oversight

DHI Mortgage Company, LTD's Scottsdale, AZ, Branches Did Not Follow FHA-Insured Loan Underwriting Requirements

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-03-19.

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

                                                                    Issue Date
                                                                            March 19, 2010
                                                                    Audit Report Number
                                                                             2010-LA-1009




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



FROM:       Joan S. Hobbs, Regional Inspector General for Audit, Region IX, 9DGA

SUBJECT: DHI Mortgage Company, LTD‘s Scottsdale, AZ, Branches Did Not Follow
         FHA-Insured Loan Underwriting Requirements

                                     HIGHLIGHTS

 What We Audited and Why

      We audited Federal Housing Administration (FHA)-insured loan processes at two DHI
      Mortgage Company, LTD (DHI Mortgage), branches in Scottsdale, AZ, to determine
      whether DHI Mortgage originated, approved, and closed FHA-insured single-family
      loans in accordance with U.S. Department of Housing and Urban Development (HUD)
      requirements. We recently conducted an audit of DHI Mortgage‘s Tucson and Scottsdale
      branches and identified significant underwriting deficiencies and improper restrictive
      addenda/liens to the purchase contracts. Based on the results of our prior audit, we chose
      to audit the remaining two DHI Mortgage Scottsdale branches.


 What We Found

      DHI Mortgage did not follow HUD requirements for originating, approving, or closing
      FHA-insured loans. Specifically, all 20 of the loans reviewed contained underwriting
      deficiencies, and 12 of these had significant deficiencies that impacted the insurability of
      the loan. The significant underwriting deficiencies included improper calculation of
      income, inadequate documentation of income, inadequate determination of credit and/or
      debt, and inadequate compensating factors when the debt-to-income ratio exceeded
     HUD‘s benchmark ratio. We also reviewed all of the loans in our audit period that were
     either ―new construction‖ or ―new condo‖ to determine whether improper restrictive
     covenants were recorded against the FHA-insured properties. We identified eight loans
     that had prohibited restrictive addenda to the purchase contracts.


What We Recommend

     We recommend that the Deputy Assistant Secretary for Single Family Housing require
     DHI Mortgage to (1) indemnify HUD for more than $2.5 million for loans that did not
     meet FHA insurance requirements and (2) reimburse HUD $265,420 for the amount of
     claims and associated fees paid on loans that did not meet FHA insurance requirements.

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

Auditee’s Response


     We provided a discussion draft report to DHI Mortgage on February 5, 2010, and held an
     exit conference on February 23, 2010. DHI Mortgage provided written comments on
     March 3, 2010. They generally disagreed with our findings.

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




                                             2
                            TABLE OF CONTENTS

Background and Objective                                                            4

Results of Audit
      Finding 1: DHI Mortgage Failed To Underwrite FHA-Insured Loans in             5
                 Accordance With HUD-FHA Requirements

      Finding 2: DHI Mortgage Did Not Prevent Restrictive Covenants That Violated   9
                 HUD-FHA Requirements

Scope and Methodology                                                               12

Internal Controls                                                                   14

Follow-up on Prior Audits                                                           15

Appendixes

   A. Schedule of Questioned Costs and Funds To Be Put to Better Use                17
        A-1 Loan Details for Significant Underwriting Deficiencies
        A-2 Loans Details for Schedule A To Purchase Contracts

   B. Auditee Comments and OIG‘s Evaluation                                         20
   C. Criteria                                                                      49
   D. Narrative Loan Summaries for Significant Underwriting Deficiencies            56




                                            3
                           BACKGROUND AND OBJECTIVE

DHI Mortgage Company, LTD (DHI Mortgage), is a nonsupervised lender1 approved June 8,
1981, to originate Federal Housing Administration (FHA) loans. DHI Mortgage originates loans
under the lender insurance program.2 The company is a wholly owned subsidiary of D.R.
Horton, Inc., a national residential homebuilder, and an affiliate of DHI Title Company (DHI
Title), another wholly owned subsidiary of D.R. Horton, Inc. DHI Mortgage headquarters is at
12357 Riata Trace Parkway, Suite C-150, Austin, TX, and the company has branches in 20
States. DHI Mortgage provides mortgage financing services principally to purchasers of D.R.
Horton, Inc., homes.

DHI Mortgage has 36 FHA-approved active branch offices.3 Between fiscal years 2007 and
2009, DHI Mortgage originated 17,993 FHA-insured loans totaling more than $3.2 billion.

We selected the remaining two DHI Mortgage Scottsdale, AZ, branches (FHA numbers
0542400095 and 0542400696) for review because our previous audit of its Tucson and other
Scottsdale branches (Report 2009-LA-1018, issued September 10, 2009) identified 24 FHA-
insured loans that had significant underwriting deficiencies and 205 FHA-insured loans that had
improper restrictive addenda/liens to the purchase contracts. Some of the personnel responsible
for originating, approving, and closing loans at the branch offices in our previous audit were also
involved with the two remaining Scottsdale branches. The two DHI Mortgage Scottsdale
branches originated 1,897 FHA-insured loans totaling more than $344 million during our audit
period.4

FHA, created by Congress in 1934, is the largest mortgage insurer in the world. The cost of
FHA mortgage insurance is paid by the homeowners, and the mortgage insurance fund is used to
operate the program. The mortgage insurance fund pays claims to lenders in the event of a
homeowner default. Between October 1, 2008, and September 30, 2009, FHA insured more than
1.8 million single-family mortgages totaling more than $328 billion, or 68 percent of the single-
family insured mortgage market—up from 39 percent the previous year.5

Our objective was to determine whether DHI Mortgage FHA branch numbers 0542400095 and
0545200696 originated, approved, and closed FHA-insured loans in accordance with U.S.
Department of Housing and Urban Development (HUD)-FHA regulations and requirements.


1
  A nonsupervised lender is a HUD-FHA-approved lending institution that has as its principal activity the lending or
investment of funds in real estate mortgages and is not a supervised lender, loan correspondent, governmental
institution, government-sponsored enterprise, or public or State housing agency and has not applied for approval for
the limited purpose of being an investing lender.
2
  The U.S. Department of Housing and Urban Development‘s (HUD) lender insurance program allows lenders to
self-insure FHA loans and submit only those case binders (paper or electronic) required for review by HUD. HUD
reviews approximately 6 percent of insured loans.
3
  According to Neighborhood Watch, as of December 28, 2009.
4
  The audit period included FHA-insured loans with beginning amortization dates between June 1, 2007, and May
31, 2009.
5
  HUD monthly report to the FHA Commissioner: FHA Portfolio Analysis Data as of September 2009.


                                                         4
                                RESULTS OF AUDIT

Finding 1: DHI Mortgage Failed To Underwrite FHA-Insured Loans in
           Accordance With HUD-FHA Requirements
DHI Mortgage did not follow HUD requirements for underwriting FHA-insured loans.
Specifically, all 20 loans reviewed contained underwriting deficiencies, and 12 of these had
significant deficiencies that impacted the insurability of the loan. This noncompliance occurred
because the lender failed to exercise due diligence in underwriting these loans. As a result, for
loans that did not meet FHA insurance requirements the FHA portfolio was exposed to increased
insurance risk for $1,186,300 in unpaid mortgage balances and incurred losses of $265,420.


