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-1811 August 4, 2010 MEMORANDUM TO: Vicki Bott, Deputy Assistant Secretary for Single Family, HU Dane Narode, Associate General Counsel for Program Enforcement, CACC FROM: Heath Wolfe, Regional Inspector General for Audit, 5AGA SUBJECT: D & R Mortgage Corporation, Farmington Hills, MI, Did Not Properly Underwrite a Selection of FHA Loans INTRODUCTION We reviewed 15 Federal Housing Administration (FHA) loans that D & R Mortgage Corporation (D & R) underwrote as an FHA direct endorsement lender. Our review objective was to determine whether D & R underwrote the 15 loans in accordance with FHA requirements. This review is part of Operation Watchdog, an Office of Inspector General (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 U.S. Department of Housing and Urban Development (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 D & R during the review. We asked D & R to provide written comments on our discussion draft memorandum report by June 30, 2010. D & R’s president provided written comments, dated June 28, 2010. The president disagreed with our findings and recommendations. The complete text of the lender’s written response, along with our evaluation of that response, can be found in appendix C of this report, except for 19 exhibits of 307 pages of documentation that was not necessary to understand the lender’s comments. We provided HUD’s Deputy Assistant Secretary for Single Family Housing and 1 Associate General Counsel for Program Enforcement with a complete copy of D & R’s written comments plus the 307 pages of documentation. METHODOLOGY AND SCOPE D & R 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 D & R 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 D & R is a nonsupervised, direct endorsement lender based in Farmington Hills, MI. FHA approved D & R as a direct endorsement lender in August 1998. 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 our review 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, D & R endorsed 6,291 loans valued at $903 million and submitted 225 claims worth $28.1 million. Our objective was to determine whether the 15 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 D & R, consider the results of previous audits, or communicate with D & R’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 fully comply with the standards, nor did our approach negatively affect our review results. RESULTS OF REVIEW D & R did not properly underwrite 9 of the 15 loans reviewed because its underwriters did not follow FHA’s requirements. As a result, FHA’s insurance fund suffered actual losses of more than $936,000 on the 9 loans, as shown in the following table. Number of FHA loan payments before Original mortgage Actual loss to number Closing date first default amount HUD 483-3712823 3/29/07 10 $128,950 $55,888 262-1650023 2/12/07 2 156,450 84,648 261-9177201 3/28/07 13 198,400 152,655 483-3758135 9/7/07 14 125,950 62,495 261-9065622 4/27/06 4 168,300 130,123 261-9065826 5/15/06 5 70,400 90,914 261-9205529 6/1/07 16 207,550 111,983 261-8996673 12/6/05 4 92,550 102,633 261-9111473 9/21/06 6 224,700 145,233 Totals $1,373,250 $936,572 The following table summarizes the material deficiencies that we identified in the nine loans. Area of noncompliance Frequency Excessive ratios 3 Credit history 7 Income 2 Liabilities 3 Assets 1 Excessive Ratios D & R improperly approved three loans when the borrowers’ ratios exceeded FHA’s requirement. Effective April 13, 2005, the fixed payment-to-income and debt-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). For example, for loan number 483-3758135, the fixed payment-to-income ratio was 47.4 percent. D & R’s underwriter did not include compensating factors on the mortgage credit analysis 3 worksheet3. The documentation in the loan file also did not support significant compensating factors. Credit History D & R did not properly evaluate the borrowers’ credit history for seven 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 261-9177201, D & R did not obtain sufficient explanations for an unpaid collection account, late payments for a previous mortgage, and judgments that were consistent with other credit information in the borrower’s file. Income D & R did not properly verify borrowers’ income or determine income stability for two 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. D & R 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). For example, for loan number 261-9065622, the borrower provided copies of his paycheck stubs. The four stubs had different check numbers and different pay dates; however, the pay periods, year-to-date earnings, and taxes withheld remained the same on each stub. Normally with each paycheck, the year-to-date amounts increase by the value of the current paycheck and deductions. The borrower’s loan file contained two additional paychecks which contained year- to-date earnings that were not accurate. For instance, the borrower’s weekly income was $950; however, for the paychecks ending February 12 and February 19, 2006, his cumulative year-to- date earnings were $6,650, and $7,600, respectively, which was $950 more than the amount that should have been reflected on the borrower’s paystubs. Further, the borrower’s verification of employment form indicated he did not work overtime or receive a bonus or commission income. Liabilities D & R did not properly assess the borrowers’ financial obligations for three 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 261-8996673, the borrower had entered into a repayment agreement of $75 per month with a collection agency to settle an unpaid collection account. The payments were for 13 months. D & R did not include this information as a liability on the mortgage credit analysis worksheet for calculating the qualifying ratios. 3 The mortgage credit analysis worksheet is used to analyze and document mortgage approval. 4 Assets D & R did not properly verify the source of the borrower’s funds to close for loan number 261- 9177201. HUD requires the lender to verify and document the borrower’s investment in the property (see appendix B for detailed requirements). Incorrect Underwriter’s Certifications Submitted to HUD We reviewed the certifications for the nine loans with material underwriting deficiencies for accuracy. D & R’s direct endorsement underwriters incorrectly certified that due diligence was used in underwriting the nine 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 statements, with an administrative remedy to (1) to recompense such agencies for losses resulting from such claims and statements; (2) permit administrative proceedings to be brought against persons who make, present, or submit such claims and statements; and (3) 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 Civil Remedies Act against D & R and/or its principals for incorrectly certifying to the integrity of the data or that due diligence was exercised during the underwriting of 9 loans that resulted in losses to HUD totaling $936,572, which could result in affirmative civil enforcement action of approximately $1,940,6444. We also recommend that HUD’s Deputy Assistant Secretary for Single Family 1B. Take appropriate administrative action against D & R 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 $936,572 4 Double damages plus a $7,500 fine for each of the 9 incorrect certifications. 5 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. 6 Appendix A SUMMARY OF MATERIAL UNDERWRITING DEFICIENCIES Excessive qualifying ratios questionable employment Significant credit related Underreported liabilities Unsupported income or Unsupported assets deficiencies history FHA loan number 483-3712823 X X 262-1650023 X X 261-9177201 X X 483-3758135 X X 261-9065622 X 261-9065826 X X 261-9205529 X X 261-8996673 X X 261-9111473 X 7 Appendix B LOANS WITH MATERIAL UNDERWRITING DEFICIENCIES Loan number: 483-3712823 Mortgage amount: $128,950 Section of Housing Act: 203(b) Loan purpose: Purchase Date of loan closing: March 29, 2007 Status: Claim Payments before first default reported: 10 Loss to HUD: $55,888 Summary: We found material underwriting deficiencies relating to the borrower’s income and liabilities. Income: D & R used excessive overtime income to approve the loan. Its underwriter used the current verification of employment to calculate the overtime income of $318 per month rather than using the actual overtime earned during the past 2 years. There was no documentation in the loan file to show that the borrower’s overtime income was analyzed to determine whether the $318 was stable and would continue. From the Internal Revenue Service Form W-2 statements, and accounting for a change in pay rate in April 2006, we determined that the actual average overtime income for the past 2 years was $204 per month. Using this average for the previous 2- year period would increase borrower’s qualifying ratios to an unacceptable level, as shown below in the liabilities section. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, chapter 2, 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 2-7A states that overtime income may be used to qualify if the borrower has received such income for the past 2 years and it is likely to continue. The lender must develop an average of overtime income for the past 2 years, and the employment verification must not state that such income is unlikely to continue. 8 Liabilities: In calculating the borrower’s monthly liabilities, D & R’s underwriter did not include a monthly installment of $109 that was disclosed on the borrower’s credit report. The borrower owed $985, and as of February 21, 2007, nine payments of $109 remained. The underwriter excluded this liability because fewer than 10 payments were left. There was no analysis in the loan file showing that this debt would not affect borrower’s ability to make the mortgage payment during the months immediately after loan closing. The borrower had limited assets. According to the borrower’s bank statements and the verification of deposit, the lowest balance in the borrower’s checking account was $8 on January 22, 2007, and the highest balance was $385 on February 23, 2007. The proper inclusion of the monthly liability and exclusion of excess overtime income would have disqualified the borrower for the loan. We recomputed the qualifying ratios excluding the excess overtime income and including the monthly installment payment. The revised qualifying ratios, mortgage payment to income and total fixed payment to income, would be 35 and 49 percent, respectively, which exceed HUD’s allowable ratios of 31 and 43 percent, respectively. 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. HUD Handbook 4155.1, REV-5, 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. If the mortgage payment expense-to-effective income ratio exceeds 29 percent and/or the total of the mortgage payment and all recurring charges exceeds 41 percent of the gross effective income, the loan may be acceptable only if significant compensating factors, as discussed in paragraph 2-13, are documented and are recorded on the mortgage credit analysis worksheet. Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and debt-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. HUD Handbook 4155.1, REV-5, paragraph 2-13, states that FHA underwriters must record in the remarks section of HUD Form 92900-WS/HUD 92900-PUR the compensating factor(s) used to support loan approval. Any compensating factor used to justify mortgage approval must be supported by documentation. 9 Loan number: 262-1650023 Mortgage amount: $156,450 Section of Housing Act: 203(b) Loan purpose: Purchase Date of loan closing: February 12, 2007 Status: Claim Payments before first default reported: Two Loss to HUD: $84,648 Summary: We found material underwriting deficiencies relating to the borrower’s liabilities and credit history. Liabilities: The borrower’s pay statement, dated December 8, 2006, showed a garnishment of $95.80 per week for child support. This liability was not reported on the borrower’s loan application or on the mortgage credit analysis worksheet. The weekly child support payment computed to a monthly amount of $415.13. Including the child support monthly payment would increase the total fixed payment-to-income ratio from 37.34 to 48.81 percent. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, paragraph 2-11A, states that recurring obligations must be considered in qualifying borrowers. The borrower’s recurring obligations 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. HUD Handbook 4155.1, REV-5, 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. If the mortgage payment expense-to-effective income ratio exceeds 29 percent and/or the total of the mortgage payment and all recurring charges exceeds 41 percent of the gross effective income, the loan may be acceptable only if significant compensating factors, as discussed in paragraph 2-13, are documented and are recorded on the mortgage credit analysis worksheet. 10 Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and debt-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. HUD Handbook 4155.1, REV-5, paragraph 2-13, states that FHA underwriters must record in the remarks section of HUD Form 92900-WS/HUD 92900-PUR the compensating factor(s) used to support loan approval. Any compensating factor used to justify mortgage approval must be supported by documentation. Credit: D & R did not adequately review the borrower’s credit history. The borrower had a bankruptcy discharged in March 2003. In the recent credit history after the bankruptcy, the borrower had an unexplained collection account opened in February 2006, two accounts with late payments, and two accounts that were over their limit. There was no verification that the collection account had been paid off, and the loan file did not contain an explanation. The borrower; however, showed payment on one of the over limit revolving credit cards, and he provided an explanation for the late payments. D & R did not document how the borrower reestablished good credit and demonstrated an ability to manage his financial affairs. HUD/FHA Requirements: According to HUD Handbook 4155.1, REV-5, paragraph 2-3, 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. When delinquent accounts are revealed, the lender must document its analysis as to whether the late payments were based on a disregard for financial obligations, an inability to manage debt, or factors beyond the control of the borrower. Major indications of derogatory credit-including judgments, collections, and any other recent credit problems-require sufficient written explanations for the borrower. The borrower’s explanation must make sense and be consistent with other credit information in the file. HUD Handbook 4155.1, REV 5, paragraph 2-3C, states that collections and judgments indicates 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 where the borrower has collection accounts or judgments. The borrower must explain in writing all collections and judgments. HUD Handbook 4155.1, REV-5, paragraph 2-3E, states that a Chapter 7 bankruptcy 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. Further, the borrower must have either reestablished good credit or chosen not to incur new credit obligations. The borrower also must have demonstrated a documented ability to responsibly manage his or her financial affairs. 11 Loan number: 261-9177201 Mortgage amount: $198,400 Section of Housing Act: 203(B) Loan purpose: Purchase Date of loan closing: March 28, 2007 Status: Claim Payments before first default reported: 13 Loss to HUD: $152,655 Summary: We found material underwriting deficiencies relating to the borrower’s assets and credit history. Assets: According to the mortgage credit analysis worksheet, the borrower needed $13,898 to close, and the loan file documents showed that the borrower had $15,401 in assets available. However, D & R did not obtain an explanation for the source of these funds. A bank statement showed a balance of $4,145 for the period ending January 24, 2007. A request for verification of deposit, dated February 27, 2007, indicated an account balance of $9,904, and a copy of a teller receipt, dated March 20, 2007, showed an account balance of $15,401. As shown above, borrower’s bank account balance increased by $5,760 between January and February 2007 and again by $5,497 between February and March 2007. Both amounts were large considering that the borrower’s gross earnings were $5,819 per month. There were no bank statements to show the dates of deposit or source of these funds. The only document in the loan file was a printout from TurboTax showing a statement that the borrower’s Federal income tax return would be $10,243. A copy of the borrower’s tax returns was not in the loan file. D & R should have obtained additional documentation or verification to ensure that the borrower did not obtain an undocumented loan, funds from an interested party, or funds from another excludable source. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, paragraph 2-10, states that all funds used for the borrower’s investment in the property must be verified and documented. Paragraph 2-10B states that a verification of deposit, along with the most recent bank statement, may be used to verify savings and checking accounts. If there is a large increase in an account or the account was opened recently, the lender must obtain a credible explanation of the source of those funds. 12 Credit: D & R did not adequately review and analyze the borrower’s credit history. The borrower’s credit history included two judgments, three open collections, and two revolving accounts with late payments in the payment history. The written explanation from the borrower did not explain the two judgments in the credit history. The borrower stated that the credit problems started during 2004, but both judgments were before 2003; one was in 2001, and one was in 2002. The judgment from 2001 was satisfied in July 2004, and the judgment from 2002 was satisfied in June 2003. As required by HUD, D & R should have obtained an explanation for these judgments. The borrower’s explanation stated that the collection accounts were caused by family medical problems, which occurred during 2004. However, the collection accounts occurred in March and December 2005, and the medical collection account was opened in August 2006. The borrower paid two of the collections before closing but not the remaining medical collection for $157. The borrower’s explanation stated that he did not pay one of the two non-medical collections for $297 on principle. Refusing to pay a bill or not properly disputing a charge does not demonstrate a responsible attitude toward credit. Further, the borrower had a number of late payments on the previous mortgage account, including delinquent payments in August and September 2005. The combination of the borrower’s unexplained judgments, disregard of a collection account on principle, recent late payments on revolving credit and delinquency on the previous mortgage were indications of derogatory credit. Although the borrower had earned adequate income of more than $190,000 during 2005 and 2006 collectively, he did not satisfy these debts. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, paragraph 2-1, states that the purpose of underwriting is to determine a borrower’s ability and willingness to repay the mortgage debt, thus limiting the probability of default and collection difficulties, and to examine the property offered as security for the loan to determine whether it is sufficient collateral. 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 and delinquent accounts, strong compensating factors will be necessary to approve the loan. The lender must document its analysis regarding whether the late payments were based on disregard for financial obligations or otherwise. Major indications of derogatory credit-including judgments, collections, and any other recent credit problems-require sufficient written explanations for the borrower. The borrower’s explanation must make sense and be consistent with other credit information in the file. HUD Handbook 4155.1, REV 5, paragraph 2-3C, states that collections and judgments indicates 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 where the 13 borrower has collection accounts or judgments. The borrower must explain in writing all collections and judgments. 14 Loan number: 483-3758135 Mortgage amount: $125,950 Section of Housing Act: 203(b) Loan purpose: Purchase Date of loan closing: September 7, 2007 Status: Claim Payments before first default reported: 14 Loss to HUD: $62,495 Summary: We found material underwriting deficiencies relating to the borrower’s debt-to-income ratio and credit history. Excessive Ratio: The borrower’s fixed payment-to-income ratio on the mortgage credit analysis worksheet was 47.4 percent. D & R did not note compensating factors in the loan file. Therefore, the loan should not have been approved. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, 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. If the mortgage payment expense-to-effective income ratio exceeds 29 percent and/or the total of the mortgage payment and all recurring charges exceeds 41 percent of the gross effective income, the loan may be acceptable only if significant compensating factors, as discussed in paragraph 2-13, are documented and are recorded on the mortgage credit analysis worksheet. Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and debt-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. HUD Handbook 4155.1, REV-5, paragraph 2-13, states that FHA underwriters must record in the remarks section of HUD Form 92900-WS/HUD 92900-PUR the compensating factor(s) used to support loan approval. Any compensating factor used to justify mortgage approval must be supported by documentation. 15 Credit: D & R did not adequately review or analyze the borrower’s credit history. The borrower had declared bankruptcy, which was discharged in June 2004, more than 3 years before the loan closed. The borrower did not reestablish good credit, as evidenced by the 22 medical collection accounts which were opened after the bankruptcy. Nine of the accounts were still open, and five of the nine were opened within 1 year of the loan closing. The borrower explained that his bankruptcy occurred because he cosigned for three car loans at the same time for friends. His friends did not make payments, and he was “stuck” with a tab he could not pay. However, there was no evidence in the loan file that this situation was the cause of the bankruptcy. Further, the borrower did not reestablish good credit or choose not to incur new obligations following the discharge of the bankruptcy. The written explanation also provided by the borrower for the derogatory items on his credit report was not consistent with other documents in the loan file. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, paragraph 2-1, states that the purpose of underwriting is to determine a borrower’s ability and willingness to repay the mortgage debt, thus limiting the probability of default and collection difficulties, and to examine the property offered as security for the loan to determine whether it is sufficient collateral. 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 and delinquent accounts, strong compensating factors will be necessary to approve the loan. The lender must document its analysis regarding whether the late payments were based on disregard for financial obligations or otherwise. Major indications of derogatory credit-including judgments, collections, and any other recent credit problems-require sufficient written explanations for the borrower. The borrower’s explanation must make sense and be consistent with other credit information in the file. HUD Handbook 4155.1, REV 5, paragraph 2-3C, states that collections and judgments indicates 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 where the borrower has collection accounts or judgments. The borrower must explain in writing all collections and judgments. HUD Handbook 4155.1, REV-5, paragraph 2-3E, states that a Chapter 7 bankruptcy 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. Further, the borrower must have either reestablished good credit or chosen not to incur new credit obligations. The borrower also must have demonstrated a documented ability to responsibly manage his or her financial affairs. 16 Loan number: 261-9065622 Mortgage amount: $168,300 Section of Housing Act: 203(b) Loan purpose: Purchase Date of loan closing: April 27, 2006 Status: Claim Payments before first default reported: Four Loss to HUD: $130,123 Summary: We found a material underwriting deficiency relating to the borrower’s income. Income: D & R did not properly verify the borrower’s employment. The documents provided by the borrower appeared to be questionable, and D & R should have required the borrower to provide additional explanation. The borrower’s verification of employment for the current job and the previous job were signed by the same person. The borrower’s previous employment was with a different employer at a different business entity. Further, the borrower provided copies of his paycheck stubs. The four stubs had different check numbers and different pay dates; however, the pay periods, year-to-date earnings, and taxes withheld remained the same on each stub. Normally with each paycheck, the year-to-date amounts increase by the values of the current paycheck and deductions. The borrower’s loan file contained two additional paychecks which contained year-to-date earnings that were not accurate. For instance, the borrower’s weekly income was $950; however, for the paychecks ending February 12 and February 19, 2006, his cumulative year-to- date earnings were $6,650, and $7,600, respectively, which was $950 more than the amount that should have been reflected on the borrower’s paystubs. Further, the borrower’s verification of employment form indicated he did not work overtime or receive a bonus or commission income. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, chapter 2, 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. 17 Loan number: 261-9065826 Mortgage amount: $70,400 Section of Housing Act: 203(b) Loan purpose: Purchase Date of loan closing: May 15, 2006 Status: Claim Payments before first default reported: Five Loss to HUD: $90,914 Summary: We found material underwriting deficiencies relating to the mortgage payment-to-income ratio and the borrower’s credit history. Excessive Ratio: The borrower’s mortgage payment-to-income ratio exceeded HUD’s allowable ratio of 31 percent by 4.88 percent. The ratio reported on the mortgage credit analysis worksheet was 35.88 percent. As a compensating factor to justify the excessive ratio, D & R’s underwriter used the borrower’s ability to pay the same mortgage payments as the rental housing expense. The borrower was residing in the property she purchased. The documentation to support the rental payment included payments of $533 per month for the landlord’s (seller) mortgage, which was supported by copies of money order receipts. The underwriter noted on the mortgage credit analysis worksheet that the borrower was also paying property taxes for the landlord of $2,567 per year. As a result, the underwriter determined that the borrower was paying $747 per month for rental expenses, which was still not equal to or greater than the proposed monthly housing expense for the new mortgage of $781 as required by HUD. To support the payment of property taxes by the borrower, the loan file contained a cancelled check for $2,567, dated February 10, 2006, made payable to the landlord. There was no assurance of whether this check was for the property taxes or some other purpose. According to a tax bill in the loan file, the total property taxes were $2,383. Further, the borrower reported on the loan application, dated May 15, 2006 (the day of loan closing), that the monthly rent was $533 per month. The borrower’s initial loan application, dated February 21, 2006, stated that the rent was $530 per month. 18 HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, 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. If the mortgage payment expense-to-effective income ratio exceeds 29 percent and/or the total of the mortgage payment and all recurring charges exceeds 41 percent of the gross effective income, the loan may be acceptable only if significant compensating factors, as discussed in paragraph 2-13, are documented and are recorded on the mortgage credit analysis worksheet. Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and debt-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. HUD Handbook 4155.1, REV-5, paragraph 2-13, states that FHA underwriters must record in the remarks section of HUD Form 92900-WS/HUD 92900-PUR the compensating factor(s) used to support loan approval. Any compensating factor used to justify mortgage approval must be supported by documentation. Credit: D & R’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 six late payments and collection accounts with past-due balances. The borrower explained that her collection accounts were due to identity theft because her checkbook was stolen in December 2004. The borrower filed a police report on February 16, 2006, just 5 days before she applied for the loan. In the police report, the borrower stated that she had already received a refund for the fraudulent checks. The underwriter should have required the borrower to provide verification from the bank. Further, there was no explanation for the delay of more than 14 months in filing the police report. D & R required the borrower to pay off the collection accounts, provide additional credit references, and provide a statement showing that she made timely payments for the previous 12 months as a condition to approve the loan. The borrower paid one of the collection accounts using a credit card. According to the credit report, the borrower did not own this credit card. D & R’s underwriter should have required the borrower to explain this discrepancy. The borrower provided three credit references, but they were not provided by an independent source. These references were faxed from the same fax number as that shown on the sales contract. The borrower also provided a letter of credit from DTE Energy that did not identify whether she made on-time payments, only the balance due. 19 HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, paragraph 2-1, states that the purpose of underwriting is to determine a borrower’s ability and willingness to repay the mortgage debt, thus limiting the probability of default and collection difficulties, and to examine the property offered as security for the loan to determine whether it is sufficient collateral. 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 and delinquent accounts, strong compensating factors will be necessary to approve the loan. The lender must document its analysis regarding whether the late payments were based on disregard for financial obligations or otherwise. Major indications of derogatory credit-including judgments, collections, and any other recent credit problems-require sufficient written explanations for the borrower. The borrower’s explanation must make sense and be consistent with other credit information in the file. HUD Handbook 4155.1, REV 5, paragraph 2-3C, states that collections and judgments indicates 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 where the borrower has collection accounts or judgments. The borrower must explain in writing all collections and judgments. HUD Handbook 4155.1, REV 5, Paragraph 2-3, for those borrowers 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. 20 Loan number: 261-9205529 Mortgage Amount: $207,550 Section of Housing Act: 203(b) Loan Purpose: Purchase Date of loan closing: June 1, 2007 Status: Claim Payments before first default reported: 16 Loss to HUD: $111,983 Summary: We found material underwriting deficiencies relating to the borrower’s excessive debt ratio and credit history. Excessive Debt Ratio: D & R improperly approved the loan when the borrower’s monthly mortgage payment-to-income ratio exceeded the FHA’s qualifying ratio. The ratio calculated by D & R on the mortgage credit analysis worksheet was 34.732 percent, which exceeded the qualifying ratio of 31 percent. D & R did not describe or document compensating factors in the loan file to justify loan approval. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, 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. If the mortgage payment expense-to-effective income ratio exceeds 29 percent and/or the total of the mortgage payment and all recurring charges exceeds 41 percent of the gross effective income, the loan may be acceptable only if significant compensating factors, as discussed in paragraph 2-13, are documented and are recorded on the mortgage credit analysis worksheet. Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and debt-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. HUD 4155.1, REV-5, paragraph 2-13, states that compensating factors that may be used to justify approval of mortgage loans with ratios exceeding our benchmark guidelines are those listed in the handbook. Underwriters must record in the “remarks” section of the HUD Form 21 92900-WS/HUD 92900-PUR the compensating factor(s) used to support loan approval. Any compensating factor used to justify mortgage approval must be supported by documentation. Credit: D & R did not adequately analyze the borrower’s credit history. The borrower had declared a bankruptcy that was discharged on February 13, 2006, less than 2 years but more than 1 year from the date of loan closing. The borrower provided an explanation for his bankruptcy in which he stated that he had medical bills of approximately $100,000 related to an injury and that the injury led to his other debts. His explanation did not agree with the bankruptcy papers or the credit report in the loan file. His bankruptcy papers listed a number of creditors with claims from 1994 through 2005, totaling $61,764. The medical claims accounted for $23,461, and the claims from other creditors accounted for the remaining $38,303. The borrower’s explanation was not accurate because the majority of the claims were not medical. Instead, the claims were for utilities, telephone bills, rent, taxes, loans, lawsuits, and credit cards. The borrower did not exhibit that he could manage his obligations responsibly following the bankruptcy. He was 2 months behind on his January 2007 utility bill and was sent to collections by a different creditor not included in the April 2006 bankruptcy. D & R did not document strong compensating factors to support approval of this loan. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, paragraph 2-1, states that the purpose of underwriting is to determine a borrower’s ability and willingness to repay the mortgage debt, thus limiting the probability of default and collection difficulties, and to examine the property offered as security for the loan to determine whether it is sufficient collateral. 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 and delinquent accounts, strong compensating factors will be necessary to approve the loan. The lender must document its analysis regarding whether the late payments were based on disregard for financial obligations or otherwise. Major indications of derogatory credit-including judgments, collections, and any other recent credit problems-require sufficient written explanations for the borrower. The borrower’s explanation must make sense and be consistent with other credit information in the file. HUD Handbook 4155.1, REV 5, paragraph 2-3C, states that collections and judgments indicates 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 where the borrower has collection accounts or judgments. The borrower must explain in writing all collections and judgments. 22 HUD Handbook 4155.1, REV-5, paragraph 2-3E, states that an elapsed period of less than 2 years but not less than 12 months following a Chapter 7 bankruptcy discharge may be acceptable if the borrower can show that the it was caused by extenuating circumstances beyond his control and has since exhibited a documented ability to manage his financial affairs in a responsible manner. Further, the borrower must have reestablished good credit or chosen not to incur new credit obligations. The borrower also must have demonstrated a documented ability to responsibly manage his or her financial affairs. 23 Loan number: 261-8996673 Mortgage amount: $92,550 Section of Housing Act: 203(b) Loan Purpose: Purchase Date of loan Closing: December 6, 2005 Status: Claim Payments before first default reported: Four Loss to HUD: $102,633 Summary: We found material underwriting deficiencies relating to the borrower’s liabilities and credit history. Liabilities: D & R did not include a monthly payment of $75 for a collection account from a previous unpaid rental account. In the loan submission documents, the loan officer noted that the borrower must satisfy the previous unpaid rental. D & R’s underwriter documented on the credit report that this account was paid off, but it was not. The loan file contained a settlement agreement for $2,075 for the unpaid rental account. It consisted of a lump-sum payment of $1,037 and 13 monthly payments of $75. The $75 monthly payment was not included in the calculation of the borrower’s qualifying ratios. If D & R had included the $75 monthly payment, the borrower’s fixed payment-to-income ratio would have been 44.45 instead of 42.29, exceeding HUD’s requirements. Further, D & R did not consider the effect the lump-sum payment would have had on the borrower’s ability to make his mortgage payments, considering that the borrower had limited cash. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, paragraph 2-11A, states that recurring obligations must be considered in qualifying borrowers. The borrower’s recurring obligations include all installment payments 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. HUD Handbook 4155.1, REV-5, 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 24 otherwise provide for the family. If the mortgage payment expense-to-effective income ratio exceeds 29 percent and/or the total of the mortgage payment and all recurring charges exceeds 41 percent of the gross effective income, the loan may be acceptable only if significant compensating factors, as discussed in paragraph 2-13, are documented and are recorded on the mortgage credit analysis worksheet. Mortgagee Letter 2005-16, dated April 13, 2005, increased the mortgage payment-to-income and debt-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. HUD 4155.1, REV-5, paragraph 2-13, states that compensating factors that may be used to justify approval of mortgage loans with ratios exceeding our benchmark guidelines are those listed in the handbook. Underwriters must record in the “remarks” section of the HUD Form 92900-WS/HUD 92900-PUR the compensating factor(s) used to support loan approval. Any compensating factor used to justify mortgage approval must be supported by documentation. Credit: D & R did not properly analyze the borrower’s credit. The borrower’s credit report identified a number of collection accounts and one revolving charge account that were delinquent. The borrower sufficiently explained the collection accounts; however, his explanation for the recent delinquent installment account was inadequate. The borrower explained that he did not make timely payments on his credit card account because he did not always receive a monthly bill. The credit report showed that he was 90 days late three times, 30 days late three times, and 60 days late once. Since the borrower’s credit report identified several derogatory accounts, D & R required him to provide additional credit references to demonstrate a positive 12-month payment history as a condition to close. The borrower provided a statement from his cable provider. However, D & R’s underwriter noted that this credit reference was not good because the borrower did not pay his cable bill in a timely manner. The borrower then provided two additional letters of credit, one from an art gallery and the other from a party company. Both of these credit references were faxed from the borrower’s place of employment, not directly from independent third parties. In addition, the borrower was unable to provide the lender with a satisfactory rental payment history. His previous landlord had actually reported him to a collection agency for failure to pay his rent. As a condition to close, D & R’s underwriter required that the prior housing collection be paid off. The borrower entered into a repayment agreement to settle the collection as discussed in the liabilities section above. 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 and delinquent accounts, strong compensating factors will be 25 necessary to approve the loan. The lender must document its analysis regarding whether the late payments were based on disregard for financial obligations or otherwise. Major indications of derogatory credit-including judgments, collections, and any other recent credit problems-require sufficient written explanations for the borrower. The borrower’s explanation must make sense and be consistent with other credit information in the file. HUD Handbook 4155.1, REV 5, paragraph 2-3C, states that collections and judgments indicates 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 where the borrower has collection accounts or judgments. The borrower must explain in writing all collections and judgments. HUD Handbook 4155.1, REV-5, paragraph 3-1, states that the lender may not accept or use documents relating to the credit, employment, or income of borrowers that are handled by or transmitted from or through interested third parties (e.g., real estate agents, builders, sellers) or by using their equipment. 26 Loan number: 261-9111473 Mortgage amount: $ 224,700 Section of Housing Act: 203(b) Loan Purpose: Purchase Date of loan closing: September 21, 2006 Status: Claim Payments before first default reported: Six Loss to HUD: $145,233 Summary: We found a material underwriting deficiency relating to the co-borrower’s credit history. Credit: D & R did not adequately analyze the co-borrower’s credit. The borrower and co-borrower were not related. The borrower would not have qualified for the mortgage without the co-borrower’s income The credit report for the co-borrower identified late payments for credit cards and utility bills and a number of collection accounts. The co-borrower provided explanations, but they were not adequate. For example, one credit card had recent late payments, and the co-borrower explained that his former spouse paid this credit card. However, the co-borrower’s credit report indicated that the co-borrower was the sole owner of the account. Further, the account did not have any authorized users. In another example, the co-borrower’s credit report indentified a telephone account with 15 late payments of 90 days that the recent late payment occurred within a month of loan closing. The co-borrower explained that he purchased a telephone for his son and was not aware that his son did not pay the telephone bills. According to the co-borrower’s credit report, he was the sole owner of the telephone account. Further, the account did not have any authorized users. HUD/FHA Requirements: HUD Handbook 4155.1, REV-5, paragraph 2-1, states that the purpose of underwriting is to determine a borrower’s ability and willingness to repay the mortgage debt, thus limiting the probability of default and collection difficulties, and to examine the property offered as security for the loan to determine whether it is sufficient collateral. 27 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 and delinquent accounts, strong compensating factors will be necessary to approve the loan. The lender must document its analysis regarding whether the late payments were based on disregard for financial obligations or otherwise. Major indications of derogatory credit-including judgments, collections, and any other recent credit problems-require sufficient written explanations for the borrower. The borrower’s explanation must make sense and be consistent with other credit information in the file. HUD Handbook 4155.1, REV 5, paragraph 2-3C, states that collections and judgments indicates 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 where the borrower has collection accounts or judgments. The borrower must explain in writing all collections and judgments. 