Issue Date
March 23, 2006
Audit Report Number
2006-PH-1008
TO: Brian D. Montgomery, Assistant Secretary for Housing – Federal Housing
Commissioner, H
FROM:
SUBJECT: 1st Preference Mortgage Corporation, York, PA, and Greenbelt, MD, Did Not
Originate All Federal Housing Administration Loans in Accordance with
HUD Requirements
HIGHLIGHTS
What We Audited and Why
We audited the York, Pennsylvania, and Greenbelt, Maryland, branch offices of
1st Preference Mortgage Corporation (1st Preference), a nonsupervised mortgage
company approved to originate Federal Housing Administration single-family
mortgage loans. We selected these branch offices because their average default
rates were above the states’ average default rates. Our audit objective was to
determine whether 1st Preference acted in a prudent manner and complied with the
U.S. Department of Housing and Urban Development’s (HUD) regulations,
procedures, and instructions in the origination of Federal Housing Administration
loans.
What We Found
1st Preference’s York, Pennsylvania, and Greenbelt, Maryland, branch offices did
not originate 38 percent of the Federal Housing Administration loans selected for
review in accordance with HUD’s loan origination requirements. Of the 16 loans
we selected to review, 1 the branch offices did not fully comply with Federal
Housing Administration requirements for six loans valued at $561,506. 1st
Preference did not exercise due diligence in the review of assets and gifts
obtained during the loan closing process. These deficiencies were caused by a
lack of due professional care at the branch offices and contributed to an increased
risk to the Federal Housing Administration insurance fund. In addition, 1st
Preference did not complete timely quality control reviews or site reviews of its
branch offices or document the review of loans that went into early default.
These deficiencies occurred because 1st Preference did not have adequate internal
controls in place to ensure the reviews were completed in a timely manner or that
the reviews of the branch offices and defaulted loans were documented. As a
result, 1st Preference did not identify or correct problems with the accuracy,
validity, and completeness of its loan origination in a timely manner.
What We Recommend
We recommend that the assistant secretary for housing – federal housing
commissioner request 1st Preference to develop internal procedures to more
closely monitor its origination and underwriting procedures. In addition, we
recommend that 1st Preference strengthen its internal control procedures to ensure
reviews are completed in a timely manner and reviews of the branch offices and
defaulted loans are documented.
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 draft report to 1st Preference on February 17, 2006. We discussed
the report with 1st Preference at the exit conference on March 6, 2006. 1st
Preference provided written comments to our draft findings on March 15, 2006.
The complete text of 1st Preference’s response, along with our evaluation of that
response, can be found in appendix A of this report.
1
Originally valued at $1,858,620.
2
TABLE OF CONTENTS
Background and Objectives 4
Results of Audit
Finding 1: 1st Preference’s York and Greenbelt Branch Offices Did Not Fully 6
Comply with HUD’s Loan Origination Requirements
Finding 2: 1st Preference’s Quality Control Plan and Its Implementation Did 9
Not Comply with HUD Requirements
Scope and Methodology 12
Internal Controls 13
Appendixes
A. Auditee Comments and OIG’s Evaluation 14
B. Schedule of 16 Federal Housing Administration-Insured Loans Selected for 20
Review
C. Schedule of Case File Discrepancies 21
3
BACKGROUND AND OBJECTIVES
The National Housing Act, as amended, established the Federal Housing Administration, an
organizational unit within the U.S. Department of Housing and Urban Development (HUD). The
Federal Housing Administration provides insurance to private lending institutions under Section
203 of the National Housing Act. HUD designates these institutions as supervised lenders,
nonsupervised lenders, loan correspondents, investing lenders, and government institutions.
Depending upon its designation, the institution has the authority to originate, purchase, hold,
service, or sell Federal Housing Administration-insured mortgages. A nonsupervised lender is a
financial institution, the principal activity of which is lending or investing funds in real estate
mortgages.
In 1983, HUD implemented the direct endorsement program, which authorized approved lenders
to underwrite loans without HUD’s prior review and approval. HUD can place the lenders on
credit watch status or terminate their approval if their rate of defaults and claims exceeds the
normal rate for the area. Many sanctions are available for taking actions against lenders or
others who abuse the program.
1st Preference Mortgage Corporation (1st Preference) was incorporated to perform all aspects of
mortgage lending on September 4, 1990, under the laws of the state of Maryland. On August 8,
1991, HUD authorized 1st Preference as a nonsupervised mortgage company. 1st Preference’s
main office is located at 9423 Bel Air Road, Nottingham, Maryland.
