oversight

Mortgage Counseling Services, Inc., College Park, Georgia, Did Not Follow HUD Requirements in Originating and Closing Loans and Implementing Its Quality Control Program

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-01-13.

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

                                                                  Issue Date
                                                                         January 13, 2010
                                                                  Audit Report Number
                                                                           2010-AT-1001




TO:         Vicki Bott, Deputy Assistant Secretary for Single Family Housing, (HU)

            //signed//

FROM:       James D. McKay, Regional Inspector General for Audit, Atlanta Region, 4AGA

SUBJECT: Mortgage Counseling Services, Inc., College Park, Georgia, Did Not Follow
          HUD Requirements in Originating and Closing Loans and Implementing Its
          Quality Control Program

                                   HIGHLIGHTS

 What We Audited and Why

             We performed an audit of Mortgage Counseling Services, Inc. (Mortgage
             Counseling Services), a Federal Housing Administration (FHA)-approved
             nonsupervised lender, to determine whether the lender followed the U.S.
             Department of Housing and Urban Development’s (HUD) requirements for (1)
             borrower eligibility and creditworthiness and property eligibility when
             underwriting loans and (2) implementing a quality control program. We selected
             this lender because of its high default rates. Based on information received during
             the audit, we expanded our audit objectives to include reviewing the closing
             process to determine whether Mortgage Counseling Services complied with HUD
             requirements when closing loans.


 What We Found

             Mortgage Counseling Services did not follow HUD requirements when
             underwriting 8 of 16 FHA loans. This noncompliance occurred because
             Mortgage Counseling Services experienced high employee turnover and did not
             adequately supervise the performance of the underwriters. As a result, HUD
             insured eight loans that unnecessarily placed the FHA insurance fund at risk for
             more than $433,000.
           Mortgage Counseling Services did not conduct its quality control reviews in a
           timely manner. In addition, the lender did not report a significant quality control
           violation to HUD. This noncompliance occurred due to lack of controls to ensure
           that the quality control function was continuously maintained. As a result,
           Mortgage Counseling Services did not ensure the accuracy, validity, and
           completeness of its loan originations.

           Mortgage Counseling Services did not fully comply with HUD requirements in
           closing two loans. Specifically, the lender misrepresented a HUD-1 settlement
           statement to HUD. In addition, the lender collected an uncustomary and
           unreasonable appraisal fee after the loan closed. This noncompliance occurred
           due to a lack of controls to ensure that loans were closed in accordance with HUD
           requirements. As a result, HUD could not be assured that loans were properly
           closed, and the noncompliance could result in an increased risk to the FHA
           insurance fund.

What We Recommend

           We recommend that the Deputy Assistant Secretary for Single Family Housing
           require Mortgage Counseling Services to indemnify HUD for the potential loss on
           the eight loans with material deficiencies, reimburse HUD for overinsuring one
           loan, and ensure that Mortgage Counseling Services conducts quality control
           reviews in a timely manner as required by HUD regulations. We also recommend
           that the Deputy Assistant Secretary for Single Family Housing take appropriate
           action against Mortgage Counseling Services for its noncompliance in closing two
           loans.

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


Auditee’s Response

           We discussed our review results with Mortgage Counseling Services and HUD
           officials during the audit. We provided a copy of the draft report to Mortgage
           Counseling Services officials on November 25, 2009, for their comments and
           discussed the report with the officials at the exit conference on December 8, 2009.
           Mortgage Counseling Services provided written comments on December 16,
           2009. It generally disagreed with our findings.

           The complete text of the auditee’s response, along with our evaluation of that
           response, can be found in appendix B of this report.


                                             2
                             TABLE OF CONTENTS

Background and Objectives                                                          4

Results of Audit
        Finding 1: Mortgage Counseling Services Did Not Follow HUD Requirements    5
                   When Underwriting Eight Loans
        Finding 2: Mortgage Counseling Services Did Not Fully Comply With HUD      9
                   Quality Control Requirements
        Finding 3: Mortgage Counseling Services Did Not Fully Comply With HUD     12
                   Requirements in Closing Two Loans

Scope and Methodology                                                             15

Internal Controls                                                                 17

Appendixes
   A.   Schedule of Funds To Be Put to Better Use                                 19
   B.   Auditee Comments and OIG’s Evaluation                                     20
   C.   Criteria                                                                  36
   D.   Schedule of Significant Underwriting Deficiencies                         42
   E.   Case Studies for Loans With Significant Deficiencies                      43
   F.   Schedule of Indemnification Amounts                                       52




                                               3
                     BACKGROUND AND OBJECTIVES

Mortgage Counseling Services, Inc., (Mortgage Counseling Services) is a Federal Housing
Administration (FHA)-approved nonsupervised lender based in College Park, GA.
Nonsupervised lenders can originate, sell, purchase, hold, and/or service FHA-insured
mortgages. Mortgage Counseling Services became an authorized FHA loan originator in June
1987. It does not have any active branch offices.

From February 2007 through January 2009, Mortgage Counseling Services originated 204 FHA
loans. As of January 31, 2009, 33 of the loans, valued at approximately $4 million, were at least
30 days delinquent. Thirteen of those loans defaulted within the first six payments. Loans that
default within the first six payments are classified as early default loans. Mortgage Counseling
Services had a default rate of 13.73 percent. This is significantly higher than the 6.85 percent
default rate for the Atlanta, GA, area.

As an FHA-approved lender, Mortgage Counseling Services 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. Mortgage Counseling Services uses a third-party
contractor to conduct its quality control reviews.

On July 23, 2009, we received information regarding some potential violations that occurred
with four loans that were closed between April and July 2009. We reviewed the four loans to
determine the validity of the alleged violations. The original loan amount of the four loans
totaled $325,311.

Our audit objectives were to determine whether Mortgage Counseling Services followed HUD
requirements for (1) borrower eligibility and creditworthiness and property eligibility when
underwriting loans and (2) implementing a quality control program. We expanded our audit
objectives to include reviewing the closing process to determine whether Mortgage Counseling
Services complied with HUD requirements when closing loans.




                                                4
                                     RESULTS OF AUDIT

Finding 1: Mortgage Counseling Services Did Not Follow HUD
           Requirements When Underwriting Eight Loans
Mortgage Counseling Services did not follow HUD requirements when underwriting 8 of 16
FHA loans. This noncompliance occurred because Mortgage Counseling Services experienced
high employee turnover and did not adequately supervise the performance of the underwriters.
As a result, HUD insured eight loans that unnecessarily placed the FHA insurance fund at risk
for more than $433,000.



    Underwriting Did Not Meet
    HUD Standards

                    Mortgage Counseling Services did not follow HUD’s requirements when
                    underwriting eight FHA loans, originally valued at more than $1 million. FHA-
                    approved lenders must follow HUD Handbook 4155.1, REV-5, Mortgage Credit
                    Analysis for Mortgage Insurance, One- to Four-Family Properties, and HUD
                    mortgagee letters when underwriting FHA loans. Appendix C provides details of
                    HUD underwriting requirements.

                    Examples of the underwriting deficiencies included the following:

                    Underreported Liabilities
                    Mortgage Counseling Services did not adequately assess liabilities of borrowers
                    for two loans. HUD Handbook 4155.1, REV-5, chapter 2, section 4, paragraph 2-
                    11A, requires the lender to include all recurring charges extending 10 months or
                    more. Debts lasting 10 months or less must be counted if the amount of debt
                    affects the borrower’s ability to make the mortgage payments during the months
                    immediately after loan closing.1 For the deficient loans, the lender did not include
                    all liabilities when calculating qualifying ratios and underwriting the loans.

