Issue Date November 6, 2006 Audit Report Number 2007-KC-1003 TO: Brian D. Montgomery, Assistant Secretary for Housing - Federal Housing Commissioner and Chairman, Mortgagee Review Board, H FROM: Ronald J. Hosking, Regional Inspector General for Audit, 7AGA SUBJECT: PlainsCapital McAfee Mortgage, Lubbock, Texas, Did Not Follow HUD Underwriting Requirements and Originated Loans from Unregistered Branch Offices HIGHLIGHTS What We Audited and Why We audited PlainsCapital McAfee Mortgage (McAfee Mortgage) because its two- year default rate for loans with amortization dates between December 2003 and November 2005 was 44 percent higher than the U.S. Department of Housing and Urban Development’s (HUD) national average for this period. In addition, the percentage of current defaults and claims was 88 percent higher than HUD’s national average. Our objective was to determine whether McAfee Mortgage originated Federal Housing Administration single-family loans in accordance with HUD requirements, including adequately monitoring its branch offices and originating loans from only HUD-approved offices. What We Found McAfee Mortgage did not follow HUD regulations when underwriting 11 of the 35 loans reviewed. These loans contained material deficiencies that affected the insurability of the loans. As a result, HUD insured 11 loans with original mortgage amounts of more than $1 million that placed the Federal Housing Administration insurance fund at unnecessary risk. In addition, between December 1, 2004, and December 31, 2005, McAfee Mortgage submitted 821 loans from unregistered branch offices. In November 2004, HUD notified McAfee Mortgage that it was violating branch office rules, but it continued the practice. By not registering its branch offices, the lender circumvented HUD’s oversight controls and placed the Federal Housing Administration insurance fund at unnecessary risk for nearly $75 million in loans. What We Recommend We recommend that the assistant secretary for housing - federal housing commissioner require McAfee Mortgage to indemnify HUD for the 11 improperly underwritten loans, including four active loans with original mortgage amounts totaling $290,430, losses of $82,604 incurred on sales of properties related to two defaulted loans, and future losses on five defaulted loans for which HUD has paid claims of $454,238 but not yet sold the properties. We also recommend that HUD take appropriate administrative action against McAfee Mortgage for not following HUD’s branch office requirements, including imposing civil money penalties for all loans originated from unregistered branches from December 1, 2004, to the present. 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 McAfee Mortgage generally disagreed with our conclusions. We provided the draft report to McAfee Mortgage on August 31, 2006, and requested a response by September 27, 2006. The lender provided written comments and additional documentation on September 26, 2006. We evaluated the information and revised the report as needed. On October 23, 2006, we provided McAfee Mortgage the opportunity to respond to the revised report but the lender chose not to provide additional comments. The complete text of the auditee’s response, along with our evaluation of that response, can be found in appendix B of this report. 2 TABLE OF CONTENTS Background and Objectives 4 Results of Audit Finding 1: McAfee Mortgage Did Not Follow HUD Underwriting Requirements 5 on 11 Federal Housing Administration Loans Finding 2: McAfee Mortgage Originated Federal Housing Administration Loans 9 from Branch Offices Not Registered with HUD Scope and Methodology 12 Internal Controls 14 Appendixes A. Schedule of Questioned Costs and Funds to Be Put to Better Use 15 B. Auditee Comments and OIG’s Evaluation 16 C. Criteria 59 D. Schedule of Material Deficiencies 68 E. Case Studies for 11 Questioned Loans 69 3 BACKGROUND AND OBJECTIVES PlainsCapital McAfee Mortgage (McAfee Mortgage) began as McAfee Mortgage and Investment Company in Lubbock, Texas, in April 1949. During our audit period of January 2004 through December 2005, McAfee Mortgage was a bank-owned company specializing in Federal Housing Administration, U.S. Department of Veterans Affairs, and conventional mortgage lending. The company performed its loan processing, underwriting, and closing procedures in house. In early 2006, McAfee Mortgage’s parent company, PlainsCapital Corporation, merged McAfee Mortgage with another subsidiary, PrimeLending. McAfee Mortgage’s corporate office in Lubbock, Texas, was closed May 1, 2006, and PrimeLending of Dallas, Texas, took over its operations. McAfee Mortgage became an approved nonsupervised lender for the Federal Housing Administration on July 11, 1984. The Federal Housing Administration provides mortgage insurance on loans made by approved lenders. The mortgage insurance protects lenders such as McAfee Mortgage against losses when homeowners default on their mortgage loan. The U.S. Department of Housing and Urban Development (HUD) endorsed 3,708 McAfee Mortgage loans with Federal Housing Administration insurance between December 2003 and November 2005. Its current default and claim rate for that period was 6.34 percent, or 88 percent higher than the national average. Our objective was to determine whether McAfee Mortgage originated Federal Housing Administration single-family loans in accordance with HUD requirements, including adequately monitoring its branch offices and originating loans from only HUD-approved offices. 4 RESULTS OF AUDIT Finding 1: McAfee Mortgage Did Not Follow HUD Underwriting Requirements on 11 Federal Housing Administration Loans McAfee Mortgage did not follow HUD requirements when underwriting 11 Federal Housing Administration loans. Its management did not implement adequate quality control procedures to ensure the loans it submitted to HUD were qualified for Federal Housing Administration insurance. As a result, the lender placed the insurance fund at unnecessary risk for more than $1 million in loans and caused HUD to incur related claims and losses. Loans Did Not Comply with HUD Requirements McAfee Mortgage underwrote 11 loans that contained significant underwriting deficiencies. These deficiencies primarily involved the following: Unsupported Income/Questionable Employment Histories McAfee Mortgage did not properly assess income of borrowers. Borrower income was either overstated or not adequately supported. McAfee Mortgage also did not adequately assess borrowers’ employment histories and income stability. Borrowers had unexplained gaps in the two-year employment history required by HUD, did not provide support for employment listed on the application, or did not provide reasonable explanations for frequent job changes. Lenders must accurately assess borrower income and employment history to make informed decisions on income stability and the borrower’s ability to repay the mortgage. For example, in case number 493-7827818, the lender did not obtain a verification of employment or pay stubs for the coborrower’s current employment but used the expected base pay of $2,167 per month from an anticipated job for qualifying the borrowers. The expected income was $521 more than the lender could support based on prior employment. The lower income increased the financial ratios to 34.9 percent and 46.7 percent, which exceeded HUD’s limits. Unsupported Assets/Questionable Gift Funds McAfee Mortgage did not adequately support assets (funds available to close) claimed by borrowers. HUD requires a verification of deposit and the most recent bank statement for automated underwriting approvals. If a verification of deposit is not available, additional months of bank statements are required. HUD requires two months of bank statements on manual underwriting approvals. The lender 5 either did not adequately document the source of funds or there was evidence that the funds came from an unallowable source. For example, in case number 291-3239808, the assets claimed in the borrower’s bank accounts included $3,000 from the seller. The loan file included a transaction receipt from the borrower’s bank showing a $3,000 deposit. A letter from the borrower stated that the deposit was a draw against a balance due the borrower from a company contracting with the borrower for future construction work. This same company was also the seller of the property. Without the $3,000, the borrower would not have had the funds necessary to close the loan. Further, one common form of assets is gift funds provided to borrowers. McAfee Mortgage did not always obtain adequate gift documentation. HUD requires extensive gift documentation to ensure the gift funds are coming from an acceptable source and not from a party related to the sales transaction. McAfee Mortgage did not accurately identify donor funds as gifts. It also did not adequately verify that funds provided to the borrower were from an allowable source and did not require repayment, or verify that repayment was deferred. McAfee Mortgage also allowed gift funds from related parties. Underreported Liabilities/Questionable Credit Histories McAfee Mortgage did not include all applicable and significant liabilities when approving loans. Credit reports and other borrower documents reflected obligations that the underwriter did not consider when calculating borrowers’ debt ratios. Underwriters must accurately assess borrower debts to make reasonable decisions on the borrowers’ ability to repay the mortgage. Also, McAfee Mortgage did not adequately assess borrower credit histories. Credit histories showed significant derogatory credit and collection items within the two years before closing. McAfee Mortgage did not document its analyses of the credit reports to explain why it approved borrowers with poor credit histories. For example, the borrower’s credit history in case number 493-7852047 included numerous late payments and a car repossession. The borrower enrolled in a debt consolidation program to pay off more than $20,000 in debt shortly before applying for the Federal Housing Administration loan. McAfee Mortgage did not verify that the debt consolidation agency granted the borrower permission to enter into the mortgage transaction, as required by HUD. Appendix D summarizes the significant deficiencies, and appendix E provides details of the deficiencies on each of the 11 questioned loans. 