oversight

Mac-Clair Mortgage Corporation, Flint, MI, Did Not Properly Underwrite a Selection of FHA Loans

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-07-22.

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

                                             U.S. Department of Housing and Urban Development
                                             Office of Inspector General for Audit, Region V
                                             Ralph H. Metcalfe Federal Building
                                             77 West Jackson Boulevard, Suite 2646
                                             Chicago, Illinois 60604-3507

                                             Phone (312) 353-7832 Fax (312) 353-8866
                                             Internet http://www.hud.gov/offices/oig/




                                                                                MEMORANDUM NO:
                                                                                     2010-CH-1808

July 22, 2010

MEMORANDUM FOR: Vicki Bott, Deputy Assistant Secretary for Single Family, HU
                Dane M. Narode, Associate General Counsel for Program
                  Enforcement, CACC


FROM: Heath Wolfe, Regional Inspector General for Audit, 5AGA

SUBJECT: Mac-Clair Mortgage Corporation, Flint, MI, Did Not Properly Underwrite a
           Selection of FHA Loans

                                      INTRODUCTION

We reviewed 20 Federal Housing Administration (FHA) loans that Mac-Clair Mortgage
Corporation (Mac-Clair) underwrote as an FHA direct endorsement lender. Our review
objective was to determine whether Mac-Clair underwrote the 20 loans in accordance with FHA
requirements. This review is part of “Operation Watchdog”, an OIG initiative to review the
underwriting of 15 direct endorsement lenders at the suggestion of the FHA Commissioner. The
Commissioner expressed concern regarding the increasing claim rates against the FHA insurance
fund for failed loans.

For each recommendation without a management decision, please respond and provide status
reports in accordance with the U.S. Department of Housing and Urban Development’s (HUD)
Handbook 2000.06, REV-3. Please furnish us copies of any correspondence or directives issued
because of the review.

We provided our discussion draft memorandum report to Mac-Clair’s management during the
review. We asked Mac-Clair to provide written comments on our discussion draft memorandum
report by June 7, 2010. Mac-Clair’s president provided written comments to the discussion draft
report, dated June 7, 2010. The president disagreed with our finding and recommendations. The
complete text of the lender’s comments, along with our evaluation of that response, can be found
in appendix C of this report, except for 45 exhibits of 121 pages of documentation that was not
necessary to understand the lender’s comments. We provided HUD’s Deputy Assistant



                                                  1
Secretary for Single Family Housing and Associate General Counsel for Program Enforcement
with a complete copy of Mac-Clair’s written comments plus the 121 pages of documentation.

                                     METHODOLOGY AND SCOPE

Mac-Clair is 1 of 15 direct endorsement lenders we selected from HUD’s publicly available
Neighborhood Watch1 system (system) for a review of underwriting quality. These direct
endorsement lenders all had a compare ratio2 in excess of 200 percent of the national average as
listed in the system for loans endorsed between November 1, 2007, and October 31, 2009. We
selected loans that had gone into a claims status. We selected loans for Mac-Clair that defaulted
within the first 30 months and were: (1) not streamline refinanced, (2) not electronically
underwritten by Fannie Mae or Freddie Mac, and (3) associated with an underwriter (usually an
individual) with a high number of claims.

                                               BACKGROUND

Mac-Clair is a nonsupervised direct endorsement lender based in Flint, MI. FHA approved Mac-
Clair as a direct endorser in November 1994. FHA’s mortgage insurance programs help low-
and moderate-income families become homeowners by lowering some of the costs of their
mortgage loans. FHA mortgage insurance also encourages lenders to approve mortgages for
otherwise creditworthy borrowers that might not be able to meet conventional underwriting
requirements by protecting the lender against default. The direct endorsement program
simplifies the process for obtaining FHA mortgage insurance by allowing lenders to underwrite
and close the mortgage loan without prior HUD review or approval. Lenders are responsible for
complying with all applicable HUD regulations and are required to evaluate the borrower’s
ability and willingness to repay the mortgage debt. Lenders are protected against default by
FHA’s mutual mortgage insurance fund, which is sustained by borrower premiums.

The goal of Operation Watchdog is to determine why there is such a high rate of defaults and
claims. We selected up to 20 loans in claims status from each of the 15 lenders. The 15 lenders
selected for Operation Watchdog endorsed 183,278 loans valued at $31.3 billion during the
period January 2005 to December 2009. These same lenders also submitted 6,560 FHA
insurance claims with an estimated value of $794.3 million from November 2007 through
December 2009. During this period, Mac-Clair endorsed 2,856 loans valued at more than $309
million and submitted 458 claims worth more than $41.4 million.

Our objective was to determine whether the 20 selected loans were properly underwritten and if
not, whether the underwriting reflected systemic problems.

We performed our work from January through April 2010. We conducted our work in
accordance with generally accepted government auditing standards, except that we did not

1
  Neighborhood Watch is a system that aids HUD/FHA staff in monitoring lenders and FHA programs. This system
allows staff to oversee lender origination activities for FHA-insured loans, and tracks mortgage defaults and claims.
2
  HUD defines “compare ratio” as a value that reveals the largest discrepancies between the direct endorser’s default
and claim percentage and the default and claim percentage to which it is being compared. FHA policy establishes a
compare ratio over 200 percent as a warning sign of a lender’s performance.


                                                            2
consider the internal controls or information systems controls of Mac-Clair, consider the results
of previous audits, or communicate with Mac-Clair’s management in advance. We did not
follow standards in these areas because our objective was to aid HUD in identifying FHA single-
family insurance program risks, and patterns of underwriting problems or potential wrongdoing
in poor performing lenders that led to a high rate of defaults and claims against the FHA
insurance fund. To meet our objective, it was not necessary to full comply with the standards,
nor did our approach negatively affect our review results.

