Issue Date
November 3, 2006
Audit Report Number
2007-AT-1002
TO: Brian D. Montgomery, Assistant Secretary for Housing-Federal Housing
Commissioner, H
FROM: James D. McKay
Regional Inspector General for Audit, 4AGA
SUBJECT: Pine State Mortgage Company, Atlanta, Georgia,
Did Not Always Comply with Federal Housing Administration
Underwriting and Quality Control Requirements
HIGHLIGHTS
What We Audited and Why
We audited loans Pine State Mortgage Company (Pine State) underwrote
at its Atlanta, Georgia, branch office. Pine State is a nonsupervised direct
endorsement lender with headquarters located in Atlanta, Georgia. We
selected the Atlanta branch office because its default rate was significantly
higher than the Georgia average.
Our audit objective was to determine whether Pine State acted in a prudent
manner and complied with U.S. Department of Housing and Urban
Development’s (HUD) regulations, procedures, and instructions in the
underwriting process for cash assets, income, and general creditworthiness
of its Federal Housing Administration-insured mortgages.
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What We Found
Pine State did not always follow HUD’s underwriting and quality control
requirements for Federal Housing Administration-insured loans. It
improperly underwrote 21 of the 108 loans reviewed. The improperly
underwritten loans contained deficiencies that affected the insurability of
the loans, including improper assessment of borrowers’ income, debts,
credit histories, and eligibility for interest rate buydowns. As a result,
HUD insured 21 loans that placed the Federal Housing Administration
insurance fund at risk for $151,687 in questioned costs and $713,495 in
funds to be put to better use. Pine State also did not maintain proper
quality controls over its underwriting process. The inadequate quality
control procedures placed HUD’s insurance fund at risk for an additional
15 loans. Our assessment of Pine State’s quality control reviews showed
these loans involved material violations not recognized by Pine State and
reported to HUD. The violations affected the loans’ insurability. These
conditions exposed HUD’s insurance fund to unnecessary risk of default,
claims, and foreclosure.
What We Recommend
We recommend that the assistant secretary for housing-federal housing
commissioner take appropriate administrative action against Pine State
based on the information contained in this report. This action should, at a
minimum, require Pine State to reimburse or hold HUD harmless against
any losses for the 21 improperly underwritten loans in finding 1 that
involve $151,687 in questioned costs and $713,495 in funds to be put to
better use, and any of the 15 loans in finding 2 that involve material
violations.
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 discussed the findings with Pine State officials during the audit. We
provided a copy of the draft report to Pine State on August 10, 2006, for
their comments and discussed the report with the officials at the exit
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conference held on August 28, 2006. Pine State provided written
comments on August 28 and September 6, 2006.
Pine State generally disagreed with our findings and case studies. The
complete text of Pine State’s response (minus exhibits); along with our
evaluation of that response, can be found in appendix B of this report.
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3
TABLE OF CONTENTS
Background and Objectives 5
Results of Audit
Finding 1: Pine State’s Atlanta Branch Office Did Not Fully Comply with 6
HUD’s Underwriting Requirements
Finding 2: Pine State Did Not Effectively Implement Quality Controls for Early 13
Payment Default Loans
Scope and Methodology 21
Internal Controls 22
Appendixes
A. Schedule of Questioned Costs and Funds to Be Put to Better Use 23
B. Auditee Comments and OIG’s Evaluation 24
C. Loan Underwriting Deficiency Charts 74
D. Loans with Temporary Interest Rate Buydowns Inappropriately Approved 76
E. Material Quality Control Findings Not Reported to HUD 80
F. Case Studies of Improperly Underwritten Loans 82
4
BACKGROUND AND OBJECTIVES
Pine State Mortgage Corporation (Pine State) is a nonsupervised direct endorsement
lender, which operates from its home office in Atlanta, Georgia. The company has been
approved to originate loans since February 11, 1993. At the time of our audit, Pine State
did not sponsor any loan correspondents. Pine State had 12 Federal Housing
Administration-approved branch offices and is approved to operate in Georgia, Florida,
Alabama, Tennessee, and South Carolina. It also did business as Bowen Family
Mortgage at two of its branch offices.
We audited loans Pine State underwrote at its Atlanta branch office for properties located
in the metropolitan Atlanta area for the period August 1, 2003, through July 31, 2005.
The Atlanta branch originated 42 percent of Pine State’s 4,163 loans but accounted for 52
percent (183/349) of the company’s defaults. The branch had a 10.54 percent two-year
default rate compared to Pine State’s overall 8.4 percent rate. The 183 Atlanta branch
defaults included 81 loans that defaulted with six or fewer payments on mortgages that
totaled $11.5 million. The branch also had a 223 percent compare ratio. The branch
compare ratio exceeded the 200 percent level generally used by HUD to identify
branches that warrant further assessment or sanctions.
Our audit objective was to determine whether Pine State 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 underwriting process for cash assets,
income, and general creditworthiness of its Federal Housing Administration-insured
mortgages.
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5
RESULTS OF AUDIT
Finding 1: Pine State’s Atlanta Branch Office Did Not Fully
Comply with HUD’s Underwriting Requirements
Pine State did not follow HUD requirements when underwriting 21 of the 108 Federal
Housing Administration-insured loans reviewed. The loans contained deficiencies that
affected the credit quality (insurability) of the loans. The loan underwriting deficiencies
occurred because Pine State’s underwriters did not adequately assess borrower eligibility.
As a result, HUD insured 21 loans that placed the Federal Housing Administration
insurance fund at risk for $151,687 in questioned costs and $713,495 in funds to be put to
better use.
Scope of Review
We reviewed 108 loans. The audit focused on early payment default loans
and loans that involved interest rate buydowns. The loans included 16 of
81 early payment default loans originated by Pine State’s Atlanta branch
office from August 1, 2003, to July 31, 2005. In addition, we examined
92 of 217 defaulted temporary interest rate buydown loans 1 originated by
Pine State, without regard to office location, between January 1, 2003, and
December 31, 2004. We limited the review to 92 loans that had defaulted
and had a debt to income ratio equal to or greater than 41 percent. We
identified significant underwriting violations for 11 of the 16 loans
reviewed for underwriting compliance and 10 of the 92 loans reviewed for
temporary interest rate buydowns.
Loans Not in Compliance with
HUD Requirements
Pine State underwrote 21 loans that contained significant loan
underwriting deficiencies. The deficiencies primarily involved
1
We expanded the review to include the interest rate buydown loans due to violations noted in loans
selected for underwriting review. We only reviewed these loans for compliance with underwriting
requirements associated with the borrower’s eligibility for the buydowns.
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Deficiency Number of loans
Number of Loans Interest rate buydown not properly assessed 11 2
Income not properly assessed 5
Debts not properly assessed 6
Credit not properly assessed 4
Quitclaim transfers 2
Gifts not properly verified 7
Other 6
These conditions occurred because underwriters did not adequately
evaluate borrower information for compliance with requirements before
approving the loans.
Each loan contained one or more significant deficiencies that are
summarized below. Appendix C summarizes the loan deficiencies for the
11 problem loans reviewed for overall underwriting, and appendix F
contains a detailed case study for each of these loans. Appendix D
summarizes the 10 loans reviewed for compliance with buydown
requirements.
Interest Rate Buydowns Not
Properly Assessed
Pine State inappropriately approved interest rate buydown loans for 11
borrowers (discussed in appendixes C and E). The files for the 11
borrowers did not show or document that Pine State assessed the
borrowers’ eligibility for the buydowns to assure that the eventual increase
in mortgage payments would not adversely affect the borrowers and likely
lead to default. The borrowers did not meet the buydown criteria. Thus,
Pine State inappropriately used the bought down monthly mortgage
amount rather than the full mortgage payment to qualify them for their
loans. Each of the 11 borrowers defaulted on their loans. The following
two examples demonstrate the conditions identified during the review.
• 105-0981353 - Pine State said they approved the buydown because
the borrower demonstrated an ability to devote a greater portion of
income to housing expense and the potential for increased income.
The credit report showed the borrower was over $20,000
delinquent on child support payments. That was not consistent
with Pine State’s justification for the buydown. Pine State based
the borrower’s increased earning potential on overtime pay. Pine
State did not assess or document that the potential increased
2
This number includes one loan listed in appendix C, reviewed for overall underwriting compliance, and
the 10 loans in appendix D, reviewed for borrower eligibility for temporary interest rate buydowns.
7
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overtime pay would be enough to pay the buydown increments.
• 105-1953205 - Pine State claimed the borrower was qualified
based on increased earning potential. We determined that Pine
State incorrectly estimated the borrower’s future earnings. The
income we projected for 2004 was less than the borrower earned in
2003. Thus, the borrower did not demonstrate the potential for
increased earning needed to pay the buydown increments.
HUD Handbook 4155.1, REV 5, paragraph 2-14B(2), provides that the
lender must establish that the eventual increase in mortgage payments will
not affect the borrower adversely and likely lead to default. The
underwriter must document that the borrower meets one of four criteria
that require borrowers to have (a) potential for increased income that
would offset the scheduled payment increases, (b) demonstrated ability to
manage financial obligations in such a way that a greater portion of
income may be devoted to housing expenses, (c) substantial assets
available to cushion the effect of the increased payments, or (d) cash
investment made that substantially exceeds the minimum required.
Although this issue was discussed in HUD’s February 2004 Quality
Assurance Division report, Pine State did not correct the documentation
problem for temporary interest rate buydown loans. Four of the ten
problem loans noted in appendix D closed after HUD completed its 2004
review 3.
Income Not Properly Assessed
Pine State did not properly assess income for five borrowers (105-
1380870, 105-2032130, 105-17491989, 105-2020030, and 105-1548492).
As a result, it overstated the borrowers’ monthly income. The following
two examples demonstrate the conditions identified during the review.
• For case 105-2020030, Pine State overstated the borrower’s
monthly income by $688. The overstatement included $478 for
overtime pay and $210 for child support. The overtime was not
allowable because the borrower had been employed at the job for
only 10 months before the loan closing and because Pine State did
not verify or document verification that the overtime would
continue. The $210 child support was not allowable because Pine
State did not properly verify the amount and resolve discrepancies
3
Effective August 2004, HUD changed its rules to no longer allow lenders to qualify borrowers at bought
down mortgage amounts. HUD changed the rule because this category of loans experienced a higher rate
of default than other loans.
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associated with the payments before it approved the loan.
Adjustments for these and other items resulted in a 58.28 percent
debt-to-income ratio compared to the 40.61 percent rate Pine State
calculated.
• For case105-1741989, Pine State overstated the borrower’s
monthly income by at least $907. The overstatement included
$627 in supplemental Social Security income and $280 for
commission income. The supplemental Social Security income
ended about 18 months after the loan closed because the
borrower’s income exceeded the eligibility limit for the benefits.
Pine State did not verify the likelihood that the income would
continue, and it inappropriately increased the $545 monthly
payment shown on the verification by 15 percent to $627. It did
not document a reason for the increase. It also overstated the
borrower’s 2002 monthly commission income by $280 because it
did not deduct expenses that offset the commission. In addition,
Pine State overstated the borrower’s 2003 commission income by
an undetermined amount due to its failure to document and deduct
commission expenses. Adjustments for the $907 resulted in a
55.43 percent debt-to-income ratio compared to the 46.34 percent
rate Pine State calculated.
Handbook 4155.1, REV 5, provides that anticipated amount of income and
likelihood of its continuance must be established to determine the
borrower’s capacity to repay the mortgage debt. Income from any source
that will not continue may not be used in calculating the borrower’s
income ratios.
Debts Not Properly Assessed
Pine State did not consider and/or properly assess borrower debts before
approving six loans (105-1380870, 105-1769305, 105-1741989, 105-
1587099, 105-1524517, and 105-1728585). The following examples
demonstrate this condition.
• For case 105-1769305, Pine State’s loan file contained no evidence
that it asked the borrower to explain a credit inquiry that resulted in
an additional $306 monthly debt for an automobile loan. The
borrower made the loan in March 2004, the same month Pine State
closed the borrower’s home loan. The additional debt was shown
on a credit report Pine State obtained during its quality control
review, but the reviewer did not detect and report the debt during
the quality control review. Adjustment for the debt and other items
Table of Contents 9
resulted in a 60.93 percent debt-to-income ratio compared to the
47.34 percent rate Pine State calculated.
• For case 105-1524517, Pine State’s loan file contained no evidence
that it asked the borrower to explain a credit inquiry that resulted in
an additional $211 monthly debt. The borrower made the loan in
October 2003. Pine State closed the borrower’s home loan on
November 7, 2003. The additional debt was shown on a credit
report Pine State obtained during its quality control review.
Adjustment for the debt resulted in a 53.42 percent debt-to-income
ratio compared to the 47.36 percent rate Pine State calculated.
HUD Handbook 4155.1, REV-5, paragraph 2-3B, provides that the lender
must determine the purpose of any recent debts. The borrower must
explain in writing all inquiries shown on the credit report in the last 90
days.
Credit Not Properly Assessed
Pine State did not consider and/or properly evaluate borrower credit
history before approving four loans (105-1380870, 105-2032130, 105-
2020030, and 105-1531395). Each loan involved borrowers whose credit
reports showed deragatory credit histories that involved collections,
judgements, and/or delinquent accounts. The following case demonstrates
this condition.