 Twelve Loan Files Contained
 Significant Underwriting
 Deficiencies

       The loan file review of 20 FHA-insured loans identified 12 with significant underwriting
       deficiencies that included improper calculation of income, inadequate documentation of
       income, inadequate determination of credit and/or debt, and inadequate compensating
       factors when the debt-to-income ratio exceeded HUD‘s benchmark ratio. DHI Mortgage
       did not underwrite the 12 loans as required by HUD Handbook 4155.1, REV-5, chapter 3,
       which states that ―the lender is responsible for asking sufficient questions to elicit a
       complete picture of the borrower‘s financial situation, source of funds for the
       transactions, and the intended use of the property. All information must be verified and
       documented.‖ The 12 loans, which totaled more than $1.7 million in unpaid mortgage
       balances, were approved based on many factors that included reported monthly income,
       debt obligations, assets, and/or compensating factors. However, DHI Mortgage closed
       many of the loans based on inadequate determination and evaluation of these factors.

               Income – The significant deficiencies included improperly calculated income;
               inadequate documentation of income as required by Mortgagee Letter 2004-47;
               and lack of documentation to support the use of overtime income as required by
               HUD Handbook 4155.1, REV-5, paragraph 2-7A.

               For example, for FHA loan number 023-2692048, the lender included the
               borrower‘s overtime hours in the overtime calculation as well as the base income
               calculation. As a result, a portion of the overtime income was doubled, and the
               borrower‘s monthly income was overstated by $425.

               Credit – The significant deficiencies included the lender‘s failure to obtain a
               credit report for a nonpurchasing spouse as required by HUD Handbook 4155.1,
               REV-5, paragraph 2-2D; exclusion of debts from the qualifying ratios; failure to
               adjust rental property mortgage payments that were scheduled to increase due to


                                                5
interest rate resets; failure to document compensating factors and that the
borrowers reestablished good credit after bankruptcy as required by HUD
Handbook 4155.1, REV-5, paragraph 2-3; and failure to provide proof of satisfied
judgments before closing as required by HUD Handbook 4155.1, REV-5,
paragraph 2-11.

For example, for FHA loan number 023-2575560, the lender excluded two
liabilities for the borrower and coborrower in the total fixed payment-to-income
ratio as required by the Fannie Mae Underwriting Findings and HUD Handbook
4155.1, REV-5, paragraph 2-11A. The borrower‘s pay stub revealed a deduction
for ―Levy-Fed‖ of $100 per month, and the coborrower‘s pay stub revealed a
deduction for ―Company Store‖ of $599 per month. The borrower‘s and co-
borrower‘s liabilities and debts were understated by $699.

Assets – The significant deficiency regarded the lender‘s failure to document the
transfer of gift funds to the borrower as required by HUD Handbook 4155.1,
REV-5, paragraph 2-10C.

For FHA loan number 023-2866499, the borrower had a downpayment of
$19,132 that was derived from a $20,000 gift received from his spouse. At
closing, the funds were wired from the borrower‘s checking account; however,
the loan file contained neither a withdrawal document showing that the
withdrawal was from the donor‘s account nor the home buyer‘s deposit slip or
bank statement that showed the deposit.

Compensating factors – The significant deficiencies regarded the lender‘s failure
to document adequate and eligible compensating factors when the borrower‘s
ratios exceeded HUD‘s benchmark guidelines as required by HUD Handbook
4155.1, REV-5, paragraph 2-13, and Mortgagee Letter 2005-16.

For example, for FHA loan number 023-2836293, the borrower‘s mortgage
payment-to-income and total fixed payment-to-income ratios exceeded HUD‘s
benchmark ratios by 16.83 and 6.14 percent, respectively. The only allowable
compensating factor listed by the lender was that the borrower had ―reserves for 3
months.‖ However, this compensating factor was not eligible because the
borrower‘s reserves were $423 less than the amount required.

The table below lists the 20 FHA loan numbers reviewed and the deficient areas
associated with each loan. The table also identifies the 12 loans for which we
concluded that the underwriting was significantly deficient and, therefore,
warranted indemnification. Appendix D provides underwriting details for each
FHA loan considered to have significant underwriting deficiencies.




                                 6
                                Underwriting deficiencies                  Significant
    FHA loan
                                                     Compensating         underwriting
    number           Income      Credit    Assets
                                                          factors          deficiencies
    023-2501805                   
    023-2510944                               
    023-2516629                              
    023-2546830                                                                
    023-2575560                                                               
    023-2577611                                                               
    023-2577634                                                               
    023-2610061                                                                
    023-2685082                                             
    023-2692048                                                               
    023-2704044                                                                
    023-2709195                                                               
    023-2715893         
    023-2728194                                                               
    023-2836048                                             
    023-2836293                                                              
    023-2866499                                                               
    023-2880511                                                               
    023-2913632                    
    023-3125199        
                       12          10            8             7                12


The Remaining Eight Loan
Files Also Contained
Underwriting Deficiencies

    The remaining eight loans reviewed also contained underwriting deficiencies that were in
    violation of HUD-FHA requirements; however, they were not deemed significant enough
    to impact the insurability of the loan. Examples of these technical underwriting
    deficiencies include loan files that did not contain the verification of deposit as required
    by HUD Handbook 4155.1, REV-5, paragraph 3-1F; compensating factors when the
    borrower‘s ratios exceeded HUD‘s benchmark guidelines as required by HUD Handbook
    4155.1, REV-5, paragraph 2-13, and Mortgagee Letter 2005-16; verification of
    employment for 2 years as required by HUD Handbook, paragraph 2-6; explanation of
    collection accounts on the credit report as required by HUD Handbook, 4155.1, REV-5,
    paragraph 2-3C; and explanation of credit inquiries that were within 90 days of the
    completed credit report as required by HUD Handbook 4155.1, REV-5, paragraph 2-3B.
    In these cases, either the technical underwriting deficiency was not significant enough to
    impact the insurability of the loan, or the loan would be eligible based on other factors



                                             7
         even if the underwriter had properly adjusted for the deficient items. The table above
         identifies the loans that contained technical underwriting deficiencies.

    Lack of Due Diligence
    Increased Risk of Loss to the
    FHA Insurance Fund

         The foreword in HUD Handbook 4155.1, REV-5, states, ―This [underwriting] decision
         must be predicated on sound underwriting principles consistent with the guidelines, rules,
         and regulations described throughout this Handbook and must be supported by sufficient
         documentation.‖ Because DHI Mortgage did not follow HUD-FHA requirements when
         underwriting, it inappropriately approved 12 loans that had significant underwriting
         deficiencies. The lender did not exercise both sound judgment and due diligence when it
         submitted these loans for FHA insurance. As a result, the FHA insurance fund was at
         increased risk for losses on seven6 loans with significant underwriting deficiencies.
         Regarding the other three loans with significant underwriting deficiencies, the FHA
         insurance fund has already realized losses. The losses resulted when the properties that
         secured these three loans were sold and the insurance claims and other expenses incurred
         by HUD exceeded the sales proceeds.

    Conclusion


         DHI Mortgage‘s failure to follow HUD-FHA regulations and requirements placed the
         FHA insurance fund at additional risk for losses. There were 10 loans that did not meet
         the requirements for FHA insurance. Seven of these loans had a total unpaid mortgage
         balance of $1,186,300 with an estimated loss to HUD of $711,7817. The remaining three
         loans had an actual loss to HUD of $265,420. (see appendix A-1).

    Recommendations

         We recommend that the Deputy Assistant Secretary for Single Family Housing

               1A. Require DHI Mortgage to indemnify HUD against losses for the seven FHA-
                   insured loans with significant underwriting deficiencies in the amount of
                   $1,186,300. The estimated loss to HUD is $711,781.