                                       RESULTS OF REVIEW

Mac-Clair did not properly underwrite 7 of the 20 loans reviewed because its underwriters did
not follow FHA’s requirements. As a result, FHA’s insurance fund suffered actual losses of
$562,551, as shown in the following table.

                                            Number of
          FHA/loan                       payments before   Original mortgage   Actual loss
           number       Closing date       first default        amount           to HUD
         261-9230184      7/31/07                2          $56,535             $47,525
         262-1625921      7/14/06                4          129,959              119,746
         262-1628044      8/14/06                3           92,449                82,764
         262-1636498     10/20/06                3           66,431                75,225
         262-1652638      4/06/07                4          125,352               96, 364
         262-1653481      3/23/07                4           44,457                46,849
         262-1673933      7/13/07                0          106,160                94,078
                              Totals                       $621,343            $562,551

The following table summarizes the material deficiencies that we identified in the seven loans.

                                                           Number of
                                 Area of noncompliance       loans
                               Income                          4
                               Liabilities                     4
                               Excessive ratios                1
                               Gift funds                      2
                               Credit report                   3
                               Verification of rent            1

Appendix A shows a schedule of material deficiencies in each of the seven loans. Appendix B
provides a detailed description of all loans with material underwriting deficiencies noted in this
report.

Income

Mac-Clair did not properly verify borrowers’ income or determine income stability for four
loans. HUD does not allow income to be used in calculating a borrower’s income ratios if it
cannot be verified, is not stable, or will not continue. Mac-Clair is required to analyze whether
income is reasonably expected to continue through at least the first 3 years of the mortgage loan
(see appendix B for detailed requirements).



                                                   3
For example, for loan number 261-9230184, Mac-Clair used the borrower’s current pay rate.
However, the borrower’s rate of pay had only recently increased by 72 percent. Further, the
same borrower had held five different jobs in the previous 2 years. Using the borrower’s average
monthly income for the previous 2-year period instead of his most recent rate of pay resulted in a
mortgage payment-to-income ratio of 138 percent.

For loan number 262-1673933, Mac-Clair’s underwriter considered the borrower’s relative’s
Social Security income to be the borrower’s income. The borrower was the Social Security
recipient’s representative payee. However, the loan file did not document the recipient’s
intention to live at the subject property.

Liabilities

Mac-Clair did not properly assess the borrowers’ financial obligations for four loans. HUD
requires lenders to consider debts if the amount of the debts affects the borrower’s ability to
make the mortgage payment during the months immediately after loan closing (see appendix B
for detailed requirements).

For example, for loan number 262-1628044, Mac-Clair did not consider a debt because there
were less than 10 payments remaining on the debt. The loan application showed that the
borrower had a bank loan of $2,685 with monthly payments of $300. However, Mac-Clair’s
underwriter did not consider that the borrower had no cash assets remaining after loan closing.
For loan number 262-1652638, two monthly installment loans totaling $199 were listed on the
borrower’s credit report, but were not shown on the loan application or the mortgage credit
analysis worksheet3.

Excessive Ratios

Mac-Clair improperly approved loan number 262-1652638 when the borrower’s total fixed
payment-to-income ratio exceeded FHA’s requirement of 43 percent. Effective April 13, 2005,
the mortgage payment-to-income and total fixed payment-to-income ratios were increased from
29 and 41 percent to 31 and 43 percent, respectively. If either or both ratios are exceeded on a
manually underwritten mortgage, the lender is required to describe the compensating factors
used to justify the mortgage approval (see appendix B for detailed requirements).

The total fixed payment-to-income ratio reported on the mortgage credit analysis worksheet was
45.62 percent. As a compensating factor, Mac-Clair’s underwriter used the borrower’s previous
history of paying housing expenses greater than the proposed mortgage payment. However, the
loan processor was unable to contact the borrower’s landlord to verify past rental payments.

Gift Funds

Mac-Clair did not properly document gift funds received by borrowers for two loans. HUD
requires that the lender must be able to determine that gift funds ultimately were not provided by
an unacceptable source (see appendix B for detailed requirements).
3
    The mortgage credit analysis worksheet is used to analyze and document mortgage approval.


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For loan number 261-9230184, the gift fund donor was the borrower’s spouse. The bank
account from which the gift funds were paid was the same bank account listed by the borrower
as an asset on his uniform residential loan application. Also, the bank account was opened
approximately 2 months before the borrower applied for the home mortgage. There were two
deposits to the account that corresponded to the amount of both the earnest money deposit and
the cash to close. Mac-Clair did not verify the source of these deposits.

For loan number 262-1652638, the loan file did not document the withdrawal of the gift funds
from the donor’s account. As a condition to close, Mac-Clair’s underwriter was to obtain the
withdrawal slip from the donor’s bank account. However, the underwriter did not do so.

Credit report

Mac-Clair did not properly evaluate the borrowers’ credit histories for three loans. HUD
requires the lender to consider collection accounts in analyzing a borrower’s creditworthiness.
The lender must explain all collections in writing (see appendix B for detailed requirements).

For example, for loan number 262-1652638, the loan file did not include letters of explanation
for past-due accounts or evidence of payoff for collection accounts. One of the conditions to
close was payoff of the collection accounts. The condition was not met at closing.