                    For example, for FHA case number 105-2954735, with an unpaid balance of
                    $98,072, the lender did not include the income or child support payments of the
                    borrower in qualifying the borrower for the loan. Based on court-ordered
                    documents contained in the file, the borrower was responsible for $271 in
                    monthly child support payments. The underwriter used only the income of the
                    coborrower in qualifying for this loan and did not include the income or child
                    support payments of the borrower. The underwriter did not want to include the
                    child support payments, so she excluded the income as well for this loan.


1
    See appendix C, criterion 9.
                                                      5
                    Maximum Mortgage Amount Exceeded
                    Mortgage Counseling Services did not ensure that the lower of the sales price or
                    appraised value was used to calculate the maximum mortgage amount. HUD
                    Handbook 4155.1, REV-5, chapter 1, section 2, paragraph 1-7, requires that the
                    property’s sales price, subject to certain required adjustments, or the appraised
                    value, if less, be multiplied by a loan-to-value ratio. The resulting amount is the
                    maximum mortgage that FHA will insure. The borrower must make a cash
                    investment at least equal to the difference between the sales price and the
                    resulting maximum mortgage amount. The lender must ensure that the
                    appropriate value is used when determining the maximum mortgage amount.2

                    For FHA case number 105-3002046, originally valued at $168,667, the lender did
                    not use the appropriate value in determining the maximum insurable mortgage
                    amount. The borrower purchased a newly constructed home. The initial sales
                    contract was dated January 28, 2007, with a sales price of $157,900. An appraisal
                    was performed on the property on April 19, 2007, through which the property was
                    valued at $170,000. On April 23, 2007, after the appraisal was complete, the
                    sales contract was amended to increase the sales price to $170,000. The sales
                    price cannot be increased after the completion of the appraisal to match the
                    appraised value. The lender must use the lower of the sales price or appraised
                    value to determine the maximum mortgage insurable amount. Therefore, the loan
                    was overinsured.

                    Questionable Credit History
                    Mortgage Counseling Services did not adequately establish the credit history of
                    the borrower for one loan. HUD Handbook 4155.1, REV-5, chapter 2, section 1,
                    paragraph 2-3, requires the lender to develop a credit history from utility payment
                    records, rental payments, automobile insurance payments, or other means of
                    direct access from the credit provider. The lender must document that the
                    providers of nontraditional credit actually exist and verify the credit information.3

                    For FHA case number 105-3097672, originally valued at $91,774, the lender did
                    not establish a credit history for the borrower. The borrower provided no credit
                    information in the credit report and did not provide nontraditional letters of credit.
                    The underwriter obtained one utility payment referral, which showed that the
                    borrower was an account holder and had not made a late payment in 12 months.
                    However, there was no payment history information, such as length of service,
                    which would indicate how long the borrower had used the utility service. The
                    lender did not have any additional credit history information.

                    See appendix E for case studies of loans with significant deficiencies.




2
    See appendix C, criterion 6.
3
    See appendix C, criterion 7.
                                                       6
Underwriters Did Not Perform
Adequately


           Mortgage Counseling Services experienced high employee turnover from 2007
           through 2009. Several employees, including underwriters, did not work very long at
           Mortgage Counseling Services. Two underwriters, including one employee and the
           company’s president, underwrote the 16 loans reviewed. However, some of the
           loans were not adequately reviewed before closing.

           The president of Mortgage Counseling Services stated that she dismissed the other
           underwriter due to poor performance. Therefore, the president was the only
           remaining underwriter in the company. The president stated that she was not always
           available to review the work of the underwriter and believed that if the files had been
           reviewed, some of the deficiencies would have been detected before the loans
           closed.

Loans Containing Material
Deficiencies Were Submitted
for FHA Insurance


           HUD cannot be assured that borrowers are eligible for FHA insurance on their
           loans when lenders do not properly monitor their underwriting efforts.

           Mortgage Counseling Services submitted eight loans that had material
           deficiencies for FHA insurance. The loans’ unpaid principal balances totaled
           more than $1 million as of June 2009. Therefore, HUD insured eight loans with
           increased risk due to underwriting deficiencies. The loans unnecessarily placed
           the FHA insurance fund at risk for more than $433,000 in potential losses that
           may occur if the FHA-insured properties are foreclosed upon and resold for less
           than the insured amount. HUD should seek indemnification from Mortgage
           Counseling Services.

Recommendations


           We recommend that the Deputy Assistant Secretary for Single Family Housing

           1A.    Require Mortgage Counseling Services to indemnify HUD $433,826 for
                  the eight actively insured loans with unpaid principal balances totaling
                  $1,032,918. The projected loss is $433,826 based on the FHA insurance
                  fund average loss rate of 42 percent for fiscal year 2008 (see appendix F).




                                              7
1B.   Determine the amount of the overinsured mortgage for FHA case number
      105-3002046 and require the lender to repay the determined amount and
      provide evidence of the principal reduction of the loan.

1C.   Require Mortgage Counseling Services to establish controls to ensure that
      the work performed by underwriters is supervised and reviewed before the
      loan is closed. In addition, the Assistant Secretary should require HUD’s
      Quality Assurance Division perform a review of Mortgage Counseling
      Services within 9 months to determine whether it has established and
      implemented adequate controls to ensure that the types of underwriting
      deficiencies identified are minimized and the work performed by
      underwriters is supervised and reviewed before closing.




                               8
Finding 2: Mortgage Counseling Services Did Not Fully Comply
           With HUD Quality Control Requirements
Mortgage Counseling Services did not conduct its quality control reviews in a timely manner. In
addition, the lender did not report a significant quality control violation to HUD. This
noncompliance occurred due to a lack of controls to ensure that the quality control function was
continuously maintained. As a result, Mortgage Counseling Services did not ensure the
accuracy, validity, and completeness of its loan originations.



    Quality Control Reviews Were
    Not Conducted As Required or
    on a Timely Basis

                    Mortgage Counseling Services did not ensure that its quality control reviews were
                    conducted quarterly and within 90 days of closing as required by HUD Handbook
                    4060.1, chapter 7-6B, and its quality control plan. Because Mortgage Counseling
                    Services closes fewer than 15 loans per month, HUD Handbook 4060.1, chapter
                    7-6B, requires it to conduct quality control reviews on a quarterly basis. From
                    February 1, 2007, through April 16, 2009, Mortgage Counseling Services
                    conducted only four quality control reviews. At least eight quarterly quality
                    control reviews were required during that period. There were approximately 27
                    loans examined during the four quality control reviews, of which none was
                    conducted within 90 days of closing.

                    In addition, Mortgage Counseling Services did not ensure that its early defaults4
                    were reviewed on a timely basis. From February 1, 2007, through April 16, 2009,
                    the lender conducted only two quality control reviews of its early defaults, which
                    were completed on January 14 and April 16, 2009. At least eight quarterly early
                    default reviews were required during that period.

                    HUD Handbook 4060.1, REV-2, chapter 7, section 7-6A, states that lenders must
                    ensure that quality control reviews are performed on a regular and timely basis,
                    specifically within 90 days of closing. It also requires lenders to review all loans
                    going into default within the first six payments. In addition, it states that lenders
                    closing 15 or fewer loans monthly may perform quality control reviews on a
                    quarterly basis.




4
    Early payment defaults are loans that become 60 days past due.
                                                           9
Significant Quality Control
Finding Was Not Reported to
HUD

         Mortgage Counseling Services did not report a significant finding contained in its
         quality control review to HUD. For FHA case number 105-3885875, the
         borrower forged a letter of employment. During the reverification of employment
         completed during the quality control review, the employer stated that the letter
         was forged and provided the authentic employment letter. The quality control
         contractor informed Mortgage Counseling Services of the forged letter; however,
         it did not report the violation to HUD. 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 (determined by the State where the
         property is located). In lieu of submitting a paper report, lenders must use the
         “lender reporting” feature in the Neighborhood Watch Early Warning System.
         The forged letter resulted in the termination of the borrower’s employment and
         contributed to the early default of this loan.

