter.
           First Residential also did not provide satisfactory explanations for the other
           matters/deficiencies noted in this section.

Comment 22 HUD Handbook 4155.1, REV-5, section 2-10 requires that all funds for the
           borrower’s investment in the property be verified and documented.

Comment 23 We provided the FHA case number of that loan to First Residential at the exit
           conference.

Comment 24 First Residential concurs with our finding on its quality controls and is willing
           to improve the current system.




                                           35
Appendix C
             Summary of Underwriting Deficiencies




                              36
Appendix D

                       CASE SUMMARY NARRATIVES
                                                                                Appendix D-1
                                                                                  Page 1 of 2
  Case number:              352-5204457
  Loan Amount:              $254,013
  Settlement date:          April 28, 2004
  Status:                   Delinquent

  Pertinent details:


  A. Verification of Deposits not Obtained

  The lender did not adequately verify the excessive deposits in the borrower’s bank account.
  The HUD Handbook, 4155.1, REV-5, section 2-10B states that if there is a large increase in a
  bank account, the lender must obtain a credible explanation of the source of those funds. The
  borrower made non-payroll deposits of $1,000 and $1,300 on December 26, 2003, and
  January 12, 2004, respectively into a bank account. No explanation was provided in the file.

  B. Inadequate Bank Account Documentation

  The lender did not properly verify the bank assets by obtaining adequate bank account
  documents. HUD Handbook 4155.1, REV-5, Section 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. The bank statements in the file
  were not consecutive. The statements covered the period from December 16, 2003 through
  January 15, 2004, and February 14, 2004 through March 15, 2004, therefore the period from
  January 16, 2004 through February 13, 2004, was missing.

  C. Negative Cash Reserve on HUD-1

  The lender did not verify or document that the borrower had adequate funds to close. HUD
  Handbook 4155.1, REV-5, Section 2-10 requires that all funds for the borrower’s investment
  in the property be verified and documented. Cash due from the borrower on the HUD-1
  settlement statement was $3,740. If the unsupported paid-outside-closing costs for hazard
  insurance premium of $1,128 (see section D) were added to the $3,740, the borrower was
  required to pay $4,868. The borrower only had an asset of $4,175 as per the Mortgage Credit
  Analysis Worksheet (MCAW). Therefore, the borrower would have had a deficit of $693 at
  closing.




                                             37
                                                                               Appendix D-1
                                                                                 Page 2 of 2

D. Verification of Paid-Outside-Closing Costs Not Obtained


The lender did not verify the payment for the paid-outside-closing costs. HUD Handbook
4155.1, REV-5, Section 2-10 requires that all funds for the borrower’s investment in the
property be verified and documented. The HUD-1 settlement statement in the file reported
that the borrower paid $1,128 outside of closing for hazard insurance premium. However,
there was no documentation to show that this had been paid before closing.

E. Inadequate Compensating Factors

The lender did not provide adequate compensating factors to justify the excessive debt to
income ratios. Mortgagee Letter 2005-16, states that the lender must describe the
compensating factors used to justify mortgage approval when the borrower’s mortgage
payment to effective income ratio (front) and total fixed payment to income ratio (back)
exceeded 31 and 43 percent respectively. The borrower’s ratios were 39.05 and 42.19
percent respectively as per the lender’s calculation. Compensating factors listed on
Mortgage Credit Analysis Worksheet were (1) employment stability, (2) excellent rental
payment history, and (3) potential for increased earnings (has been receiving raises
consistently). Employment stability and excellent rental payment history are not allowable
compensating factors as defined in HUD Handbook 4155.1, REV-5, section 2-13. The
Verification of Employment stated that the borrower received a raise in January 2004 of 6
percent. The date on the Verification of Employment was April 14, 2004. Therefore, we
determined that current annual gross pay of $64,254 incorporated the raise received in
January 2004.

Even though we took into consideration the 6 percent raise to $64,254, the front ratio would
be 36.84 percent, which is still higher than 31 percent threshold.




