oversight

Heartland Funding Corporation Violated the Real Estate Settlement Procedures Act and Did Not Fully Comply with HUD's Underwriting, Quality Control, or Employee Compensation Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2008-09-08.

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

                                                         Issue Date
                                                              September 8, 2008
                                                         Audit Report Number
                                                               2008-KC-1006




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

           //signed//
FROM:      Ronald J. Hosking, Regional Inspector General for Audit, 7AGA

SUBJECT: Heartland Funding Corporation Violated the Real Estate Settlement
           Procedures Act and Did Not Fully Comply with HUD’s Underwriting,
           Quality Control, or Employee Compensation Requirements


                               HIGHLIGHTS

 What We Audited and Why

            We audited Heartland Funding Corporation (Heartland Funding) because
            of its high 30-day delinquency rate. From January 2006 through
            December 2007, Heartland Funding originated 420 Federal Housing
            Administration (FHA) loans, valued at $44.5 million. During this same
            period, 97 of the loans (23.1 percent) had been at least 30 days delinquent
            (past due). Our audit objectives were to determine whether Heartland
            Funding followed U.S. Department of Housing and Urban Development
            (HUD) requirements for (1) borrower eligibility and creditworthiness and
            property eligibility when underwriting loans, (2) implementing a quality
            control program, and (3) compensating its loan officers.

 What We Found

            Heartland Funding violated the Real Estate Settlement Procedures Act
            (RESPA) and HUD’s requirements when processing FHA loans that
            involved downpayment assistance. In addition, Heartland Funding did not



                                         1
           follow HUD requirements when it underwrote 27 FHA loans,
           implemented its quality control plan, or reported staff compensation.

What We Recommend


           We recommend that HUD’s Office of Housing take appropriate sanctions
           against Heartland Funding for violating RESPA. We also recommend that
           the Office of Housing refer Heartland Funding to HUD’s Mortgagee
           Review Board for review and appropriate actions. In addition, we
           recommend that HUD require Heartland Funding to make principal
           reductions totaling $83,755 on the 25 loans that used the improper
           downpayment assistance program.

           Also, we recommend that the Office of Housing require Heartland
           Funding to indemnify HUD for 17 actively insured loans with unpaid
           principal balances totaling more than $1.4 million; indemnify HUD for
           future losses on nine loans with unpaid principal balances totaling $929,852,
           for which HUD has not yet sold the property; and reimburse HUD for one
           loan for which HUD has sold the property and incurred a loss of $54,415.
           Further, we recommend that the Office of Housing verify that Heartland
           Funding fully implements a quality control program that complies with
           HUD requirements and has ceased reporting staff compensation
           improperly.

           For each recommendation without a management decision, please respond
           and provide status reports in accordance with HUD Handbook 2000.06,
           REV-3. Please furnish us copies of any correspondence or directives
           issued because of the audit.

Auditee’s Response


           We provided the draft report to Heartland Funding on July 21, 2008, and
           requested a response by August 25, 2008. It provided written comments
           on the requested date of August 25, 2008. Heartland Funding generally
           disagreed with our conclusions and recommendations in findings 1 and 2;
           however, it generally agreed with conclusions and recommendations in
           finding 3.

           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: Heartland Funding Violated RESPA When Processing FHA Loans   6
                    That Involved Downpayment Assistance
        Finding 2: Heartland Funding Did Not Always Follow HUD Underwriting     12
                    Requirements on 27 FHA Loans
        Finding 3: Heartland Funding Did Not Fully Comply with HUD’s Quality    15
                    Control and Employee Compensation Requirements


Scope and Methodology                                                           18


Internal Controls                                                               20


Appendixes
   A.   Schedule of Questioned Costs and Funds to Be Put to Better Use          22
   B.   Auditee Comments and OIG’s Evaluation                                   23
   C.   Criteria                                                                49
   D.   Schedule of Significant Underwriting Deficiencies                       55
   E.   Case Studies for 27 Questioned Loans                                    57
   F.   Quality Control Plan Missing Elements                                   73




                                          3
                 BACKGROUND AND OBJECTIVES

Heartland Funding Corporation (Heartland Funding) is a nonsupervised lender that began
performing Federal Housing Administration (FHA) loan originations in September 1998.
Heartland Funding maintains its main office in Springfield, Missouri, and has several
branch offices in Missouri and Kentucky.

During the two-year audit period from January 1, 2006, through December 31, 2007,
Heartland Funding endorsed 394 loans with original mortgage amounts totaling more
than $39 million, excluding streamline refinanced loans. Of the 394 loans, 105 became at
least 30 days delinquent at some time within the first two years after endorsement, and 35
loans had ultimately incurred at least one 90-day default period.

On March 24, 2008, the U.S. Department of Housing and Urban Development (HUD)
terminated the FHA origination approval agreement for Heartland Funding. The
termination was based on Heartland Funding’s default and claim rate of 17.86 percent
during the 24-month period ending September 30, 2007. Heartland Funding’s default and
claim rate was 314 percent of the average lender default and claim rate for HUD’s
Kansas City office jurisdiction. The termination applied only to the main office in
Springfield, Missouri. Heartland Funding is still allowed to originate and underwrite
loans using its other branch office FHA identification numbers.

As an FHA-approved lender, Heartland Funding is required to follow 12 U.S.C. (United
States Code) Chapter 27, Sections 2601-2617 and 24 CFR (Code of Federal Regulations)
Part 3500, more commonly known as the Real Estate Settlement Procedures Act
(RESPA). RESPA applies to transactions involving a federally related mortgage loan.
RESPA is a consumer protection statute initially passed in 1974. The purposes of
RESPA are to help consumers become better shoppers for real estate settlement services
and to eliminate kickbacks and referral fees that unnecessarily increase the costs of
certain settlement services. HUD’s Office of RESPA and Interstate Land Sales is
responsible for enforcing RESPA.

In processing FHA loans, Heartland Funding used a downpayment assistance program
that involved a for-profit corporation, Midwest Housing Authority (Midwest), and a
nonprofit entity. Heartland Funding’s owners also own Midwest. The nonprofit entity is
not related to Heartland Funding. (Because this audit was of Heartland Funding and not
the nonprofit entity, this report contains no conclusions regarding the activities of the
nonprofit entity).

HUD’s data systems showed that from January 1, 2006, through February 29, 2008,
Heartland Funding obtained endorsement on 159 FHA loans using the downpayment
assistance program involving the nonprofit entity, making it the primary downpayment
assistance program used by Heartland Funding on FHA loans.




                                            4
Our audit objectives were to determine whether the lender followed FHA requirements
for (1) borrower eligibility and creditworthiness and property eligibility when
underwriting loans, (2) implementing a quality control program, and (3) compensating its
loan officers.




                                           5
                             RESULTS OF AUDIT

Finding 1: Heartland Funding Violated RESPA When Processing
            FHA Loans That Involved Downpayment Assistance
Heartland Funding failed to disclose an affiliated business arrangement with Midwest,
provided instructions to title companies that mischaracterized loan transactions, and
inappropriately allowed Midwest to split a portion of its fee with a nonprofit entity that
performed no services in downpayment assistance (gift) transactions. This occurred
because Heartland Funding’s owners/managers incorrectly believed that their actions
were acceptable and that HUD had approved the downpayment assistance program. As a
result, Heartland Funding did not ensure that borrowers understood the loan transactions
so that the borrowers had the opportunity to make informed decisions on their loans.
Also, it could have engaged in practices that cost borrowers more in settlement services
than allowed or reasonable and necessary.


Heartland Funding’s owners established Midwest in August 2000. Midwest’s primary
role was to help streamline the downpayment assistance process and close loans more
quickly. A May 2001 letter of understanding between Midwest and a nonprofit entity
described each party’s roles and responsibilities. In addition, a subsequent May 2001
letter of agreement described the service fees that Midwest agreed to pay the nonprofit
entity for its participation in the downpayment assistance program. One of Heartland
Funding’s owners signed the 2001 agreements on behalf of Midwest. Under the
agreements, the nonprofit entity was to provide downpayment assistance funds to
borrowers obtaining a loan from Heartland Funding and in return would receive 25
percent of the service fee that Midwest collected for facilitating the downpayment
assistance process.

Heartland Funding’s owners and staff controlled the business activities of Midwest.
According to Heartland Funding’s accounting staff, Midwest had no staff. A Heartland
Funding owner and staff accountant processed the Midwest paperwork, made deposits to
Midwest’s bank accounts, and periodically issued payments from Midwest to the
nonprofit entity participating in the downpayment assistance program. Further, according
to the Heartland Funding accountant, Midwest did not reimburse Heartland Funding for
the services that its staff provided to Midwest.

 Owners Failed to Disclose
 Affiliated Business
 Arrangement

               Heartland Funding’s owners failed to disclose their affiliated business
               relationship with Midwest to the borrowers and others involved in the loan


                                            6
            transaction. According to 12 U.S.C. 2602(7), an affiliated business
            arrangement occurs when a person who is in a position to refer business
            incident to or a part of a real estate settlement service involving a federally
            related mortgage loan or an associate of such person has either an affiliate
            relationship with or a direct or beneficial ownership interest of more than
            1 percent in a settlement service and either of such persons directly or
            indirectly refers such business to that provider or affirmatively influences
            the selection of that provider. Section 2607(c) states that there is nothing
            that prohibits an affiliated business arrangement as long as a disclosure is
            made of the existence of such an arrangement to the person being referred
            and in connection with such referral, the person is provided a written
            estimate of the charge or range of charges generally made by the provider
            to which the person is referred.