         Mortgage Counseling Services experienced high employee turnover and at times
         did not have anyone in charge of approving its quality control reviews. In
         addition, the vice president, who was responsible for the quality control function,
         suffered a serious illness and did not work for an extended period. Mortgage
         Counseling Services did not have controls in place to ensure that the quality
         control function was maintained during periods of employee turnover or illness.
         HUD Handbook 4060.1, chapter 7-1 states that all FHA-approved lenders must
         implement and continuously have in place a quality control plan as a condition of
         receiving and maintaining FHA approval. Therefore, Mortgage Counseling
         Services must ensure that it implements its quality control plan in accordance with
         HUD requirements.

         Mortgage Counseling Services adversely impacted HUD’s quality control
         program goals of ensuring compliance with HUD’s and the lender’s own
         origination or servicing requirements throughout its operations, which were
         designed to protect HUD and the lender from unacceptable risk. Quality control
         is intended to guard against errors, omissions, and fraud. Untimely quality
         control reviews do not ensure swift and appropriate corrective action.




                                          10
Recommendations



          We recommend that the Deputy Assistant Secretary for Single Family Housing

          2A.     Require Mortgage Counseling Services to ensure that its quality control
                  reviews are conducted in a timely manner and that early default loans are
                  reviewed as required by HUD regulations.

          2B.     Require Mortgage Counseling Services to ensure that all significant
                  quality control findings are reported to HUD as required.

          2C.     Require Mortgage Counseling Services to establish controls to ensure that
                  the quality control function is continuously maintained. In addition, the
                  Assistant Secretary should require the Quality Assurance Division to
                  perform a review of Mortgage Counseling Services’ controls within 9
                  months to determine whether adequate controls have been established to
                  ensure that the quality control function is continuously maintained.




                                            11
Finding 3: Mortgage Counseling Services Did Not Fully Comply
           With HUD Requirements in Closing Two Loans
Mortgage Counseling Services did not follow HUD requirements in closing two loans.
Specifically, the lender misrepresented a HUD-1 settlement statement and collected an
unreasonable and uncustomary fee. This noncompliance occurred because the lender did not
have controls in place to ensure that loans were properly closed. As a result, HUD could not be
assured that loans were closed in compliance with HUD requirements, which may result in an
increased risk to the FHA insurance fund.



 Misrepresentation of HUD-1
 Settlement Statement


              Mortgage Counseling Services submitted an altered HUD-1 settlement statement
              to HUD. In FHA case number 105-4913683, the lender revised the HUD-1 to
              reduce the amount of money the borrower owed at closing. The initial HUD-1
              showed that the borrower owed $2,320 at closing. The lender revised the HUD-1
              to show that the borrower owed only $804 at closing. The lender created a lender
              credit of $675 and removed the loan discount of $841, which decreased the
              amount the borrower owed at closing to $804 ($2,320 – $675 - $841 = $804).
              The lender instructed the borrower to write two postdated checks as follows:

                             Check number        Check date         Check amount
                             1108                  8/15/2009                 $400
                             1111                 10/15/2009                $1,116
                             Total                                          $1,516

                             Note: The total amount in postdated checks ($1,516) plus
                             the amount paid at closing ($804) totals the $2,320 required
                             on the initial HUD-1.

              According to bank statements dated June 15, 2009, the borrower had $3,330 in
              her checking account. This loan closed on July 17, 2009. There were no
              additional verifications completed before the closing. Shortly before the loan
              closed, the borrower was contacted and told that she had to bring $2,320 to
              closing. At that time (July 2009), the borrower stated that she did not have $2,320
              for closing. At this point, the lender should have terminated the loan for lack of
              sufficient funds to close. However, the president of Mortgage Counseling
              Services created another HUD-1, reducing the amount of funds needed to close
              from $2,320 to $804. The borrower must have sufficient funds to close the loan.
              HUD Handbook 4155.1, REV-5, chapter 2, section 3, paragraph 2-10, states that
              all funds for the borrower’s investment in the property must be verified and
              documented. In addition, 24 CFR (Code of Federal Regulations) 3500.8(b)(1)
              states that the HUD-1 must show the actual charges paid by the borrower.

                                                   12
           Mortgage Counseling Services’ president stated that she was not aware of the two
           postdated checks. However, after we visited the lender in August 2009 to obtain
           the loan file, the president contacted the borrower and sent her a letter stating that
           it was improper to collect the additional postdated checks, and the president
           destroyed the checks. The president stated that the loan was not reviewed after
           closing, which is why there was no knowledge of the improper activity. The
           lender should have controls in place to ensure that loans are closed in accordance
           with HUD requirements.

Collection of Unreasonable and
Uncustomary Fees From a
Borrower

           Mortgage Counseling Services improperly charged a borrower for appraisal fees
           after the loan closed. In FHA case number 105-4747554, the borrower paid
           $1,200 for an appraisal, a credit report, and home inspection fees before closing.
           The lender was able to use an existing appraisal that was completed within 90
           days of the loan closing; therefore, the HUD-1 settlement statement did not show
           appraisal fee charges. This loan closed in June 2009. After the loan closed, the
           appraiser submitted a bill to the lender for $150 for additional work performed on
           the appraisal based on requirements of the second mortgage. The president
           contacted the borrower in July 2009 and instructed the borrower to pay the $150
           to prevent the loan from going through closing again. This fee was in excess of
           reasonable and customary loan fees. According to HUD’s Quality Assurance
           Division, the lender could not require the borrower to pay for costs that were not
           listed on the HUD-1 and was responsible for absorbing the cost associated with
           the additional appraisal bill. Further, the lender had a check for $1,200 from the
           borrower to cover the appraisal, credit report, and home inspection. The credit
           report fee was $38, and the home inspection was $500, leaving $662 remaining
           from the $1,200 check. Therefore, the additional funds were not required from
           the borrower after closing.

           Mortgage Counseling Services’ president stated that because the borrower did not
           have to pay the full appraisal amount, Mortgage Counseling Services saved the
           borrower money and was justified in requesting the additional $150. HUD
           Handbook 4000.2, chapter 5-2, states that the lender may collect customary and
           reasonable fees and charges from the borrower. This additional appraisal fee after
           the loan closed was not customary or reasonable. Once we discussed the violation
           with the president in October 2009, the president corrected the HUD-1 settlement
           statement to reflect the additional $150 charge and provided the corrected HUD-1
           to the borrower. This action violated 24 CFR 3500.8(c), which states that a
           revised HUD-1 must be provided within 30 calendar days after settlement.




                                              13
Conclusion


             Mortgage Counseling Services did not fully comply with Federal requirements in
             closing two loans. The lender misrepresented the HUD-1 submitted to HUD by
             altering the charges and credits applied on the HUD-1 to decrease the amount of
             funds required for closing. In addition, the lender charged a borrower for an
             appraisal fee that was charged after the loan closed. Any charges that occur after the
             loan closes are customarily absorbed by the lender. These improper closing
             activities created an increased risk to the FHA insurance fund.


Recommendations


             We recommend that the Deputy Assistant Secretary for Single Family Housing

             3A.    Require Mortgage Counseling Services to indemnify HUD $35,231 for the
                    loan with the misrepresented HUD-1 and an unpaid principal balance of
                    $83,884. The projected loss is $35,231 based on the FHA insurance fund
                    average loss rate of 42 percent for fiscal year 2008.

             3B.    Take appropriate action against Mortgage Counseling Services for its
                    noncompliance in closing two loans.

             3C.    Require Mortgage Counseling Services to establish controls to ensure that
                    it follows HUD requirements when closing loans.