• 105-2032130 - Pine State did not adequately consider the
borrower’s past disregard for child support payments. The credit
report showed the borrower had accumulated $58,143 in
delinquent child support. The file contained an “order/notice to
withhold income for support,” dated July 22, 2003. The loan
closed on August 13, 2004; thus, the order was not current, and
Pine State did not followup or document followup to determine
whether the order had been modified. Pine State should have
reviewed and considered this matter before it approved the loan.
HUD Handbook 4155.1, REV-5, paragraph 2-3, states that past credit
performance serves as the most useful guide in determining a borrower’s
attitude toward credit obligations and predicting a borrower’s future
actions. If the credit history, despite adequate income to support
obligations, reflects continuous slow payments, judgments, and delinquent
accounts, strong compensating factors will be necessary to approve the
loan.
Table of Contents 10
Quitclaim Transfers
Pine State submitted two loans (105-1728585 and 105- 1817383) for
insurance endorsement despite knowledge that at loan closing one or more
of the coborrowers transferred their interest to individuals who were not
listed on the loan applications. The borrowers used quitclaim deeds to
make the transfers to individuals whose income, debts, and credit were
required to be but were not assessed and approved to have ownership
interest in the property.
HUD Handbook 4155.1, REV-5, paragraph 3-10 (lender responsibility at
closing), provides that the lender is required to resolve all problems
regarding title to the real estate. The loan must close in the same manner
in which it was underwritten and approved. Additional signatures on the
security instruments and/or mortgage note of individuals not reviewed
during mortgage credit analysis may be grounds for withholding
endorsement. Paragraph 2-2A states that HUD does not permit an
individual to take an ownership interest in the property at settlement
without signing the mortgage note and all security instruments.
Gifts Not Properly Verified
Pine State did not properly verify gift funds paid to closing agents for
seven borrowers (105-1380870, 105-1769305, 105-1587099, 105-
1524517, 105-1531395, 105-1728585, and 105-1548492). In each case,
the borrowers received gifts from nonprofit donors. Pine State
subsequently verified receipt of the gift funds by obtaining copies of the
wire transfers submitted by the nonprofit donors to the closing attorneys.
However, the verification does not relieve Pine State of its responsibility
to verify the transfer of gift funds to the closing attorneys before loan
closing. The missing documentation was required to provide assurance
that the gifts were paid by the nonprofit organizations and not by other
interested parties to the loan transactions.
HUD Handbook 4155.1, REV-4, paragraph 2-10C, requires that if the gift
funds are not deposited to the borrower’s account before closing, the
lender must obtain verification that the closing agent received funds from
the donor for the amount of the gift.
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11
Other Less Significant Deficiencies
Pine State also underwrote five loans that contained less significant
underwriting deficiencies. The deficiencies involved some of the same
violations cited for the cases discussed above. However, we considered
the deficiencies less significant because they did not affect the overall
credit quality (insurability) of the individual loans. Thus, the deficiencies
would not support indemnification of the defaulted loans or repayment of
losses on claims. This fact does not relieve Pine State from following all
facets of HUD requirements when originating Federal Housing
Administration loans. We provided details of these deficiencies to Pine
State during our review. Appendix C summarizes the less significant
deficiencies for the five loans.
Conclusion
Pine State’s underwriters did not adequately evaluate information
presented by borrowers for compliance with requirements before
approving 21 loans. This resulted in Pine State approving 21 loans that
did not meet HUD requirements and submitting them to HUD for Federal
Housing Administration endorsement. As a result, HUD insured 21 loans
that placed the Federal Housing Administration’s insurance fund at risk
for $151,687 in questioned costs and $713,495 in funds to be put to better
use.
Recommendations
We recommend that the assistant secretary for housing-federal housing
commissioner
1A. Take appropriate administrative action against Pine State for not
complying with HUD requirements.
1B. Require Pine State to indemnify $713,495 for 17 defaulted loans.
1C. Require Pine State to reimburse HUD $66,425 for actual loss
sustained on two claim-terminated loans that HUD sold.
1D. Require Pine State to reimburse HUD the actual losses incurred on
two claim-terminated loans that HUD has not resold. We estimate
$85,262 for the losses.
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12
Finding 2: Pine State Did Not Effectively Implement Quality
Controls for Early Payment Default Loans
Pine State did not implement effective quality controls over early payment default loans
despite HUD’s prior findings on this issue. HUD requires all nonsupervised lenders to
implement an effective quality control system to retain their HUD approval. Pine State’s
management did not take proper action to ensure compliance with this requirement.
___
We assessed Pine State’s quality controls and found that it did not properly
• Assess and classify the severity of its quality control findings,
• Report material quality control findings to HUD,
• Document resolution of its quality control findings,
• Prepare and assess trends to identify areas that warranted expanded
coverage,
• Assess underwriters with high default rates, and
• Assess branch offices with high default rates.
These issues hampered Pine State’s ability to identify and correct performance
issues and contributed to the high 10.54 percent default rate at its Atlanta branch.
The conditions also allowed underwriting problems to continue without adequate
measures to identify and correct them. For instance, 23 loans from Pine State’s
quality control findings involved violations that should have been but were not
reported to HUD. We reviewed eight of the loans as part of our sample discussed
in finding 1. The remaining 15 loans involved $1.3 million in unpaid principal for
defaulted loans, a $155,000 claim payment, and $155,000 in losses HUD incurred
on foreclosed properties.
Conditions Noted in HUD’s
Past Reviews
HUD Handbook 4060.1, paragraph 6-1, provides that all Federal Housing
Administration-approved lenders must implement and continuously have in place
a quality control plan for the origination of insured mortgages as a condition of
receiving and maintaining Federal Housing Administration approval. Quality
control must be a prescribed and routine function of each lender’s operations,
whether performed by a lender’s staff or an outside source.
HUD reviewed Pine State’s quality controls in February 2004. During our audit,
we identified several violations of the same type as those identified during HUD’s
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2004 review. The repeat issues include Pine State’s failure to (a) classify the
severity of its quality control findings, (b) take and document corrective actions,
(c) prepare and use trend results to determine the focus of quality control work,
and (e) expand its quality control review to follow up on commonalities in the
review.
We reviewed Pine State’s quality controls over loans that defaulted with six or
fewer payments (early default loans). We primarily focused on activity for Pine
State’s Atlanta branch office and its overall assessment of patterns and trends to
identify areas that might require increased quality control attention. We assessed
all Pine State quality control report findings for all early payment default loans
reviewed between May and December 2005. We noted that Pine State had
improved its quality control reviews of early payment default loans since HUD’s
2004 review. We found that Pine State was conducting the required reviews and
had gone back and performed recent reviews of older loans not reviewed in the
past.
Severity of Quality Control Violations
Not Identified
Pine State did not classify the severity of violations identified by its quality
control reviews as recommended by HUD. HUD’s Quality Assurance Division
mentioned this matter in its 2004 report, but Pine State had not implemented
corrective action. The classification would identify violations that required (a)
reporting to HUD, (b) management action to address decline in the quality of
loans, and (c) prompt corrective action. Pine State did not report material
violations to HUD and had not taken adequate measures to identify patterns and
trends from its quality control reviews nor adequately correct violations noted
during its quality control reviews.
HUD Handbook 4060.1, REV-1, paragraph 6-4, recommends that quality control
reports to lender management include an assessment of risks to enable a lender to
compare one month’s sample to previous samples so the lender may conduct trend
analysis. Management can also use this tool to respond quickly to a sudden
decline in the quality of its loans and help identify and correct the problem.
Lenders may consider a ratings system such as (a) “low risk” for loans with no or
minor problems, (b) “acceptable risk” for loans that do not involve issues material to
creditworthiness or insurability, (c) “moderate risk” for loans that contained
significant unresolved questions or missing documentation, and (d) “material risk”
for loans that involve material violations of Federal Housing Administration or
lender requirements and represent an unacceptable level of risk. Lenders must
report material risk loans, in writing, to HUD.
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14
Material Violations Not Identified
and Reported to HUD
Pine State did not identify and report to HUD material violations included in its
quality control reports. In some instances, Pine State’s quality control reports
noted that major violations were found, but the reports did not reference specific
case violations. We met with Pine State officials in January 2006, and they
acknowledged they had not self-reported any loans to HUD. HUD officials also
stated that Pine State had not self-reported any violations detected by the
company’s quality control reviews. As of April 2006, Pine State had not
identified and reported any material violations to HUD.
We examined Pine State’s quality control findings and observed material
violations for 23 loans that warranted reporting but were not reported to HUD
(appendix E). The violations were included in quality control reports for early
payment default loans for all Pine State offices conducted from May through
December 2005. We examined eight of the loans during our underwriting review.
The review confirmed the existence of the type of violations Pine State detected
for seven of the loans, although in most instances, our review detected additional
issues and details. We did not audit the other 15 loans to validate Pine State’s
review findings. The 15 loans involved more than $1.3 million in unpaid
principal for 10 loans, one claim totaling $155,193, and four loans resold by HUD
at a loss that totaled $155,402. The violations associated with the 23 loans
consisted of
• Ten loans with overstated or understated income that increased the debt-
to-income ratios to levels that adversely affected the insurability of the
loans;
• Seven loans with quitclaim deeds executed at closing to individuals who
were not subjected to assessment of their income, debts, and
creditworthiness; and
• Six loans with omitted liabilities or understated housing costs that
increased the debt-to-income ratios to levels that adversely affected the
insurability of the loans.
This condition occurred because Pine State management did not meet its
responsibility to identify and report material violations to HUD. This condition
exposed HUD to increased risk for loans with violations that impacted their
eligibility for insurance. In response to our assessment, Pine State officials
commented that they did not agree with their quality control finding results for 11
of the 23 loans.
HUD Handbook 4060.1, paragraph 6-3(J), provides that findings of fraud or other
serious violations must be referred, in writing (along with the supporting
documentation), to the appropriate director of the Quality Assurance Division in
the HUD Homeownership Center. A lender’s quality control program must
ensure that findings discovered by employees during the normal course of
Table of Contents 15
business and by quality control staff during reviews/audits of Federal Housing
Administration loans are reported to HUD within 60 days of the initial discovery.
Corrective Action Not Properly
Taken on Quality Control Findings
Pine State did not take or document adequate action to address and resolve
findings included in its quality control reports. The reports did not contain or give
reference to the required corrective actions and timetables for completing
corrective actions. Although this information was requested, Pine State could not
produce adequate written records supporting proper action to resolve quality
control findings. In some instances Pine State officials stated that they took
informal and/or undocumented actions such as sending e-mails advising staff to
be alert for certain conditions detected by its quality control reviewer. They also
stated that they discussed some of the issues with their staff. We found limited
documentation of these discussions.
Handbook 4060.1, paragraph 6-3(I), provides that review findings must be
reported to the lender’s senior management within one month of completion of
the initial report. Management must take prompt action to deal appropriately with
any material findings. The final report or an addendum must identify actions
being taken, the timetable for their completion, and any planned followup
activities.
Trending Not a Consistent Part of
the Quality Control Process
Pine State did not consistently identify patterns and commonalities among
participants for early payment defaults that required further assessment to identify
the cause and any needed corrective action and or targeted coverage in future
quality control reviews. We only found two trend assessments by Pine State.
One was dated August 2005; however, the other one was not dated, and we could
not determine when Pine State performed the assessment. The assessments
identified
• Two high default rate underwriters at its Atlanta branch office (dated August
2005) and
• A 39 percent default rate for loans that involved temporary interest rate
buydowns. As discussed in finding 1, Pine State did not properly document
and review borrowers’ eligibility for interest rate buydowns. It produced no
evidence that it initiated action to identify the cause for this high default rate
and initiated action to resolve the matter.
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16
These conditions occurred because Pine State did not require and commit staff to
identify and follow up on patterns and trends. Pine State officials said they
considered patterns in informal one-on-one meetings and decided the patterns did
not warrant further assessment or followup. Thus, Pine State missed the
opportunity to identify and correct, in a timely manner, underwriting problems
such efforts may have identified. Pine State’s failure to address the issues
allowed underwriting problems to continue unabated.
Inadequate Action to Identify and
Address the Cause for High
Underwriter Defaults
Pine State did not assess the performance of two of its highest default rate
underwriters to determine why their default rates were so high and take action to
address the matter.
Loans
defaulted Mortgages on
Loans closed Total within two Default defaulted
Underwriter between loans years percentage loans
A Dec. 2003 and June 217 55 25.35 $7,430,248
2004
July 2004 and Dec. 143 29 20.28 3,701,148
2004
Jan. 2005 and June 66 8 12.12 1,052,043
2005
Subtotal 426 92 21.60 12,183,439
B Dec. 2003 and June 93 26 27.96 $3,116,226
2005
Total 519 118 22.74 $15,299,665
Underwriter A continued to underwrite for Pine State at the time of our review.
The personnel file showed no record of concern about the underwriter’s high
default rate. Underwriter B left Pine State to work for another lender. The
personnel file showed the underwriter left Pine State in good standing. The file
showed no record of concern about the underwriter’s high default rate.