28 APPENDIX C LENDER COMMENTS AND OIG’s EVALUATION Ref to OIG Evaluation Lender Comments 29 Ref to OIG Evaluation Lender Comments 30 Ref to OIG Evaluation Lender Comments 31 Ref to OIG Evaluation Lender Comments 32 Ref to OIG Evaluation Lender Comments Comment 1 33 Ref to OIG Evaluation Lender Comments 34 Ref to OIG Evaluation Lender Comments Comment 2 Comment 3 Comment 4 35 Ref to OIG Evaluation Lender Comments Comment 5 36 Ref to OIG Evaluation Lender Comments Comment 6 Comment 7 Comment 8 37 Ref to OIG Evaluation Lender Comments Comment 9 38 Ref to OIG Evaluation Lender Comments Comment 10 39 Ref to OIG Evaluation Lender Comments Comment 11 40 Ref to OIG Evaluation Lender Comments Comment 12 Comment 13 Comment 14 41 Ref to OIG Evaluation Lender Comments Comment 15 Comment 16 42 Ref to OIG Evaluation Lender Comments Comment 17 43 Ref to OIG Evaluation Lender Comments Comment 18 Comment 19 Comment 20 44 Ref to OIG Evaluation Lender Comments Comment 21 Comment 22 45 Ref to OIG Evaluation Lender Comments Comment 23 Comment 24 Comment 25 Comment 26 46 Ref to OIG Evaluation Lender Comments Comment 27 Comment 28 Comment 29 Comment 30 47 Ref to OIG Evaluation Lender Comments Comment 31 Comment 32 48 Ref to OIG Evaluation Lender Comments Comment 33 49 Ref to OIG Evaluation Lender Comments Comment 34 50 Ref to OIG Evaluation Lender Comments Comment 35 51 Ref to OIG Evaluation Lender Comments Comment 36 52 Ref to OIG Evaluation Lender Comments Comment 37 Comment 38 Comment 39 53 Ref to OIG Evaluation Lender Comments Comment 40 54 Ref to OIG Evaluation Lender Comments Comment 41 Comment 42 55 Ref to OIG Evaluation Lender Comments Comment 43 56 Ref to OIG Evaluation Lender Comments Comment 44 57 Ref to OIG Evaluation Lender Comments Comment 45 58 Ref to OIG Evaluation Lender Comments 59 Ref to OIG Evaluation Lender Comments 60 Ref to OIG Evaluation Lender Comments 61 OIG’s Evaluation of Lender Comments Comment 1 D & R did not provide any documentation to support its statement that HUD reviewed loan number 483-3712823. However, whether or not HUD reviewed this loan would not negate the underwriting deficiencies cited for this loan. For loan numbers 483-3758135 and 261-9205529, D & R did not provide the response it provided to HUD and documentation to support that the loans were in compliance with HUD’s requirements at the time the loans closed. Further, the results of our review were based upon our independent analysis of the underwriting based on documentation contained in the loan files reviewed. Comment 2 See comment 1. Comment 3 We disagree with D & R. For loan number 483-3758135, the borrower’s fixed payment to income ratio exceeded HUD’s requirements by 4.4 percent. The mortgage credit analysis worksheet in the borrower’s loan file did not contain any compensating factors in the remarks section to justify loan approval as required by HUD Handbook 4155.1, REV 5, paragraph 2-13. Further, D & R’s assertion that the borrower’s strong job stability is a sufficient compensating factor to justify loan approval is not appropriate. Despite adequate income to meet financial obligations and no current housing expense, the borrower’s credit report demonstrated he had difficulty meeting his financial obligations. Specifically, the borrower had incurred 5 new collection accounts within 12 months before the loan closed. The borrower’s bank statement dated less than three months before the loan closed identified that the borrower had incurred more than $100 in non-sufficient funds charges. Further, the borrower also indicated in his written explanation that he incurred the collection accounts because he between jobs pursuing a different field of work. This statement contradicts D & R’s statement about the borrower’s job stability. Therefore, the documents in the file indicated that the borrower already had difficulty meeting his financial obligations at his current wage rate with no housing expense. Thus, the addition of the borrower’s mortgage payment increased his fixed monthly payments from $697 to $1,730, which represented an increase of 148 percent. Comment 4 We disagree with D & R. For loan number 261-9065826, although the underwriter provided compensating factors in the remarks section of the mortgage credit analysis worksheet to justify the borrower’s 35.88 percent mortgage payment to income ratio, the compensating factors were not adequately supported by documentation in the borrower’s loan file. The borrower’s monthly rental amount reflected on the loan application and mortgage credit analysis worksheet was $533. This amount was supported by money order receipts included in the borrower’s loan file. Therefore, the borrower’s mortgage obligation would result in a $248 increase in the borrower’s monthly expenses, which represents a 46.5 percent increase. HUD requires that the borrower demonstrates the ability to pay 62 housing expenses equal to or greater than the proposed monthly housing expense for the new mortgage over the past 12 to 24 months, or a minimal increase in the borrower’s housing expense. Further, the borrower’s loan file contained a cancelled check for $2,567, dated February 10, 2006, made payable to the landlord, not the City of Detroit. However, there was no documentation in the borrower’s loan file to indicate that the landlord used this check or the funds to pay the property taxes. Further, the property tax information sheet contained in the loan file indicated that the property taxes totaled $2,046 and were paid on July 1, 2005, and the next tax payment was due on July 1, 2006. This loan closed on May 15, 2006. Additionally, the amount of the landlord’s property taxes did not reconcile with the amount of the borrower’s check to the landlord. HUD’s Handbook 4155.1 REV 5, paragraph 2-13, states that any compensating factor used to justify mortgage approval must be supported by documentation. Therefore, using the payment of $2,567 to the landlord as one of the compensating factors was not supported. Comment 5 According to the HUD-1 settlement statement, dated May 15, 2006, in the borrower’s loan file, the escrowed amount for the property taxes was $2,046. Public records showed that the property’s taxes were reduced during the summer of 2007 due to a homestead tax reduction. Therefore, the borrower would have received the property tax reduction the following year, not during the first year of the mortgage. The borrower defaulted on her mortgage and the home went into foreclosure within the first 12 months of the loan; thus, she did not benefit from the homestead property tax reduction. Therefore, the homestead property tax reduction would not be appropriate to use as a compensating factor since it did not decrease the borrower’s housing obligation. The borrower’s monthly rental amount reflected on the loan application and mortgage credit analysis worksheet was $533. This amount was supported by money order receipts included in the borrower’s loan file. Therefore, the borrower’s housing obligations increased by $248; thus, representing a 46.5 percent increase. Further, the borrower’s loan file contained a cancelled check for $2,567, dated February 10, 2006, made payable to the landlord, not the City of Detroit. However, there was no documentation in the loan file to indicate that the landlord used this check to pay the property taxes. Therefore, listing on the mortgage credit analysis worksheet that the borrower’s property tax payment would result in the borrower’s current housing payment being only $34 less than the proposed mortgage amount was not adequately supported. Comment 6 Although the borrower worked two jobs, the borrower’s bank statements and credit report disclosed the borrower had difficulty managing her financial obligations. For instance, the bank statement, dated January 18, 2006, showed that the borrower had a number of insufficient funds charges and returned checks from November 29, 2005, through January 18, 2006. Further, the borrower’s 63 credit report identified a number of prior and recent collection accounts due to unpaid charges as a result of returned checks. HUD Handbook 4155.1, REV-5, paragraph 2-3, states that if the borrower’s credit history, despite adequate income to support obligations, reflects continuous slow payments, judgments, and delinquent accounts, strong compensating factors will be needed to approve the loan. Comment 7 See comment 1. Comment 8 For loan number 251-9205529, the mortgage credit analysis worksheet in the borrower’s loan filed did not contain compensating factors notated in the remarks section to justify loan approval in accordance with HUD Handbook 4155.1, REV- 5, paragraph 2-13. Further, D & R’s assertions the file documented the borrower’s stable rental history and his job stability as compensating factors to justify loan approval is not correct. The borrower’s current housing expense of $1,700 was not adequately supported. Specifically, D & R did not provide documentation to support that the borrower made 12 to 24 months of rental payments of $1,700. The borrower’s loan file contained four copies of cancelled checks of $550 to cover the five month period from June to October 2006 (the check for the month of September was not included in the borrower’s loan file) for one residence. Another five cancelled checks of $1,700 to cover the period of November 2006 through March 2007 for another rental residence was in the loan file. The nine cancelled checks represented only nine months of rental payments, instead of the 12 months in accordance with HUD Handbook, 4155.1, REV-5, paragraph 2-3(a). Further, the loan file did not contain a written verification of rent form from the borrower’s landlords. Therefore, the D & R did not support the borrower’s ability to pay housing expenses equal to or greater than the proposed monthly housing expense for the new mortgage over the past 12 to 24 months to use the borrower’s rental history as a significant compensating factor. Further, job stability as a compensating factor to justify loan approval is not appropriate considering the borrower’s credit history. Although the borrower’s current housing expense was $1,700 and the proposed mortgage was $1,939 (a 14 percent increase), the borrower filed for Chapter 7 bankruptcy, which was discharged less than 2 years before obtaining the loan. However, the borrower did not demonstrate a documented ability to manage his financial affairs in a responsible manner, and D & R did not document that the borrower’s current situation indicated that the events that led to the bankruptcy were not likely to recur as required by HUD Handbook 4155.1, REV-5, paragraph 2-3E. Therefore, even though the borrower had stable employment; he did not demonstrate the ability to manage his financial obligations. Comment 9 According to HUD’s requirements, underwriters must exercise due diligence when considering borrowers for mortgage approval. Specifically, a direct endorsement mortgagee shall exercise the same level of care which it would exercise in obtaining and verifying information for a loan in which the mortgagee 64 would be entirely dependent on the property as security to protect its investment. Further, according to HUD Handbook 4155.1, REV-5, Section 5, underwriting requires careful analysis of the many aspects of the mortgage. Each loan is a separate and unique transaction, and there may be other factors that demonstrate the borrower’s ability and willingness to make timely mortgage payments. The lender is responsible