            Neither HUD nor Heartland Funding loan files contained evidence that
            Heartland Funding or Midwest disclosed their affiliated business
            arrangement. In addition, we asked five borrowers participating in the
            Midwest/nonprofit downpayment assistance program whether they were
            aware that such a relationship existed between Heartland Funding and
            Midwest. All five borrowers stated that they were not aware of the
            relationship. In addition, we asked four borrowers about the
            downpayment assistance options offered to them and all four stated that
            they were not given an option of pursuing downpayment assistance from
            other entities or were strongly encouraged to use the certain nonprofit
            entity. Further, borrowers told us that they did not understand the
            downpayment assistance process.

Instructions Provided to Title
Company Mischaracterized
Downpayment Assistance
Transactions

            Heartland Funding’s loan closer provided instructions to the title company
            that caused it to mischaracterize the actual downpayment assistance
            transactions that took place. According to 24 CFR Part 3500, appendix A,
            the HUD-1 settlement statement is to be used as a statement of actual
            charges and adjustments for the parties in connection with the settlement.
            Also, 12 U.S.C. 2603(a) states that the settlement statement shall
            conspicuously and clearly itemize all charges imposed upon the borrower
            and all charges imposed upon the seller in connection with the settlement.

            The HUD-1 settlement statements consistently showed that the sellers paid
            Midwest a service fee of 3.75 to 4 percent of the sales price on all 25 of
            the loans reviewed that involved the Midwest/nonprofit entity
            downpayment assistance program. The settlement statements also showed



                                           7
             that the nonprofit entity donated downpayment assistance funds to the 25
             borrowers, equal to 3 percent of the sales price of the home. However, no
             actual transfer of funds, as depicted on the settlement statements, took
             place. The nonprofit entity’s executive director confirmed to us that it did
             not donate the downpayment assistance funds to the borrowers and,
             therefore, no funds were actually transferred from it to the borrowers.

             Heartland Funding and HUD loan files contained a statement showing that
             at closing Heartland Funding issued its version of a paper draft in lieu of
             an actual transfer of funds. The closing agent instructions and
             disbursement authorization stated that Midwest advanced the 3 percent
             downpayment assistance funds to the nonprofit entity to provide to the
             borrower and Midwest was not providing the assistance directly to the
             borrower. Heartland Funding’s owners told us that they considered this
             concurrent funding, much the same as using the proceeds from a house
             that a person sold as a downpayment on a house that the person is
             purchasing with the transactions being completed simultaneously.

             After each closing, Midwest received a check from the title company as its
             service fee for the .75 to 1 percent difference between the seller’s service
             fee and the borrower’s 3 percent downpayment assistance. However, this
             payment was not disclosed on the HUD-1 settlement statements.

             Further, the lack of an actual transfer of downpayment assistance funds
             from the nonprofit entity also violated requirements in HUD Handbook
             4155.1, REV-5, paragraph 2-10c, and Mortgagee Letter 2004-28 regarding
             the transfer of downpayment assistance funds. Finding 2 further describes
             the improper transfer of funds.

Midwest Was Inappropriately
Allowed to Split Its Fee with the
Nonprofit Entity


             Heartland Funding violated RESPA when it allowed Midwest (an
             affiliated business entity controlled by Heartland Funding) to split a
             portion of its fee with the nonprofit entity that performed no services in
             the downpayment assistance transactions. Similarly, Midwest also
             violated RESPA by splitting a portion of its fee with the nonprofit entity,
             knowing that the nonprofit entity performed no services to earn the fee.

             According to 12 U.S.C. 2607(b), no person shall give and no person shall
             accept any portion, split, or percentage of any charge made or received for
             the rendering of a real estate settlement service in connection with a
             transaction involving a federally related mortgage loan other than for




                                           8
           services actually performed. Also, 24 CFR 3500.14(c) prohibits the
           splitting of fees except for actual services performed.

           The letter of understanding between Midwest and the nonprofit entity
           stated that the nonprofit entity would help select recipients of the
           downpayment assistance funds, provide the funds, and aid in the
           administration of the program. Although the nonprofit entity received
           money from Midwest for its participation in the downpayment assistance
           program, the executive director of the nonprofit entity confirmed to us that
           it provided no such services or funds to the borrowers.

Owners Believed Their Actions
Were Acceptable

           Heartland Funding’s owners told us that they believed their actions were
           acceptable and that HUD had previously approved the downpayment
           assistance program that Heartland Funding had implemented with
           Midwest.

           When we questioned the Midwest downpayment assistance program
           during our audit, Heartland Funding’s owners insisted that HUD had
           approved the program during a May 2004 review. However, Heartland
           Funding could provide no documentation of such an approval. HUD
           confirmed that it conducted a review of Heartland Funding in May 2004;
           however, HUD records of the review do not address the Midwest
           downpayment assistance program.

           HUD’s reviewer stated that while reviewing FHA loan files he noted that
           one of Heartland Funding’s owners signed downpayment assistance
           documents on behalf of Midwest. He asked the Heartland Funding owners
           about it and they told him that they also owned Midwest. The reviewer
           was concerned about a potential conflict of interest due to the common
           ownership of Heartland Funding and Midwest. Therefore, he discussed
           the potential conflict of interest with a HUD homeownership center. The
           reviewer subsequently informed the owners that HUD did not have
           concerns about the common ownership situation. However, the reviewer
           stated that the discussions did not involve whether the Midwest
           downpayment assistance program was appropriate or the way that
           Heartland Funding operated the program.

           HUD also pointed out that Handbook 4155.1, REV-5, paragraph 2-10c,
           states that FHA does not approve downpayment assistance programs in the
           form of gifts administered by charitable organizations. Mortgage lenders
           are responsible for ensuring that the gift to the homebuyer from the
           charitable organization meets the appropriate FHA requirements and the
           transfer of funds is properly documented.



                                        9
Borrowers Were Not Afforded
Opportunity to Make Informed
Decisions


           Heartland Funding did not ensure that borrowers understood the loan
           transactions so that the borrowers had the opportunity to make informed
           decisions regarding their loan transactions. Also, it could have engaged in
           practices that cost borrowers more in settlement services than allowed or
           reasonable and necessary.

           Borrowers may have also paid more for the homes than was necessary or
           more than they were aware that they had agreed to pay. Several sellers
           stated that they had increased their list price or the initial agreed-upon
           sales price to cover the additional costs of the sale, after agreeing to
           participate in the Midwest/nonprofit downpayment assistance program and
           donate funds to a charitable organization on behalf of the borrower.
           However, borrowers told us that they were not aware that they may have
           incurred increased sales prices to accommodate the seller’s costs of
           participating in the downpayment assistance program.

           In addition, borrowers may have also unknowingly participated in an
           improper downpayment assistance program, causing HUD to overinsure
           the mortgages by the amount of the seller’s service fee, which equaled as
           much as four percent of the sales price. For the 25 borrowers that
           participated in the improper downpayment assistance program, the sellers
           paid Midwest service fees totaling nearly $84,000. Appendix D provides
           details on the costs paid by the seller to Midwest to participate in the
           downpayment assistance program.

           Heartland Funding’s owners told us that as of May 30, 2008, Heartland
           Funding had revised its policy regarding its downpayment assistance
           program involving Midwest and the nonprofit entity. Heartland Funding’s
           owners stated that they will no longer use this program and any borrower
           who needs downpayment assistance will need to use another source.

Recommendations


           We recommend that the Assistant Secretary for Housing – Federal Housing
           Commissioner and Chairman, Mortgagee Review Board

           1A. Take appropriate sanctions against Heartland Funding for violating
               RESPA.



                                       10
1B. Refer Heartland Funding to HUD’s Mortgagee Review Board for
    review and appropriate actions.

1C. Require Heartland Funding to make a principal reduction totaling
    $83,755 on the 25 loans that used the improper downpayment
    assistance program. See appendix D for details on the recommended
    reduction for each loan.

1D. Require Heartland Funding to adequately train its managers and staff
    on RESPA requirements.




                            11
Finding 2: Heartland Funding Did Not Always Follow HUD
            Underwriting Requirements on 27 FHA Loans
Heartland Funding did not always follow HUD requirements while underwriting 27 FHA
loans. This occurred because managers and underwriters believed that their efforts were
sufficient to meet HUD requirements. As a result, HUD insured 27 loans that
unnecessarily placed the FHA insurance fund at risk.



 HUD Requirements Were Not
 Always Followed

              Heartland Funding did not always follow HUD underwriting requirements
              on 27 FHA loans. FHA-approved lenders must follow HUD Handbook
              4155.1, REV-5, Mortgage Credit Analysis for Mortgage Insurance, One-
              to Four-Family Properties, and various HUD mortgagee letters when
              underwriting FHA loans. Specifically, Heartland Funding did not follow
              HUD underwriting requirements for verifying the transfer of
              downpayment assistance funds from the donor to the borrower. It also did
              not properly verify employment and calculate income, nor did it consider
              all recurring debts of borrowers when evaluating the borrowers’ ability to
              repay the FHA-insured mortgage.

              For example, in 25 of the 26 loans with improper downpayment assistance
              funds, Heartland Funding did not ensure that there was an actual transfer
              of funds from the nonprofit donor to the borrower, nor did it ensure that
              the funds came from an acceptable source. HUD requires lenders to
              determine that the downpayment assistance funds ultimately were not
              provided from an unacceptable source and were the donor’s own funds.
              HUD rules further state that the donor cannot 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. HUD considers
              donated funds from these sources as inducements to purchase, and they
              must be subtracted from the sales price. HUD also requires lenders to
              obtain specific documents to verify receipt of the funds. For the 25 loans,
              Heartland Funding did not follow HUD’s downpayment assistance
              requirements. Finding 1 contains further details on these material
              deficiencies.