                                           38
                                                                                    Appendix D-2
                                                                                      Page 1 of 2
Case number:               352-5229168
Loan amount:               $249,091
Settlement date:           May 14, 2004
Status:                    Foreclosure Started

Pertinent details:

A. Inadequate Credit Analysis

The lender did not conduct an adequate analysis of the borrowers’ credit history. HUD
Handbook 4155.1, REV-5, section 2-3, provides that major indications of derogatory credit
require a sufficient written explanation from the borrower. The credit report in the file indicated
that the co-borrower incurred 19 late payments for a car loan from June 2002 to April 2004,
including four delinquencies from January 2004 to April 2004 (during the time the borrowers
applied the loan). The co-borrower explained that the account was for a car she purchased for
her mother. Her mother was the person using the car and paying the car loan, even though the
loan was under the co-borrower’s name. HUD Handbook section 2-11B states that a contingent
liability exists when an individual will be held responsible for payment of a debt, should another
party, jointly or severally obligated, default on that payment. If the individual applying for a
Federal Housing Administration insured mortgage is a co-signer on a car loan, a contingent
liability applies unless the lender obtains documented proof that the primary obligor has been
making payments during the previous 12 months on a regular basis and does not have a history
of delinquent payments on the loan. As a result, the co-borrower’s explanation for this
derogatory account was inadequate.

The borrowers also incurred several late payments for another car loan. The borrower
explained that this was due to the dispute regarding the car’s warranty. A recent late
payment happened two months before closing. The borrower said that they missed the
payment because of the packing and moving commotion for the new home. In addition, the
borrowers showed a consistent derogatory credit history, even though they indicated that they
are trying to keep their credit clean, however, because of numerous recent late payments, we
conclude that the explanations are not satisfactory.

B. Inadequate Disclosure of Liabilities

The lender did not disclose the projected liabilities for the underwriting analysis. HUD
Handbook 4155.1, REV-1, section 2-11 C, provides that if a debt payment, such as a student
loan, is scheduled to begin within 12 months of the mortgage loan closing, the lender must
include the anticipated monthly obligation in the underwriting analysis, unless the borrower
provides evidence that the debt will be deferred to a period outside this timeframe. The credit
report in the file disclosed that the co-borrower had $13,250 in Sallie Mae student loans.
First Residential did not provide any explanation that repayment of the Sallie Mae student
loans would not start within 12 months of closing.




                                              39
                                                                                Appendix D-2
                                                                                  Page 2 of 2
C. Inaccurate Support for Income Calculation
D. Inaccurate Debt To Income Ratios

The ratios calculated by First Residential were incorrect because the monthly income was
overstated by $797.68 in overtime income. HUD Handbook 4155.1, REV-5, section 2-7A,
provides that overtime may be used as qualifying income if the borrower has received such
income for approximately the past two years and there are reasonable prospects of its
continuance. The file did not contain documentation indicating that the borrower had received
overtime income for the past two years. No indication of its continuance was provided either.
After deducting $797.68 from the borrower’s monthly income, the debt to income ratios would
increase to 32.12 and 47.87 percent, respectively.

E. Inadequate Compensating Factors

The lender did not provide adequate compensating factors for excessive debt to income
ratios. Mortgagee Letter 2005-16 states that the lender must describe the compensating
factors used to justify mortgage approval when the borrower’s mortgage payment to effective
income ratio and total fixed payment to income ratio exceed 31 and 43 percent, respectively.
HUD OIG calculated ratios are 32.12 and 47.87 percent. Compensating factors listed were
“ratios are within guidelines; employment and income stability.” However, these are not
allowable compensating factors as defined in HUD Handbook 4155.1, REV-5, Section 2-13.




                                            40
                                                                              Appendix D-3
                                                                                Page 1 of 2

Case number:              352-5230020
Loan Amount:              $274,050
Settlement date:          May 13, 2004
Status:                   First legal action to commence foreclosure

Pertinent Details:


A. Inadequate Support for Employment

The lender did not obtain an adequate explanation for the employment gap from August 2002
to March 2003 from the co-borrower. HUD Handbook, 4155.1, REV-5, section 2-6 requires
that the lender must verify the borrower's employment for the most recent two full years.
The borrower also must explain any gaps in employment spanning one month or more. The
co-borrower stated that she started collecting unemployment benefits and also stated that she
was baby sitting for two individuals from September 2002 to April 2003, and that each
individual paid her $100 a week. These two employments were not listed on a FHA loan
application. The verbal verification provided by First Residential for these two employments
did not disclose income information.

B. Verification of Deposit not Obtained
C. Inadequate Evaluation of Savings Pattern

The lender did not verify the excessive deposits in the borrower’s bank account. The HUD
Handbook, 4155.1, REV-5, Section 2-10B states that if there is a large increase in a bank
account, the lender must obtain a credible explanation of the source of those funds. No
explanation was provided for seven excessive deposits totaling $13,174 within two months
($1,826 on January 6, 2004, $1,000 on January 23, 2004, $1568.11 on January 26, 2004,
$1,333.21 on January 30, 2004, $1,500 on February 4, 2004, $3,348 on February 9, 2004,
and $2,599 on February 24, 2004).