                                                14
                         SCOPE AND METHODOLOGY

Mortgage Counseling Services originated 204 FHA-insured loans, valued at more than $25
million, with beginning amortization dates from February 1, 2007, through January 31, 2009.
Thirty-three of the loans were at least 30 days delinquent. Thirteen of the loans defaulted within
the first six payments. We selected 16 of the defaulted loans, including five early defaults, based
on the number of payments before default, loan amounts, and whether the loans were reviewed
by HUD’s Quality Assurance Division during its December 2007 review. We did not select any
loans that were previously reviewed by the Quality Assurance Division. The remaining eight
early default loans were not selected because they were either reviewed by the Quality Assurance
Division or were refinance transactions. The original mortgage amounts for the 16 selected
loans totaled $2,052,905. On July 23, 2009, we received information regarding some potential
violations that occurred with four loans that were closed between April and July 2009. We
reviewed the four loans to determine the validity of the alleged violations. The original loan
amount of the four loans totaled $325,311. Our results only apply to the items selected and
cannot be projected to the universe or population.

To accomplish the audit objectives, we

       Obtained an understanding of applicable laws and regulations that related to single-
       family requirements;
       Reviewed Mortgage Counseling Service’s loan case files and analyzed the lender’s
       evaluation and documentation of income, assets, credit histories, liabilities, borrower
       eligibility, qualifying ratios, and compensating factors;
       Reviewed Mortgage Counseling Service’s quality control plan and quality control review
       reports and analyzed the plan and reports to determine whether they complied with HUD
       requirements;
       Reviewed Mortgage Counseling Service’s management controls over originating FHA-
       insured loans;
       Reviewed the closing attorney’s files associated with the four additional files selected;
       Interviewed Mortgage Counseling Service’s staff to obtain information regarding its
       policies and procedures;
       Discussed findings with the Atlanta HUD Quality Assurance Division; and
       Obtained information and guidance on and discussed findings with the Washington D.C.
       HUD Quality Assurance Division.

We used data maintained by HUD in the Neighborhood Watch Early Warning System for
background information and in selecting our sample of loans for review. The Neighborhood
Watch Early Warning System is intended to aid HUD staff in monitoring lenders and programs
and to aid lenders and the public in self-policing the industry. The system is designed to
highlight exceptions so that potential problems are readily identifiable. In addition, the system
gives the ability to identify and analyze patterns, by geographic area or originating lender, in
loans which became 90 days delinquent during their first 2 years. We did not rely on the data as
a basis for our conclusions. Therefore, we did not assess the reliability of the data.

                                                 15
We classified $469,057 as funds to be put to better use. This is 42 percent of the $1,116,802 in
unpaid principal balances in nine FHA-insured loans that did not meet HUD’s requirements. We
used 42 percent because HUD has determined that upon sale of the mortgaged properties, FHA’s
average loss was about 42 percent of the unpaid principal balance for fiscal year 2008.

Our review generally covered the period February 1, 2007, through March 31, 2009, and was
extended as necessary during the audit. We performed work at the Home Ownership Center in
Atlanta, GA, and at Mortgage Counseling Service’s home office located in College Park, GA.
We performed the review from March to October 2009.

We conducted the audit in accordance with generally accepted government auditing 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.




                                                16
                              INTERNAL CONTROLS

Internal control is an integral component of an organization’s management that provides
reasonable assurance that the following objectives are achieved:

       Program operations,
       Relevance and reliability of information,
       Compliance with applicable laws and regulations, and
       Safeguarding of assets and resources.

Internal controls relate to management’s plans, methods, and procedures used to meet its
mission, goals, and objectives. They include the processes and procedures for planning,
organizing, directing, and controlling program operations as well as the systems for measuring,
reporting, and monitoring program performance.



 Relevant Internal Controls
              We determined that the following internal controls were relevant to our audit
              objectives:

                      Compliance with laws and regulations – Policies and procedures that
                      management has implemented to reasonably ensure that the loan origination
                      process complies with HUD program requirements.

                      Safeguarding of resources – Policies and procedures that management has
                      implemented to reasonably ensure that resources are safeguarded against
                      waste, loss, and misuse.

              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.




                                                17
Significant Weaknesses

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

                  Mortgage Counseling Services did not follow HUD requirements when
                  underwriting eight loans (see finding 1).

                  Mortgage Counseling Services did not fully comply with HUD quality
                  control requirements (see finding 2).

                  Mortgage Counseling Services did not fully comply with HUD requirements
                  in closing two loans (see finding 3).




                                             18
                                   APPENDIXES

Appendix A

     SCHEDULE OF FUNDS TO BE PUT TO BETTER USE

                        Recommendation             Funds to be put
                               number               to better use 1/
                             1A                         $ 433,826
                             3A                         $ 35,231

                              Total                     $ 469,057


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

     Implementation of our recommendations to require Mortgage Counseling Services to
     indemnify HUD for materially deficient loans will reduce the risk of loss to the FHA
     insurance fund. The amount above reflects that upon sale of the mortgaged properties,
     FHA’s average loss experience is about 42 percent of the unpaid principal balance, based
     upon statistics provided by HUD.




                                             19
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




Comment 1




                          20
Comment 2




            21
22
Comment 3




            23
Comment 4




            24
Comment 5




            25
Comment 6




            Comment 6C




                26
Comment 7




            27
Comment 8




            28
Comment 9




            29
Comment 10




             30
Comment 11




             Comment 12




                 31
                         OIG Evaluation of Auditee Comments

Comment 1   Mortgage Counseling Services stated that "the original auditors who conducted
            the audit relayed that we would be given the report and allowed time to respond to
            the report. When they originally left our office on May 21 2009, we were told of
            only three issues. We realize that additional files were requested but because we
            were not advised of any additional findings in advance of your written report, we
            do not feel we have had sufficient time to fully respond."

            The OIG met with Mortgage Counseling Services on October 20, 2009, to discuss
            the additional finding that would be included in the report. In addition, we
            provided the draft audit report to Mortgage Counseling Services on November 25,
            2009, and we discussed the report with them at the exit conference held on
            December 8, 2009.

Comment 2   Mortgage Counseling Services stated that they have been reviewed by HUD
            program staff every two years since 1990 and a review of its Quality Control Plan
            and Procedures was made in each of the previous audits. The lender stated they
            were also audited by the Atlanta HUD Quality Assurance Division in December
            2007. The lender stated HUD requested and were supplied all quality control
            reports for the previous year which included the period in dispute. The lender
            contended no further action was required by them at that time.

            Our audit period covered February 1, 2007 through March 31, 2009. The Quality
            Assurance Division reviewed Mortgage Counseling Services in December 2007.
            Their report contained one finding related to loan origination. In addition, the
            report also contains observations, which were issues that were discussed at the
            close-out conference and considered resolved. The report cited that Mortgage
            Counseling Services must ensure that their quality control contractor conducted
            reviewing according to HUD/FHA guidelines. Therefore, HUD’s Quality
            Assurance Division did note deficiencies in Mortgage Counseling Services
            quality control plan and procedures.

Comment 3   Mortgage Counseling Services stated that although the forged letter contained
            some exaggerated references to the borrower’s ability, the income earned amount
            was true and correct. The lender said it did not rely on this letter as income
            documentation for the borrower. In addition, the lender contended their failure to
            report this incident is a matter of interpretation.

            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 determined by the State where the property is located. In lieu of
            submitting a paper report, mortgagees must use the Lender Reporting feature in
            the Neighborhood Watch Early Warning System report all fraudulent activities
            disclosed in its quality control reviews to HUD in accordance with HUD

                                             32
            requirements. Therefore, the lender should have notified HUD of the forged
            employment letter.

