Department of Housing and Urban Development, Office of Inspector General | Housing and Urban Development | D & R Mortgage Corporation, Farmington Hills, MI, Did Not Properly Underwrite a Selection of FHA Loans

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)

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

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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

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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.

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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

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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.

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The mortgage credit analysis worksheet is used to analyze and document mortgage approval.

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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

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Double damages plus a $7,500 fine for each of the 9 incorrect certifications.

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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.

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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

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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.

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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.

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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.

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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.

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.

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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.

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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.

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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:

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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:

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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:

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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:

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 2-3, 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:

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:

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.

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:

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 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:

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.

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APPENDIX C

LENDER COMMENTS AND OIG’s EVALUATION

Ref to OIG Evaluation Lender Comments

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Ref to OIG Evaluation Lender Comments

30
Ref to OIG Evaluation Lender Comments

31
Ref to OIG Evaluation Lender Comments

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Ref to OIG Evaluation Lender Comments

Comment 1

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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

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Ref to OIG Evaluation Lender Comments

Comment 9

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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
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Comment 27

Comment 28

Comment 29

Comment 30

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Comment 31

Comment 32

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Comment 33

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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

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Ref to OIG Evaluation Lender Comments

Comment 37

Comment 38

Comment 39

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Ref to OIG Evaluation Lender Comments

Comment 40

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Comment 41

Comment 42

55
Ref to OIG Evaluation Lender Comments

Comment 43

56
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Comment 44

57
Ref to OIG Evaluation Lender Comments

Comment 45

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Ref to OIG Evaluation Lender Comments

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Ref to OIG Evaluation Lender Comments

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Ref to OIG Evaluation Lender Comments

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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

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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

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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.

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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.

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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.

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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

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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.

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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.

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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.

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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.