               1B. Require DHI Mortgage to reimburse HUD for the $265,420 in losses resulting
                   from the amount of claims and associated expenses paid on three loans with
                   significant underwriting deficiencies.

6
  After the start of the audit, two loans (023-2610061 and 023-2692048) were indemnified by request from the
lender.
7
  This amount was calculated based on 60 percent of the unpaid mortgage balances (according to Neighborhood
Watch as of December 21, 2009). The 60 percent indemnification rate was the average loss on FHA-insured
foreclosed properties based on the FHA Annual Management Report for Fiscal Year 2009.


                                                       8
Finding 2: DHI Mortgage Did Not Prevent Restrictive Covenants That
           Violated HUD-FHA Requirements
DHI Mortgage did not ensure that unallowable restrictive covenants were not filed against eight
FHA-insured properties. The restrictive covenants precluded the borrowers from rental or resale
of their property for 1 year and provided for the seller to recoup $40,000 in liquidated damages if
the borrower violated the restrictive covenants. DHI Mortgage allowed the restrictive covenants,
generally referred to as a schedule A to purchase contract, because officials believed it would
discourage investors from purchasing their affiliate‘s (the seller‘s) properties. Because the FHA
insurance program requires free assumability with no restrictions, the FHA insurance portfolio
had secured more than $1.3 million in unpaid mortgage balances for six loans8 that did not meet
this FHA insurance requirement.



    Restrictive Covenants Were
    Applied to Eight FHA-Insured
    Loans

           A review of the applicable county recorder‘s records revealed liens on eight FHA-insured
           properties These liens, called schedule A to purchase contacts, restricted the new
           owner(s) from resale or rental of the property during the first year of ownership. The
           execution of these contracts with the purchase agreements violated the regulations
           governing HUD‘s FHA-insured mortgage program, which prohibit restrictive covenants
           and second liens. As illustrated in the excerpt below, the contracts stated that the ―Owner
           hereby grants to Seller a lien against the Property (the ‗Lien‘) to secure Owner‘s
           obligations hereunder. Seller may promptly initiate proceedings to foreclose the Lien if
           Owner defaults in its obligation to pay Seller liquidated damages in the amount of
           $40,000 on the date that Owner or any of its successors or assigns conveys during the
           Restricted Period any rights, title, or interest in the Property without Seller‘s written
           consent.‖

           Schedule A to purchase contract corresponding to FHA loan number 023-2470369




8
    After the start of the audit, two loans (023-2470369 and 023-2488642) were terminated.


                                                           9
        DHI Mortgage was apparently aware that this practice was not allowed for FHA-insured
        mortgages because there were instances in which the occupancy/investment disclosure
        addendum to the purchase contract contained the following exclusion from the restrictive
        covenant when the buyer purchased the property using FHA financing.

        Addendum to purchase contract corresponding to FHA loan number 023-2929894



        However, despite the exclusion clause number 12 to the schedule A to purchase, the
        contract was executed and recorded in eight instances.

        Appendix A-2 contains the FHA loan numbers for which we found a schedule A to
        purchase contract. The schedule A to purchase contracts made the loans ineligible for
        FHA insurance because the contract addenda included prohibited liens against FHA-
        insured property as well as restrictive covenants that prevented the borrower from rental
        or resale of the FHA-insured property, which violated 24 CFR (Code of Federal
        Regulations) 203.32 and 203.41, respectively. The regulations at 24 CFR 203.32 state
        that after the mortgage offered for insurance has been recorded, the mortgaged property
        will be free and clear of all liens other than such mortgage. The regulations at 24 CFR
        203.41(b) state that an FHA-insured ―mortgage shall not be eligible for insurance if the
        mortgaged property is subject to legal restrictions on conveyance‖ (see appendix C).9




9
 The exception to free assumability is at 24 CFR 203.41(c) ―Exception for eligible governmental or nonprofit
programs.‖


                                                        10
     DHI Mortgage Officials Used
     the Covenants to Discourage
     Investment Purchasers

          DHI Mortgage officials stated that the schedule A to purchase contracts was a common
          practice designed to address a significant problem experienced by D.R. Horton, Inc., –
          Dietz-Crane (D.R. Horton) and other homebuilders when home prices were rapidly
          escalating. In many cases, a buyer who claimed to be purchasing a home for his or her
          residence was actually an investor seeking to purchase and then quickly sell the home at a
          profit. D.R. Horton did not consider this flipping practice to be consistent with the goal
          of building sustainable communities at a reasonable price. Officials stated that the
          ―Schedule A was not designed to prohibit or provide for liquid damages in connection
          with the bona fide purchase and resale of a home by the owner-occupant. Schedule A
          simply provides that a home may not be resold within one year of the purchase from D.R.
          Horton without D.R. Horton‘s consent.‖

     Conclusion

          The schedule A to purchase contract put additional unnecessary risk on the FHA-insured
          loans by restricting the borrower‘s ability to rent or sell a property during the first year of
          the loan and by giving sole discretion to the former seller to grant a waiver of the
          restrictions. By restricting the borrower‘s ability to rent or sell the property during the
          first year of the loan, distressed homeowners were unable to freely sell or rent their
          property in an attempt to relieve the financial burden. Therefore, the six loans with a
          total unpaid mortgage balance of more than $1.3 million did not meet the requirements
          for FHA insurance because they violated 24 CFR 203.32 and 203.41. The estimated loss
          to HUD associated with these loans is $789,98410 (see appendix A-2).

      Recommendation

          We recommend that the Deputy Assistant Secretary for Single Family Housing require
          DHI Mortgage to

               2A. Indemnify HUD against losses for the six FHA-insured loans with
                   unallowable covenants and prohibited liens in the amount of $1,316,641. The
                   estimated loss to HUD is $789,984.




10
  This amount was calculated based on 60 percent of the unpaid mortgage balances or the actual loss to HUD when
known (according to Neighborhood Watch as of December 21, 2009).


                                                      11
                             SCOPE AND METHODOLOGY

Our audit period covered loans with beginning amortization dates from June 1, 2007, to May 31,
2009. During this period, DHI Mortgage FHA branch numbers 0542400095 and 0545200696
originated 1,897 FHA-insured mortgages, with a total mortgage balance of more than $344
million. We conducted our fieldwork at DHI Mortgage‘s Scottsdale, AZ, branch office between
July and December 2009.

We reviewed underwriting documentation in the lender/FHA loan files for 20 FHA-insured
loans11 selected nonstatistically based on the existence of loan defaults and claims. We used
HUD‘s online information system for FHA-insured loans to identify all FHA-insured loans from
DHI Mortgage branch numbers 054200095 and 0545200696 with beginning amortization dates
between June 1, 2007, and May 31, 2009. There were 1,897 FHA-insured loans for the selected
branch numbers and period. We then selected loans that (1) had an FHA insurance status of
claim and/or (2) were more than 6 months in default and had less than four mortgage payments
made before the first 90-day default was reported. This methodology resulted in a sample of 17
FHA-insured loans. We also included three FHA-insured loans that were referred to the
Homeownership Center12 by the lender.