Pine State’s owner stated the high default rates were due to a higher risk market
rather than poor quality underwriting. The data we obtained from HUD’s
Neighborhood Watch system coupled with our file reviews did not support Pine
State’s assessment. The system showed an 8.25 percent default rate for loans in
Georgia that correspond to Pine State’s market. The default rate is 2.29 percent
lower than the 10.54 default rate for Pine State’s Atlanta branch where most of
Table of Contents 17
the underwriter’s default activity occurred. Furthermore, the 8.25 Georgia default
rate was 17.10 percent lower than the highest default rate for Underwriter A and
19.71 percent lower than the default rate for underwriter B.
Further, the underwriting violations detected by our review (appendixes C and D)
show poor underwriting performance contributed to the underwriters’ high default
rate. For instance, we identified 21 loans with underwriting violations that
impacted insurability. Underwriter A underwrote six or 28.6 percent of the loans,
and Underwriter B underwrote three or 14.2 percent of the loans. The violations
contributed to the underwriters’ high default rates. Pine State did not focus extra
quality control attention on these underwriters to identify the cause for the high
defaults and to initiate corrective measures where appropriate.
HUD handbook 4060.1, paragraph 6-5C, provides that lenders must identify
patterns of early defaults by location, program, and loan characteristic. Lenders
must identify commonalities among participants in the mortgage origination
process to learn the extent of their involvement in problem cases. For instance,
loans involving underwriters who have been associated with problems must be
included in the review sample.
Inadequate Action to Identify and
Address the Cause for High Branch
Office Defaults
Pine State’s quality control process did not assess or document its assessment of
performance by its Atlanta branch office, which had a high 10.54 percent default
rate. The high default rate caused a 223 percent compare ratio for the Atlanta
branch. The compare ratio exceeded the 200 percent benchmark used by HUD to
consider branch offices for possible sanction. The branch had 183 defaults for the
period August 1, 2003, through July 31, 2005, underwritten by 16 different
underwriters. Underwriters A and B, discussed above, underwrote 116 or 63.3
percent of the defaulted loans.
Total Percentage of Mortgage amounts
branch Defaults by defaults by associated with the
Underwriter defaults underwriter underwriter underwriter defaults
A 183 72 39.34 $ 9,897,155
B 183 44 24.04 6,573,135
Total 116 63.38 $16,470,290
Pine State’s owner stated the high branch default rate was due to its primary focus
on higher risk loans for new construction. However, our assessment shows other
factors also played a part. For instance, as of September 30, 2005, the branch had
an 11.55 percent default rate for new construction loans. That rate exceeded Pine
State’s overall 9.03 percent rate and the 8.83 percent default rate for all HUD-
Table of Contents 18
insured new construction loans in Georgia. As previously mentioned, the high
default rate was due in part to the underwriting activity by underwriters A and B.
Pine State did not review and assess the reason for the underwriters’ high default
activity. The explanation Pine State provided was not consistent with the
underwriting violations we noted for loans the two underwriters approved.
Regulations at 24 CFR [Code of Federal Regulations] 202.3 provide that lenders
are responsible for monitoring their default and claim rate performance. The
HUD secretary may notify a lender that its origination approval agreement will
terminate 60 days after notice is given, if the lender had a rate of defaults and
claims on insured mortgages originated in an area, which exceeded 200 percent of
the normal rate and exceeded the national default and claim rate for insured
mortgages. Further, HUD Handbook 4060.1, paragraph 6-5C, provides that
lenders must identify patterns of early defaults by location, program, and loan
characteristic. They must identify commonalities among participants in the
mortgage origination process to learn the extent of their involvement in problem
cases. For instance, loans involving underwriters who have been associated with
problems must be included in the review sample.
Conclusion
Since HUD’s 2004 review, Pine State has not implemented effective quality
controls for early payment default loans. Pine State conducted the required
reviews but it did not (a) classify quality control violations based on risk, (b)
report material risk loans to HUD, (c) properly take and document actions to
resolve quality control findings, (d) conduct frequent trending to identify patterns
that warrant followup in its quality control reviews and corrective action, (e)
conduct expanded reviews of high default rate underwriters, and (f) review and
assess the reason for the high default rate at its Atlanta branch. Thus, Pine State’s
quality controls were not adequate to identify and correct problems that adversely
affected the quality of its loans. These conditions contributed to the violations
discussed in finding 1 and to the high default rate for Pine State’s Atlanta branch
office.
Recommendations
We recommend that the assistant secretary for housing-federal housing
commissioner
2A. Take appropriate administrative action against Pine State for not
implementing proper quality controls over its early payment default loans.
This action is justified based on Pine State’s failure to correct or document
corrective action on identified quality control findings, risk rank quality
control findings, report material violations to HUD, and conduct and
Table of Contents 19
consider trending in the performance of its quality control reviews.
2B. Require Pine State to implement proper quality controls over its early
payment default loans.
2C. Require Pine State to reimburse HUD for losses or claims and/or
indemnify HUD for any of the loans listed in appendix E that involve
material violations Pine State should have reported to HUD.
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20
SCOPE AND METHODOLOGY
We performed the audit between October 2005 and May 2006. We conducted the audit
fieldwork at Pine State’s Atlanta, Georgia, office and HUD’s Office of Inspector General
(OIG) and program offices in Atlanta, Georgia. The audit covered the period August 1,
2003, through July 31, 2005, but we extended the period as necessary. We conducted the
audit in accordance with generally accepted government auditing standards.
To achieve our objective, we reviewed HUD’s rules, regulations, and guidance for proper
origination and submission of Federal Housing Administration loans. We also reviewed
previous HUD reviews of Pine State and HUD case binders. In addition, we interviewed
HUD staff to obtain background information on HUD requirements and Pine State.
We interviewed Pine State’s management and staff to obtain information regarding its
policies, procedures, and management controls. We reviewed Pine State’s written
policies and procedures to gain an understanding of how its processes are designed to
function. We also reviewed Pine State’s quality control review of early payment defaults
related to our scope. Additionally, we reviewed Pine State’s case binders for 16 of 81
early-payment default loans and 92 of 217 cases Pine State approved for interest rate
buydowns. We limited the review to 92 loans that had defaulted and had a debt-to-
income ratio equal to or greater than 41 percent. We obtained origination default and
other loan information from HUD’s Neighborhood Watch system for loans included in
our review.
The amounts shown for questioned costs and funds to be put to better use apply only to
loans reviewed during the audit. The ineligible cost represents the actual loss HUD
incurred on the resale of affected properties. The unsupported cost represents 29 percent
of the claim paid based on information provided by HUD. We estimated funds to be put
to better use at 29 percent of the unpaid principal balance. HUD provided information
that shows its loss on sales average 29 percent of the claim paid. We also used 29
percent of the unpaid principal balance because HUD had not paid claims for these loans.
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21
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:
• Controls over underwriting of Federal Housing Administration loans.
We assessed the relevant controls identified above.
A significant weakness exists if management controls do not provide
reasonable assurance that the process for planning, organizing, directing, and
controlling program operations will meet the organization’s objectives.
Significant Weaknesses
Based on our review, we believe the following items are significant
weaknesses:
• Pine State did not follow HUD requirements when underwriting 21
Federal Housing Administration-insured loans.
• Pine State did not implement its quality control plan in accordance
with HUD requirements.
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22
APPENDIXES
Appendix A
SCHEDULE OF QUESTIONED COSTS
AND FUNDS TO BE PUT TO BETTER USE
Recommendation Funds to be put to
number Ineligible 1/ Unsupported 2/ better use 3/
1B $713,495
1C $66,425
1D $85,262
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, federal, state,
local policies or regulations. The amount shown represents the actual loss HUD
incurred when it sold the affected properties.
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. In this
instance, we estimated unsupported cost to be 29 percent of the claim paid based
on information provided by HUD.
3/ “Funds to be put to better use” are quantifiable savings that are anticipated to
occur if an OIG recommendation is implemented, resulting in reduced
expenditures at a later time for the activities in question. This includes costs not
incurred, deobligation of funds, withdrawal of interest, reductions in outlays,
avoidance of unnecessary expenditures, loans and guarantees not made, and other
savings. In this instance, we estimated funds to be put to better use at 29 percent
of the unpaid principal balance. HUD provided information that shows its loss on
sales averages 29 percent of the claim paid. We used 29 percent of the unpaid
principal balance because HUD has not paid claims for these loans.
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23
Appendix B
AUDITEE COMMENTS AND OIG’S EVALUATION
Ref to OIG Evaluation Auditee Comments
Table of Contents 24
Table of Contents 25
OIG Evaluation of Auditee Comments
Comment 1
Table of Contents 26
Comment 2
Comment 3
Table of Contents 27
Comment 4
Comment 4
Comment 4
Table of Contents 28
Comment 4
Comment 5
Table of Contents 29
Comment 5
Comment 5
Comment 6
Comment 7
Table of Contents
30
Comment 8
Comment 6
Comment 9
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31
Comment 9
Comment 10
Comment 10
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32
Comment 10
Comment 11
Comment 10
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33
Comment 12
Comment 13
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34
Comment 13
Comment 12
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35
Comment 12
Comment 14
Comment 12
Comment 6
Table of Contents 36
Comment 12
Comment 16
Comment 16
Comment 15
Table of Contents 37
Comment 16
Comment 16
Comment 16
Table of Contents 38
Comment 16
Comment 16
Comment 16
Comment 16
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39
Comment 16
Comment 16
Comment 16
Comment 16
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40
Comment 16
Comment 16
Comment 16
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41
Comment 16
Comment 16
Comment 16
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42
Comment 16
Comment 16
Comment 16
Comment 16
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43
Comment 16
Comment 16
Comment 16
Comment 17
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44
Comment 17
Comment 16
Comment 18
OIG Evaluation of Auditee Comments
Comment 16
Comment 16
Comment 18
Comment 18
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45
Comment 16
Comment 16
Comment 16
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46
Comment 16
Comment 16
Comment 16
Comment 18
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47
Comment 16
Comment 19
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48
Comment 16
Comment 19
Comment 16
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49
Comment 16
Comment 18
Comment 16
Comment 16
Comment 16
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50
Comment 16
Comment 18
Comment 20
Comment 20
Comment 20
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51
Comment 20
Comment 20
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52
Comment 20
Comment 16
Comment 16
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53
Comment 16
Comment 16
Comment 16
Comment 18
Comment 21
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54
Comment 21
Comment 21
Comment 21
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Comment 16
Comment 2
Comment 22
Comment 21
Comment 22
Comment 21
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56
Comment 21
Comment 23
Comment 23
Comment 23
Table of Contents 57
Comment 23
Comment 23
Comment 23
Comment 23
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58
Comment 23
Comment 23
Comment 23
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59
Comment 23
Comment 23
Comment 24
Comment 24
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60
Comment 24
Comment 24
Comment 23
Comment 25
Comment 24
Comment 25
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61
Comment 23
Comment 23
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62
S AND OIG’S EVALUATION
Comment 23
Comment 26
Table of Contents 63
S AND OIG’S EVALUATION
Comment 26
Comment 16
Comment 27
Comment 27
Table of Contents 64
S AND OIG’S EVALUATION
Comment 27
Comment 27
Comment 28
Comment 16
Comment 16
Comment 2
Comment 2
Comment 16
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65
S AND OIG’S EVALUATION
Comment 16
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66
OIG Evaluation of Auditee Comments
Comment 1 We provided Pine State the opportunity to informally respond to our
tentative finding during the course of the audit. We considered its
comments and revised our conclusions where appropriate. We then
prepared the final draft report and provided Pine State an opportunity to
respond to the report in writing. We included its written response (minus
supporting exhibits) in this report along with our assessment of the
response. Pine State will have further opportunity to provide comments
and supporting documentation to HUD program staff, who will work with
Pine State and our office to resolve the audit recommendations.
Comment 2 We revised the report in several instances to reflect valid issues raised by
Pine State. See comments 3, 4, and 27. However, the revisions did not
materially affect the overall accuracy of the report.
Comment 3 We revised the number shown in the summary schedule of finding 1 for
cases with less significant deficiencies to agree with the number of loans
listed in appendix C.
Comment 4 We assessed and accepted Pine State’s position that 1 of the 12 questioned
buydown cases met requirements (case number 105-1380870). We
revised the report to delete all reference to this condition. The information
Pine State provided did not support its claim that the remaining 11
buydown cases met requirements. Pine State’s comments included
substantial justification for the buydowns that it prepared in response to
the audit. The justification should have been but was not prepared and
documented at the time Pine State approved the buydowns.
Comment 5 Buydown for case number 105-1587099 - This buydown was not
allowable for the reasons cited in the report. We agree with Pine State’s
reference to HUD requirements that allow lenders to consider training
when assessing a borrower’s potential for increased earning. In this case,
the borrower obtained the training as a nursing assistant and then obtained
a job in that field. We assessed the borrower’s income after the indicated
training and subsequent employment as a nursing assistant. Our
assessment did not support an earning pattern or potential needed to justify
the buydown. The file and Pine State’s comments contained no support
that the borrower had taken and completed any other training that would
further increase her earning potential. As for the coborrower, we agree
that the documents Pine State provided support a projected 2 percent raise
or approximately 20 cents per hour. The borrower needed a 45-cent per
hour raise to offset the first buydown increment. The file contained no
documentation that the borrowers’ combined earning potential was
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67
sufficient to pay the buydown increment.
Comment 6 Pine State did not recognize its responsibility to determine the adequacy of
borrowers’ earning capacity to justify buydowns. HUD’s buydown
requirements were designed to ensure that the eventual increase in
mortgage payments would not affect the borrowers adversely and likely
lead to default.