              As an example of other material deficiencies, Heartland Funding did not
              include all of the borrower’s recurring monthly obligations in the financial
              ratios. HUD requires lenders to include all installment loans, revolving
              charge accounts, and all other continuing obligations when evaluating the
              borrower’s debts and ability to repay the FHA loan. In two loans,
              Heartland Funding did not include monthly obligations that significantly


                                            12
           affected the borrowers’ financial ratios. The borrowers provided
           statements from creditors to establish supplemental, nontraditional credit
           histories. From the nontraditional histories, Heartland Funding had
           evidence that the borrowers had outstanding debts requiring monthly
           payments, but it ignored these debts when evaluating the financial ratios
           and the borrowers’ ability to repay the mortgage.

           Appendixes C through E provide details of HUD underwriting
           requirements, a schedule of significant underwriting deficiencies, and
           detailed case studies for the 27 loans.

Managers and Underwriters
Believed Actions Met HUD
Requirements


           Heartland Funding’s managers and underwriters believed that their efforts
           were sufficient to meet HUD requirements. Regarding downpayment
           assistance funds, Heartland Funding’s managers told us they believed that
           their procedures for processing loans with downpayment assistance from a
           nonprofit entity, as described in finding 1, equated to an acceptable
           transfer of funds. In these transactions, Heartland Funding provided a
           statement in the loan file showing that at closing it issued its version of a
           paper draft in lieu of an actual transfer of funds. Heartland Funding told
           us that it considered this concurrent funding and that an actual (physical)
           transfer of funds was unnecessary.

           In addition, for downpayment assistance transactions from private parties
           to the borrower, the underwriter told us she believed that a letter from the
           bank confirming that the donor had the funds available to give and a copy
           of a nonnegotiated cashier’s check was sufficient to show a transfer of
           funds from the donor to the borrower. She believed that it was not
           necessary to obtain evidence that the funds were actually transferred from
           the donor to the borrower.

           As for underreported liabilities, the senior underwriter told us that she had
           never included liabilities in financial ratios that Heartland Funding had
           identified through supplemental, nontraditional credit sources.

Loans Containing Material
Deficiencies Were Submitted
for FHA Insurance

           When proper lending practices are not followed, HUD lacks assurance that
           borrowers qualified for FHA-insured loans. The 27 loans with major
           underwriting deficiencies placed the insurance fund at unnecessary risk.


                                        13
          As of May 1, 2008, HUD’s data systems showed that the 27 loans had
          unpaid principal balances of more than $2.4 million. Seventeen of the
          loans were actively insured and had unpaid principal balances of more
          than $1.4 million. HUD had paid claims on nine loans with unpaid
          principal balances of nearly $1 million but had not yet sold the properties.
          In addition, HUD had incurred losses of more than $54,000 on the
          remaining loan.

Recommendations

          We recommend that the Assistant Secretary for Housing – Federal
          Housing Commissioner and Chairman, Mortgagee Review Board

          2A. Require Heartland Funding to indemnify HUD for 17 actively
              insured loans with unpaid principal balances of $1,423,881. The
              projected loss is $533,816 based on the FHA insurance fund average
              loss rate of 39 percent for fiscal year 2007 (see appendix D).

          2B. Require Heartland Funding to indemnify HUD for future losses on
              nine loans with unpaid principal balances totaling $929,852, for
              which HUD has not yet sold the property. The projected loss is
              $351,475 based on the FHA insurance fund average loss rate of 39
              percent for fiscal year 2007 (see appendix D).

          2C. Require Heartland Funding to reimburse HUD for one loan, for
              which HUD has sold the property and incurred a loss of $54,415 (see
              appendix D).

          2D. Require Heartland Funding to ensure that it has adequately trained
              its managers and underwriters on HUD underwriting requirements,
              particularly with regard to downpayment assistance funds, income,
              and liabilities.




                                       14
Finding 3: Heartland Funding Did Not Fully Comply with HUD’s
            Quality Control and Employee Compensation
            Requirements
Heartland Funding did not fully comply with HUD’s quality control or employee
compensation requirements. This noncompliance occurred because managers were not
aware of all HUD quality control requirements and did not effectively monitor their
quality control contractor. The managers elected to report compensation as contractor
payments rather than employee wages to take advantage of tax rules. As a result,
Heartland Funding could not ensure the accuracy, validity, and completeness of its loan
originations, and HUD unnecessarily assumed an increased risk.



 The Quality Control Plan Was
 Incomplete and Quality Control
 Reviews Were Not Adequate


              Heartland Funding did not fully comply with HUD’s quality control
              requirements.

              Heartland Funding’s quality control plan lacked 11 required elements. For
              example, the plan did not require the lender to immediately refer findings of
              fraud or other serious violations to HUD or the Office of Inspector General
              (OIG); identify patterns of early defaults by location, program, loan
              characteristic, loan correspondent, or sponsor; and determine the method
              used to establish appraised values. Appendix F contains the details of the 11
              missing elements.

              In addition, Heartland Funding did not ensure that its quality control reviews
              met HUD requirements. Specifically, it did not

                  •   Take corrective actions to reduce quality control deficiencies
                      identified by the quality control review process.

                  •   Ensure that the quality control reviews included all early defaults.

                  •   Ensure that it obtained quality control reports on loans within 90
                      days of the loan closings. The lender did not obtain reviews within
                      the required timeframe for six months of the audit period.

                  •   Document on-site quality control reviews of branch offices.



                                            15
              •   Ensure that its quality control reviews included a review of at least
                  10 percent of the FHA loans closed during that review period. The
                  lender did not meet this requirement for two months of the audit
                  period.

           HUD Handbook 4060.1, REV-2, states that all FHA-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
           FHA approval. Further, the handbook establishes several basic elements that
           are required in all quality control programs. Appendix C provides the
           detailed HUD quality control requirements.

Loan Officer Compensation
Was Improperly Reported


           Heartland Funding violated HUD requirements by using Internal Revenue
           Service Form 1099 to report loan officer compensation, which identified the
           staff members as independent contractors rather than Internal Revenue
           Service Form W-2 employees. HUD Handbook 4060.1, REV-2, paragraph
           2-9(A), states that all compensation must be reported on Internal Revenue
           Service Form W-2.

           In 2006, Heartland Funding reported earnings for 41 loan officers using
           Internal Revenue Service Form 1099. In 2007 and 2008, it reported earnings
           for 61 and 21 loan officers on Internal Revenue Service Form 1099,
           respectively.

Managers Were Unaware of All
HUD Requirements and Did Not
Monitor Their Contractor

           Heartland Funding managers were not aware of all HUD quality control
           requirements and did not effectively monitor their quality control
           contractor. A Heartland Funding co-owner stated that Heartland Funding
           relied on its quality control contractor to provide it with a quality control
           plan that met HUD’s requirements.

           As a result of our review, Heartland Funding told us that it was committed to
           making an extensive review of its quality control plan and it understood the
           need to change its in-house reviews and procedures.




                                         16
Managers Used Internal
Revenue Service Form 1099 Due
to Tax Advantages

           Heartland Funding managers told us that they elected to report loan officer
           compensation as contractor payments rather than employee wages to take
           advantage of tax rules.

           As a result of our review, Heartland Funding managers stated that they
           would begin reporting all loan officer compensation on Internal Revenue
           Service Form W-2 as of July 1, 2008.

Heartland Funding Was Unable
to Ensure Proper Loan
Originations


           Without a properly implemented quality control program, the lender is
           unable to ensure the accuracy, validity, and completeness of its loan
           origination operations. In addition, the lender may not identify potential
           deficiencies and make needed corrections in a timely manner, resulting in
           an increased risk to the FHA insurance fund.

           As a result of Heartland Funding’s improper employee compensation
           practices, HUD lacked assurance that it could originate loans within HUD
           requirements, and, therefore, HUD unnecessarily assumed an increased
           risk.

Recommendations


           We recommend that the Assistant Secretary for Housing – Federal
           Housing Commissioner and Chairman, Mortgagee Review Board

           3A. Verify that Heartland Funding fully implements a quality control
               program that complies with HUD requirements.

           3B. Verify that Heartland Funding has ceased reporting staff
               compensation using Internal Revenue Service Form 1099 and is
               reporting earnings using only Internal Revenue Service Form W-2.




                                       17
                     SCOPE AND METHODOLOGY

Our audit period was January 1, 2006, through December 31, 2007, and was expanded as
necessary to meet our audit objectives. The audit focused on the activities of Heartland
Funding but was expanded as needed to include relevant business activities of Midwest,
an affiliated business entity.

To accomplish our objectives, we reviewed HUD’s and Heartland Funding’s
underwriting policies and procedures. We interviewed Heartland Funding management,
HUD staff, and the executive director of the nonprofit entity. We also interviewed seven
borrowers and three sellers that participated in the primary downpayment assistance
program used by Heartland Funding to gain a general perspective of the program from
borrowers and sellers. In addition, we reviewed Heartland Funding’s quality control plan
and quality control reviews, the quality control contract, loan officers’ employment
contract, and the contract between the nonprofit entity and the for-profit corporation used
to facilitate the primary downpayment assistance program. We also researched RESPA
and the Missouri Secretary of State and Internal Revenue Service Web sites.

Heartland Funding originated 420 FHA loans between January 1, 2006, and December
31, 2007. Of the 420 loans, 97 became at least 30 days delinquent during our audit
period, and 35 of the 97 reached a 90-day defaulted status. We reviewed HUD and
Heartland Funding loan files for the 35 defaulted loans.

When identifying underwriting deficiencies, we assessed whether the deficiencies were
material and should have caused the lender to disapprove the loan. We considered any
deficiencies that affected the approval and insurability of the loans as significant and
recommended that HUD take appropriate action on these loans. When identifying
underwriting deficiencies that we considered minor, we informed Heartland Funding of
the deficiencies but have not recommended that HUD take action on these loans.