Verification of Rent

Mac-Clair did not properly verify borrowers’ rental histories for one loan. HUD notes that the
payment history of the borrower’s housing obligations holds significant importance in evaluating
credit. The lender must determine the borrower’s housing payment history through acceptable
means, including verification of rent directly from the landlord or through cancelled checks
covering the most recent 12-month period (see appendix B for detailed requirements).

For loan number 262-1625921, one of the conditions to close was to obtain 12 months of
cancelled checks to verify the rental payment history. The loan file only included an account
history for a 7-month period for the borrower’s wife’s bank account, showing withdrawals at the
end of each month. The loan file did not include cancelled checks or other explanations for the
rental payments.

Incorrect Underwriter’s Certifications Submitted to HUD

We reviewed the certifications for the seven loams with material underwriting deficiencies for
accuracy. Mac-Clair’s direct endorsement underwriters incorrectly certified that due diligence
was used in underwriting the seven loans. When underwriting a loan manually, HUD requires a
direct endorsement lender to certify that it used due diligence and reviewed all associated
documents during the underwriting of a loan.

The Program Fraud Civil Remedies Act of 1986 (231 U.S.C. (United States Code) 3801)
provides Federal agencies, which are the victims of false, fictitious, and fraudulent claims and



                                                   5
statements, with an administrative remedy (1) to recompense such agencies for losses resulting
from such claims and statements; (2) to permit administrative proceedings to be brought against
persons who make, present, or submit such claims and statements; and (3) to deter the making,
presenting, and submitting of such claims and statements in the future.

                                             RECOMMENDATIONS

We recommend that HUD’s Associate General Counsel for Program Enforcement
1A.   Determine legal sufficiency and if legally sufficient, pursue remedies under the Program
      Fraud Civil Remedies Act against Mac-Clair and/or its principals for incorrectly
      certifying to the integrity of the data or that due diligence was exercised during the
      underwriting of seven loans that resulted in losses to HUD totaling $562,551 which could
      result in affirmative civil enforcement action of approximately $1,177,6024.

We also recommend that HUD’s Deputy Assistant Secretary for Single Family

1B.        Take appropriate administrative action against Mac-Clair and/or its principals for the
           material underwriting deficiencies cited in this report once the affirmative civil
           enforcement action cited in Recommendation 1A is completed.


                                          Schedule of Ineligible Cost 1/

                                        Recommendation
                                            number                           Amount
                                                 1A                          $562,551


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
           policies or regulations. The amount shown represents the actual loss HUD incurred when
           it sold the affected properties.




4
    Double damages plus a $7,500 fine for each of the seven incorrect certifications.


                                                              6
                                                                                                                                                                                                       Appendix A




    262-1673933
                  262-1653481
                                262-1652638
                                              262-1636498
                                                            262-1628044
                                                                          262-1625921
                                                                                        261-9230184
                                                                                                       FHA loan number
                                                                                                      Unsupported income or questionable
                                                                                                             employment history




    X
                                X
                                                                          X
                                                                                        X
                                                                                                                         Underreported liabilities




                                X
                                              X
                                                            X
                                                                          X
                                                                                                                     Excessive debt-to-income ratio




                  X




7
                                                                                                                     Insufficient gift documentation



                                X
                                                                                        X




                                                                                                      Significant credit-related deficiencies
                  X                                                                                                or no credit
                                X
                                                                                        X




                                                                                                      Incomplete verification of rent history
                                                                          X
                                                                                                                                                       SUMMARY OF MATERIAL UNDERWRITING DEFICIENCIES
Appendix B

 LOANS WITH MATERIAL UNDERWRITING DEFICIENCIES


Loan number: 261-9230184

Mortgage amount: $56,535

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: July 31, 2007

Status: Claim

Payments before first default reported: Two

Loss to HUD: $47,525

Summary:

We found material underwriting deficiencies relating to the borrower’s income, gift funds, and
credit history.

Income:

Mac-Clair used excessive income to approve the loan. There was no documentation to show
why the borrower’s income that almost doubled just 30 days before closing would continue.

Mac-Clair’s underwriter calculated the borrower’s income as $500 per week. The income
amount was based on a letter from the borrower’s employer, dated June 4, 2007, stating that the
borrower would begin to work for a salary of $500 per week on June 25, 2007. Further, the loan
file contained pay stubs for pay periods ending July 6 and July 20, 2007, that showed a biweekly
salary of $1,000.

Documents in the loan file showed that the borrower was an hourly employee for the same
employer for the period November 17, 2006, to June 22, 2007. The employee’s hourly rate of
pay was $7.00 from November 2006 to April 2007 and $7.25 from May to June 2007. During
this period, the borrower worked an average of 28 hours per week. During 2005 and 2006, the
borrower also worked for four other employers.

For the 2-year period before the loan closing, the borrower’s average monthly income was $465.
Using this average for the previous 2-year period would increase the mortgage payment-to-


                                                 8
income ratio from 29.77 to 138.60 percent ($644.50 mortgage payment divided by $465 average
monthly income equals 138.60 percent). The total fixed payments-to-income ratio would also
increase from 29.77 to 138.60 percent.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, section 2, states that income may not be used in calculating the
borrower’s income ratios if it comes from any source that cannot be verified, is not stable, or will
not continue. Paragraph 2-6 states that 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 2 full years. 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 three years of the
mortgage loan.

Gift Funds:

Mac-Clair’s underwriter did not verify the source of gift funds. Given that the donor and
borrower shared the same bank account, the source of the gift funds should have been verified.

The borrower’s wife provided gift funds of $2,815 to the borrower. The loan file contained a
transaction history for a TCF Bank account in the name of the borrower’s wife for the period
May 2 to July 18, 2007. The uniform residential loan application listed the same account as an
asset of the borrower. The transaction history showed that the account was opened with a
deposit of $3,000 on May 2, 2007. Another deposit of $500 was made on June 15, 2007. On
July 2, 2007, $504 was withdrawn from the account. The transaction history included a notation
that this withdrawal was for the earnest money deposit.