6 McAfee Mortgage’s Inadequate Quality Control Process Caused Improper Underwriting McAfee Mortgage had an inadequate quality control process that allowed the lender to approve and submit improperly underwritten Federal Housing Administration loans to HUD for insurance. Its formal quality control plan did not include several basic elements that HUD requires in all quality control programs, and McAfee Mortgage did not properly implement the plan it had in place. For example, • The written quality control plan did not include numerous HUD-required elements. • The quality control personnel did not provide the quality control results to management in a timely manner. In some cases, the results were not reported to management until six months after loan closing. • The quality control personnel did not review 100 percent of the loans defaulting within six months of loan closing. • McAfee Mortgage did not report review findings containing fraud or other serious violations to HUD, although the quality control reviews identified numerous loans with material risks. • McAfee Mortgage’s underwriting manager stated that she conducted on-site reviews of the branch offices but could not provide documentation to confirm that she properly conducted branch office reviews. Without implementation of adequate quality control procedures, McAfee Mortgage was unable to ensure accuracy, validity, and completeness of its loan origination and underwriting operations. Therefore, HUD is not assured that the loans it insured were qualified for Federal Housing Administration insurance. Insurance Status of Improperly Underwritten Loans As of June 27, 2006, HUD systems showed that HUD had paid a claim or a claim was in process on 7 of the 11 questioned loans. Of the four remaining loans, two were in default, including one in preclaim status. Status of loans with material Number Losses Estimated deficiencies as of June 27, 2006 of loans incurred future losses Claims paid – property sold 2 $82,604 Claims paid – property not yet sold 5 $131,729 Currently insured – in default 2 $ 43,884 Currently insured – not in default 2 $ 40,341 Totals 11 $82,604 $215,954 **Estimated future losses are based on HUD’s average loss rate of 29 percent of claims paid from the Federal Housing Administration insurance fund for fiscal year 2005. 7 Conclusion McAfee Mortgage did not comply with HUD requirements when underwriting 11 Federal Housing Administration loans. Therefore, HUD’s insurance fund was placed at unnecessary risk for these loans, which had original mortgage amounts totaling more than $1 million. HUD has paid claims on 2 of the 11 improperly underwritten loans with losses totaling $82,604 and may incur further losses on five loans for which HUD has not sold the related properties but has paid claims of $454,238. HUD also remains at unnecessary risk for the other four loans that are currently insured and had original mortgage amounts totaling $290,430. If HUD implements our recommendations for the lender to indemnify the loans, it will reduce HUD’s actual and potential losses to the Federal Housing Administration insurance fund. We are not making a recommendation for HUD to take action regarding McAfee Mortgage’s inadequate quality control program because McAfee Mortgage’s former operations are currently managed by another lender, including the quality control process. Recommendations We recommend that the assistant secretary for housing - federal housing commissioner and chairman, Mortgagee Review Board, 1A. Require McAfee Mortgage to indemnify HUD for four actively insured loans with original mortgage amounts totaling $290,430. The projected loss is $84,225, based on HUD’s insurance fund average loss rate of 29 percent for fiscal year 2005 (see appendix D). 1B. Require McAfee Mortgage to reimburse HUD for two loans where HUD has already incurred losses totaling $82,604 (see appendix D). 1C. Require McAfee Mortgage to indemnify HUD for five loans where HUD has paid $454,238 in claims but not yet sold the properties. The projected loss is $131,729, based on HUD’s insurance fund average loss rate of 29 percent for fiscal year 2005 (see appendix D). 8 Finding 2: McAfee Mortgage Originated Federal Housing Administration Loans from Branch Offices Not Registered with HUD McAfee Mortgage originated 1,928 Federal Housing Administration loans between January 2004 and December 2005 from branch offices that it had not registered with HUD. Management ignored HUD regulations regarding branch office registration despite HUD warnings of the violation. As a result, McAfee Mortgage circumvented HUD’s risk management controls and placed unnecessary risk on the Federal Housing Administration insurance fund. It also avoided registration fees of $16,500 McAfee Mortgage Did Not Register All Branch Offices with HUD From January 2004 through December 2005, McAfee Mortgage originated almost 60 percent of its Federal Housing Administration-insured loans from branch offices not registered with HUD. Of the 3,326 loans endorsed by McAfee Mortgage during this period, 1,928 were originated (with original mortgage amounts of more than $172 million) from 33 branches not registered with HUD. These offices performed significant loan origination activities, including • Accepting borrower applications, • Ordering appraisals and title searches, • Ordering Federal Housing Administration case numbers, • Verifying borrower information and obtaining any additional borrower information needed for loan processing, and • Entering loan information into automated underwriting systems. Nonsupervised lenders, such as McAfee Mortgage, are allowed to maintain branch offices but must register them with HUD. HUD assigns each branch its own identification number and collects an annual registration fee. In addition, HUD uses an automated system to monitor the performance of Federal Housing Administration lenders. The system analyzes the default and claim rates in various ways, including by branch office. HUD may terminate the approval of a lender or its branch offices to originate Federal Housing Administration loans based on excessive default and claim rates. McAfee Mortgage circumvented HUD’s risk management controls by originating loans from 33 unregistered branch offices. The unregistered branches used the branch identification numbers of registered branches to access HUD systems and submit loans for insurance endorsement. For example, McAfee Mortgage operated a HUD-approved branch office in College Station, Texas. According to HUD data, the College Station branch submitted more than 900 loans for endorsement during 9 the audit period. However, McAfee Mortgage’s records showed that College Station originated only about 130 loans. It originated the remaining loans from 12 other branch offices using the College Station branch identification number. In addition, McAfee Mortgage’s failure to register the branch offices kept HUD from receiving the registration fees of $16,500 for the two-year audit period. McAfee Mortgage Ignored Branch Office Registration Requirements McAfee Mortgage management knew HUD’s branch office requirements but ignored them. In August 2004, HUD conducted a review of McAfee Mortgage’s Phoenix, Arizona, branch office. HUD identified Federal Housing Administration- insured loans that McAfee Mortgage originated from three branch offices that were not registered with HUD. In November 2004, HUD notified McAfee Mortgage of the violation. However, McAfee Mortgage continued originating loans from unregistered branches despite being notified of the violation. After the HUD review, between December 1, 2004, and December 31, 2005, McAfee Mortgage submitted 821 loans with original mortgage amounts of more than $74 million from 30 unregistered branch offices. Conclusion McAfee Mortgage originated Federal Housing Administration loans from branch offices that it had not registered with HUD. Without proper registration of branches, HUD’s automated system cannot monitor the performance of branch offices, assess lender performance, and take appropriate actions to protect the insurance fund. McAfee Mortgage’s practice of originating loans from unregistered branches circumvented HUD’s risk management controls and unnecessarily increased the risk to the Federal Housing Administration insurance fund. It also kept HUD from receiving $16,500 in fees HUD collects to increase the insurance fund. Recommendations We recommend that the assistant secretary for housing - federal housing commissioner and chairman, Mortgagee Review Board, 2A. Take appropriate administrative action against McAfee Mortgage, including imposing civil money penalties, for all loans originated from unregistered branches from December 1, 2004, to the present for failing to comply with HUD’s requirement to register all branch offices. 10 2B. Require McAfee Mortgage to properly register all of its branch offices. 2C. Require McAfee Mortgage to pay HUD the $16,500 in branch office registration fees that it would have paid if it had properly registered the branch offices. 11 SCOPE AND METHODOLOGY McAfee Mortgage endorsed 3,326 Federal Housing Administration-insured loans that closed between January 1, 2004, and December 31, 2005. Of the 3,326 loans, 310 defaulted within two years of loan closing. Of the 310 loans, HUD terminated insurance and paid claims on 33 loans. HUD’s Single Family Data Warehouse system showed that McAfee Mortgage had originated these loans from nine different branch offices. In addition, 98 of the 310 loans defaulted within the first six months after the loan closed (early defaults). We reviewed 22 of the 33 loans in claims status and 13 of the early defaults. To review loan processing by multiple branch offices, we initially grouped the 33 loans by the branch office identification number in HUD’s systems. We calculated the percentage of loans in claims status at each of the nine branch offices, then selected 10 loans based on each branch office’s pro rata share of the 33 loans. For example, HUD’s systems showed that the College Station, Texas, branch office had originated 17 of the 33 loans (51 percent). Using the pro rata share method, we selected five loans from that branch office (i.e., 51 percent of the 10 loans selected). Once we had identified the number of loans to review from each branch office, we selected the loans based on the level of risk to the Federal Housing Administration insurance fund, as follows: • HUD incurred a loss on the sale of the foreclosed property, • Loans with the fewest months paid before the first default • Highest mortgage amount. We also selected the remaining 12 loans in claims status that were identified in HUD’s systems as loans originated by the College Station branch office. McAfee Mortgage’s loan data showed that it had actually originated these loans from its Houston, Texas, area branch offices but had processed the loans using the HUD branch identification number for its College Station branch. McAfee Mortgage had not registered the Houston branch offices with HUD as required, and these branch offices had higher default rates than most other McAfee Mortgage branches. We also reviewed 13 of the 98 loans that defaulted within six months of loan closing but had not reached claims status. We evaluated the distribution of loans throughout all of McAfee Mortgage’s branch offices and selected the 13 loans from the three branches with the highest Federal Housing Administration loan volume. We selected the loans based on the level of risk to the Federal Housing Administration insurance fund, as follows: • Loans with the fewest months paid before the first default • Highest mortgage amount. We accomplished our objective by reviewing the