Comment 4   Mortgage Counseling Services stated there was documentation in the file to
            support the income; however, they could not locate the documentation. The
            lender requested the borrower's payroll history from the employer to show that the
            borrower earned $700 a week.

            The income documentation was from September 28, 2007 through December 31,
            2007. This loan closed on October 15, 2007. Therefore the documentation
            provided did not fully support the income used to qualify the borrower for this
            loan.

Comment 5   Mortgage Counseling Services stated that the child support debt was reported on
            the Uniform Residential Loan Application at closing; however, the underwriter
            did not include the borrower's debt or income as part of the loan transaction. The
            borrower was supposed to be deleted from the loan application but this was not
            properly processed. This was an oversight by the underwriter and the closing
            department. Although the child support was reported, it was not used by the
            underwriter in qualifying the borrower for the loan. Mortgage Counseling
            Services also stated that due to the borrower being a 1099 employee and his only
            employer was a small company that did not write checks, they would not allow
            the income to be used to qualify for the loan. While the underwriter felt
            comfortable that the borrower was earning the funds stated, the income was not
            included as effective income due to the overall "quality of the verification
            documentation." Mortgage Counseling Services added that had this been
            included it was more than sufficient to offset the debt. The situation in the
            household would have been the same if the borrower had been removed so the
            affect on the loan would have been the same.

            HUD requires that the borrower's liabilities be included to determine the
            borrower's ability to make mortgage payments. HUD also requires that the
            borrower and co-borrower's income, assets, liabilities, and credit history are
            considered in determining creditworthiness and the borrower's ability and
            willingness to repay the mortgage debt. Therefore, the lender should not have
            approved the loan without including the borrower's income and liabilities.

Comment 6   Mortgage Counseling Services stated that they obtained verification of rent from
            December 2005 through May 2007. They also obtained a verification of utility
            payments for 12 months.

            The lender cited Mortgagee Letter 2008-11 as the basis for the nontraditional
            credit evaluation and verification. However, Mortgagee Letter 2008-11 was not
            effective until April 29, 2008. This loan closed on July 27, 2007, which is almost
            a year before the criteria became effective. In addition, Mortgagee Letter 2008-11
            requires three credit references in verified non-traditional credit. The verification

                                              33
            of rent and one utility bill are not sufficient according to HUD requirements. The
            underwriter obtained one utility payment referral, which showed that the borrower
            was an account holder and had not made a late payment in 12 months. However,
            there was no payment history information, such as length of service, which would
            indicate how long the borrower had used the utility service. The lender did not
            have any additional credit history information. Therefore, the lender did not
            adequately establish acceptable credit history when using only one nontraditional
            letter of credit.

Comment 7   Mortgage Counseling Services stated that after several discussions with the
            borrower and loan officer regarding the failure of the loan officer to properly
            disclose the increase in funds needed for closing, they amended the closing costs
            to the borrower and issued a new good faith estimate disclosing the funds to close
            of $804.63. In addition, Mortgage Counseling Services stated they did not feel it
            was in the buyer's interest to delay the borrower's closing or penalize the borrower
            further for the loan officer's failure to follow company policy.

            The altered HUD-1 settlement statement resulted in a misrepresentation to HUD.

Comment 8   Mortgage Counseling Services stated that in order for the appraisal to be
            acceptable for the second mortgage program there were additional items that had
            to be added to the appraisal. This allowed the same appraisal to satisfy both the
            first FHA and second loan requirements. The changes that were requested were
            billed by the appraiser after closing but were a necessary part of the second
            mortgage approval process. Mortgage Counseling Services added that the loan
            closed on June 26, 2009, and the bill was tendered on June 29, 2009, for the
            additional items that were required on the appraisal for the second mortgage
            program. In addition, Mortgage Counseling Services stated the full amount the
            borrower prepaid was credited back to the borrower at closing and they did not
            retain any portion of the advance funds as indicated in your letter.

            Based on our review, we determined the lender charged a borrower for an
            appraisal fee that was charged after the loan closed. Any charges that occur after
            the loan closes are customarily absorbed by the lender.

Comment 9   Mortgage Counseling Services stated that the co-borrower was leasing her home
            to move in with the borrower. The lease was signed on June 1, 2007, with a
            move-in date of August 1, 2007. This loan closed on July 27, 2007. The lender
            states that they verified that the previous mortgage was current and paid on time
            for 12 months, and the co-borrower had sufficient cash reserves after closing to
            cover the previous housing debt for more than 12 months.

            The co-borrower's mortgage is a contingent liability. Therefore, the mortgage
            payment should have been included in the debt ratio calculation. In addition, the
            liability was large enough to adversely affect the borrower’s ability to make the
            mortgage payment immediately after closing.

                                              34
Comment 10 The $168,667 is the original insured value of the loan. Our report does not state a
           property value of $168,667. The report states the original sales price of the
           property was $157,900. After the appraisal was completed with an appraised
           value of $170,000, the sales price was increased to $170,000 to match the
           appraised value. The lender must use the lower of the sales price or appraised
           value to determine the maximum mortgage insurable amount. Therefore, the loan
           was overinsured.

Comment 11 Mortgage Counseling Services stated that according to a conversation with IRS
           regarding this matter, federal tax lien item 4 was re-filed with another tax lien
           filed in April 2007. The lender added according to IRS Publication 954, tax liens
           are automatically released after 10 years. The lender also stated that the State of
           California refused to provide any additional information to them other than the
           installment agreement was $100 per month.

              The lender's files did not document the status of all five tax liens. The borrowers
              had five tax liens on their credit report at the time of loan closing. The lender
              documented a payoff on one tax lien and installment payment agreements on two
              other tax liens. However, the lender did not document the status of the remaining
              two tax liens, nor was there any documentation that provided explanations for the
              tax liens.




                                                35
Appendix C
                                        CRITERIA


Criterion 1
HUD Handbook 4000.4, REV-1, CHG-2, paragraph 2-4C, states that HUD looks to the
underwriter as the focal point of the direct endorsement program. The underwriter must assume
the following responsibilities:

   1. Compliance with HUD instructions, the coordination of all phases of underwriting, and
      the quality of decisions made under the program.
   2. The review of appraisal reports, compliance inspections, and credit analyses performed
      by fee and staff personnel to ensure reasonable conclusions, sound reports, and
      compliance with HUD requirements.
   3. The decisions relating to the acceptability of the appraisal, the inspections, the buyers’
      capacity to repay the mortgage, and the overall acceptability of the mortgage loan for
      HUD insurance.
   4. The monitoring and evaluation of the performance of fee and staff personnel used for the
      direct endorsement program.
   5. Awareness of the warning signs that may indicate irregularities and an ability to detect
      fraud, as well as the responsibility for performing underwriting decisions with due
      diligence in a prudent manner.

Criterion 2
HUD Handbook 4155.1, REV-5, chapter 2, section 3, paragraph 2-12, states that ratios are used
to determine whether the borrower can reasonably be expected to meet the expenses involved in
homeownership and otherwise provide for the family. The lender must compute two ratios:

A. Mortgage payment expense to effective income. If the total mortgage payment (principal and
   interest, escrow deposits for real estate taxes, hazard insurance, the mortgage insurance
   premium, homeowners’ association dues, ground rent, special assessments, and payments for
   any acceptable secondary financing) does not exceed 29 percent of the gross effective
   income, the relationship of the mortgage payment to income is considered acceptable. A
   ratio exceeding 29 percent may be acceptable only if significant compensating factors are
   documented and are recorded on the mortgage credit analysis worksheet. Typically, for
   borrowers with limited recurring expense, greater latitude is permissible on this ratio than on
   the total fixed payment ratio described below.