The loan file also contained copies of two separate withdrawal slips from TCF Bank, dated July
31, 2007. One withdrawal of $2,115 came from the aforementioned account, and another
withdrawal of $200 came from a different account. These withdrawals were purportedly used
for the borrower’s cash to close.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-10C2, states that regardless of when gift funds are
made available to the home buyer, the lender must be able to determine that the gift funds
ultimately were not provided by an unacceptable source and were indeed the donor’s own funds.

Credit:

Mac-Clair did not document its reason(s) for not considering collection accounts, especially a
recent collection account of $2,490.

The borrower’s credit report showed two open medical collection accounts, one an old one
opened in August 2005 for $161 and another recent account for $2,490 opened in March 2007.



                                                   9
The first account was opened in August 2005 and showed a balance of $161. The second
account was opened in March 2007 and showed a balance of $2,490. The borrower wrote a
letter of explanation stating that the collections resulted because he did not have medical
insurance.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-3C, states that 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 a
borrower has collection accounts or judgments.

One of the collection accounts was opened only 5 months before the loan closing.




                                                10
Loan number: 262-1625921

Mortgage amount: $129,959

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: July 14, 2006

Status: Claim

Payments before first default reported: Four

Loss to HUD: $119,746

Summary:

We found material underwriting deficiencies relating to the borrower’s income, liabilities, and
credit history.

Income:

The uniform residential loan application stated that the borrower had been self-employed in the
construction business for 1 year. The borrower’s monthly self-employment income was
calculated as $5,416 per month. The loan file contained a copy of the borrower’s 2005 Federal
income tax return showing self-employment income. The loan file also contained a copy of the
profit and loss statement for the borrower’s business for the first 6 months of 2006. The loan
application stated that the borrower was previously employed by a vocational school and he
taught construction trades. The borrower’s average monthly teaching income for the previous 2
years was $2,344. If the two occupations were not considered related, self-employment income
of less than 2 years duration would not have been considered in the mortgage approval process.

Using only the borrower’s average monthly employment income would increase the mortgage
payment-to-income ratio from 21.73 to 50.20 percent ($1,177 divided by $2,344). The total
fixed payments-to-income ratio would increase from 24.09 to 55.66 percent ($1,305 divided by
$2,344).

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-9A, states that income from self-employment is
considered stable and effective if the borrower has been self-employed for 2 or more years.
Paragraph 2-9A1 states that an individual self-employed between 1 and 2 years must have at
least 2 years of documented previous successful employment in the line of work in which the
borrower is self-employed or in a related occupation to be eligible.




                                                 11
Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and
total fixed payment-to-income ratios from 29 and 41 percent to 31 and 43 percent, respectively.
It stated that if either or both ratios are exceeded on a manually underwritten mortgage, the
lender is required to describe the compensating factors used to justify the mortgage approval.

Liabilities:

The borrower’s credit report showed a past-due credit card bill for $376. The credit report
included a statement that the account was closed by the credit grantor. There was also a
handwritten note stating, “Paid see receipt.” The loan file did not include documentation
showing that the account was paid off.

One of the conditions to satisfy before loan closing required the borrower to provide proof of
payoffs for all past-due accounts.

Credit:

The loan file contained a verification of rent for the period February 2004 to July 2006 to
establish the borrower’s credit history. The loan file also contained an account history from the
Flint Area School Employees Credit Union, account number 62438, for the period January 1 to
July 12, 2006. The account holder was the borrower’s wife. There was a handwritten notation
stating, “Bank statements from Jan. to show rent payments.” The account history only showed
large withdrawals at the end of each month.

The loan file did not contain cancelled checks. Mac-Clair should have required the borrower to
provide cancelled checks before sending the loan for closing.

One of the conditions to satisfy before loan closing required the borrower to provide verification
of rent for the current residence along with 12 months of cancelled rental checks.




                                                  12
Loan number: 262-1628044

Mortgage amount: $92,449

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: August 14, 2006

Status: Claim

Payments before first default reported: Three

Loss to HUD: $82,764

Summary:

We found a material underwriting deficiency relating to the borrower’s liabilities.

Liabilities:

The initial uniform residential loan application, dated July 10, 2006, showed a bank loan balance
of $4,842 and monthly payments of $300. The borrower used a gift of $1,603 from his parents
to partially pay down the bank loan. The final uniform residential loan application, dated August
14, 2006, showed the bank loan balance as $2,685 with nine payments of $300 remaining. The
final loan application showed no liquid assets remaining after loan closing. Including the bank
loan monthly payment of $300 would increase the total fixed payments-to-income ratio from
33.08 to 46.23 percent.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-11A, states that 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, especially if the borrower will have
limited or no cash assets after loan closing.

Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and
total fixed payment-to-income ratios from 29 and 41 percent to 31 and 43 percent, respectively.
It stated that if either or both ratios are exceeded on a manually underwritten mortgage, the
lender is required to describe the compensating factors used to justify the mortgage approval.




                                                  13
Loan number: 262-1636498

Mortgage amount: $66,431

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: October 20, 2006

Status: Claim

Payments before first default reported: Three

Loss to HUD: $75,225

Summary:

We found a material underwriting deficiency relating to the borrower’s liabilities.

