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