We also reviewed 786 FHA-insured loans in our audit scope that HUD‘s information system
indicated were either ―new condo‖ or ―new construction.‖ We reviewed the applicable county
recorder‘s Web site for all 786 of the loans to determine whether improper restrictive covenants
were recorded against the FHA-insured properties. We found recorded covenants for eight
properties (approximately 1 percent of the loans reviewed). Because the percentage of loans
with recorded covenants was much lower than we found during our prior audit of DHI Mortgage
branches in Scottsdale and Tucson (see Follow-up on Prior Audits), we then randomly selected
45 of the 786 loans and requested the title files to review for restrictive covenants that were
either not recorded or had been recorded under an identifier other than the property address. We
also reviewed the title files for the eight loans already identified with recorded restrictive
covenants and for the 20 loans selected for the underwriting review sample. Therefore, we
reviewed title files for a total of 73 FHA-insured loans (45 plus 8 plus 20) to determine whether
there were improper restrictive covenants in the file.

To accomplish our objective, we

        Reviewed HUD regulations and reference materials related to single-family
        requirements;
        Reviewed DHI Mortgage‘s loan files;
        Reviewed 73 title files to determine whether there were improper restrictive covenants in
        the file;
        Interviewed appropriate DHI Mortgage staff; and

11
  These loans were all purchase mortgages.
12
  There are four Homeownership Center‘s located across the country that are responsible for administering all
single-family activities in their respective jurisdictions.


                                                        12
        Interviewed borrowers, when available, associated with the 20 FHA loans in our
        underwriting review.

We used the source documents in the loan case file to determine borrower income, employment
history, and debt. For the loans underwritten by an automated underwriting system, we reviewed
the FHA loan file to determine whether it contained the documentation to support the integrity
and accuracy of the data used by the automated underwriting system to recommend approval of
the loan. For the manually underwritten loans, we reviewed the loan documents to determine
whether they supported the underwriting decision and complied with HUD Handbook 4155.1,
REV-5, Mortgage Credit Analysis.13

We classified the underwriting deficiencies as either technical or significant. The technical
underwriting deficiencies were minor underwriting deficiencies that, even if corrected, would not
result in a significant increase in mortgage risk. We did not recommend indemnification or
reimbursement for loans that only contained technical underwriting deficiencies.

We used data maintained by HUD in its information systems for FHA loans (Neighborhood
Watch) to obtain the unpaid mortgage balances and the actual losses to HUD for each of the
loans (as of December 21, 2009). HUD paid claims on three of the loans that we determined had
significant underwriting deficiencies; however, the properties were still in HUD‘s inventory or
the sale information was not available (see appendix A-1). We requested that HUD indemnify
against losses for these loans because the total loss to HUD has not been realized.

We also used data maintained by HUD in its information systems for FHA loans to obtain
background information and to select our sample of loans for testing. We did not rely on the
data to reach our conclusions; therefore, we did not assess the reliability of the data.

We did not perform a lender quality control review because it was completed and reported
during the prior audit of DHI Mortgage (see Follow-up on Prior Audits).

We conducted the audit in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain sufficient, appropriate
evidence to provide a reasonable basis for our findings and conclusions based on our audit
objective. We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.




13
  A manually underwritten loan must comply with HUD Handbook 4155.1. HUD‘s Mortgagee Letter 2004-47
explains that mortgage loans scored as accepted or approved through FHA‘s TOTAL Mortgagee Scorecard are
granted a number of credit policy revisions and documentation relief from the instructions in HUD Handbook
4155.1. However, the lenders must still comply with outstanding eligibility requirements and ensure the integrity
and accuracy of the data used to render a decision.


                                                        13
                              INTERNAL CONTROLS

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

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

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




 Relevant Internal Controls


       We determined that the following internal controls were relevant to our audit objective:

              Policies and procedures intended to ensure that FHA-insured loans are properly
              originated, underwritten (approved), and closed.

       We assessed the relevant controls identified above.

       A significant weakness exists if internal controls do not provide reasonable assurance that
       the process for planning, organizing, directing, and controlling program operations will meet
       the organization‘s objectives.

 Significant Weaknesses

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

              DHI Mortgage did not have effective controls in place to ensure that FHA-insured
              loans were underwritten in accordance with HUD requirements, exposing the FHA
              insurance fund to unnecessary risk (see findings 1 and 2).

              DHI Mortgage did not have effective controls in place to ensure that FHA-insured
              loans closed in accordance with HUD requirements, exposing the FHA-insurance
              fund to unnecessary risk (see finding 2).



                                                14
                     FOLLOW-UP ON PRIOR AUDITS

DHI Mortgage Company, LTD’s
Scottsdale and Tucson Branches
Did Not Always Follow FHA-
Insured Loan Underwriting and
Quality Control Requirements,
HUD OIG Report 2009-LA-1018

     HUD Office of Inspector General issued an audit report on two DHI Mortgage branch
     offices (Report 2009-LA-1018) on September 10, 2009. The audit found that DHI
     Mortgage‘s Scottsdale branch (FHA number 0542400332, now closed) and Tucson branch
     (FHA number 0542400180) did not follow HUD requirements for originating, approving, or
     closing FHA-insured loans. Specifically, the audit identified 205 loans with prohibited
     restrictive addenda to the purchase contracts and 24 loans with significant underwriting
     deficiencies. In addition, the audit noted that DHI Mortgage‘s quality control processes had
     weaknesses, including failure to determine that 19 loans were not eligible for FHA
     insurance because the loan officer had been debarred from participation in FHA-insured
     loan transactions. As of March 2010, HUD generally agreed with the following
     recommendations addressed to the Assistant Secretary for Housing-Federal Housing
     Commissioner:

            1A.     Indemnify HUD against losses for the 205 FHA-insured loans with
                    unallowable covenants and prohibited liens in the amount of $36,157,343.
                    The projected loss to HUD is $15,256,783.

            1B.     Discontinue the use of unallowable covenants and prohibited liens with
                    FHA-insured loans and refrain executing these documents or filing them
                    with the county recorder‘s office.

            1C.     Develop and implement verification procedures to ensure that the
                    unallowable restrictive covenant and the prohibited liens are not executed
                    and/or filed with the county recorder‘s office for FHA-insured loans.

            2A.     Indemnify HUD against losses for the 24 FHA-insured loans with significant
                    underwriting deficiencies in the amount of $4,114,822. The projected loss to
                    HUD is $942,818.

            2B.     Refund the $15,749 in overinsurance generated from financing the loan
                    discount into the FHA-insured loan by (1) reimbursing HUD in the amount
                    of the loan discount for any claim paid on the loan; (2) paying down any
                    amount of arrears, penalties, or fees owed on the loan due to delinquency;
                    and then, if applicable, (3) applying the remaining amount of the loan
                    discount against the principal amount owed on the FHA-insured loan.



                                             15
3A.   Indemnify HUD against losses for the 19 FHA-insured loans originated by a
      debarred employee in the amount of $3,477,875. The projected loss to HUD
      is $168,773.

3B.   Revise and implement policies and procedures to reflect HUD requirements
      for updating FHA branch office changes and to ensure that offices do not
      employ or have a contract with individuals who are under debarment,
      suspension, or a limited denial of participation.

3C.   Fully implement its quality control plan related to FHA-insured loan reviews
      and FHA branch office reviews.

3D.   Discontinue or develop and implement procedures regarding officials
      working for DHI Mortgage and DHI Title to ensure that a clear and effective
      separation exists between the two entities and that borrowers know at all
      times exactly with which entity they are doing business.

3E.   Discontinue the compensation to underwriters in the form of commissions,
      in appearance and in fact.




                               16
                                    APPENDIXES

Appendix A

               SCHEDULE OF QUESTIONED COSTS
              AND FUNDS TO BE PUT TO BETTER USE

     Recommendation                 Ineligible 1/                  Funds to be put
            number                                                 to better use 2/
                    1A                                                      $711,781
                    1B                 $265,420
                    2A                                                      $789,984


                Totals                 $265,420                        $1,501,765



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.