Liabilities:

Our review of the loan file disclosed an unrecorded biweekly installment of $160 or monthly
payments of $320. On April 29, 2006, the borrower purchased a Chevy Trailer Blazer from
Mike’s Used Cars for $9,401 with a downpayment of $550. The installment invoice documented
biweekly payments of $160 applied to the outstanding balance of $8,851. As of September 25,
2006, the balance of the installment was $5,971. This liability was not reported on the
borrower’s mortgage credit analysis worksheet or uniform residential loan application, nor was it
listed on the borrower’s credit report. As a result, the borrower’s monthly debt and obligations
were understated by $320. The total fixed payment-to-income ratio increased from 32.52 to
52.16 percent when the installment was included in the calculation.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-11, states the types of liabilities that must be
considered in qualifying borrowers. 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 and alimony, etc.

Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and
total fixed payment-to-income ratios from 29 and 41 percent to 31 and 43 percent, respectively.
It stated that if either or both ratios are exceeded on a manually underwritten mortgage, the
lender is required to describe the compensating factors used to justify the mortgage approval.



                                                  14
Loan number: 262-1652638

Mortgage amount: $125,352

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: April 6, 2007

Status: Claim

Payments before first default reported: Zero

Loss to HUD: $96,364

Summary:

We found material underwriting deficiencies relating to the borrower’s income, liabilities, gift
funds, and credit history.

Income:

Mac-Clair’s underwriter overstated the borrower’s monthly income by $1,131. Unsupported
self-employment income of $583 and unemployment income of $415 were included in the
calculation of the borrower’s income. We used the hourly rate of pay from the verification of
employment to calculate the monthly income. To support the self-employment income, the loan
file contained the borrower’s 2006 Federal income tax return. The tax return listed other income
of $7,000 described as “spouse child care business.” The borrower filed as head of household,
listing his children as his dependents. There was no documentation, such as Internal Revenue
Service Form 1099 or W-2, verification of employment, or letter of explanation, in the loan file
supporting this income and reporting the period in which the income was earned. The
borrower’s 2005 Federal income tax return did not include self-employment income. Further,
the loan file did not support that the self-employment income earned was from an occupation
related to the borrower’s current employment as a driver with Penske.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-9A1, states that an individual self-employed
between 1 and 2 years must have at least 2 years of documented previous successful employment
(or a combination of 1 year of employment and formal education or training) in the line of work
in which the borrower is self-employed or in a related occupation to be eligible. Paragraph 2-
9A2 states that the income from a borrower self-employed less than 1 year may not be
considered effective income.




                                                  15
The loan file did not document the continuance of unemployment income. The verification of
employment disclosed that the borrower worked an average of 40 hours per week. The employer
did not indicate that his employment was seasonal.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-7L, states that unemployment income must be
documented for 2 years. Reasonable assurance of its continuance is also required.

Liabilities:

When calculating the borrower’s monthly liabilities, Mac-Clair’s underwriter did not include two
monthly installments of $95 and $104 that were disclosed on the borrower’s credit report. The
liabilities were not reported on the mortgage credit analysis worksheet or the borrower’s loan
application.

As identified on the credit report, the borrower had a monthly installment loan with Nelnet
Loans. The account was opened in January 2007. As of April 5, 2007, the date of the credit
report, the balance was $10,303 with a monthly payment of $95. The borrower opened a credit
card account with Discover Financial in September 1996. According to the credit report, the last
activity on the account was in February 2007. The balance on the account was $5,176 with a
minimum monthly payment of $104.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-11, states that the borrower’s liabilities include all
installment loans, revolving charge accounts, 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.

The inclusion of the monthly liabilities and the exclusion of borrower’s self-employment and
unemployment income would have disqualified him for the loan. We recomputed the qualifying
ratios excluding the self-employment and unemployment incomes and including the monthly
installment loan payments. The revised qualifying ratios (mortgage payment to income and total
fixed payment to income) would be 52.79 and 79.16 percent, well above the allowable ratios of
31 and 43 percent.

Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and
total fixed payment-to-income ratios from 29 and 41 percent to 31 and 43 percent, respectively.
It stated that if either or both ratios are exceeded on a manually underwritten mortgage, the
lender is required to describe the compensating factors used to justify the mortgage approval.

Gift:

The borrower received a gift of $9,816 from his spouse for the purchase of the property. The
loan file did not document the withdrawal of the gift funds from the donor’s account. A bank



                                                 16
statement was provided for the donor’s account to Mac-Clair. It showed that funds were
available for the amount of the gift. However, the withdrawal of the gift funds was not shown on
the bank statement.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-10C2a, states that 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.

Condition #17 reported by Mac-Clair’s underwriter on attachment 1 to the mortgage loan
commitment, under the conditions to satisfy before a loan closing is scheduled, required a copy
of the withdrawal slip from the donor’s account showing $9,816 coming out of the account.

Credit:

Mac-Clair’s underwriter did not adequately evaluate the borrower’s credit history. A review of
the borrower’s credit report disclosed 20 past-due collection accounts from 2002 through 2005
totaling $4,625. The loan file did not include letters of explanation for the past-due accounts, nor
did it address payment of the outstanding collections as identified as a condition to close by the
underwriter. The borrower paid three additional past-due collection accounts at closing totaling
$1,461.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that past credit performance serves as the
most useful guide in determining a borrower’s attitude toward credit obligations and predicting a
borrower’s future actions. If the credit history, despite adequate income to support obligations,
reflects continuous slow payments, judgments, and delinquent accounts, strong compensating
factors will be necessary to approve the loan.

HUD Handbook 4155.1, REV-5, paragraph 2-3C, states that 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 all collections in
writing.