We relied on computer-processed data contained in HUD’s Single Family Data
Warehouse system. During the audit, we assessed the reliability of the data and found it
to be adequate. We also performed sufficient tests of the data, and based on the
assessments and testing, we concluded that the data are sufficiently reliable to be used in
meeting our objectives.

We assigned a value to the potential savings to HUD if it implements our
recommendations to require Heartland Funding to indemnify loans with material
deficiencies. For those loans on which HUD has not yet incurred a loss, we applied
FHA’s average loss experience of 39 percent for fiscal year 2007, as provided by HUD.
    • For the 17 actively insured loans that participated in the improper downpayment
        assistance program, we calculated the savings at $533,816, which is the unpaid
        principal balance of $1,423,881, less $55,122 in recommended principal
        reductions, multiplied by the 39 percent loss rate.


                                            18
   •   For the eight loans that participated in the improper downpayment assistance
       program and on which HUD has paid a claim and acquired but not yet sold the
       property, we calculated the savings at $283,598, which is the unpaid principal
       balance of $755,808, less $28,633 in recommended principal reductions,
       multiplied by the 39 percent loss rate.
   •   For the one loan that did not participate in the improper downpayment assistance
       program but had underwriting deficiencies, we calculated the savings at $67,877,
       which is the unpaid principal balance of $174,044 multiplied by the 39 percent
       loss rate.

We performed audit work from January through June 2008 and conducted our audit in
accordance with generally accepted government audit standards. Those standards require
that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a
reasonable basis for our findings and conclusions based on our audit objectives. We
believe that the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives.




                                           19
                          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 to ensure that participation in gift fund/downpayment
                      assistance programs meets RESPA and HUD requirements.

               •      Controls to ensure that FHA loans meet HUD underwriting
                      requirements.

               •      Controls to ensure that the lender implements a quality control
                      program that complies with HUD requirements.

               •      Controls to ensure that staff compensation is reported in
                      accordance with HUD requirements.

               We assessed the relevant controls identified above.

               A significant weakness exists if management controls do not provide
               reasonable assurance that the process for planning, organizing, directing, and
               controlling program operations will meet the organization’s objectives.


 Significant Weaknesses


               Based on our review, we believe the following items are significant
               weaknesses:


                                             20
•   Heartland Funding participated in an improper downpayment
    assistance program, contrary to RESPA and HUD requirements
    (findings 1 and 2).

•   Heartland Funding did not have adequate controls in place to
    ensure that it followed HUD requirements when implementing its
    quality control program (finding 3).




                        21
                               APPENDIXES

Appendix A

           SCHEDULE OF QUESTIONED COSTS
          AND FUNDS TO BE PUT TO BETTER USE

                Recommendation          Ineligible 1/     Funds to be put
                number                                    to better use 2/

                        1C                $83,755
                        2A                                   $533,816
                        2B                                   $351,475
                        2C                $54,415

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/   Recommendations that funds be put to better use are estimates of amounts that
     could be used more efficiently if an OIG recommendation is implemented. This
     includes reductions in outlays, deobligation of funds, withdrawal of interest
     subsidy costs not incurred by implementing recommended improvements,
     avoidance of unnecessary expenditures noted in preaward reviews, and any other
     savings which are specifically identified.

     Implementation of our recommendations to require Heartland Funding to
     indemnify HUD for materially deficient loans will reduce the risk of loss to the
     FHA insurance fund. The amounts for recommendations 2A and 2B reflect that,
     upon sale of the mortgaged property, FHA’s average loss experience is about 39
     percent of the unpaid principal balance based upon statistics provided by HUD.




                                         22
Appendix B

     AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation    Auditee Comments




Comment 1




                        23
Ref to OIG Evaluation                            Auditee Comments




Comment 2

Comment 3



Comment 4




Comment 5




Comment 6




            Note: We redacted the identity of the nonprofit entity to protect its privacy.




                                               24
Ref to OIG Evaluation    Auditee Comments




Comment 6



Comment 7




Comment 7




Comment 7




Comment 8




                        25
Ref to OIG Evaluation    Auditee Comments




Comment 9




Comment 10




Comment 11




Comment 12




                        26
Ref to OIG Evaluation    Auditee Comments




Comment 13




Comment 13


Comment 13


Comment 14



Comment 15




Comments
  12-14

Comment 16




                        27
Ref to OIG Evaluation    Auditee Comments




Comment 17




Comment 18


Comment 19


Comment 3




Comment 20



Comment 20




                        28
Ref to OIG Evaluation    Auditee Comments




Comment 20




Comment 21




Comments
20 and 21



Comment 22




Comment 8




                        29
Ref to OIG Evaluation    Auditee Comments




Comment 23




Comment 24




Comments
3, 4, and 14



Comment 25




Comments
20 and 21



Comment 26




                        30
Ref to OIG Evaluation    Auditee Comments




Comment 27




Comments
20 and 21




Comment 27




Comment 27




                        31
Ref to OIG Evaluation    Auditee Comments




                        32
Ref to OIG Evaluation    Auditee Comments




                        33
Ref to OIG Evaluation    Auditee Comments




                        34
Ref to OIG Evaluation    Auditee Comments




                        35
Ref to OIG Evaluation    Auditee Comments




                        36
Ref to OIG Evaluation    Auditee Comments




                        37
Ref to OIG Evaluation    Auditee Comments




                        38
Ref to OIG Evaluation    Auditee Comments




                        39
                  OIG Evaluation of Auditee Comments


Comment 1   As described in the audit report, our audit period was January 1, 2006,
            through December 31, 2007, and was expanded as necessary to meet
            our audit objectives. While seller-funded downpayment assistance
            programs will be eliminated as of October 1, 2008, the information in
            the audit report remains relevant and we continue to recommend that
            HUD take appropriate actions.

Comment 2   The audit report clearly states that Heartland Funding was the auditee
            and not Midwest or the nonprofit. Heartland Funding participated in
            the downpayment assistance program when originating and obtaining
            insurance endorsement of FHA loans. As an FHA-approved lender,
            Heartland Funding is required to follow HUD requirements for FHA
            loans. In evaluating Heartland Funding’s compliance with HUD rules,
            we identified the improper downpayment assistance program and
            Heartland Funding’s role in the use of the program. In order to
            provide HUD with sufficient information to understand how the
            downpayment assistance program worked and take appropriate
            actions, it was necessary to include certain information regarding
            Midwest, an affiliated business entity controlled by Heartland
            Funding, and the unrelated nonprofit.

Comment 3   Our key conclusions were that Heartland Funding failed to comply
            with federal regulations and HUD rules when operating as an FHA-
            approved lender. The report does not claim that the increased sales
            price was the result of Heartland Funding’s conduct or that of
            Midwest’s, but was intended to notify HUD that by participating in the
            Midwest/nonprofit downpayment assistance program, borrowers
            encountered higher sales prices after the seller agreed to participate in
            the downpayment assistance program.

            In regard to the increased sales prices, we clarified the report to further
            explain that several sellers had increased their list price or the initial
            agreed-upon sales price to cover the additional costs of the sale, after
            agreeing to participate in the Midwest/nonprofit downpayment
            assistance program and donate funds to a charitable organization on
            behalf of the borrower. However, borrowers told us that they were not
            aware that they may have incurred increased sales prices to
            accommodate the seller’s costs of participating in the downpayment
            assistance program.

            We also note that the Government Accountability Office reported that
            property sellers often raised the sales price of their properties to
            recover the contribution to the seller-funded nonprofit that provided



                                      40
            the downpayment assistance. In these cases, borrowers may encounter
            mortgages that were higher than the true market value price of the
            home, and may represent 100 percent or more of the property’s true
            value. Further, a HUD consultant reported that more than 50 percent
            of respondents to its study in each subject group including appraisers,
            mortgage lenders, underwriters, seller-funded downpayment assistance
            providers, and real estate agents indicated that seller-funded
            downpayment assistance programs inflated the property sales price.
            Therefore, based on our interviews of sellers and the GAO and HUD
            studies, we believe that at least the majority of sellers for the 25 loans
            in question negotiated a higher sales price to cover the additional costs
            of participating in the Midwest/nonprofit downpayment assistance
            program, and in doing so caused HUD to overinsure the loans.

Comment 4   We did not report that Heartland Funding caused borrowers to borrow
            more money than they could afford by permitting them to participate
            in the downpayment assistance program operated by Midwest. We
            reported that Heartland Funding did not follow federal regulations and
            HUD rules when originating FHA loans that involved downpayment
            assistance.

            In addition, we concluded that Heartland Funding did not ensure that
            borrowers understood the loan transactions so that the borrowers had
            the opportunity to make informed decisions on their loans. If the
            borrowers had better understood the program and the actual or
            potential cost to them, they may have further negotiated with the seller
            to reach a lower sales price, with the seller incurring the cost of the
            downpayment assistance rather than passing that cost to the borrower
            through an increased sales price. In addition, borrowers could have
            sought out other downpayment assistance opportunities that did not
            involve seller-funded assistance and/or the borrowers incurring
            increased sales prices and/or additional settlement costs to obtain the
            assistance.

Comment 5   According to the 1998 HUD letter to Nehemiah Corporation of
            America (Nehemiah), HUD reviewed an Internal Revenue Service
            ruling and the documents submitted to the Internal Revenue Service by
            Nehemiah in relation to the ruling. HUD subsequently approved
            Nehemiah’s program as established in its application for Section
            501(c)(3) status.

            To be clear, we did not conclude that seller-funded downpayment
            assistance programs are improper. We concluded that Heartland
            Funding did not follow federal regulations and HUD rules when
            processing FHA loans using the Midwest/nonprofit seller-funded
            program. In particular, Heartland Funding did not follow HUD



                                      41
            Handbook 4155.1, REV-5, paragraph 2-10C, which states that 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.