The York and Greenbelt branches of 1st Preference are two of its seven active branch offices.
Between July 1, 2003, and June 30, 2005, 1st Preference originated 771 Federal Housing
Administration-insured mortgages totaling $94,786,292. 1st Preference’s overall compare ratio 2
for the company was 79 percent and its default rate was below the national average. The York
and Greenbelt branch offices originated 321 loans totaling $39,133,272. Of these, we reviewed
16 loans, originally valued at $1,858,620, that were in default status with 12 payments or fewer.
Branch Default Default loan
originations Loan value loans value
York 138 $12,358,113 9 $ 789,309
Branch
Greenbelt 183 $26,775,159 7 $1,069,311
Total 321 $39,133,272 16 $1,858,620
HUD’s Quality Assurance Division’s March 2004 review of 1st Preference’s loan origination
procedures cited several loan origination deficiencies. 1st Preference did not adequately
document the source and/or adequacy of funds used for gift funds, down payments, and closing
costs.
2
According to Neighborhood Watch, this ratio reveals the discrepancy between the subject’s default and claim
percentage to which it is being compared.
4
The objectives of our review were to determine whether 1st Preference originated Federal
Housing Administration-insured loans in accordance with prudent lending practices and HUD
requirements and whether the lender implemented a quality control plan that met HUD’s
requirements.
5
RESULTS OF AUDIT
Finding 1: 1st Preference’s York and Greenbelt Branch Offices Did Not
Fully Comply with HUD’s Loan Origination Requirements
1st Preference did not always originate Federal Housing Administration-insured loans in
compliance with HUD requirements. For 6 of the 16 loans we reviewed, originally valued at
$561,506, 1st Preference did not exercise due diligence in the review of assets and gifts obtained
during the loan closing process (see appendix C). The deficiencies occurred due to a lack of due
professional care at the branch offices. Consequently, 1st Preference increased the risk to the
Federal Housing Administration insurance fund. Therefore, 1st Preference should develop and
implement control procedures to more closely monitor its origination and underwriting
procedures.
1st Preference Did Not
Adequately Verify Borrowers’
Assets
Unsupported Source of Earnest Money Deposit
HUD requirements 3 state 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. For case 441-7306314, 1st Preference did not
adequately document the source of an earnest money deposit. The earnest money
deposit in this case exceeded 5 percent of the contract sales price and appeared
excessive based upon the borrowers’ savings history. Instead of obtaining a bank
statement or canceled check to support the source of funds, 1st Preference
obtained a letter from the seller acknowledging the receipt of the earnest money.
However, a letter from the seller acknowledging receipt does not support that the
deposit was from the borrowers’ own funds. As of August 1, 2005, legal action
has commenced to start the foreclosure process. We would request
indemnification for this loan with an unpaid loan balance of $98,421 since we
3
HUD Handbook 4155.1, REV-5, paragraph 2-10.
6
have no assurance the earnest money was from the borrowers’ own funds.
However, this loan was paid off on March 10, 2006.
Inaccurate Use of Child Support as Effective Income
1st Preference did not adequately support the use of child support income in one
case, resulting in an overstatement in the borrower’s financial ability to meet her
new housing obligations. HUD requirements 4 state that child support may be
included as effective income if the payments are likely to continue for the next
three years and there is evidence that payments have been received during the last
12 months. For case 241-7417716, 1st Preference’s loan files did not demonstrate
the child support had been received for three of the previous 12 months as
required. Since this is only a technical deficiency, it does not warrant
indemnification. The loan was in default, but the borrower is making repayments
to bring the loan current.
Sources of Gift Funds Not Identified
HUD requirements 5 state that the lender must document the transfer of gift funds
from the donor to the borrower to ensure that the gift funds are provided from
acceptable sources. In three of the cases reviewed, 1st Preference did not
adequately identify the sources of gift funds as required by HUD. For cases 441-
7433424, 442-2465417, and 241-7220158, 1st Preference did not obtain the wire
transfer receipts or copies of the gift checks to document the transfer of the funds.
Without identifying the sources of the gifts, there was no assurance the funds
were provided from acceptable sources. Since these are only technical
deficiencies and we were able to determine that the organizations providing the
funds were legitimate, we are not requesting that these loans be indemnified.
Secondary Financing Terms Not Clearly Identified
HUD requirements 6 state that if a borrower is obtaining secondary financing, each
transaction must be documented, and the loan instruments must be included in the
endorsement binder. In two cases, 1st Preference did not obtain the required loan
instruments for the secondary financing the borrowers received.