for adequately analyzing the probability that the borrower will be able to repay the mortgage obligation in accordance with the terms of the loan. Although HUD allows for judgment, it specifically outlines the danger of layering flexibilities in assessing mortgage insurance risk, simply establishing that a loan transaction meets minimal standards does not necessarily constitute prudent underwriting. D& R did not document its analysis as to whether the borrower’s late payments were based on a disregard for financial obligations, the inability to manage debts, or factors beyond the control of the borrower, including delayed mail deliveries or disputes with creditors as required by HUD Handbook 4155.1, REV-5, paragraph 2-3. Therefore, we could not determine whether D & R properly analyzed the borrowers’ overall pattern of credit behavior. Our assessment of the borrower’s credit was based on the credit information documented in the loan files, in conjunction with other supporting documentation. Comment 10 For loan number 262-1650023, the borrower filed for Chapter 7 bankruptcy, which was discharged more than 2 years before obtaining the loan. However, the borrower did not demonstrate a documented ability to manage his financial affairs in a responsible manner, and reestablish good credit or chose not to incur new credit obligations as required by HUD Handbook 4155.1, REV-5, paragraph 2-3E. Specifically, the borrower had recent derogatory accounts on his credit report, including two revolving accounts that were over the borrower’s spending limit and three accounts with recent late payments. Further, the borrower did not provide explanations for all the derogatory accounts, including collections, identified on his credit report. The borrower only explained the two derogatory revolving accounts; however, in his written explanation for the late payments, the borrower stated that he sent his payments in late but he did not think that the late payments would affect his credit. Further, one of the borrower’s collection accounts was opened in 2006. However, the bankruptcy document in the borrower’s loan file did not list this collection or its original credit account as one of the creditors. Therefore, we concluded that this collection account was not included in the borrower’s Chapter 7 bankruptcy filing. The borrower’s income documents indicated that the borrower was earning adequate income to meet his financial obligations as they come due. We acknowledge that the borrower’s residential mortgage credit report identified that the borrower had no late rental payments. However, the borrower’s stated rent was $590 and his proposed mortgage would be $1,259, a 113 percent increase. Therefore, although the borrower paid his rental obligations in a timely manner, 65 his credit report indicated he had difficulties meeting other financial obligations, as previously mentioned. Comment 11 For loan number 261-9177201, although the borrower’s judgments were satisfied, he did not explain the judgments in writing as required by HUD Handbook 4155.1, REV-5, paragraph 2-3C. In the borrower’s written explanations he contends that his credit problems did not start until 2003. However, his credit report identified two judgments that were incurred in 2001 and 2002. Therefore, the borrower’s explanation was not consistent with other documentation in the loan file. Further, the borrower had two recent collection accounts for telephone carriers and one medical collection. Comment 12 Although the borrower’s written explanation letter in the loan file stated that the borrower incurred financial hardships in 2003, as previously mentioned, the judgments occurred in 2001 and 2002. In addition, the borrower’s credit report identified a collection account that opened in 2003, a number of charge-off accounts in 2000 and 2001, and a number of accounts with late payments from 2000 to 2003. All of these derogatory accounts were incurred before the borrower’s documented financial hardship. In 2005, the borrower’s credit report showed collection accounts opened in 2005 and 2006, and recent late payment on two accounts within the past six months of the loan’s closing. However, the borrower’s income as reflected on his 2005 and 2006 W-2’s exceeded $190,000 collectively. Therefore, the borrower’s credit deficiencies occurred from 2000 to 2007. This loan closed in March 2007. Comment 13 Our discussion draft report did not assert that the borrower’s medical collection account did not relate to the borrower’s past medical issues. Rather, it stated that the borrower had three collection accounts, one of which was for medical. However, we clarified in our report to show that the borrower’s statement regarding his refusal to pay on principle actually referred to one of the two non- medical collection accounts. The report’s mention of the borrower’s credit, in particular the borrower’s collection accounts, excluding the one medical collection; and recent late payments on his revolving accounts showed that the borrower neglected to meet his financial obligations. Although the borrower provided written explanations for four of the derogatory items on his credit, the borrower did not explain the reasons for recent late payments on two revolving accounts and two past judgments. Comment 14 We agree that the documentation in the borrower’s file showed that the borrower paid his rental obligations when due. However, the borrower had a prior mortgage that showed he was 30-days late 21 times, 60-days late 6 times, and 90- days delinquent 1 time. According to the borrower, the home was sold in October 2005. According to the mortgage credit analysis worksheet in the borrower’s loan file, the borrower’s rental expense was $1,038 and the proposed mortgage payment was $1,902, which would be an increase of 83 percent. Although the borrower had enough income to satisfactorily make the mortgage payments, his 66 credit report identified a number of collections, judgments, and recently delinquent revolving accounts in which the borrower did not sufficiently explain as required by HUD Handbook 4155.1, REV-5, paragraph 2-3C (see comments 11, 12 and 13). Comment 15 See comments 1 and 9. Comment 16 For loan number 483-3758135, the borrower’s written explanations were not consistent with other documentation in the borrower’s loan file. For instance, the borrower stated that he incurred medical collections due to being self-employed with no health insurance at the time the medical bills were incurred. However, the documentation in the borrower’s loan file showed that the borrower had been working at his current place of employment since March 2002, whereas according to the borrower’s credit report, his medical collection accounts were opened from 2002 through 2006. Further, the borrower stated that he filed for bankruptcy because he cosigned for three car loans at the same time for friends. However, his friends did not make the car payments. The borrower’s credit report only identified that one of the borrower’s three car loans were included in the borrower’s bankruptcy filing. Additionally, for this one car loan, the credit report showed that the borrower was the primary owner. The second car loan was not included in the borrower’s bankruptcy filing; however, the borrower was listed as the sole owner. This car loan identified a number of late payments. The remaining car loan identified the borrower as a joint owner and this account was not derogatory. Further, the borrower’s credit report identified a recently obtained “recreation loan” four months prior to closing on the mortgage that was over the credit limit. Even though the borrower’s credit report indicated that he only opened two credit accounts since his bankruptcy, the recreational and automobile loans, the borrower’s combined balance for these accounts exceeded $20,000 as of the date of the credit report. Therefore, he did not choose to incur new obligations or re- established good credit as required by HUD Handbook 4155.1, REV-5, paragraph 2-3E. Comment 17 For loan number 261-9065826, the borrower’s credit report identified 15 accounts. Of the 15 accounts, 13 were collections or charged-off accounts and were opened from August 2001 through October 2005. Seven of the 13 derogatory accounts were paid in full or settled for less than the original balance. The borrower provided written explanations for the derogatory accounts identified on her credit report. However, the explanations were not consistent with the credit information contained in the borrower’s loan file. For instance, according to the borrower’s explanation letter, her collection and delinquent accounts were incurred because in 2004 she was a victim of identity theft. The borrower’s loan file contained a copy of a police report, dated February 16, 2006, five days before she applied for the mortgage. According to the police 67 report, the borrower reported that the identity theft happened between January 1, 1992, and February 16, 2006. Further, the borrower indicated on the police report that she notified the bank regarding the fraudulent charges and had received a refund. However, as of February 22, 2006, the borrower’s credit report disclosed that the collection accounts that the borrower identified as being related to the identity theft still remained as unpaid collections. According to HUD’s Handbook 4155.1 REV 5, paragraph 2-3, the borrower’s explanation must make sense and be consistent with other credit information in the file. Comment 18 We acknowledge that D & R’s underwriter required the borrower to pay off outstanding items reflected on her credit report before the loan closed. The collection agency provided information to our office indicating that the credit card the borrower used to pay off one of her collection accounts belonged to the landlord (the seller). According to D & R, the credit card used to pay the borrower’s collection belonged to her mother. However, it did not provide additional information supporting that the credit card belonged to the borrower’s mother. According to HUD Handbook 4155.1, REV 5, paragraph 2-10C, the payment of consumer debt by third parties is an inducement to purchase. When someone other than a family member has paid off debts, the funds used to pay off the debt must be treated as an inducement purchase and the sales price must be reduced by a dollar-for-dollar amount in calculating the maximum insurable mortgage. Comment 19 As indicated in the discussion draft memorandum report, the loan file contained two credit references that were not provided directly by the creditors. The fax number contained on the credit references was the same as the borrower’s sales contract. According HUD Handbook 4155.1, REV-5, paragraph 3-1, lenders may not accept or use documents relating to the credit, employment, or income of borrowers that are handled by or transmitted from or through interest third parties, or by using their equipment. Further, one of the two credit reference letters indicated that the borrower was not the account holder, but was paying on the account. However, when we contacted the creditor, we were informed that the company would not know who made the monthly payments. Further, according to HUD Handbook 4155.1 REV 