Comment 6   Our audit was of Heartland Funding, not Nehemiah. Since we did not
            audit Nehamiah’s program, we did not make any conclusions about
            that program. Our conclusions and related recommendations were
            based on Heartland Funding’s failure to abide by RESPA and HUD
            rules when participating in FHA loan processing activities (as further
            explained in Comment 5).

Comment 7   As stated in the report, HUD/FHA does not approve downpayment
            assistance (gift) programs administered by charitable organizations.
            Mortgage lenders are responsible for ensuring that the gift to the
            homebuyer from the charitable organization meets the appropriate
            FHA requirements and the transfer of funds is properly documented.
            As Heartland Funding acknowledged in its response to the report,
            using the business model of other organizations does not mean that
            lenders can rely on those business models to ensure compliance with
            applicable federal rules and regulations.

            Further, if other entities are administering a downpayment assistance
            program in the same manner as Heartland Funding, they may be
            violating federal rules and regulations as well.

Comment 8   The HUD reviewer that performed work at Heartland Funding in 2004
            was a loan specialist from HUD’s Office of Single Family Housing,
            Quality Assurance Division, not an auditor from the Office of
            Inspector General.

            The HUD reviewer told us that his discussions with Heartland Funding
            did not involve whether the Midwest/nonprofit downpayment
            assistance program was acceptable to HUD or the specific activities
            that took place when processing a loan using the assistance program.
            The only issue discussed was that of a potential conflict of interest.
            We added detail to the report to clarify this position.

Comment 9   Part of our audit objective was to determine whether the lender
            followed FHA requirements regarding borrower creditworthiness
            when underwriting loans. A borrower’s creditworthiness includes
            evaluating the validity of the source of funds used to close the loan.
            Therefore, we evaluated whether Heartland Funding followed
            applicable rules regarding funds used to close the 35 loans reviewed.
            Downpayment assistance funds are a source of funds to close loans
            and therefore, evaluating downpayment assistance funds and the



                                      42
                    Midwest/nonprofit program providing those funds for 25 of the loans
                    that we reviewed fit within our audit objectives.

Comment 10          We conducted an audit of Heartland Funding, not an investigation of
                    FHA borrowers.

                    Based on the results of our review, we maintain that Heartland
                    Funding failed to follow federal regulations and HUD rules and it is
                    appropriate to recommend that HUD impose appropriate sanctions for
                    RESPA violations and to refer Heartland Funding to HUD’s
                    Mortgagee Review Board for review and appropriate actions.

Comment 11          As explained in comment 2, Heartland Funding was the auditee and
                    not Midwest. In evaluating Heartland Funding’s compliance with
                    applicable rules and regulations, we identified what we believe were
                    RESPA violations by Heartland Funding. To provide HUD with
                    sufficient information to understand our findings and take appropriate
                    actions, it was necessary to include certain information regarding
                    Midwest, an affiliated business entity participating in loan transactions
                    in which Heartland Funding violated RESPA. We continue to
                    recommend that HUD take sanctions against Heartland Funding for
                    the RESPA violations.

Comment 12          We maintain that Midwest was an affiliated business of Heartland
                    Funding, as described in the report.

Comment 13          We believe that Midwest provided settlement services in the
                    processing of the FHA loans and is subject to RESPA requirements.
                    For each of the loans reviewed that used the improper downpayment
                    assistance program, Midwest signed a document stating that it was
                    advancing the downpayment assistance funds on behalf of the
                    nonprofit entity to facilitate the loan closing, as follows:




   Note: We redacted the identity of the nonprofit entity to protect its privacy.

                    In addition, the executive director of the nonprofit entity confirmed
                    that the nonprofit did not directly provide the downpayment assistance
                    funds to the borrowers and that Midwest handled the services for the
                    program as the nonprofit’s administrator of the program. Midwest
                    essentially acted as a contractor to the nonprofit and took on the roles
                    and responsibilities of the program for the nonprofit, including
                    settlement services. Therefore, we believe that Midwest provided


                                                   43
             settlement services by actively participating in the origination,
             processing, and funding of the FHA loans; and its relationship with
             Heartland Funding should have been disclosed to borrowers.

Comment 14   One of the purposes of RESPA is to help consumers become better
             shoppers for real estate settlement services. One way that RESPA
             does that is to require lenders to disclose affiliated business
             relationships with entities affecting a federally related mortgage loan.
             We did not conclude that borrowers would have made different
             decisions on their mortgage loans had they been made aware of the
             relationship between Heartland Funding and Midwest. However, we
             concluded that Heartland Funding did not ensure that borrowers had
             the required information that could have affected their decisions on
             their loan. Neither we nor Heartland Funding can conclude what
             borrowers would have done had they been aware of the relationship
             and fully understood the details of how the downpayment assistance
             program operated and was funded.

Comment 15   Finding 1 addresses our conclusions regarding RESPA violations
             related to Heartland Funding’s processing of FHA loans. Finding 2
             addresses all material deficiencies identified regarding borrower
             eligibility and creditworthiness. We did not evaluate whether
             borrowers needed downpayment assistance to purchase the home and
             obtain an FHA loan. We evaluated whether Heartland Funding
             followed applicable rules and regulations when evaluating the funds
             used to close the loan (i.e. funds were from allowable sources, and
             properly verified and documented).

             We disagree that it is apparent that the only alternative open to the
             borrowers was downpayment assistance from another entity, and that
             any other downpayment assistance would have entailed charging the
             seller a fee. HUD Handbook 4155.1 REV-5, explains that HUD
             allows downpayment assistance from multiple sources, including the
             borrower’s relative, employer or labor union, a charitable organization,
             a governmental agency or public entity that has a program to provide
             homeownership assistance to low- moderate-income families or first-
             time homebuyers, or a close friend with a clearly defined and
             documented interest in the borrower. Such donations would not
             necessarily involve an intermediary to process/transfer the funds;
             therefore, we believe that not all downpayment assistance options
             would have involved charging the seller a service fee.

             As noted in comment 14, neither we nor Heartland Funding are in a
             position to conclude how full disclosure would have impacted the
             borrowers’ decisions.




                                      44
Comment 16   As stated in the report, according to the Heartland Funding accountant,
             Midwest did not reimburse Heartland Funding for the services that its
             staff provided to Midwest. In addition, Heartland Funding did not
             provide the audit team, either during the audit or with its written
             response, any evidence that Midwest reimbursed Heartland Funding.

Comment 17   To clarify our conclusions, we revised the statement that borrowers
             were not aware that they had paid a service fee for receiving the
             assistance and explained that borrowers were not aware that they may
             have incurred increased sales prices to accommodate the seller’s costs
             of participating in the downpayment assistance program. Our intent
             was to point out to HUD that borrowers ultimately and unknowingly
             incurred the service fee when sellers increased the home price to
             account for the increased costs of selling their homes.

Comment 18   We maintain that a Heartland Funding employee, the loan closer,
             provided instructions to the title company that mischaracterized the
             downpayment assistance transactions. We agree that the closing
             instructions state that Midwest and the nonprofit were providing the
             instructions, as shown below in an excerpt from a typical instructions
             form:




             However, the loan closer physically completed the loan closing
             instruction forms and she or another Heartland Funding employee
             provided the instructions to the title company. Also, as pointed out in
             the report and comment 16, Heartland Funding provided no evidence
             to the audit team that Midwest reimbursed Heartland Funding for any
             services that its staff provided on behalf of Midwest.

Comment 19   As explained in comment 3, we clarified the report to explain that
             several sellers had increased their home prices to cover the additional
             costs of the sale when agreeing to participate in the Midwest/nonprofit
             downpayment assistance program. And, borrowers told us that they
             were not aware that they may have incurred increased sales prices to
             accommodate the seller’s increased costs of selling their home.


                                      45
Comment 20   We maintain that Heartland Funding did not ensure that there was an
             actual transfer of funds from the nonprofit donor to the borrower, nor
             did it ensure that the funds came from an acceptable source. HUD
             Handbook 4155.1, REV-5, paragraph 2-10C, Gift Funds (see appendix
             A, criterion 17), focuses on cash investments (verifiable, existing
             funds) needed to close the loan and how HUD requires lenders to
             verify and document the cash investment. The Midwest/nonprofit
             downpayment assistance program did not use any of the described
             ways to validate that an actual cash investment existed. The HUD
             requirement provides the rules for how lenders are to ensure that the
             donated funds actually exist and have been or will be transferred to the
             borrower from an acceptable source separate from the closing
             transactions depicted on the HUD-1 settlement statement. The
             Midwest/nonprofit program processes did not establish a real cash
             investment by the nonprofit.

Comment 21   We disagree with Heartland Funding’s conclusion that the control of
             funds through the escrow drafts effectively meets HUD’s
             requirements, or that it adequately establishes an acceptable source of
             the downpayment assistance funds. As previously explained, Midwest
             did not physically transfer donated funds to the borrower, nor did the
             nonprofit entity. The only real funds changing hands in relation to the
             downpayment assistance process was that of the title company paying
             Midwest when the loan closed. The only source of funds available to
             the borrowers as downpayment assistance funds, according to the
             HUD-1 settlement statement, was the sellers’ funds at the time of
             closing. HUD specifically states in its requirements that the seller is
             not an acceptable donor.

Comment 22   As explained in comment 13, we believe that Midwest provided
             settlement services in the processing of the FHA loans receiving the
             Midwest/nonprofit downpayment assistance. Therefore, we maintain
             that improper fee splitting took place.

             Also, we did not conclude that it was inappropriate for Heartland
             Funding’s owners to have separately organized Midwest. We
             concluded only that Heartland Funding did not disclose its affiliated
             business relationship with Midwest, as required by RESPA. Also, as
             explained in comment 8, we changed the report to better explain what
             the HUD reviewer stated took place during the 2004 review.