Federal Housing Administration and McAfee Mortgage underwriting policies and procedures and interviewing McAfee Mortgage personnel. We also reviewed the HUD and lender loan files for the 35 loans reviewed. We identified underwriting deficiencies and assessed the materiality of those deficiencies to the insurability of the loan. For significant deficiencies, we are recommending that HUD take appropriate action 12 on these loans. We informed McAfee Mortgage of minor underwriting deficiencies but have not recommended that HUD take action on these loans. We reviewed McAfee Mortgage’s quality control plan and reviews performed by the lender, including branch office reviews. We also analyzed reviews performed by HUD’s Office of Housing, Quality Assurance Division, and interviewed HUD quality assurance staff. We relied on computer-processed data contained in HUD’s Single Family Data Warehouse and Neighborhood Watch systems. We assessed the reliability of the data, performed sufficient tests of the data, and found the data adequate to meet our audit objective. We also relied on computer data from McAfee Mortgage to identify the branch offices that originated its loans. McAfee Mortgage had not registered all branch offices with HUD but allowed its unregistered branches to originate loans using registered branch identification numbers. Therefore, no independent data were available to test McAfee Mortgage’s branch office data. In assigning a value to the potential savings to HUD if it implements our recommendations on loans for which it has not yet incurred a loss, we applied the Federal Housing Administration’s average loss experience for fiscal year 2005 provided by HUD. We calculated the savings value at $84,225 for those properties currently actively insured, which is 29 percent of the original mortgage amount of $290,430. For loans for which HUD has paid a claim but not yet sold the related property, we calculated the savings value at $131,729, or 29 percent of $454,238 in claims paid. We conducted audit work at McAfee Mortgage’s former corporate office in Lubbock, Texas, and branch offices in Beaumont and Port Arthur, Texas. We conducted audit work from January through July 2006 and performed our review in accordance with generally accepted government auditing standards. 13 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 - Policies and procedures that management has implemented to reasonably ensure that underwriting activities comply with HUD’s regulations, procedures, and instructions. 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 Weakness Based on our review, we believe the following items are significant weaknesses: • McAfee Mortgage’s quality control program did not meet HUD requirements, and McAfee Mortgage did not properly implement the plan it had in place (finding 1). • McAfee Mortgage circumvented HUD’s oversight controls by operating unapproved branch offices (finding 2). 14 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS AND FUNDS TO BE PUT TO BETTER USE Recommendation Funds to be put number Ineligible 1/ to better use 2/ 1A $84,225 1B $82,604 1C $131,729 1/ Ineligible costs are costs charged to a HUD-financed or HUD-insured program or activity that the auditor believes are not allowable by law; contract; or federal, state, or local polices or regulations. 2/ “Funds to be put to better use” are quantifiable savings that are anticipated to occur if an Office of Inspector General (OIG) recommendation is implemented, resulting in reduced expenditures at a later time for the activities in question. This includes costs not incurred, deobligation of funds, withdrawal of interest, reductions in outlays, avoidance of unnecessary expenditures, loans and guarantees not made, and other savings. Implementation of our recommendation to indemnify loans that were not originated in accordance with Federal Housing Administration requirements will reduce the Federal Housing Administration’s risk of loss to its insurance fund. The amounts above reflect that, upon sale of the mortgaged property, the Federal Housing Administration’s average loss experience is about 29 percent of the claim amount based upon statistics provided by HUD. 15 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments Comment 1 Note: We redacted borrower’s names from the auditee comments and substituted the applicable Federal Housing Administration loan number, as needed, to protect the privacy of the individual borrowers. 16 Comment 1 17 Comment 1 Comment 1 18 Comment 1 19 Comment 2 20 Comment 3 21 22 Comment 4 Comment 5 23 Comment 3 24 Comment 6 Comment 4 25 Comment 4 Comment 7 26 Comment 4 Comment 4 Comment 8 27 Comment 4 Comment 8 Comment 2 28 Comment 9 29 Comment 2 Comment 2 30 31 Comment 2 32 Comment 2 33 Comment 2 34 Comment 10 35 Comment 4 Comment 3 36 Comment 3 37 Comment 11 38 Comment 4 Comment 12 39 Comment 4 40 41 42 Comment 4 Comment 13 43 Comment 2 44 Comment 3 45 Comment 4 Comment 14 Comment 15 46 Comment 16 Comment 3 47 48 Comment 17 49 50 51 Comment 18 52 Comment 19 53 Comment 20 54 55 OIG Evaluation of Auditee Comments Comment 1 In response to our initial draft report, McAfee Mortgage provided written comments and additional documentation. We reviewed the information and revised the report accordingly. The final report questions 11 loans for underwriting deficiencies. We removed 6 of the initial 17 loans from the report based on information provided in McAfee Mortgage’s response. After making these changes, we provided the revised report to McAfee Mortgage and gave it an opportunity to provide revised comments. McAfee Mortgage requested that we include their original comments. Comment 2 Based on information provided in McAfee Mortgage’s response, we removed this loan from our finding. Comment 3 Based on the information provided in McAfee Mortgage’s response, we removed this issue from a loan that remains questioned in our finding. Comment 4 Based on information provided in McAfee Mortgage’s response, we revised the language in our report to clarify this issue. Comment 5 McAfee Mortgage did not adequately verify the coborrower’s future monthly income used to qualify for the loan. The sole support for using the future income was a letter from the company that offered the coborrower a position, contingent upon the coborrower meeting certain requirements. McAfee Mortgage did not verify that the coborrower had met the stipulations and was guaranteed the new job before closing the loan. Further, the letter did not represent a guaranteed, nonrevocable contract for employment, as required by HUD to support using the future income for qualifying for a Federal Housing Administration loan. Comment 6 HUD requires lenders to obtain evidence of a two year work history to establish employment and income stability. The borrower claimed to have been self-employed for more than a year in the two years before applying for the loan. The lender supported 10 months of self-employment income in 2002 but did not obtain a 2003 tax return or other documentation to support self- employment income for five months in 2003. Comment 7 McAfee Mortgage did not establish that the borrower had a stable income despite the frequent changes in employment. The borrower had held five jobs in the two years before applying for the loan and the various jobs did not appear to be in a similar employment field as the borrower’s most recent job. Further, McAfee Mortgage did not obtain support for three months of income claimed in 2004 and the support that the lender relied on for seven months of income in 2003 was illegible. 56 Comment 8 McAfee Mortgage used an unsigned monthly budget showing that the borrower should have been able to save $1,118 per month (or $893 if the unsupported child support income is excluded). The borrower provided a signed statement to the lender that she was able to save about $375 per month for nine months before applying for the loan. The lender and borrower did not establish that the borrower had actually saved more than the $375 per month claimed as the source of her earnest deposit. The borrower’s monthly housing payment was increasing by $376, causing us to question the likelihood that the borrower would have been able to make the monthly mortgage payments. Comment 9 HUD Handbook 4155.1, Rev-5, chapter 2, section 2-10, revised October 2003, states that the lender is responsible for properly documenting the transfer of donor/gift funds and gives information on what documentation is acceptable. HUD issued the October 2003 version of the handbook as guidance after the HUD Single Family Reference Guide, dated November 2001. Therefore, the revised handbook was HUD's latest guidance and the guidance that McAfee Mortgage should have followed when documenting the gift transfer. Comment 10 In its response, McAfee Mortgage provided evidence of the transfer of funds but did not provide information on the City of Houston’s assistance program. Without additional documentation, the lender and HUD cannot be assured that repayment was deferred or not expected, and that the debt was appropriately excluded when evaluating the borrower’s liabilities. Comment 11 We maintain that the lender did not follow HUD requirements and failed to properly document the transfer of gift funds. Comment 12 We agree that the assistance program description indicated that repayment was deferred. However, McAfee Mortgage did not document receipt of the funds or obtain a promissory note. Without documents confirming that payments were deferred and that any deferment was for at least one year, HUD cannot be assured that the lender appropriately excluded the assistance loan when evaluating the borrower's liabilities. Comment 13 We agree that the six accounts either went to collection or the collateral was repossessed but disagree that this negates the borrowers' responsibility for the debts. Further, the credit report showed that two additional accounts were for defaulted federal student loans totaling nearly $5,000. The coborrower indicated that unemployment was the cause of the financial problems but the credit report showed a significant history of poor credit and numerous bad debts before the loss of employment. Comment 14 McAfee Mortgage provided contractor and materials invoices/receipts of work completed on the property. However, the information did not support remediation of noted health and safety concerns or confirm that all valuation conditions noted by the appraiser were resolved. The appraiser noted 57 conditions of damaged plumbing and the presence of mold and lead-based paint. The lender did not obtain a final verification that the health issues and safety were resolved before or after closing the loan. Comment 15 McAfee Mortgage stated that the loan was originally processed under a different Federal Housing Administration case number and that evidence of mold remediation may be in that loan file. However, the borrower's loan was not processed under a different Federal Housing Administration case number. The property was a HUD real estate owned property