Comment 7 Buydown for case number 105-1953205 - This buydown was not justified
for the reasons cited in the report. Contrary to Pine State’s claim, the
borrower’s 2004 income was $227 less than the 2003 amount. Pine State
incorrectly estimated the borrower’s 2004 income. We contacted the
employer and determined that our 2004 estimate was only $41 less than
the 2004 amount we confirmed with the employer.
Comment 8 Buydown for case number 105-1956571 - This buydown was not justified
for the reasons cited in the report. The document Pine State obtained
from the employer contained a general comment that the borrower, and
independent contractor, was a hard worker with a potential for increased
earnings. Pine State did not determine or show how much of a pay
increase the borrower would receive. Also, it did not show whether the
borrower’s past earning supported projected increases sufficient to pay the
buydown increments.
Comment 9 Buydown for case number 105-1386555 - This buydown was not justified
for the reasons cited in the report. Pine State provided a copy of the
borrower’s employment contract that indicated the possibility of bonuses.
However, the contract only guaranteed the borrower a basic salary
amount. Pine State provided no information to show when and how much
of a pay increase or bonus the borrower would receive.
Comment 10 Buydown for case number 105-1606248 - This buydown was not justified
for the reasons cited in the report. Pine State said it properly excluded the
$145 monthly payment because the debt had less than 10 months
remaining when the loan closed. Handbook 4155.1, REV-4, provides that
debts lasting less than 10 months must be counted if the amount of the
debt affects the borrower’s ability to make mortgage payments during the
months immediately after loan closing. This was the case considering that
the payment increased the borrower’s debt-to-income ratio from 43.10 to
49.42 percent. Pine State also made an unsupported claim that the
borrower qualified for the buydown based on increased earning. To
support its position Pine State provided joint income tax data that showed
the borrower’s and his wife’s combined income increased from 2001 to
2002. However, the borrower’s wife was not a party to the loan. Thus,
her income and credit were not assessed to determine eligibility for the
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68
loan and are not relevant to the borrower’s qualification for the buydown.
Comment 11 Buydown for case number 105-1696401 - This buydown was not justified
for the reasons cited in the report. The borrower had worked as a police
officer for 19 months. We determined that the officer’s earning rate for
2003 was less than the rate for 2002. We did not determine the reason for
this condition. However, Pine State should have obtained and considered
an explanation as part of its buydown assessment. HUD’s Neighborhood
Watch system shows the borrower defaulted due to a curtailment of
income. Pine State was responsible for assessing the adequacy of
potential pay increases to cover the buydown increments.
In its response, Pine State also said the borrower qualified for the
buydown because of a $242 monthly debt that would be paid off within 20
months and before the buydown period ended. The liquidation of this debt
20 months into the buydown period was not relevant to the borrower’s
eligibility for the buydown.
Comment 12 Buydowns for case numbers 105-1072865, 105-1751832, and 105-
1969307 - We assessed Pine State’s comments and supporting documents.
They provided no new information for our consideration. The buydowns
are not justified for the reasons cited in the report.
Comment 13 Buydown for case number 105-0981353 - This buydown was not justified
for the reasons cited in the report. The collection accounts, increasing
housing cost, and the delinquent child support payments were not
consistent with Pine State’s claim concerning the borrower’s ability to
manage increased housing expense. We consider it unreasonable to accept
that the borrower accumulated more than $20,000 in delinquent child
support due to an address mix-up. The borrower was or should have been
aware of the child support obligation.
In addition, Pine State claimed the borrower was qualified for the
buydown because of an increased earning potential associated with
overtime pay not included as effective income. We agree with Pine
State’s comment that HUD criteria do not require lenders to document
overtime earnings for a two-year period for the purpose of satisfying the
buydown requirement. However, Pine State was responsible for but did
not assess or document its assessment of the adequacy of potential pay
increases to pay the buydown increments.
Comment 14 Buydown for case number 105-1644709 - This buydown was not justified
for the reasons cited in the report. The documents Pine State provided
understated the borrower’s 2002 income it used to compare against the
2003 amount. The loan file showed the borrower worked for three
different employers in 2002 and earned $35,796 versus the $27,635
Table of Contents 69
claimed by Pine State. The borrower worked for one employer in 2003 at
an hourly pay rate that equated to $35,360 in regular pay or $436 less than
the amount earned in 2002. The borrower started work for the employer
in February 2002 and continued in the job through the September 2003
date reflected in Pine State’s comments. The verification of employment
indicated no past pay increases. The employer entered question marks in
the boxes on the verification form that inquired about the projected date
and amount of the next pay increase. The verification of employment did
not show whether overtime would continue. The borrower’s September
2003 pay stub showed only $485 in year-to-date overtime pay.
Comment 15 We disagree with Pine State’s comments that compensating factors exist
that would offset its omission of a $142 monthly payment from the
borrower’s credit assessment (FHA case number 105-1969307). The
omitted debt contributed to a 47.59 debt-to-income ratio with the buydown
and a 52.54 percent ratio without the buydown.
Comment 16 We disagree with Pine State’s assessment that the reported violations are
not valid and should be removed from the report. The report provides an
accurate presentation of the conditions found and the HUD criteria
designed to regulate those conditions. Pine State provided no new
information for our consideration.
Comment 17 The Fannie Mae underwriting finding, item 17, required Pine State to
include new debt payments resulting from material inquiries listed on the
credit report in the debt ratio. Item 21 of the finding contained a similar
requirement. Thus, we disagree with Pine State’s assessment that it was
not required to follow up on the inquiry and that we should remove this
issue from the report.
Comment 18 The recommendation for indemnification was based on our consideration
of all violations detected for each loan versus individual violations. We
further assessed the violations giving consideration to Pine State’s
comments and supporting documents. We found no justification to
change the recommendation.
Comment 19 We disagree with Pine State’s comment that the file documented an
explanation for insufficient fund charges listed on the borrower’s June
2003 bank statement. The borrower’s explanation, dated June 18, 2003,
explained derogatory credit information listed on the credit report.
However, the credit report in the file was dated July 25, 2003, over a
month after the letter of explanation. Notwithstanding this discrepancy,
item 6 of the explanation attributes a delinquent Blockbuster account to
two returned checks that resulted from fraudulent activity in the
borrower’s account. The credit report did not show a Blockbuster
account. The report did show two unpaid collection accounts for another
Table of Contents 70
video company that did not appear to be recent. The balances had been
outstanding long enough to be transferred from the video company to a
collection agency. Thus, the two checks mentioned did not appear to be
related to the three returned checks shown on the borrower’s June 2003
bank statement. The borrower’s June bank statement showed no evidence
of the account being frozen due to fraudulent activity. Thus, the
comments and documents Pine State provided did not resolve issues we
raised concerning returned checks.
Comment 20 We recognize the positive actions Pine State indicated to prevent and
identify future quitclaim transfers. However, Pine State should have had
such measures in place already to ensure compliance with HUD’s
requirements. Pine State either knew or should have known about the
quitclaim transfers before it submitted the loans for HUD’s endorsement.
We disagree with Pine State’s position that indemnification of the cases
would be inappropriate.
Comment 21 We recognize Pine State’s disagreement with the method we used to
calculate potential losses for loans that have not been resold by HUD. The
calculations represent the effect for loans that do not meet HUD’s
underwriting requirements whether or not they go into default. These
decisions increased risk to HUD for insurance losses.
Comment 22 Pine State objected to OIG’s making its report public before the
Department makes a final determination on the recommendations. We
recognize but disagree with Pine State’s categorization of the process and
the way it suggests the process works. The OIG policy requires public
disclosure of issued audit reports. HUD management officials are
responsible for taking action to resolve reported findings and
recommendations.
Comment 23 We recognize Pine State’s claimed actions to improve its quality control
program. However, we disagree with its assertion that it consistently
complied with HUD guidelines regarding the areas cited as violations in
finding 2. The finding accurately describes the conditions detected by the
audit, the HUD requirements involved, and the impact associated with the
violations. Pine State did not provide adequate documentation during or
subsequent to the audit to support its claimed compliance and objection to
the finding.
Comment 24 Pine State’s comment misrepresents the meaning of material risk defined by
HUD Handbook 4060.1, REV-1, paragraph 6-4. The handbook defines
material risk as material violations of FHA or mortgagee requirements and
represents an unacceptable level of risk; for example, a significant
miscalculation of the insurable mortgage amount or the applicant’s capacity
to repay, failure to underwrite an assumption or protect abandoned property
Table of Contents 71
from damage, or fraud. Mortgagees must report these loans, in writing, to
HUD. We relied on this criterion to determine which loans Pine State should
have reported to HUD. Contrary to Pine State’s comments, the report never
stated or implied that lenders report to HUD every underwriting issue raised
by their quality control reviews. Also, if Pine State disagreed with its own
quality control findings, it should have but did not document the basis for the
disagreement and resolution of the disagreement(s).
Comment 25 Contrary to Pine State’s claim, the issues cited in the report comply with
auditing standards and provide a balanced presentation of the facts. Pine
State should have but did not evaluate its quality control findings and report
material risk loans to HUD. We tested the accuracy of Pine State’s quality
control findings for 8 of the 23 loans listed in appendix E. The review
confirmed the type of violations detected by the quality control reviewer for
seven of the loans (appendix E, notes a and b). We also asked Pine State to
review the quality control finding, and it agreed with the results for 11 of the
23 loans. It disagreed with the results for the remaining loans even though in
three cases our underwriting review confirmed the type of violations
detected by the quality control review. We appropriately requested that HUD
review and determine whether Pine State should indemnify the loans in
appendix E.
Comment 26 Pine State provided no support for the claim that it performed monthly
reviews of the Neighborhood Watch report to assess underwriter and branch
office performance. It also did not provide support to show when its review
identified high defaults for interest rate buydown loans. As cited in the
report, Pine State produced only one instance to support trending that
identified a high default rate for buydown loans. The analysis was not dated,
and we could not determine when it was performed.
Furthermore, the March 2004 guidelines included in Pine State’s response
were not specifically designed to address buydown loans. The guidelines
provided specific instructions for automated underwritten loans that
warranted referral for manual underwriting. The guidelines included, among
other provisions, review considerations for buydowns. The guidelines did
not mention the default rate for buydown loans, nor did the guidelines
require staff to document the files to include the type of information we
found to be missing.
Comment 27 The report does not ignore Pine State’s justification for the high default rate
at its Atlanta branch office. We simply disagree with Pine State’s
explanation. We revised the report to clarify that Pine State primarily made
loans for new construction. Pine State commented “ …the Report’s statistics
do not represent the ‘higher risk market’ that Pine State identified as the
cause of the branch office’s higher-than-average default rate. …” We
disagree. The supporting information Pine State included with its comments
Table of Contents 72
was dated September 30, 2004, and was not current. We updated the June
30, 2005, statistics in our report through September 30, 2005. The updated
information continued to support the conditions cited in the report. The
report accurately describes Pine State’s loan market and how the branch
office’s high default rate compared to Pine State’s overall default rate and the
default rate associated with that market for all lenders in the state of Georgia.
Comment 28 Pine State provided no documentation to support its claim that the
company’s overall and its Atlanta branch’s high default rates resulted solely
from the company’s focus on new construction loans. The data we obtained
from Neighborhood Watch as of September 30, 2005, showed Pine State’s
Atlanta branch default rate (11.55 percent) and Pine State’s overall default
rate (9.03 percent) for new construction loans exceeded the Georgia average
(8.83 percent). Thus, as cited in the report, the company’s lack of proper
underwriting practices further contributed to the high default rates.
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Appendix C
Page 1 of 2
LOAN UNDERWRITING DEFICIENCY CHARTS
Loans with deficiencies that affected insurability
Credit not properly assessed
Debts not properly assessed
Gifts not properly assessed
Interest rate buydown not
Unauthorized quitclaims
Income not properly
properly assessed
Total errors per loan
assessed
Case number Questioned Funds put to better
Other
costs use
Ineligible
105-1380870 X X X X 4 $39,728
105-2032130 X X 2 $46,530
105-1769305 X X X(1) 3* $41,651
105-1741989 X X X(2) 3* $50,516
105-2020030 X X X(1) 3 $45,918
105-1587099 X X X X(1) 4* $50,510
105-1524517 X X 2* $33,603
105-1531395 X X X(1) 3 $40,309
105-1817383 X X 1) 2 $41,171
105-1728585 X X X 3 $47,162
105-1548492 X X 2 $45,641
Total 5 4 6 2 7 1 6 31 $33,603** $ $449,136 **
* These were automated underwritten loans. The other loans were manually underwritten.
** These calculations are based on 29 percent of the insured loan amount in recognition that this is the
average percentage of net loss HUD eventually experiences on loans that enter its inventory.
(1) Housing costs understated.
(2) Outdated verification documents.
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Appendix C
Page 2 of 2
Loans with less significant deficiencies
Buydown requirement
signed by all required
Loan application not
Understated housing
Income not properly
met but Pine State’s
Credit not properly
Gifts not properly
Total violations
assessment not
documented
assessed
assessed
assessed
parties
costs
Case number
105-2074685 X X X 3
105-1353324 X X X 3*
105-1565006 X X X 3
105-1794657 X X X 3
105-1676147 X X X X 4
Total 4 2 2 4 3 1 16
* Loan terminated.