Comment 23   We disagree and continue to believe that Heartland Funding controlled
             the business activities of Midwest and violated RESPA when it
             allowed Midwest to split a portion of its fee with the nonprofit entity




                                      46
             that performed no services in the downpayment assistance
             transactions.

Comment 24   We do not agree that the nonprofit entity performed a service that
             allowed it to earn a fee for its connection to the downpayment
             assistance program. In addition, the nonprofit’s executive director
             confirmed that the entity provided no services for the program and
             relied on Midwest, as its administrator of the program, to handle the
             program activities.

             We also disagree that the nonprofit performed a service simply by
             permitting Midwest to donate funds (by advancing the funds to the
             nonprofit via the escrow draft process in question) that Heartland
             Funding contends that the nonprofit legally controlled.

Comment 25   As further explained in comment 3, the report does not claim that the
             increased sales price was the result of Heartland Funding’s conduct or
             that of Midwest’s. Our intent was to notify HUD that some borrowers
             participating in the program encountered higher sales prices than
             originally offered by the seller after the seller agreed to participate in
             the downpayment assistance program.

             In addition, we disagree that borrowers’ participation in other
             downpayment assistance programs or receipt of funds from other
             allowable sources would have resulted in increased sales prices. For
             example, sellers could have agreed to participate in a program by
             donating the necessary funds to the entity donating to the borrower,
             without raising the original sales price of the home but instead,
             considering the donation as a mere cost of selling their home. Also,
             borrowers could have received assistance from individuals other than
             the seller or other entities that would not have affected the selling price
             of the home.

Comment 26   We did not report that borrowers had no option on what entity
             provided downpayment assistance. We reported what borrowers told
             us about their experience with Heartland Funding and the options
             presented for downpayment assistance.

             We disagree that the named entities provided downpayment assistance
             to any of the 35 loans reviewed. Of the 35 loans, 25 borrowers used
             the Midwest/nonprofit program. For the remaining 10 loans, only two
             involved a nonprofit entity providing downpayment assistance and the
             donor identified on the HUD-1 settlement statement and gift
             documentation was neither of the named entities.




                                       47
Comment 27   Based on the conclusions reached during the audit and detailed in this
             report, we maintain that the recommendations made to HUD are
             supported and appropriate.




                                      48
Appendix C
                                     CRITERIA


Criterion 1
HUD Handbook 4060.1, REV-2, section 7-3, states that there are several basic elements
that are required in all quality control programs that apply to both origination and
servicing. Paragraph 7-3F states that all aspects of the mortgage operation, including but
not limited to all branch offices or sites, FHA-approved loan correspondents, authorized
agents, loan officers or originators, processors, underwriters, appraisers, closing
personnel, and all FHA loan programs, must be subject to the lender’s quality control
reviews.

Criterion 2
HUD Handbook 4060.1, REV-2, paragraph 7-3G, states that lender offices, including
traditional, nontraditional branch, and direct lending offices engaged in origination or
servicing of FHA-insured loans, must be reviewed to determine that they are in
compliance with HUD’s requirements.

Criterion 3
HUD Handbook 4060.1, REV-2, paragraph 7-3J, states that findings of fraud or other
serious violations must be immediately referred in writing (along with any available
supporting documentation) to the Director of the Quality Assurance Division in the HUD
homeownership center having jurisdiction. If HUD staff is suspected of involvement,
refer to OIG.

Criterion 4
HUD Handbook 4060.1, REV-2, paragraph 7-5A, states that lenders should monitor the
application process and must verify the identity of the loan applicant.

Criterion 5
HUD Handbook 4060.1, REV-2, paragraph 7-5C, states that lenders must identify
patterns of early defaults by location, program, loan characteristic, loan correspondent, or
sponsor.

Criterion 6
HUD Handbook 4060.1, REV-2, paragraph 7-6E(2), states that documents contained in
the loan file should be checked for sufficiency and subjected to written reverification.
Examples of items that must be reverified include but are not limited to the borrowers’
employment or other income, deposits, gift letters, alternate credit sources, and other
sources of funds.




                                             49
Criterion 7
HUD Handbook 4060.1, REV-2, paragraph 7-6E(3), states that a desk review of the
property appraisal must be performed on all loans chosen for a quality control review
except streamline refinances and HUD real estate owned sales. The desk review must
include a review of the appraisal data, the validity of the comparables, the value
conclusion, any changes made by the underwriter, and the overall quality of the appraisal.
Field reviews must be performed by licensed appraisers listed on FHA’s roster of
appraisers.

Criterion 8
HUD Handbook 4060.1, REV-2, paragraph 7-6G, states that each loan selected for a
quality control review must be reviewed to determine whether conditions required to be
satisfied before closing were met before closing, the seller was the owner of record or
was exempt from the owner of record requirement in accordance with HUD regulations,
the loan was closed and funds disbursed in accordance with the lender’s underwriting and
subsequent closings instructions, and the closing and legal documents are accurate and
complete.

Criterion 9
HUD Handbook 4060.1, REV-2, paragraph 7-7B, states that the lender must determine
whether the appraised value was established using reasonable comparables, reasonable
adjustments, and in expectation of repairs required to meet minimum safety and
soundness requirements.

Criterion 10
HUD Handbook 4060.1, REV-2, paragraph 7-7C, states that the lender must determine
whether loan documents requiring signature (other than blanket verification releases)
were signed by the borrower or employee(s) of the lender only after completion and that
all corrections were initialed by the borrower or employee(s) of the lender.

Criterion 11
HUD Handbook 4060.1, REV-2, paragraph 7-7P, states that the lender must determine
whether the seller acquired the property at the time of or soon before closing, indicating a
possible property flip.

Criterion 12
HUD Handbook 4060.1, REV-2, paragraph 7-3I, states 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.

Criterion 13
Heartland Funding’s quality control plan states that for on-site branch office audits, the
audit is conducted, at a minimum, once each calendar year on the premises of each
branch office, unannounced. It also states that reports are prepared and provided to




                                             50
senior management by the inspecting individual within Heartland Funding within 30 days
following the audit.

Criterion 14
HUD Handbook 4060.1, REV-2, paragraph 7-6D, states that in addition to loans selected
for routine quality control reviews, lenders must review all loans going into default
within the first six payments. Early payment defaults are loans that become 60 days past
due.

Criterion 15
HUD Handbook 4060.1, REV-2, paragraph 7-6A, states that loans must be reviewed
within 90 days from the end of the month in which the loan closed. This requirement is
intended to ensure that problems left undetected before closing are identified as early
after closing as possible.

Criterion 16
HUD Handbook 4060.1, REV-2, paragraph 7-6C, states that a lender who originates
and/or underwrites 3,500 or fewer FHA loans per year must review 10 percent of the
FHA loans it originates.

Criterion 17
HUD Handbook 4155.1, REV-5, paragraph 2-10C, 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.



                                           51
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.

NOTE: FHA does not “approve” downpayment assistance programs in the form of gifts
administered by charitable organizations (i.e., nonprofits). Mortgage lenders are
responsible for ensuring that the gift to the homebuyer from the charitable organization
meets the appropriate FHA requirements and the transfer of funds is properly
documented. In addition, FHA does not allow nonprofit entities to provide gifts to
homebuyers for the purpose of paying off installment loans, credit cards, collections,
judgments, and similar debts.

Criterion 18
Mortgagee Letter 2004-28 states that HUD Handbook 4155.1, REV-5, sets forth the
documentation requirements for showing the transfer of gift funds (see paragraph 2-10C).
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,
the lender must obtain and keep the documentation of the wire transfer in the mortgage
loan application binder. While that document need not be provided in the insurance
binder, it must be available for inspection by HUD when it conducts on-site reviews of
lenders.

Criterion 19
HUD Handbook 4155.1, REV-5, paragraph 2-11A, states that the borrower’s liabilities
include all installment loans, revolving charge accounts, real estate loans, alimony, child



                                             52
support, and all other continuing obligations. In computing the debt-to-income ratios, the
lender must include the monthly housing expense and all other recurring charges
extending 10 months or more, including payments on installment accounts, child support
or separate maintenance payments, revolving accounts, alimony, etc. 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 loan closing. This is
especially true if the borrower will have limited or no cash assets after loan closing.

Criterion 20
HUD Handbook 4155.1, REV-5, paragraph 2-11A(1), states that if a borrower has a
revolving account with an outstanding balance, the monthly payments for qualifying
purposes must be calculated at the greater of 5 percent of the balance or $10 (unless the
account shows a specific minimum payment).

Criterion 21
Mortgagee Letter 2005-16 states that for manually underwritten mortgages in which the
direct endorsement underwriter make the credit decision, the qualifying ratios are raised
to 31 percent and 43 percent. This change will allow a larger number of deserving
families to purchase their first home while not increasing their risk of default. As always,
if either or both ratios are exceeded on a manually underwritten mortgage, the lender
must describe the compensating factors used to justify mortgage approval.

Criterion 22
HUD Handbook 4155.1, REV-5, paragraph 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. This section describes acceptable types of income,
procedures for calculating effective income, and requirements for establishing income
stability. 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. 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.

Criterion 23
HUD Handbook 4155.1, REV-5, paragraph 2-7(O), states that only the amount by which
the borrower’s automobile allowance or expense account payments exceed actual
expenditures may be considered income.