In addition, section 2-1 of the handbook also provides that the lender must evaluate the
borrower’s capacity to make payments. The bank statements in the file showed eight non-
sufficient fund charges during the period of December 16, 2003 to January 16, 2004.
Explanation in the file was inadequate.




                                           41
                                                                                 Appendix D-3
                                                                                   Page 2 of 2
D. Inadequate Credit Analysis

The lender did not apply an adequate analysis to the borrower’s credit history. HUD
Handbook 4155.1, REV-5, section 2-3 requires that indications of derogatory credit including
judgments, collections, and any other recent credit problems require sufficient written
explanation from the borrower. The borrower’s explanation must make sense and be
consistent with other credit information in the file. The credit report indicated that the co-
borrower had three derogatory accounts. However, no explanation was provided. Two out of
these three derogatory accounts were placed for collection. Another account did not show
that it was placed for collection, but the file contained a letter, which was dated after the
credit report, which indicated that if the amount agreed to settle the account is not paid, then
it will be placed for collection. There was no documentation on file to show whether the
amount agreed to settle the account was paid or not.

E. Inadequate Compensating Factors

Mortgagee Letter 2005-16, states that the lender must describe the compensating factors used
to justify mortgage approval when the borrower’s mortgage payment to effective income
ratio (front) and total fixed payment to income ratio (back) exceeded 31 percent and 43
percent respectively. The borrower’s ratios were 34.92 percent and 37.67percent
respectively as per lender’s calculations. Compensating factors listed on the MCAW were
(1) low loan-to-value (LTV) ratio (2) strong reserves after closing. Low LTV ratio is not an
allowable compensating factor, and funds from gifts from any source are not to be included
as cash reserves as defined in HUD Handbook 4155.1, REV-5, section 2-13. If we exclude
the gift of equity in calculating cash reserves, the borrower would have had negative cash
reserves of $10,926.




                                            42
                                                                                Appendix D-4
                                                                                  Page 1 of 1
Case number:              352- 5213442
Loan Amount:              $267,858
Settlement date:          September 13, 2004
Status:                   Foreclosure Started

Pertinent Details:


A. Principal, Interest, Taxes and Insurance (PITI) Cash Requirement not Met

HUD handbook, 4155.1, REV-5, Section 1-8 C requires that the borrower must have reserves
equivalent to three months’ principal, interest, taxes and insurance expenses after closing on
purchase transactions for three and four units property. Reserves cannot be derived from a
gift. On the Mortgage Credit Analysis Worksheet, the cash reserves was $79.71, which was
less than one month’s principal, interest, taxes and insurance costs of $2,312.90.

B.   Inadequate Credit Analysis

HUD Handbook, 4155.1, REV-5, Section 2-3, states that major indications of derogatory
credit–including judgments, collections, and any other recent credit problems require
sufficient written explanation from the borrower. The borrower's explanation must make
sense and be consistent with other credit information in the file. The borrower’s credit report
showed several derogatory accounts. The borrower explained that these late payments were
due to the creditor’s computer errors or that the bills were sent to the neighbor’s house. We
consider this an inadequate explanation.

C. Verification of Deposits not obtained
D. Inadequate Evaluation of Savings Pattern

HUD Handbook, 4155.1, REV-5, Section 2-10B states that if there is a large increase in a
bank account, the lender must obtain a credible explanation of the source of those funds. The
bank statements indicated that the borrower had five non-payroll deposits totaling $1,790
during the period from July 15, 2004, through September 3, 2004. No explanation of these
excessive deposits was contained in the file.

HUD Handbook 4155.1, REV-5, section 2-1 also requires the lender to evaluate the
borrower’s capacity to make payments. We noted the beginning balance of the bank account
was $2,641.49 as of July 15, 2004, and the ending balance was reduced to $353.63 as of
September 3, 2004. With five unverified non-payroll deposits of $1,790, the borrower had
withdrawn a significant amount of funds from her bank account. The file did not contain an
indication that any withdrawals were made towards the purchase of the property. We
concluded that the borrower did not demonstrate savings ability, and may lack the capacity to
make the mortgage payment.




                                            43
                                                                                 Appendix D-5
                                                                                   Page 1 of 2
Case number:              352-5167847
Loan amount:              $236,241
Settlement date:          January 6, 2004
Status:                   First Legal Action to Commence Foreclosure

Pertinent details:


A. Inadequate Credit Analysis

HUD Handbook 4155.1, REV-5, section 2-3, provides that major indications of derogatory
credit require a sufficient written explanation from the borrower. The credit report indicated
that the borrower had 48 instances of late payments for one of her creditors, of which
numerous late payments incurred recently. The borrower explained she was unaware of this
account. The borrower also incurred numerous delinquencies with another creditor. The
borrower explained that the delinquencies happened due to her irresponsible employer who
did not pay her on time and the payment was less than promised. We consider these
inadequate explanations.