2/   Recommendations that funds be put to better use are estimates of amounts that could be
     used more efficiently if an Office of Inspector General recommendation is implemented.
     These amounts include reductions in outlays, deobligation of funds, withdrawal of
     interest, costs not incurred by implementing recommended improvements, avoidance of
     unnecessary expenditures noted in preaward reviews, and any other savings that are
     specifically identified. If HUD implements our recommendations to indemnify loans that
     were not originated in accordance with FHA requirements, it will reduce FHA‘s risk of
     loss to the insurance fund. The amount above reflects HUD‘s calculation that FHA loses
     an average of about 60 percent of the unpaid mortgage balance when it sells a foreclosed
     property.

     See the appendixes in this section for further explanation of costs.




                                              17
Appendix A-1

       LOAN DETAILS FOR SIGNIFICANT UNDERWRITING
                      DEFICIENCIES
The table below contains the actual, if known, and estimated losses to HUD corresponding to the
loans recommended for indemnification under finding 1.

                                 Unpaid
        FHA loan                                                   Actual loss to      Estimated loss
                                mortgage         Claim paid14
        number                                                        HUD15            to HUD (60%)16
                                balance
        023-2546830              $128,660          $137,879                                 $77,196
        023-2575560               161,577                              $55,902
        023-2577611               134,220                               81,153
        023-2577634               253,997                              128,365
        023-261006117               –                   –                –                    –
        023-269204817               –                   –                –                    –
        023-2704044               173,946                                                   104,368
        023-2709195               149,270           156,640                                  89,562
        023-2728194               154,684           167,477                                  92,810
        023-2836293               159,866                                                    95,920
        023-2866499               220,761           237,886                                 132,457
        023-2880511               199,113                                                   119,468
        Totals                 $1,736,094          $699,882           $265,420             $711,781




14
   Property conveyed to insurer (HUD) and no sale had been completed or the sale information was not available.
15
   Preforeclosure sale had been completed or property conveyed to insurer (HUD) and sale had been completed.
16
   Amounts were calculated based on 60 percent of the unpaid mortgage balances.
17
   After the start of the audit, these loans were indemnified by request from the lender.


                                                       18
Appendix A-2

             LOAN DETAILS FOR SCHEDULE A TO PURCHASE
                            CONTRACTS
The table below contains the unpaid mortgage balance and estimated loss to HUD corresponding
to the loans recommended for indemnification under finding 2 resulting from FHA-insured loans
with schedule A to purchase contracts.

                     FHA loan                   Unpaid mortgage    Estimated loss to
                     number                         balance           HUD (60%)
                     023-2469200                   $203,897            $122,338
                     023-247036918                     –                  –
                     023-2471335                    218,622             131,173
                     023-2471568                    219,416             131,650
                     023-2478701                    208,952             125,371
                     023-248864218                     –                  –
                     023-2495541                    238,467             143,080
                     023-2497089                    227,287             136,372
                     Totals                      $1,316,641            $789,984




18
     After the start of the audit, these loans were terminated.


                                                              19
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                         20
Comment 1




            21
Comment 2




Comment 3




            22
Comment 4




Comment 5




Comment 6




            23
24
Comment 7




            25
26
27
Comment 8




Comment 9




            28
Comment 10




             29
Comment 11




Comment 12




             30
31
Comment 13




             32
33
Comment 14




Comment 15




             34
35
Comment 16




             36
Comment 17




             37
38
39
40
Comment 18




             41
                         OIG Evaluation of Auditee Comments

Comment 1   As stated in our previous audit, we disagree with the auditee‘s assertion that it
            lacked knowledge that the restrictive covenants were recorded and therefore had
            no responsibility to ensure its FHA-insured loans were (1) freely assumable as
            required under 24 CFR (Code of Federal Regulations) 203.41 and (2) free and
            clear of all other liens as required under 24 CFR 203.32(a). The regulations under
            24 CFR 203.32(a) state ―a mortgagor must establish that, after the mortgage
            offered for insurance has been recorded, the mortgaged property will be free and
            clear of all liens other than such mortgage, and that there will not be outstanding
            any other unpaid obligations contracted in connection with the mortgage
            transaction or purchase of the mortgaged property, except obligations that are
            secured by property or collateral owned by the mortgagor independently of the
            mortgaged property.‖ Thus, it was DHI Mortgage‘s responsibility to ensure that
            the liens, which were included in the restrictive covenant, were not placed against
            the FHA-insured property. If DHI Mortgage had ensured its FHA loans were free
            of the improper liens, then it would have been aware that the related properties
            also had restrictive covenants that violated FHA‘s free assumability rule.

            We agree that the contractual agreement form which the schedule A to purchase
            contract originated provided exclusionary language for FHA and VA financed
            loans. Additionally, 24 CFR 203.41(b) explicitly states, ―[a] mortgage shall not
            be eligible for insurance if the mortgaged property is subject to legal restrictions
            on conveyance.‖ Because the 8 loans discussed under finding 2 of the report were
            subject to legal restrictions on conveyance, these loans were clearly ineligible for
            FHA insurance.

Comment 2   We disagree with the auditee‘s response that the two statements in finding 2 of the
            report are inaccurate and unsupported by the evidence. As stated in comment 1, it
            was DHI Mortgage‘s responsibility to ensure that the liens, which were included
            in the restrictive covenant, were not placed against the FHA-insured property. If
            DHI Mortgage had ensured its FHA loans were free of the improper liens, then it
            would have been aware that the related properties also had restrictive covenants
            that violated FHA‘s free assumability rule. The statements were also based upon
            the following excerpt from a letter dated June 5, 2009 provided to the OIG by
            DHI Mortgage‘s attorney:




            We acknowledge that DHI Mortgage used the Schedule A to Purchase Contract
            with the conventional market in mind. However, 24 CFR (Code of Federal


                                             42
            Regulations) 203.41 was clear that such a restriction on the resale of a property
            made the mortgage ineligible for FHA insurance.

                   24 CFR 203.41 Free Assumability

                   (a)(3) Legal restrictions on conveyance means any provision in any legal
                   instrument, law or regulation applicable to the mortgagor or the mortgaged
                   property, including but not limited to a lease, deed, sales contract,
                   declaration of covenants, declaration of condominium, option, right of first
                   refusal, will, or trust agreement, that attempts to cause a conveyance
                   (including a lease) made by the mortgagor to:… (ii) Be the basis of
                   contractual liability of the mortgagor for breach of an agreement not to
                   convey, including rights of first refusal, pre-emptive rights or options
                   related to mortgagor efforts to convey; (iii) Terminate or subject to
                   termination all or a part of the interest held by the mortgagor in the
                   mortgaged property if a conveyance is attempted; (iv) Be subject to the
                   consent of a third party;….

                   (b) Policy of free assumability with no restrictions. A mortgage shall not
                   be eligible for insurance if the mortgaged property is subject to legal
                   restrictions on conveyance, except as permitted by this part.

            The auditee‘s response notes that, for the audit time period, DHI‘s loan
            origination activity was primarily conventional financing. It is OIG‘s opinion
            that, because DHI officials were aware that the use of the schedule A was a
            common practice, they should have taken extra steps to ensure that the covenant
            was removed once it was determined that a specific loan would be FHA-insured.