and the previous owner had a Federal Housing Administration insured loan under the case number referenced by the lender. Comment 16 We maintain that the borrower’s pay stubs being faxed from the seller’s office was against HUD requirements and that the lender should not have relied on the pay stubs unless received from a party not related to the transaction. Comment 17 As standard practice, OIG reports contain amounts considered as funds to be put to better use if the recommendations are implemented. The purpose of this practice is to estimate the monetary benefit of the audit, not to claim an amount of damages for violations committed by the auditee. In the case of indemnifications, OIG and HUD have agreed that 29 percent of the loan amount is a reasonable estimate of funds to be put to better use. Comment 18 Using loan origination data provided by McAfee Mortgage, we identified 50 of the lender’s office locations processing Federal Housing Administration loans in 2004 and 2005. A senior vice president in McAfee Mortgage’s corporate office identified the 50 offices as branch offices and not satellite offices. The 33 unregistered offices were included in the list of 50 offices. Comment 19 We interviewed a McAfee Mortgage senior vice president and a direct endorsement underwriter in the corporate office, and various employees in two branch offices. Based on the interviews, we concluded that the lender’s staff conducted activities in the 33 offices beyond those allowed in satellite offices. In addition, several staff, including a corporate direct endorsement underwriter, told us that direct endorsement underwriters reviewed only the property appraisal on loans approved by an automated underwriting system. The underwriters did not perform a full review of the automated approvals. Comment 20 HUD notified McAfee's Mortgage’s president and chief executive officer in November 2004 that the practice the lender had in place for processing loans in its unregistered branch offices was unacceptable and violated HUD requirements. A senior vice president in the corporate office responded to HUD’s letter, indicating that the situation was resolved because McAfee Mortgage had closed the branch offices. HUD adequately notified the lender’s management of the improper practices and the lender should have taken action to rectify the situation in all of its offices. 58 Appendix C CRITERIA Criteria 1 HUD Handbook 4000.2, REV-3, chapter 1, section 1-7, states that property flipping is a practice whereby recently acquired property is resold for a considerable profit with an artificially inflated value, often abetted by a lender’s collusion with the appraiser. C. Resales Occurring 90 Days or Less Following Acquisition. A property acquired by the seller is not eligible for a mortgage to be insured by the Federal Housing Administration for the buyer unless the seller has owned that property for at least 90 days. If a property is resold 90 days or fewer following the date of acquisition by the seller, the property is not eligible for a mortgage insured by the Federal Housing Administration. The Federal Housing Administration defines the seller’s date of acquisition as the date of settlement on the seller’s purchase of that property. The resale date is the date of execution of the sales contract by a buyer intending to finance the property with a Federal Housing Administration-insured loan. Criteria 2 HUD Handbook 4155.1, REV-5, chapter 1, section 1-7-A, states that the seller may contribute up to 6 percent of the property’s sales price toward the buyer’s actual closing costs, prepaid expenses, discount points, and other financing concessions. Contributions exceeding 6 percent of the sales price or exceeding the actual cost of prepaid expenses, discounts points, and other financing concessions will be treated as inducements to purchase, thereby reducing the amount of the mortgage. Closing costs normally paid by the borrower are considered contributions if paid by the seller. Criteria 3 HUD Handbook 4155.1, REV-5, chapter 1, section 1-13-A, states that any financing (other than the Federal Housing Administration-insured first mortgage) that creates a lien against the property is considered secondary financing and not a gift, even if it is a “soft” or “silent” second (i.e., has no monthly repayment provisions) or has other features forgiving the debt. Documentation from the provider of the secondary financing must show the amount of funds provided to the borrower in each transaction, and copies of the loan instruments are to be included in the endorsement binder. Costs incurred for participating in a downpayment assistance secondary financing program may only be included in the amount of the second lien. Permissible secondary financing arrangements include A. Government Agencies. Federal, state, and local government agencies, as well as nonprofit agencies considered instrumentalities of government, may provide secondary financing for the borrower’s entire cash investment. The second lien itself must be made or held by the eligible governmental body or instrumentality. Neither governmental units nor their established nonprofit instrumentalities may use “agents,” including other nonprofits or for-profit enterprises, to make the second lien regardless of the source of those funds. In other words, even if the funds 59 used for the secondary financing were derived from an acceptable source such as HUD Homeownership Investment Partnership funds or from a unit of government or eligible nonprofit instrumentality, the subordinate lien must be in the name of the eligible entity; i.e., the state, county, city, or eligible nonprofit instrumentality must be the lien holder. This authority cannot be delegated to another party that is not itself permitted to provide this level of secondary financing. These other entities, however, may be used to service the subordinate lien if regularly scheduled payments are to be made by the borrower. Loans secured by secondary mortgages are subject to the conditions described below: 1. The Federal Housing Administration-insured first mortgage, when combined with any second mortgage or other junior liens from government agencies, may not result in cash back to the borrower. The sum of all liens cannot exceed 100 percent of the cost to acquire the property. The cost to acquire is the sales price plus allowable borrower-paid closing costs, discount points, repair and rehabilitation expenses, and prepaid expenses. The cost to acquire may exceed the appraised value of the property under these types of government assistance programs. 2. The required monthly payment under the insured mortgage and the second mortgage or lien, plus other housing expenses and all recurring charges, cannot exceed the borrower’s reasonable ability to pay. 3. The source, amount, and repayment terms must be disclosed in the mortgage application, and the borrower must acknowledge that he or she understands and agrees to the terms. Criteria 4 HUD Handbook 4155.1, REV-5, chapter 2, section 2-2-B, details citizenship and immigration status requirements. B. Citizenship and Immigration Status. When a mortgage loan applicant indicates on the loan application that he or she holds something other than U.S. citizenship, the lender must determine residency status from the documentation provided by the borrower. Nonpermanent Resident Aliens. The Federal Housing Administration will insure a mortgage made to a nonpermanent resident alien, provided the property will be the borrower’s principal residence, the borrower has a valid Social Security number, and the borrower is eligible to work in the United States as evidenced by an employment authorization document issued by the Bureau of Citizenship and Immigration Services. If the authorization for temporary residency status will expire within one year and a prior history of residency status renewals exists, the lender may assume continuation will be granted. If there are no prior renewals, the lender must determine the likelihood of renewal, based on information from the Bureau of Citizenship and Immigration Services. Although Social Security cards may indicate work status, such as “not valid for work purposes,” an individual’s work status may change without the change being reflected on the Social Security card. Therefore, the Social Security card is not to be used as evidence of work status for nonpermanent resident aliens; the Bureau of Citizenship and Immigration Services employment authorization document is to be used instead. 60 Criteria 5 HUD Handbook 4155.1, REV-5, chapter 2, section 2-2-D, states that although the nonpurchasing spouse’s credit history is not to be considered a reason for credit denial, a credit report that complies with other HUD requirements must be obtained for the nonpurchasing spouse to determine the debt-to-income ratio. Criteria 6 HUD Handbook 4155.1, REV-5, chapter 2, section 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. When analyzing a borrower’s credit history, the lender is to examine the overall pattern of credit behavior, rather than isolated occurrences of unsatisfactory or slow payments. When delinquent accounts are revealed, the lender must document its analysis as to whether the late payments were based on a disregard for financial obligations, an inability to manage debt, or factors beyond the control of the borrower, including delayed mail delivery or disputes with creditors. While minor derogatory information occurring two or more years in the past does not require explanation, major indications of derogatory credit--including judgments, collections, and any other recent credit problems--require sufficient written explanation from the borrower. Neither the lack of credit history nor the borrower’s decision not to use credit may be used as a basis for rejecting the loan application. HUD also recognizes that some prospective borrowers may not have an established credit history. For those borrowers, and for those who do not use traditional credit, the lender must develop a credit history from utility payment records, rental payments, automobile insurance payments, or other means of direct access from the credit provider. The lender must document that the providers of nontraditional credit exist and verify the credit information. As an alternative, the lender may elect to use a nontraditional mortgage credit report developed by a credit-reporting agency, provided the credit-reporting agency has verified the existence of the credit providers and the lender verifies that the nontraditional credit was extended to the applicant. The lender must verify the credit using a published address or telephone number to make that verification. Criteria 7 HUD Handbook 4155.1, REV-5, chapter 2, section 2-3-A, states that the payment history of the borrower’s housing obligations holds significant importance in evaluating credit. The lender must determine the borrower’s payment history of housing obligations through either the credit report, verification of rent directly from the landlord (with no identity-of-interest with the borrower) or verification of mortgage directly from the mortgage servicer, or through canceled checks covering the most recent 12-month period. 