Condition #16 reported by Mac-Clair’s underwriter on attachment 1 to the mortgage loan
commitment, under the conditions to satisfy before a loan closing is scheduled, required proof of
payoffs for all judgments, collections, and past-due accounts.

In December 2001, the borrower filed for Chapter 7 bankruptcy protection. The borrower
received a discharge from his debts on April 19, 2002. The underwriter claimed that the
previously mentioned outstanding collection accounts were discharged in the bankruptcy.
However, evidence supporting the debts discharged was not maintained in the loan file. As
noted above, the credit report specifically identified collections that were not included in the



                                                   17
bankruptcy. Also, as indicated on the credit report, the date of last activity for some of the
collections occurred after the date of discharge. Therefore, Mac-Clair’s underwriter should have
obtained letters of explanation from the borrower for these outstanding collections as required by
HUD and considered these in determining the borrower’s creditworthiness. To comply with
Mac-Clair’s condition to close, the collection accounts should have been satisfied.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-3E, states that a Chapter 7 bankruptcy (liquidation)
does not disqualify a borrower from obtaining an FHA-insured mortgage if at least 2 years have
elapsed since the date of the discharge of the bankruptcy. Additionally, the borrower must have
reestablished good credit or chosen not to incur new credit obligations. The borrower must have
demonstrated a documented ability to responsibly manage his or her financial affairs.

HUD Review:

Each year HUD performs post-endorsement technical reviews on a percentage of the FHA-
insured loans. These reviews are performed to monitor the performance of lenders, underwriters,
and lenders’ technical staff. Loan number 262-1652638 was reviewed by HUD. Initially, Mac-
Clair received an unacceptable rating during HUD’s post-endorsement technical review. In a
letter, dated May 3, 2007, HUD informed Mac-Clair that a rating of unacceptable meant that
deficiencies were identified that resulted in a change in the eligibility of the borrower or property
or a significant increase in mortgage risk. HUD cited the following deficiencies:

      Unsupported self-employment income of $583. HUD requested 2 years of Federal tax
       returns to support the self-employment income. Also, the returns were to include the
       unemployment income paid during years 2005 and 2006. HUD explained that income
       ratios would be increased without inclusion of the self-employment income and cited the
       increase in ratios and a lack of compensating factors.

      The credit report showed open collection accounts and charge-offs after Chapter 7
       bankruptcy, demonstrating a poor credit risk for loan approval.

In a letter, dated May 14, 2007, Mac-Clair’s quality control division provided a response to the
deficiencies identified by HUD. Mac-Clair provided the borrower’s 2006 Federal income tax
return as support for the self-employment income. Mac-Clair explained that the borrower had
been self-employed for 16 months as a child care bus driver. Further, it stated that while there
were collections and charge-offs after bankruptcy, these occurred several years ago. Mac-Clair
believed that the borrower had demonstrated his ability and willingness to pay by establishing
good credit within the past 16 months, citing five new accounts that were opened since 2006
with excellent credit history.

HUD accepted the response and in June 2007, HUD informed Mac-Clair that it considered the
issues satisfactorily addressed. As a result, HUD revised Mac-Clair’s rating of the loan in
FHA’s Connection system.




                                                   18
The support provided for the self-employment income did not specify the period during which
this income was earned in 2006. Further, Mac-Clair did not provide documentation verifying
income earned from self-employment after December 31, 2006. Therefore, the 16-month period
of self-employment was not supported.

Concerning the borrower’s credit history, the recent accounts cited by Mac-Clair were opened in
October and November 2006, only 5 to 6 months before the loan closing. Therefore, the 16-
month period of good credit was not supported. Also, neither HUD nor Mac-Clair addressed the
two outstanding liabilities previously discussed, which were not included when calculating the
borrower’s monthly obligations.




                                                19
Loan number: 262-1653481

Mortgage amount: $44,457

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: March 23, 2007

Status: Claim

Payments before first default reported: Four

Loss to HUD: $46,849

Summary:

We found material underwriting deficiencies relating to the borrower’s debt ratio and credit
history.

Excessive Debt Ratio:

The borrower’s total fixed payment-to-income ratio exceeded HUD’s allowable ratio of 43
percent. The ratio reported on the mortgage credit analysis worksheet was 45.62 percent. As a
compensating factor to justify the excessive ratio, Mac-Clair’s underwriter used the borrower’s
previous ability to pay housing expenses greater than the proposed monthly housing expense.

The verification of rent reported the borrower’s rent payment as $636 for the past 9 months. The
proposed mortgage payment was $432, resulting in a monthly cost savings of $204. However,
the loan file did not include documentation supporting the borrower’s rent payment history over
the past 12-24 months.

The loan processor was only able to verify past rent for a 9-month period. The processor was
unable to contact the borrower’s previous landlord to verify past rent payments beyond the 9-
month period. The loan processor also did not obtain evidence from the borrower for rental
payments made to the previous landlord.

HUD/FHA Requirements:

Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and
total fixed payment-to-income ratios from 29 and 41 percent to 31 and 43 percent, respectively.
If either or both ratios are exceeded on a manually underwritten mortgage, the lender is required
to describe the compensating factors used to justify the mortgage approval.




                                                 20
HUD Handbook 4155.1, REV-5, paragraph 2-13A, states that compensating factors include
successfully demonstrating the ability to pay housing expenses equal to or greater than the
proposed monthly housing expense for the new mortgage over the past 12-24 months.

Condition #26 reported by Mac-Clair’s underwriter on attachment 1 to the mortgage loan
commitment, under the conditions to satisfy before a loan closing is scheduled, stated that the
verification of rent for the current residence was to cover 12 months.