Comment 3   As stated in our previous audit, we disagree with the auditee‘s implied response
            that the use of the restrictive covenant could not have harmed the homebuyers
            because it was used at a time of unprecedented growth in the homebuilding
            industry. The schedule A to purchase contract, as discussed under finding 2,
            states the ―[s]eller may promptly initiate proceedings to foreclose the Lien if
            Owner defaults in its obligation to pay Seller liquidated damages in the amount of
            $40,000 on the date that Owner or any of its successors or assigns conveys during
            the Restricted Period any rights, title, or interest in the Property without Seller‘s
            written consent.‖ The prospect of the $40,000 liability could readily deter a
            borrower from renting or selling their property if the need arose. The notion
            expressed in the auditee‘s response that it is obvious that the FHA-exclusionary
            language in the original sales contract would likely take precedence over the
            recorded lien assumes the homebuyer has sophisticated legal knowledge. The
            previous OIG audit noted an instance where a borrower who experienced
            financial difficulties after the first four month‘s mortgage payments believed that
            she could not attempt to find a renter for the property because of the restrictive
            covenant. However, after the one-year restriction period expired, the borrower
            decided that the housing market decline had depressed prices to a point that made



                                             43
            it unlikely she could sell or rent the home for an amount that would cover the
            mortgage. As a result, the home went into foreclosure.

Comment 4   This portion of the auditee‘s response pertains to conventional loans and therefore
            is not relevant to the finding regarding FHA-insured loans. Moreover, the ―life
            events‖ presented in the auditee‘s response as reasons the lien would be released
            do not include financial difficulties alone.

Comment 5   See OIG responses to comments 1 and 2.

Comment 6   See OIG responses to comment 3.

            In addition, the auditee‘s response asserts that, the fact that two loans had already
            been terminated without payment of the alleged schedule A restriction further
            reinforces that there is no risk to the insurance fund. We disagree with the
            auditee‘s assertion because the termination of these two loans occurred more than
            2 years after the loans had closed. Therefore the relevant 1-year period restricting
            resale or rental of the property had expired. Specifically, FHA loan number 023-
            2470369 closed on June 14, 2007 and was terminated on December 30, 2009.
            FHA loan number 023-2488642 closed on July 20, 2007 and was terminated on
            November 23, 2009.

Comment 7   We disagree with the auditee‘s response. As stated in the report, the borrowers
            did not reestablish good credit and did not demonstrate the ability to responsibly
            manage their affairs, as required by HUD Handbook 4155, REV-5, paragraph 2-
            3E, after being discharged from a Chapter 7 bankruptcy. The response from the
            auditee did not address this issue. The borrowers had multiple collection accounts
            on their credit report after the bankruptcies were discharged. Even though the
            collection accounts were medical related and explained by the borrowers, they
            showed that the borrower‘s did not reestablish good credit or demonstrate the
            ability to responsibly manage their affairs.

            In addition, we believe that the borrower‘s credit history (a Chapter 7 bankruptcy
            in 2001, a Chapter 7 bankruptcy in 2003, and multiple collection accounts) did
            represent a disregard for credit by the borrowers.

Comment 8   We disagree with the auditee‘s response that the paystub in the file supports a
            base monthly salary of $3,090 and that the year-to-date base pay on the paystub
            supports a monthly average of $3,076.57. The paystub does show that the
            borrower was paid $1,545.45 semi-monthly; however, the borrower was a school
            teacher and the contract with her employer states ―The term of this Agreement is
            for one school year, starting on July 15th, 2007 and ending June 15th, 2008…‖
            Therefore, the borrower‘s income should have been calculated based on 11
            months (July 15, 2007 to June 15, 2008) instead of 12 months. The OIG
            calculated her annual salary as follows: $1,545.45 multiplied by 22 paychecks
            (11 months multiplied by 2 paychecks per month) equals $33,999.90. This annual



                                             44
              salary is also supported by the borrower‘s contract which states ―…the School
              will pay you an annual salary of $34,000 plus any 301 monies that you qualify to
              receive…‖ This supports monthly income of $2,833.33 ($33,999.90 divided by
              12 months).

              In addition, the year-to-date base pay on the paystub does show $10,768.15 and
              this does represent a 3.5 month average; however, as stated earlier, the borrower‘s
              employment contract is for 11 months. Therefore, if using the year-to-date based
              pay on the paystub, the borrower‘s annual salary should be calculated as follows:
              $3,076.57 per month average ($10,768.15 year-to-date divided by 3.5 months)
              multiplied by 11 months (the length of the contract) equals $33,842.76. This
              supports monthly income of $2,820.23 ($33,842.76 divided by 12 months).

Comment 9     We disagree with the auditee‘s response that implies the borrower received an
              average of $285.71 per month of additional income that was not used in
              qualifying and therefore is an adequate compensating factor to support approval
              of this loan. The borrower‘s paystub shows that the borrower received year-to-
              date earnings of $1,000 for Prop 301; however the paystub did not show any
              current earnings for Prop 301. The file did not contain any documentation that
              the borrower expected to receive additional Prop 301 earnings for the remainder
              of her contract. Therefore, we do not agree that the borrower‘s additional income
              that was not used in qualifying the borrower is an adequate compensating factor
              that should be considered in supporting the approval of the loan. HUD Handbook
              4155.1, REV-5, paragraph 2-13E states that a compensating factor that may be
              used to justify approval of mortgage loans is ―The borrower receives documented
              compensation or income not reflected in effective income, but directly affecting
              the ability to pay the mortgage, including food stamps and similar public
              benefits.‖ Additional income of $1,000 per year for Prop 301 did not directly
              affect the borrower‘s ability to pay the mortgage when the revised mortgage
              payment-to-income and total fixed payment-to-income ratios were 39.25 and
              50.51 percent, respectively, which far exceed HUD‘s benchmark ratios

Comment 10 We disagree with the auditee‘s response that the three collection accounts did not
           require an explanation because they were all over two years old at the time of
           approval. HUD Handbook 4155.1, REV-5, paragraph 2-3 states ―While minor
           derogatory information occurring two or more years in the past does not require
           explanation, major indications of derogatory credit – including judgments,
           collections, and any other credit problems – require sufficient written explanation
           from the borrower.‖ Therefore, all major indications of derogatory credit,
           regardless of when they occurred, require sufficient written explanation from the
           borrower.

Comment 11 We disagree that the underwriter would not have known at the time of approval
           that the borrower‘s mortgage loan for his rental property had an adjustable rate
           mortgage that was due to reset in 5.5 months and that the rental property belonged
           to an HOA. HUD Handbook 4155.1, REV-5, chapter 3 states ―The lender is



                                              45
              responsible for asking sufficient questions to elicit a complete picture of the
              borrower‘s financial situation, source of funds for the transactions, and the
              intended use of the property. All information must be verified and documented.‖
              The lender should have asked sufficient questions regarding the payment and any
              potential changes that could occur to the borrower‘s rental property. The
              underwriter also could have obtained information about the borrower‘s mortgage
              loan from the appropriate county recorder‘s office which is public information
              and easily accessible through the county recorder‘s Web site.

              The lender also should have asked questions regarding the community in which
              the property was located. The HOA dues could be verified through the HOA‘s
              Web site.