• In case 441-7433424, an incomplete draft copy of the loan instrument was
provided in the file. It lacked the borrower’s name, signature, and loan
amount. The actual loan amount the borrower received differed
considerably from the amount originally stated in the gift letter.
• In case 241-7523242, the loan instrument was not provided. Therefore,
the secondary loan amount and contingencies were not clearly identified.
4
HUD Handbook 4155.1, REV-5, paragraph 2-7(F).
5
HUD Handbook 4155.1, REV-5, paragraph 2-10.
6
HUD Handbook 4155.1, REV-5, paragraph 1-13.
7
Had the secondary financing not been received, the borrower would not
have had sufficient funds to close.
We were able to obtain copies of the loan instruments, so we are not requesting
indemnification on these loans. However, it is 1st Preference’s responsibility to
obtain these documents to ensure the funds were provided from acceptable
sources and that the terms were allowable under HUD regulations.
Recommendations
We recommend that the assistant secretary for housing – federal housing
commissioner
1A. Require 1st Preference to develop and implement internal control
procedures to more closely monitor its origination and underwriting
process (specifically in the areas of earnest money deposits, child support,
gift funds, and secondary financing).
8
Finding 2: 1st Preference’s Quality Control Plan and Its Implementation
Did Not Comply with HUD Requirements
1st Preference’s quality control reviews and plan did not fully comply with HUD regulations. 1st
Preference did not complete its quality control reviews within 90 days, complete site reviews of
its branch offices, or document its review of loans that went into early default. These
deficiencies occurred because 1st Preference did not have adequate internal controls in place to
ensure the reviews were completed in a timely manner or that the reviews of the branch offices
and defaulted loans were documented. As a result, 1st Preference did not identify or correct
problems with the accuracy, validity, and completeness of its loan origination in a timely
manner.
Quality Control Reviews Were
Not Completed within the 90-
Day Requirement
HUD Handbook 4060.1 7 states that loans must be reviewed within 90 days of the
closing of the loan. To ensure that the 90-day goal is met, 1st Preference
contracted out the review process to Qualimae. 8 Each month, Qualimae selected
10 percent of all of the loans issued to determine that the files were complete and
all necessary verifications were completed. Once Qualimae completed its review,
it provided a status report to 1st Preference, denoting any discrepancies found in
the file.
We reviewed the quality control reviews for 11 loans that closed from April 2004
through March 2005 and found that only five of the reviews were performed
within the 90-day requirement. The remaining six loans were reviewed from 91
to 162 calendar days after the loan closed.
Part of the reason the reviews were not completed within the 90-day requirement
was that 1st Preference did not submit the copies of the loan files to Qualimae in a
timely manner. In addition, 1st Preference did not ensure that Qualimae
completed the reviews. For example, in September 2005, we requested copies of
the Qualimae reports for loans that closed in January 2005. 1st Preference did not
realize it had never received the reports from Qualimae. As a result of these
untimely reviews, 1st Preference was unable to identify loan origination
7
Paragraph 6-6(A).
8
Qualimae was hired by 1st Preference to conduct its post closing reviews.
9
deficiencies in a timely manner and take prompt corrective actions when
necessary.
Required Reviews of Branch
Offices Were Not Documented
in Plan
HUD Handbook 4060.1 9 states that a lender’s quality control plan should include
plans to complete site reviews of traditional and nontraditional branch offices
engaged in origination or servicing of Federal Housing Administration-insured
loans. However, 1st Preference’s quality control plan did not require site reviews.
Thus, there was limited assurance that 1st Preference’s branch offices were in
compliance with HUD’s requirements and that its staff was knowledgeable of
HUD’s loan origination and underwriting requirements.
Review of Defaulted Loans Was
Not Documented
HUD Handbook 4060.1 10 states that all loans going into default within the first
six payments must be reviewed. 1st Preference’s quality control plan did not
require its independent agent to review early default loans as required by HUD.
Instead, 1st Preference officials reviewed the early default loans themselves, but
did not formally document their review. Review of early default loans assists in
detecting loan origination deficiencies in a timely manner. Since 1st Preference’s
quality control process did not formally document early default reviews, we have
limited assurance that HUD was protected from unacceptable risk; guarded
against errors, omissions, and fraud; and assured that swift and appropriate
corrective action would be taken when necessary in the origination of Federal
Housing Administration-insured loans.
Recommendations
We recommend that the assistant secretary for housing – federal housing
commissioner require 1st Preference to
2A. Develop and implement procedures to ensure its quality control reviews
are performed/completed within HUD’s required timeframe.
9
Paragraph 6-3(G).