Not all errors pertaining to income, credit, or liabilities were considered material
deficiencies. Only those errors that could have changed the underwriting decision were
considered material. For instance, some errors in income or liabilities did not
significantly affect the housing and debt ratios.
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75
Appendix D
LOANS WITH TEMPORARY INTEREST RATE
BUYDOWNS
INAPPROPRIATELY APPROVED
The deficiencies affected insurability
Debt-to-Income
Ratio Questioned Cost
Funds put
With Without Closing Ineligible Unsupported to better
Case number buydown buydown date cost cost use Notes
Manual underwritten loans
1 105-1953205 44.45 49.75 05/28/04 $44,503 a, b, d
2 105-1956571 44.20 48.93 06/21/04 $42,554 a, b, e
3 105-1386555 43.00 48.00 07/23/03 $28,154 a, b, f
4 105-1606248 43.10 49.42 10/02/03 $37,544 a, b, g
5 105-1696401 42.15 47.64 12/18/03 $33,323 a, b, h
6 105-1072865 43.59 49.01 04/28/03 $29,421 a, b, i
7 105-0981353 44.48 47.79 03/21/03 $32,822 a, b, j
8 105-1751832 41.64 47.40 05/24/04 $46,066 a, b, k
9 105-1644709 49.21 55.86 10/31/03 $47,297 a, b, l
Automated underwritten loan
10 105-1969307 47.59 52.54 07/15/04 ______ $40,759 ______ a, c, m
$32,822 $85,262 $264,359
Total
Note
a Pine State did not determine or document the required determinations needed to justify the
use of an interest rate buydown to qualify the borrower for the loan. The file did not show or
document that Pine State assessed the buydown to assure that the eventual increase in
mortgage payments would not adversely affect the borrower and likely lead to default. We
reviewed the file and determined that the borrower did not meet at least one of the four
buydown criteria. Thus, Pine State inappropriately used the monthly bought down mortgage
amount rather than the full payment to qualify the borrower for the loan. Adjustment for the
buydown resulted in substantial increases in the debt-to-income ratio for each borrower.
HUD Handbook 4155.1, REV 5, paragraph 2-14B(2), provides that the lender must establish
that the eventual increase in mortgage payments will not affect the borrower adversely and
likely lead to default. The underwriter must document that the borrower meets one of these
four criteria: (a) the borrower has a potential for increased income that would offset the
scheduled payment increases, (b) the borrower has a demonstrated ability to manage
financial obligations in such a way that a greater portion of income may be devoted to
housing expenses, (c) the borrower has substantial assets available to cushion the effect of
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the increased payments, or (d) the cash investment made by the borrower substantially
exceeds the minimum required.
b The revised debt-to-income ratio exceeded HUD’s limit for loan approval.
c Pine State’s inappropriate approval of the buydown caused it to enter an understated
mortgage payment amount into its automated underwriting system to assess the borrower’s
eligibility for the loan.
d Pine State’s representative stated that the borrower had a potential for increased income to
offset the increased mortgage payments required by the buydown. We determined that Pine
State incorrectly estimated the borrower’s future earning capacity. Based on information
contained in the loan file, the borrower’s projected effective income for 2004 would be $220
less than the prior 2003 income amount. Thus, the borrower did not demonstrate the
potential for increased earning needed to pay either the first $1,122 or the second $1,175
annual buydown increment.
e Pine State’s representative stated that the borrower had a potential for increased income to
offset the increased mortgage payments required by the buydown. Pine State stated that the
borrower’s historical income showed increases each year and indicated that the borrower’s
fiancée would contribute to paying housing expense. The borrower’s fiancée was not a party
to the loan, and her income was not relevant to this assessment. The loan closed in 2004.
The file showed the borrower’s income increased only $873 from 2002 to 2003 and deceased
by $439 from 2003 to 2004. Thus, the borrower’s income history did not support the
potential for salary increases sufficient to pay either the first $1,071 or the second $1,131
annual buydown increment.
f Pine State’s representative stated that the borrower had a potential for increased income from
bonus and overtime pay to offset the increased mortgage payments. The total effective
income included the employer’s confirmed standard provision for a 62.5-hour week to allow
for overtime. The file showed the borrower had worked for the employer less than four
months and was a trainee. That was not long enough to establish a pattern of job and income
stability. The employer did not answer the question on the verification of employment
concerning the borrower’s prospect for continued employment. We recognize that the
verification of employment showed the borrower would receive various bonuses. However,
the verification did not indicate how much the payments would be or how often the
payments would occur. The file did not contain sufficient evidence of job and income
stability or future pay increases large enough to pay either the first $735 or the second $774
annual buydown increment.
g Pine State’s representative stated that the borrower demonstrated an ability to manage
financial obligations in such a way that a greater portion of income may be devoted to
housing expenses. Pine State incorrectly claimed that the borrower had one debt with a
monthly payment of $291 that would not extend beyond the term of the buydown. The debt
extended well into if not beyond the last term of the last buydown increment. Pine State did
not verify the remaining terms of the debt with the creditor. Pine State also inappropriately
excluded a $145 monthly payment from its assessment of the borrower’s credit. We accept
Pine State’s position that the debt had less than 10 months remaining. However, the
payment was high enough to affect the borrower’s ability to make mortgage payments during
the months immediately after loan closing. The added payment would have increased the
debt-to-income ratio from 43.10 to 49.42 percent. The credit report showed the borrower
had serious and recent delinquencies.
h Pine State’s representative stated that the borrower had a potential for increased income to
offset the increased mortgage payments. Pine State stated that the borrower was a police
officer and was likely to receive annual income increases. The loan closed in December
2003. The file showed the borrower’s average monthly income decreased approximately
$236 from 2002 to 2003. The file did not contain sufficient evidence of future pay increases
large enough to pay either the first $871 or the second $915 annual buydown increment.
i Pine State’s representative stated that the borrower demonstrated an ability to manage
financial obligations in such a way that a greater portion of income could be devoted to
housing expense. Pine State also stated that the borrower would receive a tax deduction due
Table of Contents 77
to mortgage interest. The loan closed on April 28, 2003, with a 43.59 percent debt-to-
income ratio. The credit report showed several collection accounts including two that were
settled or paid in 2003 just prior to loan closing. The collection accounts were not consistent
with Pine State’s comments concerning the borrower’s ability to devote a greater portion of
income to housing expense. The borrower’s housing cost for the new loan, giving
consideration to the buydown, was slightly less than the borrower’s prior rent. However, the
collections accounts did not support Pine States justification for the buydown.
j Pine State’s representative stated that the borrower demonstrated an ability to manage
financial obligations in such a way that a greater portion of income could be devoted to
housing expense. The representative also stated that the borrower had a potential for
increased income to offset the increased mortgage payments. We disagree with Pine State’s
assessment. The credit report showed recent collection accounts and a $20,090 delinquency
on child support payments. The total mortgage payments (at the bought down amount)
exceeded the borrower’s prior rent amount. The collections, delinquent child support, and
increased housing costs were not consistent with Pine State’s claim concerning the
borrower’s ability to manage increased housing expense.
In addition, the file did not support Pine State’s claim concerning the borrower’s increased
earning capacity. Pine State’s calculation included overtime pay based on the borrower’s
current pay stubs. The file did not contain documentation needed to assess overtime pay
over the required two-year trend period to determine whether the amount was stable enough
to warrant such consideration in projecting the borrower’s future earning capacity. The file
contained no verification stating whether overtime was likely to continue. We requested but
Pine State could not produce documentation needed to assess the borrower’s prior year
income for comparison to later years. Thus, the file did not contain adequate documentation
to support that the borrower would receive pay increases sufficient to pay either the first
$1,307 or the second $1,380 annual buydown increment.
k Pine State’s representative stated that the borrower demonstrated an ability to manage
financial obligations in such a way that a greater portion of income could be devoted to
housing expense. Pine State commented that the borrower was able to make timely monthly
payments with a rental expense comparable to the proposed housing expense. The loan
closed on May 24, 2004. Pine State’s position appeared plausible except that the file showed
the borrower issued 18 insufficient fund checks between March 19 and May 5, 2004. The
borrower provided a written explanation blaming the insufficient fund checks on a variation
in pay dates from those the borrower was use to. The borrower’s comments did not make
sense. The borrower, despite any variation in pay dates, either knew or should have known
the actual pay dates and should not have written any checks against funds not on deposit at
the bank. Pine State’s position concerning the borrower’s ability to manage financial
obligations was not supported by what the file showed.
l Pine State’s representative stated that the borrower had a potential for increased income to
offset the increased mortgage payments. Pine State based its position on its estimate of the
borrower’s 2003 income that included consideration for overtime. The borrower had worked
for the current employer 20 months before loan closed on October 31, 2003. The
verification of employment did not identify overtime or past or future pay increases and did
not contain a response to a question regarding whether overtime would continue. Based on
the borrower’s pay stubs, the 2003 income without consideration to overtime would be $436
less than the income for 2002. The file contained no basis for determining whether the
borrower would receive salary increases sufficient to pay either the first $1,247 or the second
$1,309 annual buydown increment.
m Pine State’s representative stated that the borrower had a potential for increased income to
offset the increased mortgage payments. Pine State claimed that the borrower’s income
increased from 2001 to 2004 and that the borrower received a car allowance that was not
included in effective income. Generally, Pine State’s position concerning increased income
appeared correct. The file showed the borrower’s 2004 annual income increased by $902
without regard to the car allowance. The $902 salary increase was not sufficient to pay
either the first $1,015 or the second $1,064 annual buydown increment. Pine State did not
78
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document how much of the car allowance (net of expenses) represented effective income.
During our assessment, we noticed that Pine State did not enter a $142 monthly revolving
account debt into its automated underwriting system that assessed the borrower’s eligibility
for the loan. The omitted debt brings into question whether the loan should have been
approved.
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79
Appendix E
MATERIAL QUALITY CONTROL FINDINGS NOT
REPORTED TO HUD
The deficiencies could or did affect insurability
Did
Unpaid HUD’s Pine
mortgage Claim loss on State
Case number Description amount paid resale agree? Notes
Income overstated
1 105-1187781 Debt ratio increased from 46.7 to 49 percent $120,669 No a, c
2 105-1428807 Debt ratio increased from 43.2 to 50 percent 99,021 No a, c
3 105-1720581 Debt ratio increased from 38.2 to 48 percent 119,772 No a, c
4 105-1741989 Debt ratio increased from 46.34 to 51 percent No b, e
Unsupported income
5 105-1236876 Debt ratio increased from 42.3 to 49 percent 108,863 No a, c
6 105-0793308 Debt ratio increased from 32.6 to 60 percent 0 36,457 No a, c
7 105-0684284 Debt ratio increased from 43.2 to 47 percent 148,271 No a, c
8 105-0637652 Debt ratio increased from 42 to 60 percent 41,541 No a, c
9 105-1548492 Debt ratio increased from 39.59 to 57 percent No b, e
10 105-1676147 Debt ratio increased from 44.43 to 47 percent b,
Quitclaim transfer at closing
11 105-1530774 No underwriting assessment of transferee 149,135 Yes a, d
12 105-1290106 No underwriting assessment of transferee 144,935 Yes a, d
13 105-0107916 No underwriting assessment of transferee 124,268 Yes a, d
14 105-1317601 No underwriting assessment of transferee 155,193 Yes a, d
15 105-0306702 No underwriting assessment of transferee 23,364 Yes a, d
16 105-1728585 No underwriting assessment of transferee Yes b, f
17 105-1817383 No underwriting assessment of transferee Yes b, f
Liability omitted
18 105-0365985 Debt ratio increased from 47.7 to 53 percent 54,040 No a, c
19 105-1380870 Debt ratio increased from 43.03 to 46 percent No b, e
20 105-1524517 Debt ratio increased from 47.36 to 57 percent Yes b, f
Housing expenses understated
21 105-0703913 Debt ratio increased from 43.9 to 46 percent 109,734 Yes a, d
22 105-2008495 Debt ratio increased from 44.5 to 46 percent 189,347 Yes a, d
23 105-1769305 Debt ratio increased from 47.34 to 50 percent Yes b, f
Total $1,314,015 $155,193 $155,402
Notes
a These 15 loans were not included in our audit sample.
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b We reviewed these remaining eight loans. Our review substantiated the general finding issues raised by Pine
State’s reviewer for seven loans with mortgages that totaled more than $1 million (see appendix C). Our review did
not substantiate the finding issue Pine State raised for the eighth loan (105-1676147).
c Pine State reviewed the case during the course of our audit and disagreed with the finding cited in its quality control
report. Pine State claimed that the borrowers’ correct debt-to-income ratios were lower than cited in the quality
control report and were within HUD’s limit for approval. We did not audit Pine State’s reassessment of its quality
control results.
d Pine State reviewed these seven loans during the course of our audit and agreed with the material findings cited in
its quality control report. We did not audit Pine State’s reassessment of its quality control results.
e Pine State reviewed these three loans during the course of our audit and disagreed with the material finding cited in
its quality control report. Pine State claimed that the borrowers were within HUD’s requirements for approval.
However, our review (appendix C) confirmed the general nature of the violations cited in the Pine State quality
control report although the scope of violations we detected was broader than those indicated by the Pine State
review.
f Pine State reviewed these four loans during the course of our audit and agreed with the material findings cited its
quality control report.