Comment 12 We disagree that the borrower‘s earnest money deposit was properly verified by
           only obtaining a copy of the borrower‘s cancelled check. HUD Handbook
           4155.1, REV-5, paragraph 2-10 states ―If the amount of the earnest money deposit
           exceeds 2 percent of the sales price or appears excessive based on the borrower‘s
           history of accumulating savings, the lender must verify with documentation the
           deposit amount and the source of funds. Satisfactory documentation includes a
           copy of the borrower‘s cancelled check. A certification from the deposit-holder
           acknowledging receipt of funds and separate evidence of the source of funds is
           also acceptable. Evidence of source of funds includes a verification of deposit or
           bank statement showing that at the time the deposit was made the average balance
           was sufficient to cover the amount of the earnest money deposit.‖ Therefore, the
           lender is not only required to verify documentation of the deposit amount but also
           the source of funds. The lender did obtain documentation of the deposit amount
           through a copy of the borrower‘s cancelled check; however, the lender did not
           verify the source of the funds as required.

Comment 13 We agree that this loan has already been indemnified. We removed the
           recommendation to seek indemnification for this loan and also changed the
           language in the report to identify that this loan has already been indemnified.

Comment 14 We agree that the monthly payment on all student loans were included in the
           qualifying ratios at five percent of the unpaid balance. We removed this
           underwriting deficiency from the report; however we did not change our
           conclusion to seek indemnification for this loan because we did not revise the
           qualifying ratios based on the student loans. As stated in the report, we are
           seeking indemnification of this loan based on the lender‘s failure to document
           adequate compensating factors when the borrower‘s ratios exceeded HUD‘s
           benchmark guidelines. The loan was manually approved with mortgage payment-
           to-income and total fixed payment-to-income ratios of 44.13 and 52.71 percent,
           respectively.

Comment 15 We agree that a verification of deposit was not required. We removed this
           underwriting deficiency from the report; however, we did not change our



                                              46
              conclusion to seek indemnification for this loan because the missing verification
              of deposit was considered to be a technical underwriting deficiency. As stated in
              the report, we are seeking indemnification of this loan based on the lender‘s
              failure to document adequate compensating factors when the borrower‘s ratios
              exceeded HUD‘s benchmark guidelines. The loan was manually approved with
              mortgage payment-to-income and total fixed payment-to-income ratios of 44.13
              and 52.71 percent, respectively.

Comment 16 We disagree that a two year average of overtime was the most appropriate income
           calculation. Even though the overtime income for 2006 and 2007 was very
           consistent, there were several indicators that the overtime was in decline for the
           current year 2008.
                       As stated in the report, the borrower‘s overtime income averaged only
                       $383.50 per month for the first 2 months of 2008 while the overtime
                       income averaged $843.25 and $881.67 per month for 2006 and 2007,
                       respectively. Further, the borrower‘s paystub in the file, dated
                       February 9, 2008, stated that the year-to-date overtime was $691.67,
                       and the verification of employment stated that as of March 1, 2008, the
                       year-to-date overtime income was $767. This showed that in
                       approximately 3 weeks, the borrower earned only $75.33 in overtime
                       income.
                       The written verification of employment, dated March 11, 2008, states
                       that average number of hours per week was 40.
                       The weekly paystub in the file only shows 1.61 hours of overtime for
                       that pay period, which supports the written verification of employment
                       that the borrower only averages about 40 hours per week.
           The lender calculated the borrower‘s overtime to be $826, which was
           inappropriate. While we acknowledge that the borrower could have earned the
           majority of his overtime during peak periods of the year, this is information that
           should have been asked of the borrower by the lender when the overtime appeared
           to be in decline. This information should have also been documented at the time
           of approval.

Comment 17 We agree that the credit report states that the account was a collection account;
           however, the borrower explained to the lender that the account was for a ticket by
           the police and the judge fined the borrower late fees and additional court fees.
           Information that was readily available to the lender from the applicable municipal
           court‘s Web site revealed that the account was a judgment. We did not change
           our conclusion to seek indemnification for this loan because the revised mortgage
           payment-to-income and total fixed payment-to-income ratios (40.05 percent and
           51.07 percent), which reflect the allowable qualifying income as calculated by
           OIG in accordance with HUD-FHA requirements, far exceeded HUD‘s
           benchmark ratios of 31 and 43 percent, respectively.

Comment 18 We disagree that the underwriter would not have known at the time of approval
           that the borrower‘s mortgage loan had an adjustable rate mortgage that was due to


                                              47
reset every 6 months. HUD Handbook 4155.1, REV-5, chapter 3 states ―The
lender is responsible for asking sufficient questions to elicit a complete picture of
the borrower‘s financial situation, source of funds for the transactions, and the
intended use of the property. All information must be verified and documented.‖
The lender should have asked sufficient questions regarding the payment and any
potential changes that could occur to the borrower‘s rental property. The
underwriter also could have obtained information about the borrower‘s mortgage
loan from the appropriate county recorder‘s office which is public information
and easily accessible through the county recorder‘s Web site.




                                 48
Appendix C

                                         CRITERIA
1. HUD Handbook 4155.1, REV-5

            Foreword states, ―This Handbook describes the basic mortgage credit
            underwriting requirements for single family (one to four units) mortgage loans
            insured under the National Housing Act. For each loan FHA insures, the lender
            must establish that the borrower has the ability and willingness to repay the
            mortgage debt. This decision must be predicated on sound underwriting
            principles consistent with the guidelines, rules, and regulations described
            throughout this Handbook and must be supported by sufficient
            documentation…While it is not FHA‘s intent to insure mortgages that are likely
            to result in default, regardless of the borrower‘s equity, lenders may exercise
            some discretion in the underwriting of home mortgages where the borrower‘s
            financial and other circumstances are not specifically addressed by this
            Handbook. However, lenders are expected to exercise both sound judgment and
            due diligence in the underwriting of loans to be insured by FHA.‖

            Paragraph 1-7 states, ―The borrower must make a cash investment at least equal to
            the difference between the sales price and the resulting maximum mortgage
            amount.‖

            Paragraph 2-2D states, ―Except for the obligations specifically excluded by state
            law, the debts of the non-purchasing spouse must be included in the borrower‘s
            qualifying ratios if the borrower resides in a community property state or the
            property to be insured is located in a community property state. Although the
            non-purchasing spouse‘s credit history is not to be considered a reason for credit
            denial, a credit report that complies with the requirements of paragraph 2-4 must
            be obtained for the non-purchasing spouse in order to determine the debt-to-
            income ratio.‖

            Paragraph 2-3 states, ―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. A borrower who has made payments on previous and
            current obligations in a timely manner represents reduced risk. Conversely, if the
            credit history, despite adequate income to support obligations, reflects slow
            payments, judgments, and delinquent accounts, strong compensating factors will
            be necessary to approve the loan…While minor derogatory information occurring
            two or more years in the past does not require explanation, major indications of
            derogatory credit – including judgments, collections, and any other recent credit
            problems – require sufficient written explanation from the borrower.‖




                                             49
Paragraph 2-3A states, ―The payment history of the borrower‘s housing
obligations hold significant importance in evaluating credit. The lender must
determine the borrower‘s payment history of housing obligations through either
the credit report, verification of rent directly from the landlord (with no identity-
of-interest with the borrower) or verification of mortgage directly from the
mortgage servicer, or through canceled checks covering the most recent 12-month
period.‖

Paragraph 2-3B states, ―The lender must ascertain the purpose of any recent debts,
as the indebtedness may have been incurred to obtain part of the required cash
investment on the property being purchased. Similarly, the borrower must
provide a satisfactory explanation for any significant debt that is shown on the
credit report but not listed on the loan application. The borrower must explain in
writing all inquiries shown on the credit report in the last 90 days.‖