B. Total fixed payment to effective income. If the total of the mortgage payment and all
   recurring charges does not exceed 41 percent of the gross effective income, the relationship
   of total obligations to income is considered acceptable. A ratio exceeding 41 percent may be
   acceptable only if significant compensating factors are documented and are recorded on the
   mortgage credit analysis worksheet.



                                                36
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 (determined by the State where the property is located). In lieu of
submitting a paper report, lenders must use the “lender reporting” feature in the Neighborhood
Watch Early Warning System.

Criterion 4
HUD Handbook 4155.1, REV-5, chapter 2, section 1, paragraph 2-5B, states that if the borrower,
as revealed by public records, credit information, or HUD’s Credit Alert Interactive Voice
Response System, is presently delinquent on any Federal debt (e.g., U.S. Department of Veterans
Affairs-guaranteed mortgage, Title I loan, Federal student loan, Small Business Administration
loan, delinquent Federal taxes) or has a lien, including taxes, placed against his or her property
for a debt owed to the United States, the borrower is not eligible until the delinquent account is
brought current, paid, or otherwise satisfied or a satisfactory repayment plan is made between the
borrower and the Federal agency owed and is verified in writing. Tax liens may remain unpaid
provided the lien holder subordinates the tax lien to the FHA-insured mortgage. If any regular
payments are to be made, they must be included in the qualifying ratios.

Criterion 5
HUD Handbook 4155.1, REV-5, chapter 2, paragraph 2-2A, states that borrowers and
coborrowers take title to the property and are obligated on the mortgage note and must also sign
the security instrument. The coborrower’s income, assets, liabilities, and credit history are
considered in determining creditworthiness.

Criterion 6
HUD Handbook 4155.1, REV-5, chapter 1, section 2, paragraph 1-7, states that the property’s
sales price, subject to certain required adjustments as described in A-C below, or the appraised
value, if less, is multiplied by a loan-to-value ratio. The resulting amount is the maximum
mortgage that FHA will insure. The borrower must make a cash investment at least equal to the
difference between the sales price and the resulting maximum mortgage amount.

Criterion 7
HUD Handbook 4155.1, REV-5, chapter 2, section 1, paragraph 2-3, states that for those
borrowers without established credit history and for those who do not use traditional credit, the
lender must develop a credit history from utility payment records, rental payments, automobile
insurance payments, or other means of direct access from the credit provider. The lender must
document that the providers of nontraditional credit do, in fact, exist and verify the credit
information. Documents confirming the existence of a nontraditional credit provider may
include a public record from the State, county, or city records or other means providing a similar
level of objective confirmation. To verify the credit information, lenders must use a published
address or telephone number for that creditor.




                                                 37
Criterion 8
HUD Handbook 4155.1, REV-5, chapter 2, section 2, paragraph 2-6, states that we do 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 2 full
years. If a borrower indicates that he or she was in school or in the military during any of this
time, the borrower must provide evidence supporting this claim, such as college transcripts or
discharge papers. The borrower also must explain any gaps in employment spanning one month
or more.

Criterion 9
HUD Handbook 4155.1, REV-5, chapter 2, section 4, paragraph 2-11A, states that the
borrower’s liabilities include all installment loans, revolving charge accounts, real estate loans,
alimony, child 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.

The following additional information deals with revolving accounts and alimony payments:

1. If the account shown on the credit report has an outstanding balance, 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 monthly payment).
2. Because of the tax consequences of alimony payments, the lender may choose to treat the
   monthly alimony obligation as a reduction from the borrower’s gross income in calculating
   qualifying ratios, rather than as a monthly obligation.

Criterion 10
HUD Handbook 4155.1, REV-5, chapter 3, section 1, paragraph 3-1E, states that the verification
of employment and the borrower’s most recent pay stub are to be provided. “Most recent”
means at the time the initial 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 updated.

As an alternative to obtaining a verification of employment, the lender may obtain the
borrower’s original pay stub(s) covering the most recent 30-day period, along with original
Internal Revenue Service (IRS) Forms W-2 from the previous 2 years. The pay stub(s) must
show the borrower’s name, Social Security number, and year-to-date earnings. Any copies of
the Form W-2 not submitted with the borrower’s income tax returns are considered “original”
W-2s. (These original documents may be photocopied and returned to the borrower.) The
lender also must verify by telephone all current employers. The loan file must include a
certification from the lender that 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 Form IRS 4506, Request for Copy of
Tax Form; Form IRS 8821; or a document that is appropriate for obtaining tax returns directly

                                                 38
from the IRS. The lender also may use an electronic retrieval service for obtaining W-2 and tax
return information. If the employer will not give telephone confirmation of employment or if the
W-2 indicates inconsistencies (e.g., FICA (Federal Insurance Contributions Act) payments not
reflecting earnings), standard employment documentation must be used.

Criterion 11
HUD Handbook 4155.1, REV-5, chapter 2, section 2, paragraph 2-7, states that the income of
each borrower to be obligated for the mortgage debt must be analyzed to determine whether it
can reasonably be expected to continue through at least the first 3 years of the mortgage loan. If
the borrower intends to retire during this period, the effective income must be the amount of
documented retirement benefits, Social Security payments, or other payments expected to be
received in retirement. No inquiry may be made regarding possible future maternity leave. In
most cases, the borrower’s income will be limited to salaries or wages. Income from other
sources can be included as effective income with proper verification by the lender.

Criterion 12
HUD Handbook 4155.1, REV-5, chapter 2, section 1, paragraph 2-3C, states that court-ordered
judgments must be paid off before the mortgage loan is eligible for FHA insurance endorsement.
(An exception may be made if the borrower has agreed with the creditor to make regular and
timely payments on the judgment and documentation is provided showing that the payments
have been made in accordance with the agreement.) FHA does not require that collection
accounts be paid off as a condition of mortgage approval. Collections and judgments indicate a
borrower’s regard for credit obligations and must be considered in the analysis of
creditworthiness with the lender documenting its reasons for approving a mortgage when the
borrower has collection accounts or judgments. The borrower must explain in writing all
collections and judgments.

Criterion 13
Mortgagee Letter 2005-16 states that FHA’s benchmark payment-to-income and debt-to-income
ratios of 29 percent and 41 percent, respectively, were promulgated before Congress enacted
recent federal tax cuts. Consequently, most borrowers seeking FHA mortgage insurance have
enjoyed a reduction to their Federal income tax during the last several years, thus increasing their
buying power and disposable income.

Therefore, for manually underwritten mortgages in which the direct endorsement underwriter
must 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 the 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 14
Regulations at 24 CFR 3500.8(b)(1) state that the settlement agent shall state the actual charges
paid by the borrower and seller on the HUD-1 or by the borrower on the HUD-1A. The
settlement agent must separately itemize each third-party charge paid by the borrower and seller.
All origination services performed by or on behalf of the loan originator must be included in the

                                                 39
loan originator’s own charge. Administrative and processing services related to title services
must be included in the title underwriter’s or title agent’s own charge. The amount stated on the
HUD-1 or HUD-1A for any itemized service cannot exceed the amount actually received by the
settlement service provider for that itemized service, unless the charge is an average charge in
accordance with paragraph (b)(2) of this section

Criterion 15
Regulations at 24 CFR 3500.8(c) state that an inadvertent or technical error in completing the
HUD-1 or HUD-1A shall not be deemed a violation of section 4 of the Real Estate Settlement
Procedures Act if a revised HUD-1 or HUD-1A is provided in accordance with the requirements
of this section within 30 calendar days after settlement.

Criterion 16
HUD Handbook 4000.2, chapter 5, paragraph 5-2, states that below are the customary and
reasonable fees and charges that may be collected from the borrower by the lender and used to meet
the minimum investment requirement for purchases and added to the existing indebtedness for
refinances. The cost for any item charged to the borrower must not exceed the cost paid by the
lender or charged to the lender by the service provider.