5, paragraph 2-3, for those borrowers 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. However, the borrower used traditional credit as evidenced by her credit report. Therefore, the use of alternative credit references to support the approval for this loan was not appropriate. D & R contends that the borrower provided an additional credit reference from Z Tel Company and the borrower’s landlord evidencing the borrower had an excellent payment history. We disagree with D & R. The borrower’s loan file contained a credit reference letter from Z Tel Company and her current landlord, which was the seller. HUD Handbook 4155.1, REV-5, paragraph 2-3, states the 68 lender must determine the borrower’s payment history of housing obligations through either the credit report or a verification of rent directly from the landlord (with no identify-of-interest with the borrower). The borrower’s two credit reference letters were more than three years old from the date of the borrower’s loan application. According to HUD Handbook 4155.1, REV-5, paragraph 3-1, all documents may be up to 120 days old at the time the loan closed, unless this or other applicable HUD instructions specify a different time frames or the nature of the documents is such that its validity for underwriting purpose is not affected by being older than the number of prescribed days. Additionally, the letter from Z Tel Company did not contain a payment history. Comment 20 See comments 5, 6, 17, 18, and 19. Comment 21 See comment 1. Comment 22 For loan number 261-9205529, according to the borrower’s bankruptcy petition in the loan file, the borrower’s bankruptcy was discharged in February 2006 and the mortgage loan closed on June 1, 2007; which means less than 2 years had elapsed. According to the borrower’s written explanations, he petitioned for bankruptcy in September 2005 due to medical bills totaling nearly $100,000 from being injured in a car accident, but he did not state when the accident occurred. The borrower’s explanations stated that as a result of his medical bills, he was unable to meet his other financial obligations. However, the borrower’s statement was not consistent with other information from the loan file. Specifically, a copy of the borrower’s filed bankruptcy petition and discharge in the loan file included debts and collections dating back to 1994 and only approximately $20,000 of the $60,000 total was for medical bills. HUD Handbook 4155.1, REV-5, paragraph 2-3E, states that after a Chapter 7 bankruptcy/ liquidation, an elapsed period of less than two years, but not less than 12 months may be acceptable if the borrower can show that the bankruptcy was caused by extenuating circumstances beyond his control and has since exhibited a documented ability to manage his financial affairs in a responsible manner. Since the borrower’s explanation letter did not indicate when the borrower’s car accident occurred and the range of the borrower debts included items from 1994 through 2005, the borrower did not show he filed for bankruptcy due to extenuating circumstances. Further, after the borrower’s bankruptcy was discharged, the borrower had two recently opened revolving accounts with no late payments; however, his credit report also identified that he had one recent 60 day late payment on an installment account. The borrower’s bank transaction inquiry document identified that the borrower incurred $330 of insufficient funds charges during February and March 2007 collectively. Comment 23 See comment 8. 69 Comment 24 For loan number 261-8996673, the borrower provided explanations for collection accounts that were not adequately supported and consistent with the information contained in the borrower’s loan file. For instance, the borrower stated that the Sprint cellular telephone account belonged to his former spouse. However, the borrower’s credit report indicated that he was the sole owner of the account. Further, D & R conditioned on the borrower’s loan submission documents that the borrower must satisfy his previous unpaid rental obligation that was listed on his credit report and D & R wrote on the credit report that the rental collection account was paid off. The borrower explained that he was going to make one lump sum payment of $1,037 as soon as possible and monthly installment payments of $75 until the collection was satisfied. According to a letter of agreement between the creditor and the borrower, the borrower agreed to pay one lump sum payment of $ 1,037 by September 30, 2005, and $75 per month thereafter until the collection for the borrower’s prior housing obligation was satisfied. However, at the time loan closed on December 6, 2005, there was no supporting documentation in the borrower’s loan file to show that the borrower made any payments to his creditor as agreed. When we contacted the collection agency, we were informed that the borrower never made any payments. HUD Handbook 4155.1, REV-5, paragraph 2-3(c), 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 credit worthiness with the lender documenting its reason for approving a mortgage where the borrower has collection accounts or judgments. However, D & R did not provide documentation of its analysis. Comment 25 The borrower’s credit report identified a recently delinquent Capital One credit card account which the borrower explained that he did not pay timely because he did not always receive a monthly bill. The borrower’s credit report disclosed the borrower was 90 days late three times, 30 days late three times, and 60 days late once, within three months before the loan closed. According to HUD’s requirements, when delinquent accounts are revealed, the lender must document its analysis as to whether the borrower’s late payments were based on a disregard for financial obligations, an inability to manage debt, or factors beyond the control of the borrower, including delayed mail delivery or dispute with creditors. D & R’s analysis was not included in the borrower’s loan file. Comment 26 As indicated in our discussion draft memorandum report, the borrower’s loan file contained statements from his cable provider as an additional credit reference. However, D & R’s underwriter notated on the underwriting worksheet contained in the borrower’s loan file that the credit reference was not good because the borrower did not make timely payments. Consequently, the underwriter required the borrower to provide a different credit reference. 70 The borrower provided two additional credit references, one from an art gallery and another from a party company. These credit references were not installments or revolving accounts, and were not provided directly by the creditors. Further, the borrower used traditional credit as evidenced by his credit report. Therefore, the use of alternative credit references to support the approval for this loan was not appropriate. Further, HUD Handbook 4155.1, REV 5, paragraph 2-3, states for those borrowers 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 handbook also states that the basic hierarchy of credit evaluation is the manner of payments made on previous housing expenses, including utilities, followed by the payment history of installment debts and then revolving accounts. Comment 27 The borrower is required to provide evidence of his rental payment history for the past 12-24 months. However, the borrower’s loan file contained seven money order receipts that did not disclose the name of the person who purchased the money orders. HUD requires the lender to obtain and verify the borrower’s payment history of rent directly from the landlord, or verification of mortgage directly from the mortgage servicer, or through cancelled checks covering the most recent 12-month period. The borrower’s loan file contained a verification of rent for his current residence. However, the borrower’s landlord did not identify whether the borrower had any late payments for the past 12 months. The form specifically requires the landlord to indicate the borrower’s payment history for the previous 12 months in order to comply with secondary mortgage market requirements. Comment 28 See comments 24, 25, and 26. Comment 29 In reviewing the documentation provided by D & R for loan number 261- 9111473, we agree that the borrowers provided a check payable to the collection agency for the medical judgment. We adjusted our memorandum report as appropriate. However, this loan remained in the report due to other material underwriting deficiencies. Comment 30 We acknowledge that the coborrower satisfied many of his outstanding financial obligations before the loan closed. However, we disagree with D & R’s statements that the coborrower’s debts were incurred by others. The coborrower provided written explanations for the derogatory accounts listed on his credit report. However, his explanations were not adequately supported and consistent with other information in the loan file. For instance, the coborrower had a number of delinquent and collection accounts, some with recent late payments. However, according the coborrower’s written explanations contained in the loan file, his son or former wife was responsible for making the payments. However, the coborrower’s credit report indicated that he was the sole owner of the derogatory accounts. Therefore, he was responsible for paying his recurring financial obligations in a timely manner. 71 Comment 31 Despite the coborrower’s stable employment and high income, his credit report identified he had a number of slow payments and collection accounts as previously mentioned in comment 30. According to HUD Handbook 4155.1, REV 5, paragraph 2-3, if the credit history, despite adequate income to support obligations, reflects continuous slow payments, judgments, or delinquent accounts, strong compensating factors will be necessary to approve the loan. The mortgage credit analysis worksheet in the borrowers’ loan file did not identify compensating factors used to justify approving the loan. Although the borrower sufficiently explained her credit deficiencies, the coborrower’s whose income was a significant factor in approving the loan credit demonstrated a disregard for financial obligations. Without the coborrower being included on the mortgage, the borrowers’ mortgage payment-to-income ratio would have been approximately 51 percent, which exceeded HUD’s benchmark by approximately 20 percent, and their total fixed payment-to-income ratio would have been approximately 58 percent; thus exceeding HUD’s benchmark by 25 percent. Comment 32 See comment 1. Comment 33 We partially agree with D & R’s calculation of the borrower’s income for loan number 483-3712823. However, since the borrower’s verification of employment form did not identify the amount of the borrower’s pay increase effective April 2007, we did not include the pay increase in our calculations. Therefore, using the borrower’s average overtime income of $203.66, the borrower’s mortgage payment-to-income and fixed payment-to-income ratios would be 35 and 45 percent, respectively. Thus, the ratios exceeded HUD’s benchmark by approximately 4 and 2 percent, respectively. The mortgage credit analysis worksheet in the borrower’s loan file identified that the borrower’s qualifying