In addition, section 2-3C requires that the borrower must explain in writing all collections
and judgments. However, the file did not contain a written explanation for one judgment
incurred in June 2003, with an amount of $4,213. The borrower also incurred two other
judgments a few years back. The charges of these two judgments were not paid until the
closing date. No explanation was obtained from the borrower for the delayed payments.

The borrower stated in her letter that she did not like credit, and always made purchases with
cash or money orders. However, the borrower made five inquiries from April 15, 2003, to
August 19, 2003, to obtain credit cards. In addition, from August 28, 2003, to November 17,
2003, the borrower made another five inquires. No explanation was obtained for these
additional inquiries. The borrower did not demonstrate a conservative attitude toward the use
of credit.

B. Inadequate Earnest Money Deposit Documentation

HUD Handbook 4155.1, REV-5, section 2-10A, provides that if the amount of the earnest
money deposit exceeds 2 percent of the sales price or appears excessive, based on the
borrower’s history of accumulating savings, the lender must verify the amount of deposit and
the source of funds. The borrower’s bank statement indicated that the regular payroll
deposits were about $50 every two weeks. Also, the balance of the borrower’s bank account
was minimal before her mortgage application. Therefore, $3,500 was excessive compared to
the borrower’s accumulated savings. The file only contained an attorney’s letter indicating
that the seller held the borrower’s earnest money deposit. However, no verification of the
source of funds was obtained.




                                            44
                                                                               Appendix D-5
                                                                                 Page 2 of 2
C. Negative Cash Reserve on HUD-1

HUD Handbook 4155.1, REV-5, section 2-10, provides that all of the funds for the
borrower’s investment in the property must be verified and documented. The borrower did
not appear to have sufficient funds to close. If we do not include the $3,500 earnest money
deposit due to its unverified source, as described in section B, the borrower would have a
$578.95 shortage at closing.

D. Verification of Deposit Not Obtained

The lender did not adequately verify the excessive deposits into the borrower’s bank account.
HUD Handbook 4155.1, REV-5, section 2-10B, provides that if there is a large increase in a
bank account or the bank account was opened recently, the lender must obtain an explanation
and evidence of the source of funds from the borrower. The borrower deposited $2,414.96 to
her bank account on November 5, 2003, without adequate explanation and source documents
from the borrower. In addition, no explanation was obtained for an $844.23 deposit on
December 12, 2003.




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                                                                                  Appendix D-6
                                                                                    Page 1 of 1
Case number:               352-5246588
Loan amount:               $182,141
Settlement date:           May 14, 2004
Status:                    Reinstated by Mortgagor or Who Retains Ownership

Pertinent details:


A. Verification of Deposit Not Obtained

HUD Handbook 4155.1, REV-5, section 2-10B provides that if there is a large increase in a
bank account or the bank account was opened recently, the lender must obtain an explanation
and evidence of the source of funds from the borrower. The bank statement in the file indicated
that the borrower made non-payroll deposits of $2,798 on February 19, 2004 and $1,000 on
April 15, 2004. Also, the borrower made ten non-payroll deposits to her savings account and
four to her checking account, which totaled $4,107 during the period from February 26, 2004, to
May 13, 2004. However, no written explanation from borrower was contained in the file.

B. Inadequate Credit Analysis

HUD Handbook 4155.1, REV-5, section 2-3, provides that major indications of derogatory
credit require a sufficient written explanation from the borrower. Section 2-3C specifically
requires that the borrower must explain in writing all collections and judgments. The credit
report in the file indicated that the borrower had numerous late payments for several creditors.
One creditor stated on the credit report that the borrower was not responsible for the debt. The
file did not contain a written explanation of these delinquencies. In addition, the borrower
incurred four collections including the one from US Department of Education for the $6,611
student loan. However, the lender did not obtain any written explanation from the borrower.

C. Inadequate Evaluation of Savings Pattern

HUD Handbook 4155.1, REV-5, section 2-1, requires the lender to evaluate the borrower’s
capacity to make payments. Section 3-1 also requires that when standard documentation
does not provide enough information to support this 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. The file contained a
bank statement indicating that the borrower incurred seven overdrafts of her checking
account during the period from April 5, 2004 to May 5, 2004, while the closing date was
May 14, 2004. However, no explanation was obtained from the borrower for these
overdrafts. As a result, we concluded that the borrower did not demonstrate her savings
ability, and may lack the capacity to make the mortgage payments. The lender did not
evaluate the borrower’s ability to repay as required.