Credit History:

Mac-Clair’s underwriter did not adequately evaluate the borrower’s credit history or obtain
strong compensating factors to support loan approval. The borrower’s credit report disclosed
only one current installment and many recent collection accounts for utilities.

The loan was approved using alternative credit reference letters. One credit letter, dated
February 20, 2007, was provided by Consumers Energy. It stated that the borrower’s length of
service was 7 months, during which the borrower received two notices of delinquency. The
borrower provided a letter of explanation claiming that the delinquencies were due to a change in
payment due dates. The second credit letter, dated March 14, 2007, was provided for child care
services. The loan file did not contain a third credit reference letter.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, paragraph 2-3, states that past credit performance serves as the
most useful guide in determining a borrower’s attitude toward credit obligations and predicting a
borrower’s future actions. If the credit history, despite adequate income to support obligations,
reflects continuous slow payments, judgments, and delinquent accounts, strong compensating
factors will be necessary to approve the loan.

Condition #16 reported by Mac-Clair’s underwriter on attachment 1 to the mortgage loan
commitment, under the conditions to satisfy before a loan closing is scheduled, stated that three
alternative credit references covering 12 months were required.




                                                  21
Loan number: 262-1673933

Mortgage amount: $106,160

Section of Housing Act: 203(b)

Loan purpose: Purchase

Date of loan closing: July 13, 2007

Status: Claim

Payments before first default reported: Zero

Loss to HUD: $94,078

Summary:

We found a material underwriting deficiency relating to the borrower’s income.

Income:

The borrower’s monthly income included $1,526 from Social Security disability income. The
recipient of the income was not the borrower or coborrower on the loan. An undated letter from
the Social Security Administration stated that the borrower was the recipient’s representative
payee. The letter stated that the funds were to be used for the recipient’s needs.

The loan file did not document that the recipient was a dependent of the borrower, nor did it
document the recipient’s intention to reside at the subject property. Further, the loan file did not
document that the income would be available to be used for the monthly mortgage payment.

HUD/FHA Requirements:

HUD Handbook 4155.1, REV-5, section 2, states that 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.

Excluding the $1,526 monthly benefit payment from the borrower’s monthly income, increased
the mortgage payment-to-income ratio from 27.52 to 49.56 percent ($944.53 mortgage payment
divided by $1,906 in average monthly income). The total fixed payments-to-income ratio
increased from 35.09 to 63.19 percent ($1,205 mortgage payment divided by $1,906 in average
monthly income).

Mortgagee Letter 2005-16, dated April 13, 2005, increased the payment-to-income and debt-to-
income ratios from 29 and 41 percent to 31 and 43 percent, respectively. It stated that if either or




                                                   22
both ratios are exceeded on a manually underwritten mortgage, the lender is required to describe
the compensating factors used to justify the mortgage approval.




                                                 23
APPENDIX C

         LENDER COMMENTS AND OIG’s EVALUATION


Ref to OIG Evaluation    Lender Comments




                            24
Ref to OIG Evaluation   Lender Comments




                           25
Ref to OIG Evaluation   Lender Comments




                           26
Ref to OIG Evaluation   Lender Comments




                           27
Ref to OIG Evaluation   Lender Comments




Comment 1




                           28
Ref to OIG Evaluation   Lender Comments




Comment 2




                           29
Ref to OIG Evaluation   Lender Comments




                           30
Ref to OIG Evaluation   Lender Comments




Comment 3




                           31
Ref to OIG Evaluation   Lender Comments




Comment 4




                           32
Ref to OIG Evaluation   Lender Comments




Comment 5




Comment 6




                           33
Ref to OIG Evaluation   Lender Comments




                           34
Ref to OIG Evaluation   Lender Comments




Comment 7




                           35
Ref to OIG Evaluation   Lender Comments




Comment 8




                           36
Ref to OIG Evaluation   Lender Comments




                           37
Ref to OIG Evaluation   Lender Comments




                           38
Ref to OIG Evaluation   Lender Comments




Comment 9




Comment 10




                           39
Ref to OIG Evaluation   Lender Comments




                           40
Ref to OIG Evaluation   Lender Comments




Comment 11




Comment 12




                           41
Ref to OIG Evaluation   Lender Comments




                           42
Ref to OIG Evaluation   Lender Comments




                           43
Ref to OIG Evaluation   Lender Comments




                           44
Ref to OIG Evaluation   Lender Comments




                           45
                           OIG’s Evaluation of Lender Comments

Comment 1   We agree that there is no specific HUD requirement that requires a lender to
            document reasons for a borrower’s pay raise or why such a pay raise will
            continue. We also agree and specifically cited in our discussion draft
            memorandum report that HUD does not impose a minimum length of time a
            borrower must have held a position to be eligible for FHA financing. However,
            HUD does require lenders to verify employment for the previous 2 years in order
            to analyze income stability. Specifically, to analyze and document the probability
            of continued employment, HUD requires lenders to examine the borrower’s past
            employment record, qualifications for the position, previous training and
            education, and the employer’s confirmation of continued employment.

            In this case, the borrower did not show stable employment for approximately 15
            of the 24-month period preceding the loan closing. Based on tax returns and other
            supporting documentation in Mac-Clair’s loan file, employment prior to the
            borrower’s current job was sporadic and both the number and duration of periods
            of unemployment were not determinable.