ratios as 33.69 and 43.22 percent, respectively. However, it did not contain compensating factors. Comment 34 Although loan number 483-3695773 contained underwriting deficiencies that D & R was unable to resolve, we agree to remove this loan from the audit memorandum report since the unresolved issues presented no material underwriting deficiencies based on the documentation provided. Comment 35 For loan number 261-9065622, our draft memorandum report did not address whether the signatures contained on the borrower’s verification of employment form were questionable or dispute the borrower’s current place of employment. However, it did mention that the borrower’s current employer completed the borrower’s verification of employment form as the current and previous employer even though the borrower was previously employed for another company. As stated on the borrower’s verbal employment verification form signed by D & R’s loan processor, the borrower’s previous place of employment was no longer in business. However, D & R contends that it verified the previous employment through the borrower’s credit report. When we contacted the independent consumer credit reporting agency, we were informed that if the agency verified 72 the borrower’s employment information it would be notated on the borrower’s credit report. However, the borrower’s credit report only disclosed the borrower’s employment information without any notation that the credit report agency verified the borrower’s employment. According to HUD Handbook 4155.1, REV-4, paragraph 2-A, a credit report obtained from an independent consumer-reporting agency, the residential mortgage credit report must access at least two named repositories and meet all the requirements for the traditional residential mortgage credit report plus (a) provide a detailed account of the borrower’s employment history; and (b) verify the borrower’s current employment and income. It also must include a statement attesting to certification of employment and date verified. Comment 36 D & R acknowledges that four of the borrower’s pay stubs for the beginning of 2006 reflected a pay period, year-to-date earnings, and taxes withheld for a December 2005 time period. It also acknowledges that the underwriter’s resolution of this discrepancy should have been documented in the borrower’s loan file. However, it contends that the underwriter obtained sufficient documentation prior to closing to resolve any concerns regarding the discrepancy. We disagree. The borrower’s loan file contained two additional pay stubs for February 2006, which reflected the borrower’s current cumulative earnings and taxes withheld. However, these two paystubs contained year-to-date earnings that were not accurate. For instance, the borrower’s weekly income was $950; however, for the paychecks ending February 12 and February 19, 2006, his cumulative year-to-date earnings were $6,650, and $7,600 respectively, which was $950 more than the amount that should have been reflected on the borrower’s paystubs. Further, the borrower’s verification of employment form indicated he did not work overtime or receive bonus or commission income. The borrower’s paystubs and W-2’s also appeared to be computer generated documents. Comment 37 See comment 1. Comment 38 As mentioned in our discussion draft memorandum report for loan number 483- 3712823, the borrower’s debt of $109 per month should have been included in the determination of the borrower’s qualifying ratios even though the borrower only had nine payments remaining on the account. According to HUD Handbook 4155.1, REV-5, paragraph 2-11A, debts lasting less than 10 months must be counted if the amount of the debts affects the borrower’s ability to make the mortgage payments during the months immediately after loan closing, especially if the borrower will have limited or no cash assets after the loan closing. The borrower’s loan file did not contain evidence that the borrower would have cash assets after closing the loan. Therefore, the inclusion of this liability in the calculation of the borrower’s qualifying ratio would have resulted in the borrower’s fixed payment-to-income ratio being nearly 49 percent; thus exceeding HUD’s benchmark by 6 percent. 73 Further, the mortgage credit analysis worksheet in the borrower’s loan file identified job stability as a compensating factor for approving this loan. D & R contends that the borrower’s job stability of more than six years with his current employer would have offset the effect of the excluded monthly liability. We disagree. Although the borrower was employed with his current employer for approximately three and a half years, instead of six, job stability is not an appropriate compensating factor. The borrower’s employment does not compensate for the ability to manage increasing financial obligations, since the borrower would be receiving the same rate of pay. Further, the mortgage credit analysis worksheet in the borrower’s file disclosed that the amount of the borrower his cash reserves were determined to be $281.20. Moreover, the borrower’s mortgage payment of $1,018 would result in a 28 percent increase in his housing expense. Comment 39 We disagree with D & R. The borrower made 10 payments until the first 90-day default was reported by the mortgage servicer. However, the borrower had been delinquent in making his mortgage payments every month starting with his first mortgage payment. Comment 40 See comment 34. Comment 41 For loan number 262-1650023, the borrower’s loan file contained documentation that the borrower was obligated to pay child support. Specifically, section VIII of the borrower’s initial and final loan applications disclosed that the borrower was obligated to pay alimony, child support, or separate maintenance. Further, the borrower’s statement of earnings, dated December 8, 2006, identified a wage garnishment of $95.80 for child support. The borrower’s loan file also contained a petition for bankruptcy document, dated December 2002, that disclosed the borrower paid child support of $409.50 per month since 1993. Further, the ages of the borrower’s dependent children indicated that the borrower’s child support obligation would have continued after the loan closed. Comment 42 We disagree with D & R. The inclusion of the borrower’s child support obligation would have resulted in the borrower’s mortgage payment-to-income ratio being 37 percent and the fixed payment-to income ratio being 49 percent; thus, exceeding HUD’s benchmark of 31 and 43 percent, respectively. D & R did not notate any compensating in the remarks section of the mortgage credit analysis worksheet. However, D & R contends that the borrower’s past two years of verified rental payments of $590 per month was a strong compensating factor to justify approving the loan. As previously mentioned in comment 10, the borrower’ proposed mortgage expense of $1,259 would be a 113.39 percent increase from his current monthly housing obligation of $590. Further, the borrower’s credit report indicated that the borrower had difficulty meeting his other financial obligations even though his current rental payment was less than half of the proposed mortgage. 74 Comment 43 D & R acknowledged that the borrower’s installment debt of $75 was inadvertently omitted from the qualifying ratio calculation for loan number 261- 8996673. As stated in our discussion draft memorandum report, if D & R’s underwriter had included the $75 installment debt in calculating the borrower’s fixed payment-to income ratio, the ratio would have been 44.5 percent; thus exceeding HUD’s benchmark by 1.5 percent without documentation of compensating factors in the borrower’s loan file or on the mortgage credit analysis worksheet. D & R contends that the borrower’s slightly higher than average ratio would have been offset by the borrower’s excellent 12-month rental payment history, stable employment, and the eligibility for a homestead tax exemption. We agree that the borrower’s loan file contained a verification of rent form, which indicated that he paid his rent in a timely manner. However, the borrower’s credit report disclosed a prior collection account derived from a previous delinquent rental obligation that was still outstanding at time the loan closed. The borrower’s report also identified a collection account from a telephone carrier and a revolving account with three 30-day, one 60-day, and three 90-day late payments. Three of these delinquencies occurred within six months of the loan closing. The borrower’s credit report disclosed he had difficulty meeting his financial obligations at his current employment pay rate. Further, the borrower’s proposed mortgage expense increased the borrower’s monthly housing obligation from $675 to $844, a 25 percent increase. Therefore, using the borrower’s employment as a compensating factor would not adequately justify approval for the loan. Further, the loan closed on December 6, 2005, and according to public records the property’s 2006 property winter tax (county tax) was due in December 2006 and the summer 2007 tax (city tax) was due in August 2007. The property taxes are due annually. However, since the borrower defaulted on the loan within the first 12-months of the mortgage, the borrower did not benefit from the homestead property tax reduction, which was reduced during the second year of the mortgage. Therefore, using the homestead property tax reduction as a compensating factor would not be appropriate since it did not decrease the borrower’s housing obligation. Comment 44 For loan number 261-9177201, the mortgage credit analysis worksheet in the borrower’s loan file indicated that the borrower needed $13,898 to close. The borrower’s loan file contained a verification of deposit, dated January 24, 2007, which indicated that the borrower’s bank balance was $4,145. A second verification of deposit disclosed that the borrower had a balance of $9,904 as of February 27, 2007. The borrower’s bank balance increased by $5,759 over a one month period. Further, a teller receipt in the borrower’s loan file identified that the borrower’s bank balance was $15,401, an increase of $5,497. The borrower’s loan file did not contain any written explanations for the large increases in the borrower’s bank account. 75 The borrower’s loan file contained a summary printout from Turbo Tax that disclosed the borrower was expected to receive an income tax refund of $10,243. However, the summary printout, which was not filed, signed, or dated, contained a reminder to the user preparing the tax documents that the tax payer’s taxes were not finished until all steps were completed. Therefore, the amount of the borrower’s alleged anticipated tax refund was not adequately supported to justify the large increases in the borrower’s bank account. Comment 45 The recommendations in the discussion draft memorandum report are appropriate based on the issues cited. Violations of FHA rules are subject to civil and administrative action. 76
D & R Mortgage Corporation, Farmington Hills, MI, Did Not Properly Underwrite a Selection of FHA Loans
Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-08-04.
Below is a raw (and likely hideous) rendition of the original report. (PDF)