Criterion 24
HUD Handbook 4155.1, REV-5, paragraph 3-1(E), states that a verification of
employment and the borrower’s most recent pay stub are to be provided. “Most recent”
means at time the loan application is made. If the document is not more than 120 days
old when the loan closes (180 days old on new construction), it does not have to be



                                            53
updated. As an alternative to obtaining a verification of employment, the lender may
obtain the original pay stubs covering the most recent 30-day period, along with the
original Internal Revenue Service Forms W-2 from the previous two years. The pay
stubs must show the borrower’s name, Social Security number, and year-to-date earnings.
Any copy of the W-2 not submitted with the borrower’s income tax returns are
considered “original W-2s.”

The lender must also verify by telephone all current employers. The loan file must
include a certification from the lender that the original documents were examined and the
name, title, and telephone number of the person with whom employment was verified.
For all loans processed in this manner, the lender also must obtain a signed copy of
Internal Revenue Service Form 4506, Request for Copy of Tax Form; Internal Revenue
Service Form 8821; or a document that is appropriate for obtaining tax returns directly
from the Internal Revenue Service. The lender may also use an electronic retrieval
service for obtaining W-2 and other tax return information. If the employer will not give
telephone confirmation of employment or if the W-2 indicates inconsistencies (e.g.,
Federal Insurance Contributions Act (FICA) payments not reflecting earnings), standard
employment documentation must be used.

Criterion 25
HUD Handbook 4155.1, REV-5, paragraph 2-10, states that all funds for the borrower’s
investment in the property must be verified and documented. In addition, paragraph 2-
10A states that if the amount of earnest money deposit exceeds 2 percent of the sales
price or appears excessive based on the borrower’s history of accumulating savings, the
lender must verify with documentation the deposit amount and the source of funds.
Paragraph 2-10B adds that a verification of deposit, along with the most recent bank
statement, may be used to verify savings and checking accounts. If there was 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.

Criterion 26
HUD Handbook 4155.1, REV-5, paragraph 2-10M, 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.




                                           54
     Appendix D

                           SCHEDULE OF SIGNIFICANT
                          UNDERWRITING DEFICIENCIES




                                                                                                                           Underreported
                                                                                downpayment

                                                                                              Unsupported




                                                                                                             Unsupported
                                                                                              questionable
                                                                                              employment
                                                                    Midwest




                                                                                  Improper




                                                                                                                             liabilities
                                                                                                income/




                                                                                                               assets
                                                                     service




                                                                                    funds
                                       Potential         Actual     fee paid
                            Unpaid      loss on         loss on    by seller/
 FHA case     Insurance    principal     active          sale of   principal
  number        status     balance       loans*         property   reduction

291-3436225    Active      $88,478     $33,085                      $3,645         X

291-3445329    Active      $72,233     $27,094                      $2,762         X

291-3491171    Active      $58,579     $21,968                      $2,250         X

291-3497962    Active      $167,372    $62,760                      $6,450         X

291-3504173    Active      $76,818     $28,824                      $2,910         X

291-3510603    Active      $137,505    $51,592                      $5,217         X

291-3515216    Active      $60,935     $22,852                      $2,340         X

291-3523490    Active      $112,158    $42,069                      $4,288         X

291-3534543    Active      $68,653     $25,694                      $2,772         X

291-3536810    Active      $53,315     $20,003                      $2,026         X

292-4750043    Active      $53,085     $19,913                      $2,025         X

291-3451490    Active      $85,475     $32,058                      $3,274         X

291-3501879    Active      $77,615     $29,122                      $2,942         X

291-3457458    Active      $120,882    $45,200                      $4,984         X

183-0050764    Active      $63,205     $23,716                      $2,396         X

291-3478304    Active      $59,273     $22,239                      $2,250         X                                           X

291-3514867    Active      $68,300     $25,627                      $2,591         X                                           X

 Subtotal                 $1,423,881 $533,816*                      $55,122


                                                   55
                                                                                                                                        Underreported
                                                                                             downpayment

                                                                                                           Unsupported




                                                                                                                          Unsupported
                                                                                                           questionable
                                                                                                           employment
                                                                               Midwest




                                                                                               Improper




                                                                                                                                          liabilities
                                                                                                             income/




                                                                                                                            assets
                                                                                service




                                                                                                 funds
                                                  Potential         Actual     fee paid
                                    Unpaid         loss on         loss on    by seller/
   FHA case        Insurance       principal        active          sale of   principal
    number           status        balance          loans*         property   reduction
                    Claims –
 291-3470693         not sold      $69,553         $26,094                     $2,644           X
                    Claims –
 291-3437844         not sold      $80,376         $30,154                     $3,058           X
                    Claims –
 031-3342094         not sold      $96,245         $36,095                     $3,694           X
                    Claims –
 291-3473099         not sold      $85,069         $31,919                     $3,225           X
                    Claims –
 291-3444897         not sold      $74,164         $27,827                     $2,813           X
                    Claims –
 292-4759348         not sold      $139,505        $52,333                     $5,318           X
                    Claims –
 291-3451881         not sold      $72,621         $27,251                     $2,747           X
                    Claims –
 291-3438912         not sold      $138,275        $51,925                     $5,134           X               X

    Subtotal                       $755,808      $283,598*                     $28,633
                    Claims –
 291-3445667        not sold       $174,044        $67,877                                                                    X

    Subtotal                      $929,852        $351,475
                    Claims -
 291-3433547          sold                                         $54,415                      X

     Totals                       $2,353,733      $885,291         $54,415     $83,755

* Estimated future losses are based on HUD’s average loss rate of 39 percent of the unpaid principal balance for claims paid
    from the FHA insurance fund for fiscal year 2007. For the 25 loans that participated in the improper downpayment
    assistance program (17 active loans and 8 loans with claims paid but the property had not yet been sold), we reduced the
    unpaid principal balances by the sales price increases/principal reductions before applying the 39 percent loss rate.




                                                              56
Appendix E

             CASE STUDIES FOR 27 QUESTIONED LOANS

    Case number: 291-3436225                      Insured amount: $89,708

    Section of Housing Act: 234(c)                Status upon selection: Defaulted on 14th
                                                      payment

    Date of loan closing: April 12, 2006          Underwriter type: Manual


    Improper Downpayment Assistance Funds
    The HUD-1 settlement statement showed that the borrower received downpayment
    assistance of $2,734 from a nonprofit entity. The settlement statement showed that the
    seller paid a service fee of $3,645 (4 percent of the sales price) to Midwest. However,
    there was no evidence of actual transfer of funds from the nonprofit entity to the
    borrower.

    HUD Requirements – Appendix C
    HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
    Mortgagee Letter 2004-28 (criterion 18)


    Case number: 291-3445329                      Insured amount: $73,084

    Section of Housing Act: 203(b)                Status upon selection: Defaulted on 12th
                                                      payment

    Date of loan closing: May 12, 2006            Underwriter type: Manual


    Improper Downpayment Assistance Funds
    The HUD-1 settlement statement showed that the borrower received downpayment
    assistance of $2,210 from a nonprofit entity. The settlement statement showed that the
    seller paid a service fee of $2,762 (3.75 percent of the sales price) to Midwest. However,
    there was no evidence of actual funds transferred from the nonprofit entity to the
    borrower.

    HUD Requirements – Appendix C
    HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
    Mortgagee Letter 2004-28 (criterion 18)




                                                57
Case number: 291-3491171                      Insured amount: $59,529

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 5th
                                                  payment

Date of loan closing: December 7, 2006        Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $1,800 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,250 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3497962                      Insured amount: $169,342

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 1st
                                                  payment

Date of loan closing: January 18, 2007        Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $5,160 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $6,450 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




                                            58
Case number: 291-3504173                      Insured amount: $76,991

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 3rd
                                                  payment

Date of loan closing: February 23, 2007       Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,328 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,910 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3510603                      Insured amount: $138,024

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 5th
                                                  payment

Date of loan closing: March 8, 2007           Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $4,173 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $5,217 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




                                            59
Case number: 291-3515216                      Insured amount: $61,165

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 2nd
                                                  payment

Date of loan closing: April 4, 2007           Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $1,755 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,340 (3.8 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3523490                      Insured amount: $112,582

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 4th
                                                  payment

Date of loan closing: April 27, 2007          Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $3,431 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $4,288 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




                                            60
Case number: 291-3534543                      Insured amount: $68,756

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 3rd
                                                  payment

Date of loan closing: June 12, 2007           Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,079 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,772 (4 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3536810                      Insured amount: $53,601

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 2nd
                                                  payment

Date of loan closing: June 4, 2007            Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $1,621 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,026 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




                                            61
Case number: 292-4750043                      Insured amount: $53,165

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 3rd
                                                  payment

Date of loan closing: May 8, 2007             Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $1,620 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,025 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3451490                      Insured amount: $86,615

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 10th
                                                  payment

Date of loan closing: June 12, 2006           Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,619 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $3,274 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




                                            62
Case number: 291-3501879                      Insured amount: $77,826

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 5th
                                                  payment

Date of loan closing: January 29, 2007        Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,353 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,942 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3457458                      Insured amount: $122,674

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 15th
                                                  payment

Date of loan closing: June 28, 2006           Underwriter type: Manual



Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $3,738 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $4,984 (4 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




                                            63
Case number: 183-0050764                      Insured amount: $63,395

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 5th
                                                  payment

Date of loan closing: October 12, 2006        Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $1,917 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,396 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3478304                      Insured amount: $59,529

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 5th
                                                  payment

Date of loan closing: September 29, 2006      Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $1,800 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,250 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




                                            64
Underreported Liabilities
The lender did not include monthly obligations of $691 in the borrower’s financial ratios.
The borrower provided statements from creditors to establish a supplemental,
nontraditional credit history. The lender had evidence that the borrower had two
accounts with a television sales and rental company with balances of $6,548 and $1,300.
HUD requires that at least 5 percent of the balance be used in calculating the minimum
monthly payment. Therefore, the borrower had installment/revolving debt of $327
($6,548 X .05) and $65 ($1,300 X .05) that the lender had not considered when
evaluating the borrower’s debts.