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                                                                                  Appendix D-7
                                                                                    Page 1 of 3

Case number:               352-5217394
Loan Amount:               $211, 678 (Claim paid amount: $221,445)
Settlement date:           April 22, 2004
Status:                    Claim

Pertinent Details:


A. Inadequate Verification of Assets at Private Savings Club
B. Verification of Deposit not obtained

HUD Handbook 4155.1, REV-5, section 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. Provided the bank statement shows the
previous month's balance, this requirement is met by obtaining the two most recent,
consecutive statements. Section 2-10B of the handbook also states that if there is a large
increase in an account, or the account was opened recently, the lender must obtain a credible
explanation of the source of the funds. According to a letter dated March 9, 2004, the file
indicated that the borrower did not have a bank account. The bank statement dated February
29, 2004, listed the beginning balance was zero. Therefore, we concluded that the bank
account was opened in February 2004. We noted that $9,000 was deposited into that bank
account on February 9, 2004. Contrary to HUD regulations, the lender did not obtain an
explanation of the source of the funds.

We noted that the co-borrower had $9,000 in assets available at her private savings club.
Section 2-10R provides that while private savings clubs are not supervised banking
institutions, at a minimum, the clubs must have account ledgers, receipts from the club,
verification from the club treasurer, and identification of the club so that the lender can re-
verify the information provided. The underwriter must be able to determine that it was
reasonable for the borrower to have saved the money claimed and that there is no evidence
these funds were borrowed with an expectation of repayment. The file only contained a
verification and an affidavit that provided that the borrower started contributing to the club in
October 2003. The verification indicated that contributions to the account are made bi-
weekly for $900, while the affidavit that was signed by the club treasurer listed the
contributions as $900 monthly.




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                                                                                     Appendix D-7
                                                                                       Page 2 of 3
C. Inadequate Earnest Money Deposit Documentation

HUD Handbook, 4155.1, REV-5, Section 2-10A provides that if the amount of the earnest
money deposit exceeds 2 percent of the sales price or appears excessive based on the
borrower's history of accumulating savings, the lender must verify with documentation the
deposit amount and the source of funds. The HUD-1 settlement statement and Mortgage
Credit Analysis Worksheet listed $6,450 as the earnest money deposit. The file contained a
copy of an escrow letter from realtor acknowledging the receipt of $6,450. However, except
for an official bank check of $5,450 from an unsupported source, the file did not contain any
other evidence that the source of the funds was properly verified. According to the bank
statement on file, the source of the earnest money deposit was from the inadequately verified
$9,000 from the private savings club as explained in section A and B, therefore, the
borrowers did not have sufficient funds to cover the earnest money deposit.


D. Negative Cash Reserve on HUD-1

HUD Handbook 4155.1, REV-5, section 2-10, provides that all of the funds for the
borrower’s investment in the property must be verified and documented. Cash due from
borrower on the HUD-1 statement was $ 2,756.20. Due to unsupported paid-outside of-
closing costs of $475, and the unverified earnest money deposit of $6,450, the borrower
would have been required to pay $9,681.20 at closing. Since the verification of $9,000 from
private savings club was inadequate, we conclude that the borrower could not meet this cash
requirement at closing.

E. Inadequate Credit Analysis

No satisfactory explanation was obtained for the late payments of the co-borrower’s derogatory
accounts. The co-borrower had incurred numerous late payments with one creditor recently
(within 6 months) without any explanations. The co-borrower’s credit report indicated that the
rental payment was made to the same individual who was also the co-borrower’s private savings
club treasurer. Also the borrower’s credit report indicates that the credit history was insufficient;
no credit score appeared on the credit report. HUD Handbook 4155.1, REV-5, provides that
some prospective borrowers may not have an established credit history. For those borrowers,
and for those who do not use 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. However, no alternative credit documents such as utility
payment records or verification of rental payments were contained in the file.




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                                                                                 Appendix D-7
                                                                                   Page 3 of 3
F. Verification of costs Paid-Outside of-Closing not Obtained

HUD Handbook 4155.1, REV-5, section 2-10 requires that all funds for the borrower’s
investment in the property be verified and documented. The HUD-1 settlement statement in
the file reported that the borrower paid $450 for appraisal fees, $25 credit reports fees and
$395 for commitment fees. A copy of a cancelled check for a commitment fee indicates that
it was paid by the co-borrower’s private savings club treasurer who was also the co-
borrower’s landlord. In addition, there were only invoices on file for appraisal fees and credit
report fees and there were no copies of cancelled checks on file.




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