61 Criteria 8 HUD Handbook 4155.1, REV-5, chapter 2, section 2-3-F, states that participation in a consumer credit counseling payment program does not disqualify a borrower from obtaining a Federal Housing Administration-insured mortgage, provided the lender documents that one year of the pay-out period has elapsed under the plan and the borrower’s payment performance has been satisfactory (i.e., all required payments made on time). In addition, the borrower must receive written permission from the counseling agency to enter into the mortgage transaction. Criteria 9 HUD Handbook 4155.1, REV-5, chapter 2, section 2-6, states 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. HUD does not impose a minimum length of time a borrower must have held a position of employment to be eligible. However, the lender must verify the borrower’s employment for the most recent two full years. If a borrower indicates he or she was in school or in the military during any of this time, the borrower must provide supporting evidence, such as college transcripts or discharge papers. The borrower also must explain any gaps in employment spanning one month or more. Allowances for seasonal employment, such as is typical in the building trades, etc., may be made if documented by the lender. To analyze and document the probability of continued employment, lenders must examine the borrower’s past employment record, qualifications for the position, previous training and education, and the employer’s confirmation of continued employment. A borrower who changes jobs frequently within the same line of work but continues to advance in income or benefits, should be considered favorably. In this analysis, income stability takes precedence over job stability. Criteria 10 HUD Handbook 4155.1, REV-5, chapter 2, section 2-7, states 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, Social Security payments, or other payments expected to be received in retirement. In most cases, the borrower’s income will be limited to salaries or wages. Income from other sources can be included as effective income with proper verification by the lender. Procedures for analyzing other acceptable income sources besides salaries and wages are described below: A. Overtime and Bonus Income. Both overtime and bonus 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 bonus or overtime income for the past two years, and the employment verification must not state that such income is unlikely to continue. Periods of 62 less than two years may be acceptable, provided the lender justifies and documents in writing the reason for using the income for qualifying purposes. An earnings trend also must be established and documented for overtime and bonus income. If either type shows a continual decline, the lender must provide a sound rationalization in writing for including the income for borrower qualifying. If bonus income varies significantly from year to year, a period of more than two years must be used in calculating the average income. R. Projected Income. Projected or hypothetical income is not acceptable for qualifying purposes. However, exceptions are permitted to this rule for income from cost-of-living adjustments, performance raises, bonuses, etc., which are both verified by the employer in writing and scheduled to begin within 60 days of loan closing. If a borrower is about to start a new job and has a guaranteed, nonrevocable contract for employment that will begin within 60 days of loan closing, the income is acceptable for qualifying purposes. The lender also must verify that the borrower will have sufficient income or cash reserves to support the mortgage payments and any other obligations during the interim between loan closing and the start of employment. However, if the loan will close more than 60 days before the borrower's employment begins, the loan is not eligible for endorsement until the lender provides a pay stub or other acceptable evidence that the borrower has begun the new job. Criteria 11 HUD Handbook 4155.1, REV-5, chapter 2, section 2-9-B, states that the following documents are required from self-employed borrowers: 1. Signed and dated individual tax returns, plus all applicable schedules, for the most recent two years. 2. Signed copies of federal business income tax returns for the last two years, with all applicable schedules, if the business is a corporation, an S corporation, or a partnership. 3. A year-to-date profit-and-loss statement and balance sheet. 4. A business credit report on corporations and S corporations. Criteria 12 HUD Handbook 4155.1, REV-5, chapter 2, section 2-10, states that all funds for the borrower’s investment in the property must be verified and documented. Criteria 13 HUD Handbook 4155.1, REV-5, chapter 2, section 2-10-B, states that a verification of deposit, along with the most recent bank statement, may be used to verify savings and checking accounts. If there is a large increase in an account or the account was opened recently, the lender must obtain a credible explanation of the source of those funds. 63 Criteria 14 HUD Handbook 4155.1, REV-5, chapter 2, section 2-10-C, states that an outright gift of the cash investment is acceptable if the donor is the borrower’s relative, the borrower’s employer or labor union, a charitable organization, a governmental agency or public entity that has a program to provide homeownership assistance to low- and moderate-income families or first-time homebuyers, or a close friend with a clearly defined and documented interest in the borrower. The gift donor may not be a person or entity with an interest in the sale of the property, such as the seller, real estate agent or broker, builder, or any entity associated with them. Gifts from these sources are considered inducements to purchase and must be subtracted from the sales price. No repayment of the gift may be expected or implied. As a rule, HUD is not concerned with how the donor obtains the gift funds, provided they are not derived in any manner from a party to the sales transaction. Donors may borrow gift funds from any other acceptable source, provided the mortgage borrowers are not obligors to any note to secure money borrowed to give the gift. The lender must document the gift funds by obtaining a gift letter, signed by the donor and borrower, that specifies the dollar amount of the gift; states that no repayment is required; shows the donor’s name, address, and telephone number; and states the nature of the donor’s relationship to the borrower. In addition, the lender must document the transfer of funds from the donor to the borrower, as follows: 1. If the gift funds are in the homebuyer’s bank account, the lender must document the transfer of the funds from the donor to the homebuyer by obtaining a copy of the canceled check or other withdrawal document showing that the withdrawal is from the donor’s account. The homebuyer’s deposit slip and bank statement that shows the deposit are also required. 2. If the gift funds are to be provided at closing, a. If the transfer of the gift funds is by certified check made on the donor’s account, the lender must obtain a bank statement showing the withdrawal from the donor’s account, as well as a copy of the certified check. b. If the donor purchased a cashier’s check, money order, official check, or any other type of bank check as a means of transferring the gift funds, the donor must provide a withdrawal document or canceled check for the amount of the gift, showing that the funds came from the donor’s personal account. If the donor borrowed the gift funds and cannot provide documentation from the bank or other savings account, the donor must provide written evidence that those funds were borrowed from an acceptable source; i.e., not from a party to the transaction, including the lender. “Cash on hand” is not an acceptable source of the donor’s gift funds. Regardless of when the gift funds are made available to the homebuyer, the lender must be able to determine that the gift funds ultimately were not provided from an unacceptable source and were indeed the donor’s own funds. When the transfer occurs at closing, the lender remains responsible for obtaining verification that the closing agent received funds from the donor for the amount of the purported gift and that those funds came from an acceptable source. 64 Criteria 15 HUD Handbook 4155.1, REV-5, chapter 2, section 2-10-M, states that borrowers who have saved cash at home and are able to demonstrate adequately the ability to do so are permitted to have this money included as an acceptable source of funds to close the mortgage. To include such funds in assessing the homebuyer’s cash assets for closing, the money must be verified-- whether deposited in a financial institution or held by the escrow/title company--and the borrower must provide satisfactory evidence of the ability to accumulate such savings. The asset verification process requires the borrower to explain in writing how such funds were accumulated and the amount of time taken to do so. The lender must determine the reasonableness of the accumulation of the funds based on the borrower’s income stream, the period during which the funds were saved, the borrower’s spending habits, documented expenses, and the borrower’s history of using financial institutions. All other factors being equal, individuals with checking and/or savings accounts are less likely to save money at home than an individual with no history of such accounts. Criteria 16 HUD Handbook 4155.1, REV-5, chapter 2, section 2-11-C, states that that if a debt payment, such as a student loan, is scheduled to begin within 12 months of the mortgage loan closing, the lender must include the anticipated monthly obligation in the underwriting analysis, unless the borrower provides written evidence that the debt will be deferred to a period outside this timeframe. Criteria 17 HUD Handbook 4155.1, REV-5, chapter 2, section 2-12, states that ratios are used to determine whether the borrower can reasonably be expected to meet the expenses involved in homeownership and otherwise provide for the family. The lender must compute two ratios: A. Mortgage Payment Expense to Effective Income. If the total mortgage payment (principal and interest, escrow deposits for real estate taxes, hazard insurance, the mortgage insurance premium, homeowners’ association dues, ground rent, special assessments, and payments for any acceptable secondary financing) does not exceed 29 percent of the gross effective income, the relationship of the mortgage payment to income is considered acceptable. A ratio exceeding 29 percent may be acceptable only if significant compensating factors are documented and recorded on the mortgage credit analysis worksheet. Typically, for borrowers with limited recurring expense, greater latitude is permissible on