       A.      Appraisal fee and inspection fee. The borrower may be charged an appraisal
               fee. This fee may not exceed the actual appraisal fee, divided by the number of
               lots covered by the appraisal. Inspection fees may be collected from the borrower
               for any inspections that must be conducted on the property.

The appropriate Homeownership Center may authorize or reject any other charge or the amount
of any charge, based on what is reasonable and customary in the area.

Criterion 17
HUD Handbook 4155.1, REV-5, chapter 2, section 3, paragraph 2-10, states that the cash
investment in the property must equal the difference between the amount of the insured mortgage,
excluding any up-front mortgage insurance premium, and the total cost to acquire the property
including prepaid expenses and closing costs as described in paragraph 1-9. All funds for the
borrower’s investment in the property must be verified and documented. Acceptable sources of
these funds include the following:

       A.      Earnest money deposit. If the amount of the earnest money deposit exceeds 2
               percent of the sales price or appears excessive based on the borrower’s history of
               accumulating savings, the lender must verify with documentation the deposit
               amount and the source of funds. Satisfactory documentation includes a copy of
               the borrower’s cancelled check. A certification from the deposit holder
               acknowledging receipt of funds and separate evidence of the source of funds is
               also acceptable. Evidence of source of funds includes a verification of deposit or
               bank statement showing that at the time the deposit was made, the average
               balance was sufficient to cover the amount of the earnest money deposit.




                                                 40
       B.      Savings and checking accounts. A verification of deposit, along with the most
               recent bank statement, may be used to verify savings and checking accounts. If
               there is a large increase in an account or the account was opened recently, the
               lender must obtain a credible explanation of the source of those funds.

Criterion 18
HUD Handbook 4060.1, REV-2, chapter 7, paragraph 7-1 states that all FHA approved
mortgagees, including loan correspondents, must implement and continuously have in place a
quality control plan for the origination and/or servicing of insured mortgages as a condition of
receiving and maintaining FHA approval.

Criterion 19
HUD Handbook 4060.1, REV-2, chapter 7, paragraph 7-6B states that for mortgagees closing
more than 15 loans monthly, quality control reviews must be conducted at least monthly and
must address one month’s activity. Mortgagees closing 15 or fewer loans monthly may perform
quality control reviews on a quarterly basis.

Criterion 20
HUD Handbook 4060.1, REV-2, chapter 7, 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 prior to closing are identified as early after closing as
possible.




                                                 41
Appendix D

          SCHEDULE OF SIGNIFICANT UNDERWRITING
                      DEFICIENCIES


                                                                                                       Deficiency area(s)




                                                                                                                                                                                                                          Misrepresentation of
                                                                                                                                                                                  Maximum mortgage
                                          Forged employment




                                                                                                                                                                                                     employment history
                                                              Questionable credit




                                                                                                                                           Overstated income




                                                                                                                                                                                  amount exceeded
                                                                                                                         Excluded income
                                                                                    Unpaid tax liens




                                                                                                                                                               Excessive ratios
                                                                                                         Underreported




                                                                                                                                                                                                     Questionable
                                                                                                         liabilities




                                                                                                                                                                                                                          HUD-1
                                                              history
                Unpaid
  FHA case     principal      Insurance   letter
   number       balance         status
105-3105552   $     179,391   Active                                                                         X                                                 X
105-3002046   $     164,690   Active                                                                                                                                                 X
105-3095528   $     150,267   Active                                                X
105-3212712   $     122,455   Active                                                                                                                                                                     X
105-3885875   $     114,856   Active          X
105-3231684   $     113,014   Active                                                                                                       X                   X
105-2954735   $      98,072   Active                                                                         X           X
105-3097672   $      90,173   Active                               X
105-4913683   $      83,884   Active                                                                                                                                                                                           X
Total         $ 1,116,802




                                                              42
Appendix E

          CASE STUDIES FOR LOANS WITH SIGNIFICANT
                        DEFICIENCIES


Case number: 105-3105552                      Insured amount: $182,899

Section of Housing Act: 203(b)                Unpaid principal balance: $179,391

Date of loan closing: July 27, 2007           Default reason: Curtailment of borrower’s income


Underreported Liabilities
Mortgage Counseling Services did not include the coborrower’s mortgage payments, totaling
$855 per month, in the debt-to-income ratios. The coborrower had converted her primary
residence into a rental property. The lender documented the 2-year lease agreement; however,
the lease did not take effect until August 1, 2007, which was after the July 27, 2007, closing date.
Therefore, the mortgage payment should have been included in the debt ratio calculation. In
addition, the liability was large enough to adversely affect the borrower’s ability to make the
mortgage payment immediately after closing. When the underreported liability of $855 per
month is applied to the ratios, the ratios increase to 38.41 and 63.42 percent.

HUD Requirements-Appendix C
HUD Handbook 4004.4, REV-1, CHG-2, paragraph 2-4C (criterion 1)
HUD Handbook 4155.1, REV-5, chapter 2, section 4, paragraph 2-11A (criterion 9)
HUD Handbook 4155.1, REV-5, chapter 2, paragraph 2-2A (criterion 5)
Mortgagee Letter 2005-16 (criterion 13)




                                                 43
Case number: 105-3002046                    Insured amount: $168,667

Section of Housing Act: 203(b)              Unpaid principal balance: $164,690

Date of loan closing: April 24, 2007        Default reason: Curtailment of borrower income


Maximum Mortgage Amount Exceeded
Mortgage Counseling Services did not use the appropriate value in determining the maximum
insurable mortgage amount. The lender did not use the lower of sales price or appraised value to
determine the maximum insurable mortgage amount. The borrower purchased a newly
constructed home. The initial sales contract was dated January 28, 2007, with a sales price of
$157,900. An appraisal was performed on the property on April 19, 2007, during which the
property was valued at $170,000. On April 23, 2007, an amendment to the agreement was
executed that increased the sales price to $170,000.

HUD Requirements-Appendix C
HUD Handbook 4155.1, REV-5, chapter 1, section 2, paragraph 1-7 (criterion 6)




                                                44
Case number: 105-3095528                         Insured amount: $152,793

Section of Housing Act: 203(b)                   Unpaid principal balance: $150,267

Date of loan closing: October 15, 2007           Default reason: Death of borrower’s family


Unpaid Tax Liens
Mortgage Counseling Services did not ensure that all Federal tax liens had established payment
plans. The borrowers had five tax liens on their credit report at the time of loan closing.


                   Tax lien   Type of tax lien      Amount          Date filed
                   1          Federal                 25,200        March-95
                   2          State                   11,700      September-95
                   3          Federal                 13,899        April-07
                   4          Federal                  7,434       January-96
                   5          State                      512       February-06



The lender documented a payoff on tax lien no. 5 and installment payment agreements on tax
liens nos. 1 and 3. However, the lender did not document the status of the remaining two tax
liens (nos. 2 and 4), nor was there any documentation that provided explanations for the tax
liens. The additional tax lien payments would have affected the borrowers’ ability to make
mortgage payments and should have been included in the qualifying ratios for this loan.

HUD Requirements-Appendix C
HUD Handbook 4000.4, REV-1, CHG-2, paragraph 2-4C (criterion 1)
HUD Handbook 4155.1, REV-5, chapter 2, section 1, paragraph 2-5B (criterion 4)
HUD Handbook 4155.1, REV-5, chapter 2, section 1, paragraph 2-3C (criterion 12)




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Case number: 105-3212712                    Insured amount: $124,615

Section of Housing Act: 203(b)              Unpaid principal balance: $122,455

Date of loan closing: September 28, 2007    Default reason: Curtailment of borrower’s income


Questionable Employment History
Mortgage Counseling Services did not establish an acceptable employment history for the
coborrower or obtain adequate supporting documentation. The lender did not verify the
coborrower’s previous employment for the most recent full 2 years or obtain a verification of
previous employment that would have indicated the borrower’s rate of pay and duration of
employment.