The lender also had evidence that the borrower had an auto loan and was making
payments of $69 per week, or $299 per month, with an outstanding balance of
approximately $2,137. The lender did not consider this debt in the financial ratios either.
Although at $299 per month the borrower was scheduled to pay off the auto loan in about
seven months, the lender should have included the $299 monthly auto loan in the
financial ratios because the debt affected the borrower’s ability to make the mortgage
payment immediately after loan closing. The additional debts increased the monthly debt
by $691 ($327+$65+ $299).

Further, the borrower had no cash assets after closing. The mortgage credit analysis
worksheet showed that the borrower had only $90 in reserves, the two monthly bank
statements showed less than $2 balances at the end of each month, the borrower reported
no cash assets on the application (only a small 401K), and a note in the loan file stated
that the borrower had to take the entire $278 balance from his bank account and make a
deposit on the way to closing to have sufficient funds of $279 to close the loan. This
information further showed that the auto loan would have significantly affected the
borrower’s ability to repay the mortgage. The additional debts increased the debt-to-
income (back) ratio from to 32.09 percent to 76.11 percent. This well exceeded HUD’s
requirement of 43 percent.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-11A (criterion 19)
HUD Handbook 4155.1, REV-5, paragraph 2-11A(1) (criterion 20)
Mortgagee Letter 2005-16 (criterion 21)




                                            65
Case number: 291-3514867                      Insured amount: $68,558

Section of Housing Act: 203(b)                Status upon selection: Defaulted on 4th
                                                  payment

Date of loan closing: March 26, 2007          Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,073 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,591 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)


Underreported Liabilities
The lender did not include monthly obligations of $254 in the borrower’s financial ratios.
The only liability reported on the mortgage credit analysis worksheet and loan application
was $136 per month. The lender had obtained two additional statements of nontraditional
credit to evaluate the borrower’s credit history. One statement was from a car dealer,
showing a balance of $3,581 and a weekly payment of $30 (or $130 monthly, based on a
yearly cost). The other credit was from a rent-to-own store with no balance listed but a
history of paying $124 per month. However, the lender did not include these liabilities in
the debt ratios. If these additional liabilities had been included, the debt-to-income
(back) ratio would have increased from 35.54 percent to 48.9 percent. In addition, the
lender used an incorrect monthly principal and interest amount ($428.49), which was
$50.88 less than the actual note amount ($479.37), in computing the back ratio. If the
lender had used the correct liabilities and principal and interest amounts, this would have
increased the back ratio to 51.6 percent. The lender did not provide compensating factors
on the mortgage credit analysis worksheet. The back ratio exceeded HUD’s limit of 43
percent.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-11A (criterion 19)
Mortgagee Letter 2005-16 (criterion 21)




Case number: 291-3470693                      Insured amount: $69,946



                                            66
Section of Housing Act: 203(b)                Status upon selection: Claim - defaulted on 7th
                                                  payment

Date of loan closing: August 28, 2006         Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,115 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,644 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3437844                      Insured amount: $80,918

Section of Housing Act: 203(b)                Status upon selection: Claim - defaulted on 1st
                                                  payment

Date of loan closing: May 4, 2006             Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,447 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $3,058 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 031-3342094                      Insured amount: $96,978



                                            67
Section of Housing Act: 203(b)                Status upon selection: Claim - defaulted on 6th
                                                  payment

Date of loan closing: March 13, 2006          Underwriter type: Automated


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,955 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $3,694 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3473099                      Insured amount: $85,325

Section of Housing Act: 203(b)                Status upon selection: Claim - defaulted on 5th
                                                  payment

Date of loan closing: September 22, 2006      Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,580 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $3,225 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)



Case number: 291-3444897                      Insured amount: $74,411

Section of Housing Act: 203(b)                Status upon selection: Claim - defaulted on 5th
                                                  payment



                                            68
Date of loan closing: May 15, 2006            Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,250 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,813 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 292-4759348                      Insured amount: $139,609

Section of Housing Act: 203(b)                Status upon selection: Claim - defaulted on 2nd
                                                  payment

Date of loan closing: May 2, 2007             Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $4,254 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $5,318 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3451881                      Insured amount: $72,675

Section of Housing Act: 203(b)                Status upon selection: Claim - defaulted on 2nd
                                                  payment



                                            69
Date of loan closing: June 9, 2006            Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $2,198 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $2,747 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3438912                      Insured amount: $139,838

Section of Housing Act: 203(b)                Status upon selection: Claim - defaulted on
                                                  13th payment

Date of loan closing: May 18, 2006            Underwriter type: Manual


Improper Downpayment Assistance Funds
The HUD-1 settlement statement showed that the borrower received downpayment
assistance of $4,261 from a nonprofit entity. The settlement statement showed that the
seller paid a service fee of $5,134 (3.75 percent of the sales price) to Midwest. However,
there was no evidence of actual funds transferred from the nonprofit entity to the
borrower.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




                                            70
Unsupported Income/Questionable Employment History
The lender did not adequately confirm the borrower’s income/employment information.
The lender did not obtain a verification of employment, and neither the loan application
nor paystubs identified the borrower’s employer, drawing into question the validity of the
reported employment and income. Using the income data in the loan file, the lender also
overstated the borrower’s income. The lender calculated the monthly income using the
borrower’s gross pay, expense reimbursements, and advances. However, the lender
should not have included the expense reimbursements in the borrower’s income. The
lender did not document sufficient information in the loan file to determine the proper
monthly income, and, therefore, it was unable to show what the financial ratios should
have been to determine the borrower’s ability to repay the mortgage.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-6 (criterion 22)
HUD Handbook 4155.1, REV-5, paragraph 2-7O (criterion 23)
HUD Handbook 4155.1, REV-5, paragraph 3-1E (criterion 24)




Case number: 291-3445667                      Insured amount: $167,373

Section of Housing Act: 203(b)                Status upon selection: Claim - defaulted on 8th
                                                  payment

Date of loan closing: May 10, 2006            Underwriter type: Automated


Unsupported Assets
The lender did not verify assets used to close the loan. According to the sales contract
and the HUD-1 settlement statement, the borrower paid a $3,500 earnest deposit.
However, there were no bank statements or verification of deposit to indicate the source
of funds for the $3,500. Also, the borrower did not provide satisfactory evidence of the
borrower’s ability to accumulate such savings.

Also, the lender did not verify the source of $6,617 that the borrower paid in cash at
closing. The HUD-1 settlement statement did not indicate downpayment assistance funds
used on the loan, but the mortgage credit analysis worksheet indicated that the borrower
had $9,500 in assistance funds available. The lender obtained an assistance letter from a
relative for $6,000 and a copy of a cashier’s check for that amount payable to the title
company. The donor’s bank confirmed that the donor had the funds available to give the
borrower; however, there was no evidence in the loan documentation that the donor
actually transferred the funds to the borrower. The lender did not obtain a withdrawal
document or canceled check for the funds.




                                           71
HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraphs 2-10 & 2-10A (criterion 25)
HUD Handbook 4155.1, REV-5, paragraph 2-10M (criterion 26)
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




Case number: 291-3433547                      Insured amount: $77,484

Section of Housing Act: 203(b)                Status upon selection: Claim - defaulted on 2nd
                                                  payment

Date of loan closing: April 10, 2006          HUD costs incurred: Loss on sale of property -
                                                $54,415

Underwriter type: Manual


Improper Downpayment Assistance Funds
The lender did not adequately document that the donor transferred the downpayment
assistance funds to the borrower. The lender obtained an assistance letter from a relative
for $4,800 and a copy of a cashier’s check for that amount payable to the borrower. The
donor’s bank confirmed that the donor had the funds available to give the borrower;
however, there was no evidence that the donor gave the funds to the borrower. The
lender did not obtain bank statements of either the donor or the borrower, the cashier’s
check did not show that it was negotiated, and there was no other evidence of the transfer
of funds.

HUD Requirements – Appendix C
HUD Handbook 4155.1, REV-5, paragraph 2-10C (criterion 17)
Mortgagee Letter 2004-28 (criterion 18)




                                            72
Appendix F

                           QUALITY CONTROL PLAN
                             MISSING ELEMENTS

    Heartland Funding’s quality control plan did not contain the following 11 required
    elements. The plan did not require the lender to

               o Review certain items at the branch offices, including whether the office
                 provided toll-free lines or accepted collect calls from borrowers and
                 whether personnel were employees of the lender or contract employees
                 performing functions that FHA allows to be outsourced.

               o Immediately refer findings of fraud or other serious violations in writing
                 (along with available documentation) to HUD or to refer HUD staff
                 suspected of involvement to OIG.

               o Verify the identity of the loan applicant.

               o Identify patterns of early defaults by location, program, loan characteristic,
                 loan correspondent, or sponsor.

               o Reverify other income.

               o Ensure that appraisal desk reviews included a review of the appraisal data,
                 validity of the comparables, value assigned, any changes made by the
                 underwriter, and overall quality of the appraisal.

               o Ensure that appraisal field reviews be performed by licensed appraisers
                 listed on FHA’s roster of appraisers.

               o Ensure that conditions required for closing were met, the seller was the
                 owner of record, the loan was closed and funds properly disbursed, and
                 closing and legal documents were accurate and complete.

               o Determine whether appraised values were established using reasonable
                 comparables, reasonable adjustments, and in expectation of repairs
                 required to meet minimum safety and soundness requirements.

               o Determine whether loan documents, requiring signature, were signed by
                 the borrower or employees of the lender only after completion and that all
                 corrections were initialed by the borrower and/or employees of the lender,
                 as appropriate.



                                                73
o Determine whether the seller acquired the property at the time of closing
  or shortly before the closing, indicating a possible property flip.




                               74