10
Paragraph 6-6(D).
10
2B. Revise its quality control plan to comply with HUD requirements, thus
ensuring site reviews and early default loan reviews are completed and
documented.
11
SCOPE AND METHODOLOGY
To accomplish our objectives, we
• Reviewed 100 percent of the Federal Housing Administration-insured loans (16 cases)
originated by 1st Preference’s branch offices in York, Pennsylvania, and Greenbelt,
Maryland, between July 1, 2003, and June 30, 2005, that had gone into default at least
once.
• Examined records and related documents of 1st Preference.
• Reviewed applicable HUD handbooks, mortgagee letters, and other relevant HUD
publications.
• Conducted interviews with officials and employees of 1st Preference and the HUD
Quality Assurance Division.
In addition, we relied in part on data maintained by HUD in its Neighborhood Watch system.
We did not perform a detailed analysis of the reliability of this data.
The audit generally covered the period from July 1, 2003, to June 30, 2005. When applicable,
the audit period was expanded to include current data through December 31, 2005. We
conducted our field work from September through December 2005.
We performed our review in accordance with generally accepted government auditing standards.
12
INTERNAL CONTROLS
Internal control is an integral component of an organization’s management that provides
reasonable assurance that the following objectives are being achieved:
• Effectiveness and efficiency of operations,
• Reliability of financial reporting, and
• Compliance with applicable laws and regulations.
Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals, and objectives. Internal controls include the processes and procedures for
planning, organizing, directing, and controlling program operations. They include the systems
for measuring, reporting, and monitoring program performance.
Relevant Internal Controls
We determined the following internal controls were relevant to our audit objectives:
• Loan origination process – Policies and procedures that management has in
place to reasonably ensure that the loan origination process complies with
HUD program requirements.
• Quality control plan – Policies and procedures that management has in place
to reasonably ensure implementation of HUD’s quality control requirements.
We assessed the relevant controls identified above.
A significant weakness exists if management controls do not provide reasonable
assurance that the process for planning, organizing, directing, and controlling
program operations will meet the organization’s objectives.
Significant Weaknesses
Based on our review, we believe the following item is a significant weakness:
• 1st Preference did not operate in accordance with HUD requirements as they
relate to loan origination and quality control.
The deficiencies are discussed in detail in the Results of Audit section of this
report.
13
APPENDIXES
Appendix A
AUDITEE COMMENTS AND OIG’S EVALUATION
Ref to OIG Evaluation Auditee Comments
Comment 1
Comment 2
Comment 3
14
Comment 4
Comment 5
Comment 6
Comment 7
15
16
17
OIG Evaluation of Auditee Comments
Comment 1 We have verified loan 441-7306314 was paid off on March 10, 2006, through a
sale of the property by the borrower. The report has been revised to reflect this
change.
Comment 2 For loan 241-7417716, we disagree with 1st Preference’s assessment to include
child support as part of the borrower’s effective income. Based upon the
payments documented, we do not believe 1st Preference obtained sufficient
documentation to demonstrate both the consistency of and a willingness to pay
child support payments. HUD Handbook 4155.1, REV-5, paragraph 2-7(F) states
that there must be evidence that payments have been received during the last
twelve months prior to receiving the loan. Periods of less than twelve months
may be acceptable, provided the payer’s ability and willingness to make timely
payments is adequately documented by the lender. The file contained
documentation to support the borrower received child support payments for 9 of
the previous 12 months. However, the loan entered early default due to a
curtailment in the borrower’s income. This curtailment of the borrower’s income
may be related to the borrower not receiving regular child support payments. The
letter provided by the borrower explaining the missing three months worth of
child support payments due to a reconciliation period was not adequate to
conclude the nine months worth of child support received established consistency
and a willingness to pay. As a result, the child support payments should not have
been included as effective income.
Comment 3 We are pleased that 1st Preference has started to take corrective action by updating
its closing instructions to include obtaining a copy of the wire transfers of gift
funds from the Title Companies. Though we have not audited this action, we
hope this action will bring 1st Preference into full compliance with HUD’s gift
fund documentation requirements found in HUD Handbook 4155.1, REV-5,
paragraph 2-10(C).
Comment 4 We agree that the funds the borrower received in loan 441-7433424 were labeled
a grant from Dauphin County on the HUD-1 Settlement Statement. However,
based upon documentation reviewed in the loan file, the borrower received a
second or subordinated mortgage for $3,266. Though no interest is attached to
this fund, the program stipulates the entire amount of the mortgage received will
be repaid upon the sooner of (1) the sale of the property, (2) the transfer of legal
or equitable title, or (3) the repayment of all borrowed principal. Thus, the
borrower’s receipt of the funds creates a secondary financing agreement. For loan
241-7523242, the borrower received $4,750 from the Housing Venture Fund. The
reservation request form for this funding clearly stated the funds were secured.