HUD Requirements-Appendix C
HUD Handbook 4000.4, REV-1, CHG-2, paragraph 2-4C (criterion 1)
HUD Handbook 4155.1, REV-5, chapter 3, section 1, paragraph 3-1E (criterion 10)
HUD Handbook 4155.1, REV-5, chapter 2, section 2, paragraph 2-6 (criterion 8)




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Case number: 105-3885875                      Insured amount: $115,983

Section of Housing Act: 203(b)                Unpaid principal balance: $114,856

Date of loan closing: July 29, 2008           Default reason: Unemployment


Forged Offer of Employment Letter
Mortgage Counseling Services’s third-party contractor conducted a quality control review. The
quality control findings exposed a forged offer of employment letter obtained from the
borrower’s former employer. During the reverification of employment performed during the
quality control review, the employer provided a written statement as well as the authentic offer
of employment letter. The written statement stated, “that the letter, its contents, and its signature
were fabricated and were not prepared, endorsed or authorized by any representative.” As a
result of the forged offer of employment letter, the employer terminated the borrower’s
employment, causing the borrower to default on the loan. Mortgage Counseling Services
decided not to report the finding to HUD.

HUD Requirements-Appendix C
HUD Handbook 4000.4, REV-1, CHG-2, paragraph 2-4C (criterion 1)
HUD Handbook 4060.1, REV-2, paragraph 7-3J (criterion 3)




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Case number: 105-3231684                    Insured amount: $115,090

Section of Housing Act: 203(b)              Unpaid principal balance: $113,014

Date of loan closing: October 15, 2007      Default status: Curtailment of borrower income


Overstated Income/Excessive Ratios
Mortgage Counseling Services overstated the borrower’s employment income by $200 per week,
resulting in excessive qualifying ratios of 44.71 percent and 45.64 percent ($969 / $2,167 and
$989 / $2,167). The lender relied on a verbal verification of employment, which stated a current
gross base pay of $700 weekly ($700 x 52 weeks / 12 = $3,033). However, pay stubs for the
borrower documented a pay rate of $500 per week ($500 x 52 weeks / 12 = $2,167). Therefore,
the lender overstated the borrower’s monthly income by $867 ($3,033 – $2,167).

HUD Requirements-Appendix C
HUD Handbook 4000.4, REV-1, CHG-2, paragraph 2-4C (criterion 1)
HUD Handbook 4155.1, REV-5, chapter 2, section 2, paragraph 2-7 (criterion 11)
Mortgagee Letter 2005-16 (criterion 13)




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Case number: 105-2954735                  Insured amount: $100,604

Section of Housing Act: 203(b)            Unpaid principal balance: $98,072

Date of loan closing: March 23, 2007      Default reason: Excessive obligations


Underreported Liabilities and Income
Mortgage Counseling Services underreported the borrower’s monthly child support payments by
$271. In addition, the underwriter did not include the borrower’s income in determining the
qualifying ratios. The lender excluded the borrower’s income to offset the child support
payments, which led to including only the coborrower’s income to qualify for the loan.
However, the lender was required to include all liabilities and income in determining the
qualifying ratios.

HUD Requirements-Appendix C
HUD Handbook 4004.4, REV-1, CHG-2, paragraph 2-4C (criterion 1)
HUD Handbook 4155.1, REV-5, chapter 2, section 4, paragraph 2-11A (criterion 9)




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Case number: 105-3097672                    Insured amount: $ 91,774

Section of Housing Act: 203(b)              Unpaid principal balance: $90,173

Date of loan closing: July 27, 2007         Default reason: Curtailment of borrower income


Questionable Credit History
Mortgage Counseling Services did not establish a credit history for the borrower. The credit
report did not contain any information about the borrower, and the borrower did not provide any
nontraditional letters of credit. The underwriter obtained one utility payment referral, which
showed that the borrower was an account holder and had not made a late payment in 12 months.
However, there was no payment history information, such as length of service, which would
indicate how long the borrower had used the utility service. The lender did not have any
additional credit history information. Therefore, the lender did not adequately establish
acceptable credit history when using only one nontraditional letter of credit.

HUD Requirements-Appendix C
HUD Handbook 4004.4, REV-1, CHG-2, paragraph 2-4C (criterion 1)
HUD Handbook 4155.1, REV-5, chapter 2, section 1, paragraph 2-3 (criterion 7)




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Case number: 105-4913683                       Insured amount: $ 84,111

Section of Housing Act: 203(b)                 Unpaid principal balance: $83,884

Date of loan closing: July 17, 2009            Loan status: Current


Misrepresentation of HUD-1
Mortgage Counseling Services misrepresented a HUD-1 that was submitted for FHA insurance.
The initial HUD-1 showed that the borrower owed $2,320 at closing. The lender revised the
HUD-1 to show that the borrower owed only $804 at closing. The Mortgage Counseling
Services president created a lender credit of $675 and removed the loan discount of $841, which
decreased the amount the borrower owed at closing to $804 (2,320 – 675 – 841 = 804). The
lender instructed the borrower to write two postdated checks as follows:

                              Check number        Check date         Check amount
                              1108                8/15/2009          $400
                              1111                10/15/2009         $1,116
                              Total                                  $1,516

                              Note: The total amount in postdated checks ($1,516) plus
                              the amount paid at closing ($804) totals the $2,320 required
                              on the initial HUD-1.

According to bank statements, dated June 15, 2009, the borrower had $3,330 in her checking
account. This loan closed on July 17, 2009. There were no additional verifications completed
before the closing. Shortly before the loan closed, the borrower was contacted and told that she
had to bring $2,320 to closing. At that time (July 2009), the borrower stated that she did not
have $2,320 for closing. At this point, the lender should have terminated the loan for lack of
sufficient funds to close. However, the president created another HUD-1, reducing the amount
of funds needed to close from $2,320 to $804. The borrower must have sufficient funds to close
the loan.

The Mortgage Counseling Services president stated that she was not aware of the two postdated
checks. However, after we visited the lender in August 2009 to obtain the loan file, the president
contacted the borrower and sent her a letter stating that it was improper to collect the additional
postdated checks, and the president destroyed the checks. The president stated that the loan was
not reviewed after closing, which is why there was no knowledge of the improper activity.

Federal Requirements-Appendix C
24 CFR 3500.8(b)(1) (criterion 14)
HUD Handbook 4155.1, REV-5, section 3, chapter 2, paragraph 2-10, (criterion 17)




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Appendix F

      SCHEDULE OF INDEMNIFICATION AMOUNTS




                                                        Loss
                FHA case        Unpaid principal percentage Indemnification
                 number               balance          rate*             amount
              105-3105552         $      179,391         42            $ 75,344
              105-3002046         $      164,690         42            $ 69,170
              105-3095528         $      150,267         42            $ 63,112
              105-3212712         $      122,455         42            $ 51,431
              105-3885875         $      114,856         42            $ 48,240
              105-3231684         $      113,014         42            $ 47,466
              105-2954735         $        98,072        42            $ 41,190
              105-3097672         $        90,173        42            $ 37,873
              105-4913683        $         83,884        42            $ 35,231
             Totals              $     1,116,802                       $ 469,057
             *We classified $469,057 as funds to be put to better use. This is 42
             percent of the $1,116,802 in unpaid principal balances in nine FHA-
             insured loans that did not meet HUD’s requirements. We used 42
             percent because HUD has determined that upon sale of the mortgaged
             properties, FHA’s average loss was about 42 percent of the unpaid
             principal balance for fiscal year 2008.




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