this ratio than on the total fixed payment ratio. B. Total Fixed Payment to Effective Income. If the total of the mortgage payment and all recurring charges does not exceed 41 percent of the gross effective income, the relationship of total obligations to income is considered acceptable. A ratio exceeding 41 percent may be acceptable only if significant compensating factors are documented and recorded on the mortgage credit analysis worksheet. Criteria 18 HUD Handbook 4155.1, REV-5, chapter 3, section 3-1, states that the application package must contain all documentation supporting the lender’s decision to approve the mortgage loan. When 65 standard documentation does not provide enough information to support this decision, the lender must provide additional explanatory statements, consistent with other information in the application, to clarify or to supplement the documentation submitted by the borrower. Lenders may not accept or use documents relating to the credit, employment, or income of borrowers that are handled by or transmitted from or through interested third parties (e.g., real estate agents, builders, sellers) or by using their equipment. Criteria 19 HUD Handbook 4155.1, REV-5, chapter 3, section 3-1-C, states that for all borrowers, including U.S. citizens, the lender is required to document a valid Social Security number for each borrower, coborrower, and cosigner on the mortgage. All individuals eligible for legal employment in the United States must have a Social Security number. Each borrower must provide the lender with evidence of his or her own valid Social Security number as issued by the Social Security Administration. This applies to purchase money loans and all refinances, including streamline refinances. While the Social Security card is not required, the lender is required to validate the Social Security number. Lenders may use various means for validating the Social Security number, including examining the borrower’s pay stubs, passport, and valid tax returns, and may use service providers including those with direct access to the Social Security Administration. The lender is also required to resolve any inconsistencies or multiple Social Security numbers for individual borrowers that are revealed during loan processing and underwriting. Criteria 20 Mortgagee Letter 00-27 provides processing instructions for Federal Housing Administration- insured financing that involves a HUD real estate owned property. Appraisal Type - Upon conveyance of properties to HUD’s real estate owned inventory, HUD’s management and marketing contractor shall obtain an as-is appraisal (not as-repaired) for each HUD real estate owned property to determine the listing price. Utility Issues - Utilities should be on at the time the appraisal is conducted, unless there are documented extenuating circumstances. In the event of extenuating circumstances, the appraiser should note the following: • On the uniform residential appraisal report, the appraiser will annotate “The following utilities were not on at the time the appraisal was conducted (e.g., electric, gas, and/or water) --Unable to verify their functionality.” • On the valuation condition sheet, it also should be clearly noted that “The following utilities were not on at the time the appraisal was conducted (e.g., electric, gas, and/or water)--Unable to verify their functionality.” However, the appraiser should note any readily observable condition that is evident. Completion of the valuation condition sheet requires observation of 13 areas, that include but are not limited to the well and individual water supply, the septic system, structural conditions, and mechanical systems, to determine any obvious defects (i.e., exposed wiring, frayed wiring, presence of leaks, and structural damage of plumbing 66 fixtures). Extra attention should be given to the readily observable condition of the utility systems that are not activated at the time of the appraisal. • HUD’s management and marketing contractor shall permit entry to the purchaser(s) during the contract period to activate the utilities for the purposes of conducting a home inspection. If the HUD real estate owned appraisal was completed without the utilities being activated, the mortgage lender or purchaser(s) must complete the systems check while the utilities are activated. Marketing Approach - A property that requires no more than $5,000 for repairs to meet the Federal Housing Administration’s minimum property requirements as determined by the appraiser is eligible to be marketed for sale in its as-is condition with Federal Housing Administration mortgage insurance available, provided the purchaser(s) establishes a cash escrow to ensure the completion of the required repairs. Purchaser(s) are permitted to include in the mortgage an amount equal to 110 percent of the estimated cost of the repairs. When a repair escrow is required, the escrow account should be established and administered in accordance with the procedures outlined in HUD Handbook 4145.1. A completed form HUD- 92300, Mortgagee’s Assurance of Completion, should be included in the case binder submitted for insurance endorsement. A completed form HUD-92051, Compliance Inspection Report, must be submitted after the completion of repairs. Criteria 21 Mortgagee Letter 04-28 requires that any resale of a property may not occur 90 or fewer days from the last sale to be eligible for Federal Housing Administration financing. Criteria 22 Mortgagee Letter 04-28 states that HUD Handbook 4155.1, REV-5, sets forth the documentation requirements for showing the transfer of gift funds. The instructions also state that when the transfer occurs at closing, the lender remains responsible for obtaining verification that the closing agent received funds from the donor for the amount of the purported gift and that those funds came from an acceptable source. Since most transfers of downpayment funds from charities are by means of wire transfers, when that situation occurs, the lender must obtain and keep the documentation of the wire transfer in its mortgage loan application binder. While that document need not be provided in the insurance binder, it must be available for inspection by HUD’s Quality Assurance Division when that office conducts its on-site review of lenders. Criteria 23 Underwriting requires careful analysis of the many aspects of the mortgage. Each loan is a separate and unique transaction, and there may be other factors that demonstrate the borrowers' ability and willingness to make timely mortgage payments. There is a danger of "layering flexibilities" in assessing mortgage insurance risk, and simply establishing that a loan transaction meets minimal standards does not necessarily constitute prudent underwriting. The lender is responsible for adequately analyzing the probability that the borrower will be able to repay the mortgage obligation in accordance with the terms of the loan. 67 Appendix D SCHEDULE OF MATERIAL DEFICIENCIES Unsupported assets Ineligible property Underreported credit history Questionable Questionable Questionable Unsupported employment or borrower Federal 29% of gift funds liabilities Housing Original original 29% of income Other Administration mortgage Claims mortgage Loss claims case number amount paid amount to HUD paid 161-2097168 $63,995 $18,559 x x 491-8444756 $65,000 $18,850 x 493-7681268 $86,325 $25,034 x 493-7770482 $75,110 $21,782 x x x 291-3239808 $98,356 $105,536 $55,091 x x x x 493-7888318 $113,754 $121,916 $27,513 x 493-7775178 $65,772 $68,780 $19,946 x 493-7827818 $113,591 $118,911 $34,484 x x x 493-7852047 $145,960 $149,249 $43,282 x x 493-7905859 $90,972 $94,157 $27,306 x x 493-7908169 $113,326 $23,141 $6,711 x x Totals $1,032,161 $681,690 $84,225 $82,604 $131,729 2 3 3 3 2 3 3 3 68 Appendix E CASE STUDIES FOR 11 QUESTIONED LOANS Case number: 161-2097168 Insured amount: $63,995 Section of Housing Act: 203(b) Status upon selection: Active Date of loan closing: May 10, 2004 Underwriter type: Automated Ineligible Property The property was resold within 90 days of the last sale for a substantial profit. The seller of the property took ownership on December 22, 2003, paying $38,000 for the property. The new contract was executed on March 1, 2004, for $65,000. The seller owned the property for only 69 days before reselling. A property resold within 90 days following the date of acquisition by the seller is not eligible for a Federal Housing Administration-insured loan. In response to the audit, McAfee Mortgage agreed with this finding. HUD Requirements HUD Handbook 4000.2, REV-3, chapter 1, section 1-7-C (appendix C – criteria 1) Mortgagee Letter 2003-07 (appendix C – criteria 21) Questionable Gift Funds The lender did not adequately document gift funds provided by a charitable organization. The settlement statement reflected gift funds of $1,950 to the borrower from the nonprofit and the associated funds from the seller to the same nonprofit. The HUD case binder contained the gift letter but did not include support for the transfer of funds. Without additional gift fund documentation, such as wire transfer documents, the lender could not verify that the funds came from an allowable source. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-10-C (appendix C – criteria 14) Mortgagee Letter 2004-28 (appendix C – criteria 22) Case number: 491-8444756 Insured amount: $65,000 Section of Housing Act: 203(b) Status upon selection: Active Date of loan closing: June 18, 2004 Underwriter type: Manual Ineligible Property The lender did not accurately process this loan as a HUD real estate owned property. The appraiser noted several repairs necessary to meet Federal Housing Administration minimum property requirements and estimated the cost of those repairs to be $4,900. The appraiser was unable to check the plumbing system because the water was not turned on. There was no documentation that an inspection was performed once the water was activated. The appraisal 69 also noted the presence of lead-based paint and mold, both health hazards. Neither the HUD case binder nor the lender file contained documentation of lead paint repairs or mold remediation. Neither a lender’s assurance of completion (HUD-82300) nor a compliance inspection report (HUD-92051) was in the file. The file also did not contain support for completion of the required repairs or administration of the repair escrow. A loan information sheet prepared by the lender, dated June 23, 2004, stated that the repairs were not complete. In response to our audit, McAfee Mortgage provided documentation to address some of the conditions noted by the appraisal. However, McAfee Mortgage did not provide evidence of paint repairs or mold remediation, a plumbing inspection, or a final inspection. HUD Requirements Mortgagee Letter 00-27 (appendix C – criteria 20) Case number: 493-7681268 Insured amount: $86,325 Section of Housing Act: 203(b) Status upon selection: Active Date of loan closing: January 16, 2004 Underwriter type: Automated Unsupported Assets The lender did not adequately support funds used to close the loan or the borrower’s ability to pay a substantial increase in housing costs. The borrower provided a monthly budget savings plan stating that she was able to save $1,118 per month, or half of her monthly income. The savings plan included income of $225 from unsupported child support. State child support records showed that she was not receiving the child support consistently. The records, dated December 9, 2003, showed that the borrower had not received any child support since March 2003. The payments recorded by the state ranged from $34 to $113 per month – not the $225 used to support the borrower’s ability to save and have additional income available to offset increased housing expenses. In addition, the borrower provided a statement that she had only been able to save $375 per month over a nine month period to accumulate the earnest money. The borrower’s housing expense (principal and interest) increased $376, from $550 per month to $926 per month. The lender did not adequately demonstrate that the borrower had the ability to absorb the 68 percent increase in her housing payment. Additionally, the file contained copies of a cashier’s check for $3,150, with the borrower as the remitter, and a personal check from the borrower for $500. The borrower deposited both checks with the seller and not a third party having no interest in the sale. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-10-B (appendix C – criteria 13) HUD Handbook 4155.1, REV-5, chapter 2, section 2-10-M (appendix C – criteria 15) 70 Case number: 493-7770482 Insured amount: $75,110 Section of Housing Act: 203(b) Status upon selection: Active Date of loan closing: May 13, 2004 Underwriter type: Manual Citizenship and Immigration Status The lender did not adequately document the borrower’s eligibility as a nonpermanent resident alien, nor did it adequately ensure that the Social Security number claimed by the borrower legitimately belonged to the borrower. The lender obtained a verification of employment and a memorandum from the employer indicating that the borrower was working under the H-2B visa program but did not provide his employment authorization document issued by the Bureau of Citizenship and Immigration Services. The borrower’s work visa expired a month after closing, and the lender did not provide proof of a renewal history or other documentation from the Bureau of Citizenship and Immigration Services, ensuring that the borrower’s work status would be renewed, thereby allowing him to legally reside in the country and be eligible for a Federal Housing Administration-insured loan. Additionally, the lender conducted checks on the borrower’s Social Security number that indicated the number was associated with someone else and was issued in Michigan. The loan file showed no indication that the lender attempted to resolve the discrepancy, which draws into question the legitimacy of the Social Security number belonging to the borrower. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, paragraph 2-2-B (appendix C – criteria 4) HUD Handbook 4155.1, REV-5, chapter 3, section 3-1-C (appendix C – criteria 19) Unsupported Assets/Questionable Secondary Financing The lender did not adequately document a deferred payment loan from a municipal downpayment assistance program. The mortgage credit analysis worksheet and settlement statement reflected $5,000 from the program. The lender file contained a conditional commitment letter verifying the borrower’s eligibility for the program, pending the borrower meeting additional conditions. The loan file did not indicate that the borrower met the additional conditions or that the funds were transferred. The lender should have also obtained a promissory note evidencing the secondary financing agreement. Without the appropriate documentation, the lender could not be assured that the funds were received on the borrower’s behalf and came from an allowable source, or that repayment of the municipal loan was deferred. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 1, section 5, paragraph 1-13-A (appendix C – criteria 3) HUD Handbook 4155.1, REV-5, chapter 2, section 2-11-C (appendix C – criteria 16) Inadequate Documentation The seller faxed the borrower’s pay stubs to the lender. When an interested third party handles or transmits documents critical to the underwriting process, the lender cannot be assured of the legitimacy of those documents. The lender cannot use pay stubs faxed from the seller to support income. 71 HUD Requirements HUD Handbook 4155.1, REV-5, chapter 3, section 5-1 (appendix C – criteria 18) Case number: 291-3239808 Insured amount: $98,356 Section of Housing Act: 203(b) Status upon selection: Claim - sold for loss of $55,166 Date of loan closing: February 10, 2004 Underwriter type: Manual Unsupported and Ineligible Assets The seller contributed to the cash needed to close the loan. The borrower claimed his bank account balance of $4,386 on February 5, 2004, as funds available to close. The account contained $3,000 from the seller of the property, deposited on that same day. The deposit was supported by a letter from the seller stating that the funds were a draw against a balance owed the borrower for upcoming construction work contracted for by the seller. The settlement statement showed the borrower needed $2,316 to close. Bank records showed the borrower had only $1,524 on February 3, 2004. Without the $3,000, the borrower would not have had the funds necessary to close the loan. Additionally, other bank accounts for the borrower showed negative daily balances, multiple negative balance fees, and insufficient funds charges. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-10 (appendix C – criteria 12) HUD Handbook 4155.1, REV-5, chapter 2, section 2-10-B (appendix C – criteria 13) Overinsured Loan The seller contributed more than 6 percent of the sales price for borrower closing costs. The settlement statement showed that the seller contributed $4,339 toward borrower closing costs. The seller also provided $3,000 directly to the borrower. The seller contributed 7.35 percent of the sales price for borrower closing costs, causing the loan to be $1,345 overinsured. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 1, section 1-7-A (appendix C – criteria 2) Unsupported Income and Invalid Compensating Factors The lender overstated the borrower’s income by $94 per month. The lender incorrectly added back the self-employment tax to the adjusted gross income. The financial ratios increase to 38.6 percent with the correct effective income. Additionally, the borrower provided his 2002 and 2003 tax returns, but neither was signed. The lender also failed to obtain a year-to-date profit- and-loss statement and balance sheet for the self-employed borrower. The borrower’s mortgage payment was $807 per month with no other liabilities listed on the mortgage credit analysis worksheet. The borrower’s housing ratio significantly exceeded HUD’s limit of 29 percent, and the lender listed multiple compensating factors. However, the factors were invalid, as follows: 72 • The lender claimed an excellent rental history, but one rent verification passed through the seller, and the seller also provided a verification of rent for a few months of the rental period. • The lender claimed a minimal increase in housing expense, but the borrower’s housing costs were increasing by 25 percent from the current rent and 80 percent from the rent paid until five months before the loan closed. • The lender claimed that the alternative credit provided an acceptable credit history; however, the alternative credit was not sufficiently supported. • The lender claimed the borrower had reserves after closing, but the seller provided $3,000 to the borrower for funds to close, which effectively created the reserves. • The lender claimed that the borrower had no recurring debt. While this may have been true, this was not sufficient to offset the other questionable issues of the loan or the high housing ratio. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-9-B (appendix C – criteria 11) HUD Handbook 4155.1, REV-5, chapter 2, section 2-12 (appendix C – criteria 17) Identity of Interest The seller of the property was the borrower’s landlord, and the seller had contracted with the borrower for construction services, including rehabilitating the property being insured. The seller also provided a verification of rent, which stated that the borrower paid $650 per month from October 15, 2003, to the time of the loan application. An additional verification of rent from another party stated that the borrower’s spouse paid $450 per month from 2001 to October 15, 2003. The seller faxed the earlier rent verification to the lender. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-3-A (appendix C – criteria 7) Questionable Credit History The borrower had no credit scores. The only items on the borrower’s credit report were two collections. Additionally, the borrower was married, but the lender did not obtain credit reports for the nonpurchasing spouse. HUD requires that credit reports be obtained for the nonpurchasing spouse to determine the debt-to-income ratio. In addition, the lender required the borrower to obtain a nontraditional credit history. The borrower provided a letter of credit for a cell phone from a construction company. The letter indicated that the borrower paid the company a monthly fee for its use. No payment history was provided to support the legitimacy of the letter of credit. Also, the seller faxed the letter of credit to the lender. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-2-D (appendix C – criteria 5) HUD Handbook 4155.1, REV-5, chapter 2, section 2-3 (appendix C – criteria 6) 73 Questionable Appraisal Two appraisals listed the property as vacant. The borrower claimed that he had lived in the subject property for three years. The appraisals were performed 12 days apart, just before the loan closed. One listed the borrower as the purchaser, and the other listed the borrower’s nonpurchasing spouse as the purchaser. Also, both appraisals said there were no sales of the property within the prior three years; however, the seller acquired the property in October 2003, according to the verification of rent. In response to the audit, McAfee Mortgage agreed with the findings on this loan. Case number: 493-7888318 Insured amount: $113,754 Section of Housing Act: 203(b) Status upon selection: Claim Date of loan closing: September 28, 2004 Underwriter type: Automated Questionable Credit History The credit report showed that an automobile was repossessed less than a year before loan closing and listed more than $11,000 in collection accounts within the two years before loan closing. The collection accounts included two defaulted federal student loans totaling nearly $5,000. The lender excluded six debts from the credit report in the automated underwriting system but did not provide documentation to explain why the items were excluded. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-3 (appendix C – criteria 6) Case number: 493-7775178 Insured amount: $65,772 Section of Housing Act: 203(b) Status upon selection: Claim Date of loan closing: June 4, 2004 Underwriter type: Manual Questionable Gift Funds The lender did not adequately document gift funds of $5,000 and a $500 earnest deposit paid by parties other than the borrower. The mortgage credit analysis worksheet and settlement statement reflected funds of $5,000 provided from the City of Houston. Neither the HUD nor McAfee Mortgage loan file contained documentation supporting these funds, nor did they include support for the transfer of funds. Without additional documentation, such as the wire transfer documents and acceptance/award letter, the lender could not verify that the funds came from an allowable source and that no repayment was required. Additionally, the settlement statement, mortgage credit analysis worksheet, and sales contract listed an earnest deposit of $500. The file contained a money order to the title company for $500 from someone other than the borrower. The loan files contained no evidence that the funds came from an allowable source and that no repayment was required. Additionally, the individual that purchased the money order also signed the termite inspection and was listed as the borrower. However, the borrower that closed the loan signed an affidavit that he was not known by any 74 other names, and he signed the termite inspection as well, evidencing that the two names appearing on the various documents are not the same person. In response to our audit, McAfee Mortgage provided additional documentation but no documentation regarding the City of Houston funds or a gift letter for the $500. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-10-C (appendix C – criteria 14) Mortgagee Letter 2004-28 (appendix C – criteria 22) Case number: 493-7827818 Insured amount: $113,591 Section of Housing Act: 203(b) Status upon selection: Claim Date of loan closing: June 29, 2004 Underwriter type: Automated Unsupported Income The lender overstated income by $521 per month when approving the loan. The lender used the coborrower’s expected base pay of $2,167 for qualifying. The only support for this employment at the time the lender approved the loan was a letter offering the borrower a position. The lender did not obtain a guaranteed, nonrevocable contract, as required by HUD to use future income for qualifying. Further, the coborrower had been in the new position for three weeks at the time the loan closed. The lender obtained two pay stubs from the new position but these were for work performed after the loan closed. At the time the lender approved the loan, the coborrower was earning $10 per hour working through a staffing agency for four months. A pay history showed that she averaged more than 37 hours per week. At that rate, her monthly income was $1,646, which was supported by three weeks of pay stubs. The lower, supported income of $1,646 increases the ratios to 34.9 percent and 46.7 percent. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-7 (appendix C – criteria 10) HUD Handbook 4155.1, REV-5, chapter 2, section 2-12 (appendix C – criteria 17) Questionable Income Stability/Employment The lender did not establish income stability or a two year work history. It did not adequately verify the borrower’s employment or education/training to fulfill the two year requirement. The loan application showed that the borrower was self-employed in the home repair business for just over a year before his current job, which began May 23, 2003. The lender did not obtain a tax return for 2003 to support the five months of self-employment income claimed. The coborrower’s two-year work history included four months of unemployment and three different jobs. The coborrower explained the gaps in employment and that she changed jobs frequently seeking better pay. According to the loan file, her income remained the same in each of the three jobs prior to employment by the staffing agency. 75 HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-6 (appendix C – criteria 9) HUD Handbook 4155.1, REV-5, chapter 2, section 2-9-B (appendix C – criteria 11) Additional Factors The borrowers had no cash assets. Their bank balance was less than $6 when verified. Case number: 493-7852047 Insured amount: $145,960 Section of Housing Act: 203(b) Status upon selection: Claim - property not yet sold Date of loan closing: July 30, 2004 Underwriter type: Automated Questionable Employment History The lender did not establish employment stability. The borrower changed jobs frequently in the two years before applying for the loan and did not adequately support employment in the same line of work. While the verification of employment and current pay stubs supported the income used to qualify the borrower, she had been on the job for only one month. She was unemployed for the 4.5 months before the current job and provided no explanation for the gap in employment. The borrower wrote a letter stating that employment for the previous 10 years was in the procurement field, but another letter stated that in 2001 and 2002 she was unable to find a position in her career field. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-6 (appendix C – criteria 9) Questionable Credit History The borrower’s vehicle was repossessed at the end of 2003. She had recent late payments on several accounts. The credit report showed several profit-and-loss writeoffs totaling more than $13,000. She had enrolled in a debt consolidation program in May 2004 to pay off more than $20,000 of debt. At the time she applied for the loan, she had been enrolled in the program for only three months--not for at least one year of the pay-out period. The file contained an authorization for automatic withdrawals from her bank account to pay the debts but no debt consolidation agreement. Additionally, the borrower did not provide written permission from the debt consolidation agency to enter into the mortgage transaction. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-3 (appendix C – criteria 6) HUD Handbook 4155.1, REV-5, chapter 2, section 2-3-F (appendix C – criteria 8) 76 Case number: 493-7905859 Insured amount: $90,972 Section of Housing Act: 203(b) Status upon selection: Claim Date of loan closing: October 29, 2004 Underwriter type: Manual Underreported Liabilities The lender did not obtain a credit report for the nonpurchasing spouse. The property was in a community property state, so debts of the nonpurchasing spouse that are not excluded by state law should have been included in the qualifying ratios. The lender approved the loan with ratios of 33.78 percent and 47.68 percent. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-2-D (appendix C – criteria 5) HUD Handbook 4155.1, REV-5, chapter 2, section 2-3 (appendix C – criteria 6) HUD Handbook 4155.1, REV-5, chapter 2, section 2-12 (appendix C – criteria 17) Questionable Employment History/Stability of Income The borrower did not present a stable income. The borrower had worked for his current employer for only seven months. His application listed five jobs during the two years before the loan application. The application did not identify titles of each job, and none of the places of employment appeared related to his current position as a cable installer. Employers provided Internal Revenue Service forms W-2 for some of the jobs, but not all. The tax documentation did not support two consecutive years of employment, nor did it indicate that the job changes were related to increased pay or benefits. Based on the data provided, the borrower’s earnings ranged from $746 per month to $1,309 per month. The information did not support a trend of increasing income. The borrower's income for the seven months at his current job was significantly higher than from any of his past jobs. HUD's regulations state that income stability can be more important than job stability if the borrower changes jobs within the same line of work and continues to advance in income or benefits. The lender did not sufficiently demonstrate that the borrower met the HUD criteria. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-6 (appendix C – criteria 9) Case number: 493-7908169 Insured amount: $113,326 Section of Housing Act: 203(b) Status upon selection: Claim Date of loan closing: October 28, 2004 Underwriter type: Automated Questionable Gift Funds The lender did not adequately document gift funds provided by a nonprofit. The settlement statement reflected gift funds of $3,585 from the nonprofit and the associated funds from the seller to the same nonprofit. The case binder contained the gift letter but did not include support for the transfer of funds. Without additional gift fund documentation, such as the wire transfer documents, the lender could not verify that the funds came from an allowable source. 77 HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-10-C (appendix C – criteria 14) Mortgagee Letter 2004-28 (appendix C – criteria 22) Underreported Liabilities The lender did not include a projected monthly obligation of $639 in the borrower’s financial ratios. The credit report listed a deferred student loan payment of $639 per month, which was deferred until December 2005. While HUD requires a lender to only include a recurring debt in the financial ratios that will begin within 12 months of closing, the loan payment was significant and was scheduled to begin only 13.5 months after closing. Considering the student loan payment, the total debt ratio would have been 57 percent. Further, HUD regulations state that simply establishing that a loan meets minimum standards does not necessarily constitute prudent underwriting. The lender is still responsible for analyzing the borrowers' ability to repay the mortgage. Using the same gross earnings used by the lender, the borrower's student loan payment beginning 13.5 months after closing was 20 percent of the borrowers' combined monthly income of $3,212. Additionally, based on the information provided regarding the coborrower's college education, her student loan payments were to begin around the same time. The coborrower had more than $24,000 in federal student loans. Additionally, based on the loan information the coborrower provided, she should have been making monthly payments of at least $53 for accrued interest on the loans. This amount was not included in the borrowers’ recurring liabilities. HUD Requirements HUD Handbook 4155.1, REV-5, chapter 2, section 2-11-C (appendix C – criteria 16) HUD Handbook 4155.1, REV-5, chapter 2, section 2-12 (appendix C – criteria 17) HUD Handbook 4155.1, REV-5, chapter 2, section 2-5 (appendix C – criteria 23) 78
PlainsCapital McAfee Mortgage, Lubbock, Texas, Did Not Follow HUD Underwriting Requirements and Originated Loans from Unregistered Branch Offices
Published by the Department of Housing and Urban Development, Office of Inspector General on 2006-11-06.
Below is a raw (and likely hideous) rendition of the original report. (PDF)