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81
Appendix F
CASE STUDIES OF IMPROPERLY UNDERWRITTEN
LOANS
Case number: 105-1380870
Loan purpose: Purchase
Underwriter type: Manually underwritten
Date of loan closing: July 25, 2003
Insured amount: $141,500
Debt-to-income ratio: 43.60 percent
Status: Reinstated
Default reason: Excessive obligations
Credit Not Properly Assessed
The file did not contain an explanation for three insufficient fund charges shown on the
borrower’s June 2003 bank statement. At the time, the borrower had been employed for
only five months following a four-month gap in employment to care for sick family
members. HUD’s system showed the borrower defaulted due to excessive obligations.
The credit report Pine State obtained for the quality control review showed the borrower
filed for bankruptcy protection in April 2004, about nine months after the loan closed.
The bankruptcy was dismissed in July 2004, but the borrower filed for bankruptcy
protection again in August 2004. These conditions indicate the borrower may have
bought the house before fully recovering from the gap in employment.
HUD Requirements
HUD Handbook 4155.1, REV-4, paragraphs 2-3 and 2-3B, states that past credit
performance serves as the most useful guide in determining a borrower’s attitude toward
credit obligation and predicting a borrower’s future actions. When analyzing the
borrower’s credit record, it is the overall pattern of credit behavior that must be
examined. The handbook further states that if the credit history reflects continuous slow
payments, judgments, and delinquent accounts, strong compensating factors will be
necessary to approve a loan.
Income Not Properly Assessed
Pine State approved the loan based on a $1,734 monthly effective income although the
borrower had not held the job long enough to support stability of the income amount.
The borrower had only been employed for five months in his job, not the required six
months needed to support income stability. The employment immediately followed a
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four-month employment gap, during which time the file showed the borrower was taking
care of sick relatives. We question whether Pine State should have included the $1,734
as effective income, but we did not deduct the amount.
HUD Requirements
HUD Handbook 4155.1, REV-4, CHG-1, section 2 provides that income from any source
that is not stable may not be used in calculating the borrower’s income ratios. Paragraph
2-6 provides that in some cases, a borrower may have recently returned to the workforce
after an extended absence. In these circumstances, the borrower’s income may be
considered effective and stable, provided the borrower has been employed in the current
job for six months or more.
Debts Not Properly Assessed
Pine State’s loan file contained no evidence that it asked the borrower to explain two
credit inquiries that resulted in two new loans. The first inquiry, dated April 21, 2003,
resulted in a new loan in September 2003 with a $358 monthly payment. The second
inquiry, dated May 14, 2003, resulted in a new loan in August 2003 with a $21 monthly
payment. Both loans were shown on the credit report Pine State obtained more than a
year later on November 7, 2004, during its quality control review of the loan. Pine State
did not resolve issues related to the inquiries before it approved the loan. Pine State
agreed with our adjustment to include the new $21 monthly payment. However, it stated
that the $358 debt replaced a prior car loan it included in its analysis at $462 per month
and that we should use the lower $358 payment in our assessment. We did not make the
adjustment because Pine State’s approval decision was based on information it possessed
at the time and without conducting the required followup.
HUD Requirements
HUD Handbook 4155.1, REV-4, CHG-1, paragraph 2-3B, provides that the lender must
determine the purpose of any recent debts. The borrower must explain all inquiries
shown on the credit report.
Gift Funds Not Properly Verified
The loan file contained no documentation that Pine State verified receipt of a $4,321 gift
paid at closing by a nonprofit donor. Thus, Pine State allowed the loan to close without
support that the closing agent received the nonprofit gift used to pay the borrower’s
required investment in the property. The HUD-1 settlement statement shows the gift was
paid. The missing document was required to provide assurance that the gift was paid by
the nonprofit organization and not by some other interested party to the loan transaction.
We discussed this matter with Pine State officials, and they followed up and obtained the
documents needed to confirm receipt of the gift.
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HUD Requirements
HUD Handbook 4155.1, REV-4, paragraph 2-10C, requires that if the gift funds are not
deposited to the borrower’s account before closing, the lender must obtain verification
that the closing agent received funds from the donor for the amount of the gift.
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Case number: 105-2032130
Loan purpose: Purchase
Underwriter type: Manually underwritten
Date of loan closing: August 13, 2004
Insured amount: $163,871
Debt-to-income ratio: 59.80 percent
Status: Default
Default reason: Curtailment of income
Income Not Properly Assessed
Pine State included $1,343 as effective monthly income although it did not establish
and document the amount to be stable and likely to continue. The coborrower had
worked for the employer less than three months. The employer completed the
verification but entered “N/A” to the question concerning the probability of continued
employment. The file contained no evidence that Pine State followed up and
obtained an answer to the question. The coborrower had a history of unstable
employment in different lines of work broken by periods of unemployment. The
coborrower was unemployed and looking for work for more than a month and a half
before finding a job as a sheet metal worker. Previously, the coborrower worked for
about two months as a sales person in a department store preceded by a month of
unemployment. Before the department store job, the coborrower worked for about 14
months as an assistant manager at a restaurant. HUD’s system shows the default
resulted from a curtailment of income. The default reason was consistent with the
coborrower’s inconsistent employment history. Adjustment for the $1,343 resulted in
a 59.80 percent debt-to-income ratio compared to the 44.24 percent Pine State
calculated.
Pine State said the verification of employment confirmed that overtime was likely to
continue, and it took this to also mean that the borrower’s employment was likely to
continue. Confirmation that overtime will continue is not the same as confirmation of
continued employment. Pine State should have obtained a response from the
employer concerning the borrower’s likelihood of continued employment.
We noted two other issues associated with Pine State’s assessment of the borrower’s
income, but we did not deduct the amounts when we adjusted the debt-to-income
ratio.
• Pine State allowed $389 per month for the borrower’s overtime pay without
documenting how it calculated the amount. When asked to explain the
calculation, it provided a different $415 overtime figure and said the $389 was
a conservative amount. The files should have contained support for the actual
overtime amount Pine State used to approve the loan.
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• Pine State included $1,504 in monthly income for another coborrower, but it
did not confirm or document confirmation with the employer that the income
was likely to continue. The borrower had been employed in the position for
about 19 months.
HUD Requirements
Handbook 4155.1, REV 5, section 2, provides that anticipated amount of income and the
likelihood of its continuance must be established to determine a borrower’s capacity to
repay mortgage debt. Income may not be used in calculating the borrower’s income
ratios if it comes from any source that cannot be verified, is not stable, or will not
continue. Paragraph 2-7A states that overtime income may be used to qualify if the
borrower has received such income for the past two years and it is likely to continue. The
lender must develop an average of overtime income for the past two years, and the
employment verification must not state that such income is unlikely to continue. Periods
of less than two years may be acceptable, provided the lender justifies and documents in
writing the reason for using the income for qualifying purposes.
Credit Not Properly Assessed
Pine State’s credit analysis did not adequately consider the borrower’s consistent
disregard for child support obligations. The August 6, 2004, credit report showed the
borrower had accumulated $58,143 in delinquent child support payments. The file
contained an “order/notice to withhold income for support,” dated July 22, 2003. The
order required the borrower to pay $420 per month. The payment consisted of $150 for
current support and $270 for past due support or $210 biweekly. The loan closed on
August 13, 2004; thus, the order was not current. Pine State did not follow up or
document followup to determine whether the order had been modified before it approved
the loan.
Pine State officials stated they accepted the borrower’s explanation concerning credit
issues although it did not specifically address the child support. We considered the
borrower’s explanation to be inadequate.
Further, Pine State did not properly assess the borrower’s poor credit performance
evidenced by three other delinquent collection accounts. The credit report showed the
borrower owed $4,669 on the three accounts, but the creditors were willing to settle the
accounts for $2,427. Pine State required the borrower to pay off one of the collections as
a condition to the loan closing. However, in view of the delinquent accounts and the
delinquent child support payments, Pine State should have documented specific
compensating factors to support its processing and approval of the loan. Pine State
officials stated that HUD does not require collection accounts to be paid and considered
the borrower to be working to improve his credit and to honor his responsibilities. We
maintain that the borrower’s poor credit history warranted further assessment and
consideration, given the significant issues involved.
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86
HUD Requirements
HUD Handbook 4155.1, REV-5, paragraph 2-3, states that past credit performance serves
as the most useful guide in determining a borrower’s attitude toward credit obligations
and predicting a borrower’s future actions. A borrower who has made payments on
previous and current obligations in a timely manner represents reduced risk. Conversely,
if the credit history, despite adequate income to support obligations, reflects continuous
slow payments, judgments, and delinquent accounts, strong compensating factors will be
necessary to approve the loan.
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87
Case number: 105-1769305
Loan purpose: Purchase
Underwriter type Automated underwritten
Date of loan closing: March 19, 2004
Insured amount: $147,175
Debt-to-income ratio: 60.93 percent
Status: Default
Default reason: Curtailment of income
Debts Not Properly Assessed
Pine State’s loan file contained no evidence that it asked the borrower to explain a credit
inquiry that resulted in an additional $306 monthly debt. The borrower made the loan in
March 2004, the same month Pine State closed the borrower’s home loan. The credit
report showed the inquiry, dated December 17, 2003. The additional debt was for an auto
loan shown on a credit report Pine State obtained on February 20, 2005, during its quality
control review. However, Pine State’s quality control review did not detect the additional
debt. The borrower had a responsibility to report all credit obligations. However, Pine
State was required to ask the borrower to explain the reason for the inquiry and whether it
resulted in an additional debt. Thus, Pine State missed the opportunity to identify the
debt and to input the debt into its automated underwriting system for consideration in
determining the borrower’s eligibility. Adjustment for the debt and housing cost
(discussed below) resulted in a 60.93 percent debt-to-income ratio compared to the 47.34
percent rate Pine State calculated.
Pine State officials stated that they did not follow up on the inquiry because it occurred
more than 90 days before their loan approval. Pine State’s position was not consistent
with the requirement to follow up on inquiries that occurred within 90 days of the credit
report date.
HUD Requirements
HUD Handbook 4155.1, REV-5, paragraph 2-3B, states that inquiries shown on the credit
report within the last 90 days are to be considered when analyzing the borrower’s credit
worthiness.
Gift Not Properly verified
Pine State’s file contained no documentation that it verified a $4,395 gift paid to the
closing agent by a nonprofit donor. Thus, Pine State allowed the loan to close without
support that the closing agent received the nonprofit gift used to pay the borrower’s
required investment in the property. We discussed this matter with Pine State officials,
and they followed up and obtained the documents needed to confirm receipt of the gift.
However, their verification does not relieve Pine State of its responsibility to verify the
transfer of gift funds before loan closing.
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HUD Requirements
HUD Handbook 4155.1, REV-5, paragraph 2-10C, provides that if the gift funds are not
deposited to the borrower’s account before closing, the lender must obtain verification
that the closing agent received funds from the donor for the amount of the gift.
Other - Understated Liabilities (Housing Cost)
Pine State understated the borrower’s monthly housing cost by $59. We used the
amounts reflected on the HUD-1 settlement statement for housing costs. The $59 is the
net of a $72 understatement for taxes and an ($13) overstatement for insurance. The
understated amount contributed to the borrower’s high debt-to-income ratio. Pine State
also noted this condition during its quality control review.
HUD Requirement
Handbook 4155.1, REV 5, paragraph 2-11A, provides that in computing the debt-to-
income ratios, the lender must include the monthly housing expense and all other
additional recurring charges extending 10 months or more.
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89
Case number: 105-1741989
Loan purpose: Purchase
Underwriter type: Automated underwritten
Date of loan closing: February 3, 2004
Insured amount: $178,690
Debt-to-income ratio: 55.43 percent
Status: Default
Default reason: Other – not specified
Income Not Properly Assessed
Pine State overstated the borrower’s monthly income by at least $907. The overstatement
included $627 for Social Security and $280 for commissions. Pine State
• Allowed $627 in Social Security pay without verifying the likelihood that the
income would continue for the first three years of the loan. We contacted the
Social Security Administration and determined that it terminated the payments in
August 2005, 18 months after the loan closed. It terminated the payments
because the borrower’s income exceeded the eligibility limit. In addition, Pine
State did not document why it increased the $545 shown on the verification by 15
percent to $627. The increase was not justified based on our reconfirmation of
the payment.
• Overstated the borrower’s 2002 monthly commission income by $280 because it
did not deduct $6,728 in expenses that offset commissions. In addition, Pine State
overstated the borrower’s 2003 commission income by an undetermined amount
due to its failure to document and deduct commission expenses.
Pine State agreed with our assessment that the income was overstated by at least $907.
Adjustment for overstatement and debts discussed below resulted in a 55.43 percent debt-
to-income ratio compared to the 46.34 percent rate Pine State calculated.
HUD Requirements
Handbook 4155.1, REV 5, section 2, provides that the anticipated amount of income, and
the likelihood of its continuance, must be established to determine a borrower’s capacity
to repay mortgage debt. Income may not be used in calculating the borrower’s income
ratios if it comes from any source that cannot be verified, is not stable, or will not
continue. Paragraph 2-7 provides that the income obligated for the mortgage debt must
be analyzed to determine whether it can reasonably be expected to continue through at
least the first three years of the mortgage loan. Paragraph 2-7D requires lenders to
subtract unreimbursed business expenses from gross income. The automated underwriter
findings report required Pine State to consider business expenses when underwriting the
loan.