Also, program information specified the repayment contingencies for the funds.
The borrower is required to live in the property for a minimum of five years, with
20% of the amount provided reduced each year. If the property is sold within this
18
five-year period, a lien is created against the property. Since secondary financing
is created, completed loan instruments are required in this case as well. HUD
Handbook 4155.1, REV-5, paragraph 1-13 states that any financing, other than a
Federal Housing Administration-insured first mortgage, that creates a lien against
the property is considered secondary financing and not a gift, and copies of the
loan instrument are to be included in the loan files.
Comment 5 We are encouraged that 1st Preference is taking steps to ensure that its quality
control reviews are performed within HUD’s 90-day requirement, and that it is
going to begin documenting management reviews of Qualimae reports, as well as
any defaulted loans. We hope these steps taken by 1st Preference will bring them
in full compliance with HUD’s quality control guidelines found in HUD
Handbook 4060.1, REV-1 paragraphs 6-6(A) and 6-6(D).
Comment 6 Based on the results of our review, there was no documentation to support that 1st
Preference completed site reviews in compliance with requirements stated in
HUD Handbook 4060.1, REV-1, paragraph 6-3(G). Specifically, some of HUD’s
requirements include confirming the following: (1) ensuring the offices are
properly registered with HUD with its current address, (2) operations are
conducted in a professional, businesslike environment, and (3) the offices are
sufficiently staffed with trained personnel. Also, 1st Preference’s quality control
plan did not require site reviews. Though 1st Preference’s President may visit his
branch offices regularly, there is no documentation to support his visits entailed
the review of the required elements specified in paragraph 6-3(G).
Comment 7 In 1st Preference’s conclusion, its President stated, “you are all auditors, and it is
your job to find faults.” On the contrary, our main objective in this audit was to
determine whether the lender acted in a prudent manner and complied with
established requirements when originating Federal Housing Administration-
insured loans.
19
Appendix B
SCHEDULE OF 16 FEDERAL HOUSING
ADMINISTRATION-INSURED LOANS SELECTED FOR
REVIEW
The following shows the 16 loans selected for review:
Default Information
Status
Currently code as
Mortgage in of Dec.
Case number amount default 30, 2005 Current servicing sponsor
081-0777169 $148,393 Y 12 Wells Fargo Bank
241-6990028 $100,434 Y 68 Wells Fargo Bank
241-7417716 $173,615 Y 12 Wells Fargo Bank
249-4796890 $155,295 NR 20 Chase Home Finance
241-7220158 $ 70,350 Y 12 SunTrust Mortgage
249-4807515 $267,452 N 13 Washington Mutual
249-4853742 $153,772 N 13 Washington Mutual
441-7433611 $ 63,945 N 20 Wells Fargo Bank
442-2489051 $ 83,331 Y 68 Wells Fargo Bank
442-2465417 $ 40,904 N 19 Chase Home Finance
241-7523242 $118,958 N 20 National City Mortgage
441-7551464 $112,106 N 20 National City Mortgage
441-7306314 $ 93,227 Y 68 GMAC Mortgage
441-7217278 $137,786 N 20 GMAC Mortgage
441-7433424 $ 64,452 Y 12 Washington Mutual Bank
441-7427169 $ 74,600 N 20 M&T Bank
Default status
Codes Descriptions
12 Repayment
13 Paid in full
19 Partial reinstatement
Reinstated by borrower who retains
20 ownership
68 First legal action to commence foreclosure
NR Not reported in Neighborhood Watch
20
Appendix C
SCHEDULE OF CASE FILE DISCREPANCIES
Original Unpaid Incomplete
Case mortgage principal asset
number amount balance support
441-
7433424 $ 64,452 $ 63,349 X
442-
2465417 $ 40,904 $ 39,189 X
441-
7306314 $ 93,227 $ 98,421 X
241-
7523242 $118,958 $131,255 X
241-
7220158 $ 70,350 $ 68,019 X
241-
7417716 $173,615 $170,828 X
TOTAL $561,506 $571,061
21
1st Preference Mortgage Corporation, York, PA, and Greenbelt, MD, Did Not Originate All Federal Housing Administration Loans in Accordance with HUD Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-03-23.
Below is a raw (and likely hideous) rendition of the original report. (PDF)