Comment 2   The borrower served as a teaching assistant for construction trades at a vocational
            school. Teaching construction trades as an assistant is not the same line of work
            as being self employed, owning and operating a construction business. As stated
            in our review, if the two occupations were not considered related, self
            employment income of less than 2 years would not have been considered in the
            mortgage approval process. Further, while the loan application stated that the
            borrower had been self-employed for 1 year, there was no documentation in the
            loan file to establish the date that he started working in his own business.
            According to the verification of employment from the vocational school, the
            borrower’s employment ended on September 2, 2005, less than 1 year prior to the
            loan closing. While the borrower may have been working on his own prior to this
            date, the actual start date was not documented by Mac-Clair.

Comment 3   While Mac-Clair’s underwriter has discretion to waive and/or clear underwriting
            conditions, the loan file did not indicate that the payoff condition had been
            waived. Further, Mac-Clair did not provide evidence of the payoff of the debt
            with its comments. The underwriter had required the borrower to provide proof
            of payoff of a credit card bill of $376 before loan closing.

Comment 4   The borrower’s automobile loan was reduced to nine payments remaining only
            through a gift from his parents. Given that the borrower would have no liquid
            assets remaining after loan closing, the $300 monthly payment would affect his
            ability to make the mortgage payment.

            Mac-Clair stated that its underwriter used a very conservative calculation of the
            borrower’s income, an average over 18.75 months. It contended that using only
            the borrower’s documented 2005 monthly earnings of $2,443, and including the



                                              46
            $300 debt in the calculation, the qualifying ratios would have been acceptable.
            We disagree with Mac-Clair. Using only the borrower’s 2005 wage income to
            support an acceptable debt-to-income ratio would not be appropriate given the
            discrepancies in income from 2004 to 2006. While the borrower earned $29,326
            in wages for 2005, he had earned only $14,072 in 2004. Further, he was
            unemployed for almost the first 5 months of 2006 and had only earned $5,800 as
            of July 21, 2006.

Comment 5   Mac-Clair stated in its response that an oversight regarding exclusion of the $320
            monthly payment was a harmless error. It further stated that the borrower had
            earned an average of $170 per month in overtime income. It asserted that if both
            the overtime income and the monthly payment were considered, the ratios would
            be acceptable. We disagree with Mac-Clair. Although the verification of
            employment showed that the borrower had earned $1,564 in 2006 overtime
            income as of October 2, 2006, the verification did not indicate whether the
            overtime was expected to continue. The verification also did not show that the
            borrower earned any overtime in 2005. Over a 24-month period, the average
            amount of overtime earned was $65 per month. This amount of additional
            monthly income would still result in an excessive total fixed payment-to-income
            ratio of 50.16 percent.

Comment 6   HUD Handbook 4155.1, REV-5, paragraph 2-13, specifies the compensating
            factors that may be used to justify approval of mortgage loans with ratios
            exceeding HUD’s guidelines. One compensating factor is the potential for
            increased earnings, as indicated by job training or education in the borrower’s
            profession. Mac-Clair stated that the borrower’s employment as a certified nurse
            aid required continuing education that leads to the potential for increased
            earnings. However, there was no evidence provided by Mac-Clair to show that
            the continuing education was actually required or received, and that it could lead
            to increased earnings.

            Another compensating factor is at least 3 months worth of cash reserves after loan
            closing. In this instance, the mortgage credit analysis worksheet supported only 2
            months of cash reserves. Also, neither a reduction in monthly housing expense
            nor an appraised value exceeding the sales price of the property are HUD-
            accepted compensating factors.

Comment 7   Based on Mac-Clair’s comments and additional documentation regarding the
            borrower’s assets for FHA loan 262-1625921, we removed it as a material
            deficiency.

Comment 8   The TCF bank account is shown as an asset of the borrower on both the initial and
            final loan applications. Further, the initial loan application stated that the source
            of the borrower’s downpayment was a checking account and the final loan
            application showed the source as a checking/savings account. Although the
            transaction history showed the account to be only in the name of the borrower’s



                                               47
              spouse, the fact that the borrower listed the same bank account as an asset should
              have been questioned by Mac-Clair’s underwriter.

              Mac-Clair also cited in its comments that $3,000 was deposited into the donor
              spouse’s bank account on May 2, 2006, or almost 60 days before the borrower
              signed the sales contract. However, the borrower’s credit report showed
              numerous credit inquiries starting in May 2006 that the borrower stated were
              related to his search for a mortgage lender. Therefore, given that the deposit was
              made at the same time that the borrower was purchasing a home, Mac-Clair
              should have ensured that the funds were not provided by an unacceptable source,
              like a party to the sales transaction.

Comment 9     We agree and specifically cited in our discussion draft memorandum report that
              HUD does not require collection accounts to be satisfied prior to closing.
              However, in this instance, the borrower’s credit report showed that the medical
              account was opened only 5 months before the loan closing and the entire amount
              of the original debt was delinquent. While we recognize that unexpected medical
              costs can create financial hardship, the fact that no payment was made on the debt
              shortly before applying for a home mortgage could question a borrower’s
              creditworthiness.

Comment 10 As stated in our discussion draft memorandum report, Mac-Clair’s underwriter
           conditioned loan approval on the receipt of three alternative credit references
           covering 12 months with no late payments. Because only two credit references
           were provided of which one covered only 7 months, the condition was not met.
           Further, there was no evidence that the closing condition was waived.

              See comment 6.

Comment 11 While Mac-Clair’s underwriter has discretion to waive and/or clear underwriting
           conditions, the loan file did not indicate that the condition to provide cancelled
           rent checks had been waived.

Comment 12 Mac-Clair believes that our recommendations for remedies under the Program
           Fraud Civil Remedies Act and administrative action are not appropriate. We did
           not change our recommendations, because these recommendations are appropriate
           based on the issues cited in the memorandum. Violations of FHA rules are
           subject to civil and administrative action.




                                                48