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Debts Not Properly Assessed
Pine State’s loan file contained no evidence that it asked the borrower to explain a credit
inquiry that resulted in an additional $3,430 debt. The borrower made the loan in
November 2003. The credit report showed the inquiry, dated October 22, 2003. The
additional debt was shown on a credit report Pine State obtained on February 18, 2005,
during its quality control review. The credit report did not show the monthly payment
amount. The borrower had a responsibility to report all credit obligations. However,
Pine State was required to ask the borrower to explain the reason for the inquiry and
whether it resulted in or might result in an additional debt. The debt further contributed
to the borrower’s already high 59.47 percent debt-to-income ratio.
HUD Requirements
HUD Handbook 4155.1, REV-5, paragraph 2-3B, provides that the lender must
determine the purpose of any recent debts. The borrower must explain in writing all
inquiries shown on the credit report in the last 90 days. The automated underwriter
finding (17) required the lender to include new debt resulting from material inquiries
listed on the credit report.
Other - Outdated Income Verification
Pine State relied on an outdated February 20, 2002, verification for the borrower’s Social
Security income. The verification was more than 120 days old when the loan closed on
February 3, 2004.
HUD Requirements
Handbook 4155.1, REV 5, paragraph 3-1, provides that all documents may be up to 120
days old at the time the loan closes (180 days for new construction). Updated, written
verifications must be obtained when the age of the documents exceed these limits.
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Case number: 105-2020030
Loan purpose: Purchase
Underwriter type: Manually underwritten
Date of loan closing: July 30, 2004
Insured amount: $161,283
Debt-to-income ratio: 58.28 percent
Status: Default
Default reason: Other – not specified
Income Overstated
Pine State overstated the borrower’s monthly income by $688. The overstatement
included $478 for employment and $210 for child support. Pine State
Allowed $478 in monthly overtime pay that did not meet requirements. The borrower
had been employed at the job for only 10 months before the loan closing. This was
not long enough to demonstrate the two-year pattern generally required to justify
including overtime as effective income. Also, Pine State did not verify that the
overtime was likely to continue. The file did not contain a written explanation for
including overtime earned for less than the required two-year period.
Allowed $210 per month for child support without documenting the file to show that
it identified and considered discrepancies associated with the payment. The file
showed the borrower had three children. The file did not contain a copy of a final
divorce decree, legal separation agreement, or voluntary payment agreement, setting
forth the legal basis for the payments, payment amount, which was responsible for the
payment, and for how long the payments would continue. The file contained a copy
of a divorce decree that dissolved a prior marriage between the borrower and the
father of two of the children. The divorce decree did not mention child custody or
child support and the payments received were not from the borrower’s prior husband.
The file did not identify the father of the third child and did not contain any
documentation that stipulated an obligation for anyone to pay child support for the
child. The underwriting findings requested evidence that the payments would
continue for at least three years. The file contained no evidence that Pine State
followed up to obtain the requested information.
Further, for the period January 1, 2003, to May 17, 2004, the support payments varied
from a low of $210 to a high of $441. The most recurring payments amounted to
$280 and $210 (latest three payments), but several months had irregular highs of
$350, $420, and $441. The file contained no evidence that Pine State attempted to
identify why the payments fluctuated.
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We adjusted the borrower’s income to omit the $688 and other amounts discussed below.
The adjustments resulted in a 58.28 percent debt-to-income ratio compared to the 40.61
percent rate Pine State calculated.
HUD Requirements
HUD Handbook 4155.1, REV-5, paragraph 2-7, provides that the income of each
borrower to be obligated for the mortgage debt must be analyzed to determine whether it
can reasonably be expected to continue through at least the first three years of the
mortgage loan. Paragraph 2-7A, provides that overtime income may be used to qualify if
the borrower has received such income for the past two years and it is likely to continue.
The lender must develop an average of overtime income for the past two years, and the
employment verification must not state that such income is unlikely to continue. Periods
of less than two years may be acceptable, provided the lender justifies and documents in
writing the reason for using the income for qualifying purposes.
Paragraph 2-7F discusses child support income. The handbook provides that income in
this category may be considered as effective if such payments are likely to be consistently
received for the first three years of the mortgage. The borrower must provide a copy of
the final divorce decree, legal separation agreement, or voluntary payment agreement, as
well as evidence that payments have been received during the last 12 months. Periods
less than 12 months may be acceptable, provided the payer’s ability and willingness to
make timely payments is adequately documented by the lender.
Credit Not Properly Assessed
Pine State did not properly assess or document its assessment of the borrower’s poor
credit performance following a release from a bankruptcy on May 29, 2001. Between
January and June 2001, the borrower opened three accounts that were $1,556 delinquent
when Pine State pulled its credit report. The delinquencies consisted of accounts with
balances of $932, $334, and $290. Pine State required the borrower to pay off the
accounts as a condition to its approval of the loan. The HUD-1 settlement statement
showed the amounts were paid. However, the files did not document compensating
factors Pine State considered to offset the borrower’s poor credit performance.
HUD Requirements
HUD Handbook 4155.1, REV-5, paragraph 2-3, states that past credit performance serves
as the most useful guide in determining a borrower’s attitude toward credit obligation and
predicting a borrower’s future actions. It further states that if the credit history, despite
adequate income to support obligations, reflects continuous slow payments, judgments,
and delinquent accounts, strong compensating factors will be necessary to approve the
loan.
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Other - Understated Liabilities (Housing Cost)
Pine State understated the borrower’s monthly housing cost by $88. We used the
amounts reflected on the HUD-1 settlement statement for housing costs. The
understatement includes $50 for taxes and $38 for insurance. Adjustment for the
understatement contributed to the borrower’s high 58.28 percent debt-to-income ratio.
Pine State also noted this condition during its quality control review.
HUD Requirement
HUD Handbook 4155.1, REV-5, paragraph 2-11A, provides that lenders must include the
monthly housing expense and all other additional recurring charges extending 10 months
or more.
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Case number: 105-1587099
Loan purpose: Purchase
Underwriter type: Automated underwritten
Date of loan closing: October 20, 2003
Insured amount: $179,200
Debt-to-income ratio: 54.14 percent
Status: Default
Default reason: Other
Interest Rate Buydown Not Properly Assessed
Pine State did not make or document the required determinations needed to justify the use
of an interest rate buydown to qualify the borrower for the loan. The file did not show or
document that Pine State assessed the buydown to assure that the eventual increased
mortgage payments would not adversely affect the borrower and likely lead to default.
We reviewed the file and determined that the borrower did not meet at least one of the
four buydown criteria. Thus, Pine State inappropriately used the $935 monthly bought
down mortgage amount rather than the full $1,162 payment to qualify the borrower.
Adjustment for the buydown and the other issues discussed below resulted in a 54.14
percent debt-to-income ratio compared to the 46.97 percent ratio Pine State calculated.
HUD Requirements
HUD Handbook 4155.1, REV 4, paragraph 2-14B(2), provides that the lender must
establish that the eventual increase in mortgage payments will not affect the borrower
adversely and likely lead to default. The underwriter must document that the borrower
meets one of four criteria that require borrowers to have (a) potential for increased
income that would offset the scheduled payment increases, (b) demonstrated ability to
manage financial obligations in such a way that a greater portion of income may be
devoted to housing expenses, (c) substantial assets available to cushion the effect of the
increased payments, or (d) cash investment made that substantially exceeds the minimum
required.
Pine State officials stated that the borrower and coborrowers had the potential for
increased earnings to offset the buydown amount. The files did not support Pine State’s
position. The first monthly buydown increment amounted to $111. The file showed the
coborrower was to receive a $37 per month raise. The raise was $74 less than the amount
needed to offset the buydown. The borrower was to receive an unspecified raise within
two months of closing. The borrower’s prior raise amounted to 10 cents per hour. The
file and the borrower’s past pay increase provided no grounds to anticipate that the next
raise would amount to the 45 cents per hour needed to offset the $74 balance of the
buydown increment. Pine State also stated the coborrower earned overtime that was not
counted as effective income. We did not recognize the overtime because the file did not
contain documents needed to determine overtime pay for the required two-year period.
The overtime paid during the past seven and a half months totaled only $284.
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Debts Not Properly Assessed
Pine State’s loan file contained no evidence that it asked the borrower to explain a credit
inquiry that resulted in an additional $39 monthly debt. The borrower made the loan in
August 2003, and Pine State closed the borrower’s home loan on October 20, 2003. The
credit report showed the inquiry, dated August 17, 2003. The additional $1,634 debt was
shown on the credit report Pine State obtained on October 9, 2005, during its quality
control review. The borrower had a responsibility to report all credit obligations.
However, Pine State was required to ask the borrower to explain the reason for the
inquiry and whether it resulted in an additional debt. The debt contributed to the
borrower’s high 54.14 percent debt-to-income ratio.
HUD Requirements
HUD Handbook 4155.1, REV-4, paragraph 2-3B, provides that the borrower must
explain all inquiries shown on the credit report. Paragraph 2-11A requires the lender to
consider all recurring obligations extending 10 months or more. The automated
underwriter findings report required the lender to include all new debt payments resulting
from material inquiries listed on the credit report.
Gift Not Properly Verified
Pine State’s file contained no documentation that it verified receipt of a $5,482 gift paid
to the closing agent by a nonprofit donor. Thus, Pine State allowed the loan to close
without verifying that the closing agent received the nonprofit gift used to pay the
borrower’s required investment in the property. Pine State also noted this condition
during its quality control review of the loan. We discussed this matter with Pine State
officials, and they followed up and obtained the documents needed to confirm receipt of
the gift.
HUD Requirements
HUD Handbook 4155.1, REV-4, paragraph 2-10C, provides that if the gift funds are not
deposited to the borrower’s account before closing, the lender must obtain verification
that the closing agent received funds from the donor for the amount of the gift.
Other - Understated Liabilities (Housing Cost)
Pine State understated the borrower’s monthly housing insurance cost by $26. We used
the insurance amount reflected on the HUD-1 settlement statement. The understatement
contributed to the borrower’s high 54.14 percent debt-to-income ratio.
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HUD Requirement
Handbook 4155.1, REV 4, paragraph 2-11A, provides that in computing the debt-to-
income ratios, the lender must include the monthly housing expense and all other
additional recurring charges extending 10 months or more.
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Case number: 105-1524517
Loan purpose: Purchase
Underwriter type: Automated underwritten
Date of loan closing: November 7, 2003
Insured amount: 135,600
Debt-to-income ratio: 53.42 percent
Status: Default
Default reason: Excessive obligations
Debts Not Properly Assessed
Pine State’s loan file contained no evidence that it asked the borrower to explain a credit
inquiry that resulted in an additional $211 monthly debt. The borrower made the loan in
October 2003, and Pine State closed the borrower’s home loan on November 7, 2003.
The credit report showed the inquiry, dated September 30, 2003. The additional $6,174
debt was shown on a credit report Pine State obtained on July 29, 2005, during its quality
control review. The borrower had a responsibility to report all credit obligations.
However, Pine State was required to ask the borrower to explain the reason for the
inquiry and whether it resulted in an additional debt. Thus, Pine State missed the
opportunity to identify the debt and enter it into its automated underwriting system for
consideration in determining the borrower’s eligibility. Pine State’s quality control
review also identified the new debt. Adjustments for the debt resulted in a 53.42 4 percent
debt-to-income ratio compared to the 47.36 percent rate Pine State calculated.
Pine State officials stated that they did not follow up on the credit inquiry because they
did not think they were required to do so based on wording contained in the automated
underwriting finding report. We reviewed the wording and determined that it intended
for Pine State to follow up on the inquiry.
HUD Requirements
HUD Handbook 4155.1, REV-4, paragraph 2-3B, provides that the borrower must
explain all inquiries shown on the credit report. Paragraph 2-11A requires the lender to
consider all recurring obligations extending 10 months or more. Also, debts lasting less
than 10 months must be counted if the amount of the debt affects the borrower’s ability to
make the mortgage payment during the months immediately after the loan closing. The
Fannie Mae underwriter findings report required the lender to include all new debt
payments resulting from material inquiries listed on the report in the debt ratios.
4
Pine State overstated the borrower’s monthly housing cost by $57. We made an adjustment for the
overstatement when we recalculated the debt-to-income ratio.
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Gift Not Properly Verified
Pine State’s file contained no documentation that it verified receipt of a $4,100 gift paid
to the closing agent by a nonprofit donor. Thus, Pine State allowed the loan to close
without confirming that the closing agent received the nonprofit gift used to pay the
borrower’s required investment in the property. Pine State obtained a copy of the wire
transfer during the course of our audit. However, the later verification does not relieve
Pine State of its responsibility to verify the transfer of gift funds before loan closing.
HUD Requirements
HUD Handbook 4155.1, REV-4, paragraph 2-10C, requires that if the gift funds are not
deposited to the borrower’s account before closing, the lender must obtain verification
that the closing agent received funds from the donor for the amount of the gift.
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Case number: 105-1531395
Loan purpose: Purchase
Underwriter type: Manually underwritten
Date of loan closing: November 21, 2003
Insured amount: $142,950
Debt-to-income ratio: 45.25 percent
Status: Partial reinstatement
Default reason: Excessive obligations
Credit Not Properly Assessed
Pine State did not properly assess or document its assessment to justify why it approved
the loan despite the borrower’s poor credit. The automated underwriting finding report
referred the loan for manual underwriting because the loan exceeded the risk threshold
for automated approval. The credit report showed that the borrower had serious
delinquencies and derogatory public records or collections and that the length of time
since derogatory public records or collection was too recent or unknown. Pine State did
not properly assess or document its assessment of
• The borrower’s collection accounts and a judgment. The credit report showed
five collection accounts that totaled $2,467 and one $4,652 judgment that had
been satisfied. The collection accounts each occurred within 8 to 19 months of
the loan closing, and the judgment was within 11 months of closing. The file did
not contain a written explanation for the judgment. Further, in some instances,
the borrower’s written explanation for the collections did not make sense. For
instance, the borrower stated that most of the collections occurred before
obtaining stable employment and salary increases. The credit report showed the
judgment and four of the collection accounts occurred after July 2002. This was
after the borrower started work for the employer in 2001 and established a stable
earning pattern. The file showed three 2002 collections (one each in August,
November, and December) resulted from insufficient fund checks. The
insufficient fund checks were not consistent with the borrower’s generalized
explanation for the collection accounts. The file contained no evidence that Pine
State questioned the inconsistencies and the missing explanation for the judgment.
• The reason for a 60-day delinquency shown on the credit report for an auto loan.
• The borrower’s explanation for 16 credit inquiries (none mortgage lender related)
within three months of loan closing. The borrower’s letter of explanation stated,
“I have not opened any new accounts.” Pine State could not locate and produce
the credit report it was supposed to obtain for the borrower to assess why the loan
defaulted with fewer than six payments. Thus, we did not determine whether the
inquiries resulted in additional debts. HUD’s system showed the borrower
defaulted due to excessive obligations.
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HUD Requirements
HUD Handbook 4155.1, REV-4, paragraphs 2-3 and 2-3B, states that past credit
performance serves as the most useful guide in determining a borrower’s attitude toward
credit obligations. If the credit history reflects continuous slow payments, judgments,
and delinquent accounts, strong offsetting factors will be necessary to approve the loan.
When delinquent accounts are revealed, the lender must determine whether the late
payments were due to a disregard for or an inability to manage financial obligations or
other factors beyond the borrower’s control. While minor derogatory information
occurring two or more years in the past does not require explanation, major indications of
derogatory credit, including judgments and collections, require written explanations. The
explanations must make sense and be consistent with other credit information in the file.
Paragraph 2-3B provides that the borrower must explain all inquiries shown on the credit
report.
Gift Not Properly Verified
Pine State’s file contained no documentation that it verified receipt of a $4,293 gift paid
at closing by a nonprofit donor. Thus, Pine State allowed the loan to close without
support that the closing agent received the nonprofit gift used to pay the borrower’s
required investment in the property. Pine State obtained a copy of the wire transfer
during the course of our audit. However, their later verification does not relieve Pine
State of its responsibility to verify the transfer of gift funds before loan closing. Pine
State also noted this issue during its quality control review of the loan.
HUD Requirements
HUD Handbook 4155.1, REV-4, paragraph 2-10C, requires that if the gift funds are not
deposited to the borrower’s account before closing, the lender must obtain verification
that the closing agent received funds from the donor for the amount of the gift.
Other - Understated Liabilities (Housing Cost)
Pine State understated the borrower’s monthly housing cost by $40. We used the
amounts reflected on the HUD-1 settlement statement for housing costs. The
understatement consists of $24 for taxes and $16 for insurance. Adjustment for the
understatement increased the borrower’s debt-to-income ratio from 44.19 to 45.25
percent.
HUD Requirement
Handbook 4155.1, REV-4, paragraph 2-11A, provides that the lender must include the
monthly housing expense and all other additional recurring charges extending 10 months
or more.
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Case number: 105-1817383
Loan purpose: Purchase
Underwriter type Manually underwritten
Date of loan closing: March 31, 2004
Insured amount: $146,007
Debt-to-income ratio: 34.43 percent
Status: Default
Default reason: Excessive obligations
Inappropriate Quitclaim
Pine State submitted the loan for insurance endorsement knowing that the coborrower
had inappropriately transferred by quitclaim deed an interest in the property to his wife.
The borrower’s wife was not listed on the loan application, and Pine State did not identify
and assess the wife’s income and credit. Pine State’s representatives stated they did not
learn of the quitclaim until after they received the closing documents from the closing
attorney. Pine State either knew or should have known about the transfer before it
submitted the loan to HUD for endorsement. The loan closed on March 31, 2004. Pine
State successfully completed the insurance application on May 3, 2004. It was required
to resolve all problems regarding title to the real estate and to ensure that the loan closed
in the same manner in which it was underwritten and approved. Pine State did not
include the quitclaim in the documents sent to HUD for the Federal Housing
Administration case file. HUD’s system showed the borrower defaulted due to excessive
obligations.
HUD Requirements
HUD Handbook 4155.1, REV-5, paragraph 3-10 (lender responsibility at closing),
provides that the lender is required to resolve all problems regarding title to the real
estate. The loan must close in the same manner in which it was underwritten and
approved. Additional signatures on the security instruments and/or mortgage note of
individuals not reviewed during mortgage credit analysis may be grounds for withholding
endorsement. Paragraph 2-2A states that HUD does not permit an individual to take an
ownership interest in the property at settlement without signing the mortgage note and all
security instruments.
Other - Understated Liabilities (Housing Cost)
Pine State understated the borrower’s monthly housing cost by $58. We used the
amounts reflected on the HUD-1 settlement statement as the correct statement of the
borrower’s housing costs. The $58 is the sum of a $47 understatement for taxes and an
$11 understatement for insurance. Pine State also noted this condition during its quality
control review. Adjustment for the understatement increased the debt-to-income ratio
from 32.68 to 34.43 percent.
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HUD Requirement
Handbook 4155.1, REV 5, paragraph 2-11A, provides that the lender must include the
monthly housing expense and all other additional recurring charges extending 10 months
or more.
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Case number: 105-1728585
Loan purpose: Purchase
Underwriter type: Manually underwritten
Date of loan closing: January 15, 2004
Insured amount: $167,322
Debt-to-income ratio: 44.51 percent
Status: Default
Default reason: Excessive obligations
Inappropriate Quitclaim
Pine State submitted the loan for insurance endorsement knowing that both coborrowers
had inappropriately quitclaimed their interest in the property to the borrower and her
husband. The coborrowers were the borrower’s mother and father. The borrower’s
husband was not listed on the loan application, and Pine State did not identify and assess
the husband’s income and credit. Pine State’s representatives stated they did not learn of
the quitclaim until after they received the closing documents from the closing attorney.
Pine State either knew or should have known about the transfer before it submitted the
loan to HUD for endorsement. The loan closed on January 15, 2004. Pine State
successfully completed the insurance application on February 10, 2004. It was required
to resolve all problems regarding title to the real estate and to ensure that the loan closed
in the same manner in which it was underwritten and approved. Pine State did not
include the quitclaim in the documents sent to HUD for the Federal Housing
Administration case file.
HUD Requirements
HUD Handbook 4155.1, REV-5, paragraph 3-10 (lender responsibility at closing),
provides that the lender is required to resolve all problems regarding title to the real
estate. The loan must close in the same manner in which it was underwritten and
approved. Additional signatures on the security instruments and/or mortgage note of
individuals not reviewed during mortgage credit analysis may be grounds for withholding
endorsement. Paragraph 2-2A states that HUD does not permit an individual to take an
ownership interest in the property at settlement without signing the mortgage note and all
security instruments.
Debts Not Properly Assessed
Pine State understated the borrower’s monthly debts by $680 because it either omitted
debts shown on credit reports or did not use the payment terms shown on the most recent
credit reports. Pine State officials reviewed our calculations and said we double counted
one debt with a $127 monthly payment. The credit report showed two $127 monthly
payments to the same creditor for different accounts. We also observed that the credit
report indicated the borrowers had experienced some credit problems. For instance, Pine
State required the borrower to pay $1,794 for a delinquent account and a judgment as a
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condition to its approval of the loan. Adjustments for the understated debts and income
(discussed below) resulted in a 44.51 percent back ratio compared to the 34.93 percent
ratio Pine State calculated. HUD’s system showed the loan went into default due to
excessive obligations.
HUD Requirements
HUD Handbook 4155.1, REV-5, paragraph 2-11A, requires the lender to consider all
recurring obligations extending 10 months or more. Paragraph 2-3 states that past credit
performance serves as the most useful guide in determining a borrower’s attitude toward
credit obligations and predicting a borrower’s future actions. A borrower who has made
payments on previous and current obligations in a timely manner represents reduced risk.
Conversely, if the credit history, despite adequate income to support obligations, reflects
continuous slow payments, judgments, and delinquent accounts, strong compensating
factors will be necessary to approve the loan.
Income Discrepancy
Pine State did not include $804 in monthly retirement income for a coborrower. We did
not add the amount because the coborrower transferred her interest in the property at
closing.
HUD Requirement
HUD Handbook 4155.1, REV-5, paragraph 2-7, provides that the income of each
borrower to be obligated for the mortgage debt must be analyzed to determine whether it
can reasonably be expected to continue through at least the first three years of the
mortgage loan. If the borrower intends to retire during this period, the effective income
must be the amount of documented retirement benefits payments expected to be received
in retirement.
Gift Not Properly verified
Pine State’s file contained no documentation that it verified a $5,060 gift paid to the
closing agent by a nonprofit donor. Thus, Pine State allowed the loan to close without
support that the closing agent received the nonprofit gift used to pay the borrower’s
required investment in the property. Pine State obtained a copy of the wire transfer
during its quality control review of the loan. However, their later verification does not
relieve Pine State of its responsibility to verify the transfer of gift funds before loan
closing.
HUD Requirements
HUD Handbook 4155.1, REV-5, paragraph 2-10C, provides that the lender must
document the transfer of the funds from the donor to the borrower. If the funds are not
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deposited to the borrower’s account before closing, the lender must obtain verification
that the closing agent received funds from the donor for the amount of the gift.
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Case number: 105-1548492
Loan purpose: Purchase
Underwriter type: Manually underwritten
Date of loan closing: November 21, 2003
Insured amount: $162,300
Debt-to-income ratio: Unknown
Status: Default
Default reason: Other
Unsupported Income
Pine State underwrote the loan with no support for how it calculated and verified the
borrower’s effective income. The file showed the borrower worked as a contractor and
as an employee for different clients or employers at different times. The current
employment verification showed the borrower had been employed as a contract worker
for 10 weeks before loan closing and that the borrower’s continued employment
depended on the availability of assignments. Pine State could not support the effective
income it used to approve the loan. In response to our request for support, Pine State
provided a different and lower effective income that used an unsupported 25 percent
factor to estimate the borrower’s business expense deductions. The recalculation resulted
in a 45.21 percent debt-to-income ratio compared to the 39.59 percent Pine State used to
approve the loan.
Pine State should have required the borrower to provide documentation of actual business
expenses incurred for determination of effective income. The borrower’s 2002 federal
tax return showed business expenses amounted to 66 percent of gross contract revenue.
The 66 percent factor is substantially higher than the unsupported 25 percent factor Pine
State used. The 66 percent factor would result in a 60.30 percent debt-to-income ratio
compared to the 45.21 percent ratio Pine State calculated. However, the determination of
effective income should not involve assumption. HUD does not allow income from any
source that cannot be verified or will not continue. Thus, the borrower’s actual debt-to-
income ratio is not known. Pine State’s quality control review also identified a problem
with the borrower’s income.
HUD Requirement
Handbook 4155.1, REV-4, CHG-1, section 2, provides that the anticipated amount of
income and likelihood of its continuance must be established to determine the borrower's
capacity to repay the mortgage debt. Income from any source that cannot be verified, is
not stable, or will not continue may not be used in calculating the borrower’s income
ratios. Paragraph 2-6 requires lenders to analyze and document the probability of
continued employment and states that lenders must examine the borrower’s past
employment and the employer’s confirmation of continued employment. Paragraph 2-7
provides that the income obligated for the mortgage debt must be analyzed to determine
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whether it can reasonably be expected to continue through at least the first three years of
the mortgage loan. Paragraph 2-9C discusses employee business expenses and requires
determination of actual cash expenses that must be deducted from the borrower’s
adjusted income.
Gift Not Properly Verified
Pine State's file contained no documentation that it verified receipt of a $4,909 gift paid
at closing by a nonprofit donor. Thus, Pine State allowed the loan to close without
support that the closing agent received the nonprofit gift used to pay the borrower’s
required investment in the property. The HUD-1 settlement statement showed the gift
was paid. At our request, Pine State obtained a copy of the wire transfer. However, the
later verification does not relieve Pine State of its responsibility to verify the transfer of
gift funds before loan closing. The missing documentation was required to provide
assurance that the gift was paid by the nonprofit organization and not by some other
interested party to the loan transaction.
HUD Requirements
HUD Handbook 4155.1, REV-4, paragraph 2-10C, requires that if the gift funds are not
deposited to the borrower’s account before closing, the lender must obtain verification
that the closing agent received funds from the donor for the amount of the gift.
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Pine State Mortgage Company, Atlanta, Georgia, Did Not Always Comply with Federal Housing Administration Underwriting and Quality Control Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-11-03.
Below is a raw (and likely hideous) rendition of the original report. (PDF)