Paragraph 2-3C states, ―Court-ordered judgments must be paid off before the
mortgage loan is eligible for FHA insurance endorsement…FHA does not require
that collection accounts be paid off as a condition of mortgage approval.
Collections and judgments indicate a borrower‘s regard for credit obligations and
must be considered in the analysis of creditworthiness with the lender
documenting its reasons for approving a mortgage where the borrower has
collection accounts or judgments. The borrower must explain in writing all
collections and judgments.‖

Paragraph 2-3E states, ―A Chapter 7 bankruptcy (liquidation) does not disqualify
a borrower from obtaining an FHA-insured mortgage if at least two years have
elapsed since the date of the discharge of the bankruptcy. Additionally, the
borrower must have re-established good credit or chosen not to incur new credit
obligations. The borrower also must have demonstrated documented ability to
responsibly manage his or her financial affairs.‖

Chapter 2, section 2, states, ―The anticipated amount of income, and the
likelihood of its continuance, must be established to determine a borrower‘s
capacity to repay mortgage debt. Income may not be used in calculating the
borrower‘s income ratios if it comes from any source that cannot be verified, is
not stable, or will not continue. This section describes acceptable types of
income, procedures for calculating effective income, and requirements for
establishing income stability.‖

Paragraph 2-5B states, ―If the borrower, as revealed by public records, credit
information, or HUD‘s Credit Alert Interactive Voice Response System
(CAIVRS), is presently delinquent on any Federal debt (e.g., VA-guaranteed
mortgage, Title I loan, Federal student loan, Small Business Administration loan,
delinquent Federal taxes) or has a lien, including taxes, placed against his or her
property for a debt owed to the U.S., the borrower is not eligible until the
delinquent account is brought current, paid, otherwise satisfied, or a satisfactory


                                 50
repayment plan is made between the borrower and the Federal agency owed and
is verified in writing.‖

Paragraph 2-6 states, ―We do not impose a minimum length of time a borrower
must have held a position of employment to be eligible. However, the lender
must verify the borrower‘s employment for the most recent two full years.‖

Paragraph 2-7 states, ―The income of each borrower to be obligated for the
mortgage debt must be analyzed to determine whether it can reasonably be
expected to continue through at least the first three years of the mortgage loan.‖

Paragraph 2-7A states, ―Both overtime and bonus income may be used to qualify
if the borrower has received such income for the past two years and it is likely to
continue. The lender must develop an average of bonus or overtime income for
the past two years, and the employment verification must not state that such
income is unlikely to continue. Periods of less than two years may be acceptable
provided the lender justifies and documents in writing the reason for using the
income for qualifying purposes. An earnings trend also must be established and
documented for overtime and bonus income. If either type shows a continual
decline, the lender must provide a sound rationalization in writing for including
the income for borrower qualifying. If bonus income varies significantly from
year to year, a period of more than two years must be used in calculating the
average income.‖

Paragraph 2-7D states, ―Commission income must be averaged over the previous
two years. The borrower must provide copies of signed tax returns for the last
two years, along with the most recent pay stub…Individuals whose commission
income shows a decrease from one year to the next require significant
compensating factors to allow for loan approval.‖

Paragraph 2-7M (2) states, ―If a property was acquired since the last income tax
filing and is not shown on Schedule E, a current signed lease or other rental
agreement must be provided. The gross rental amount must be reduced for
vacancies and maintenance by 25 percent (or the percentage developed by the
jurisdictional HOC [Homeownership Center]), before subtracting PITI [principal,
interest, taxes, and insurance] and any homeowners‘ association dues, etc., and
applying the remainder to income (or recurring debts, if negative).‖

Paragraph 2-10 states, ―All funds for the borrower‘s investment in the property
must be verified and documented.‖

Paragraph 2-10A states, ―If the amount of the earnest money deposit exceeds 2
percent of the sales price or appears excessive based on the borrower‘s history of
accumulating savings, the lender must verify with documentation the deposit
amount and the source of funds. Satisfactory documentation includes a copy of
the borrower‘s cancelled check. A certification from the deposit-holder


                                 51
acknowledging receipt of funds and separate evidence of the source of funds is
also acceptable. Evidence of source of funds includes a verification of deposit or
bank statement showing that at the time the deposit was made the average balance
was sufficient to cover the amount of the earnest money deposit.‖

Paragraph 2-10B states, ―A verification of deposit (VOD), 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.‖

Paragraph 2-10C states, ―An outright gift of the cash investment is acceptable if
the donor is the borrower‘s relative, the borrower‘s employer or labor union, a
charitable organization, a governmental agency or public entity that has a program
to provide homeownership assistance to low- and moderate-income families or
first-time homebuyers, or a close friend with a clearly defined and documented
interest in the borrower…The lender must document the gift funds by obtaining a
gift letter, signed by the donor and borrower, that specifies the dollar amount of
the gift, states that no repayment is required, shows the donor‘s name, address,
telephone number and states the nature of the donor‘s relationship to the
borrower. In addition, the lender must document the transfer of funds from the
donor to the borrower, as follows: 1. If the gift funds are in the homebuyer‘s bank
account, the lender must document the transfer of the funds from the donor to the
homebuyer by obtaining a copy of the canceled check or other withdrawal
document showing that the withdrawal is from the donor‘s account. The
homebuyer‘s deposit slip and bank statement that shows the deposit is also
required…‖

Paragraph 2-11A states, ―The borrower‘s liabilities include all installment loans,
revolving charge accounts, real estate loans, alimony, child support, and all other
continuing obligations. In computing the debt-to-income ratios, the lender must
include the monthly housing expense and all other additional recurring charges
extending ten months or more, including payments on installment accounts, child
support or separate maintenance payments, revolving accounts and alimony, etc.
Debts lasting less than ten months must be counted if the amount of the debt
affects the borrower‘s ability to make the mortgage payment during the months
immediately after loan closing; this is especially true if the borrower will have
limited or no cash assets after loan closing. The following additional information
deals with revolving accounts and alimony payments: 1. If the account shown on
the credit report has an outstanding balance, monthly payments for qualifying
purposes must be calculated at the greater of 5 percent of the balance or $10
(unless the account shows a specific minimum monthly payment).‖

Paragraph 2-11C states, ―If a debt payment, such as a student loan, is scheduled to
begin within twelve months of the mortgage loan closing, the lender must include
the anticipated monthly obligation in the underwriting analysis, unless the



                                 52
borrower provides written evidence that the debt will be deferred to a period
outside this timeframe.‖

Paragraph 2-13 states, ―Compensating factors that may be used to justify approval
of mortgage loans with ratios exceeding our benchmark guidelines are those listed
below. Underwriters must record on the ‗remarks‘ section of the HUD 92900-WS
[Mortgage Credit Analysis Worksheet]/HUD 92900-PUR [Mortgage Credit
Analysis Worksheet Purchase Money Mortgages] the compensating factor(s) used
to support loan approval. Any compensating factor used to justify mortgage
approval must be supported by documentation. A. The borrower has successfully
demonstrated the ability to pay housing expenses equal to or greater than the
proposed monthly housing expense for the new mortgage over the past 12-24
months. B. The borrower makes a large down payment (ten percent or more)
toward the purchase of the property. C. The borrower has demonstrated an ability
to accumulate savings and a conservative attitude toward the use of credit. D.
Previous credit history shows that the borrower has the ability to devote a greater
portion of income to housing expenses. E. The borrower receives documented
compensation or income not reflected in effective income, but directly affecting
the ability to pay the mortgage, including food stamps and similar public benefits.
F. There is only minimal increase in the borrower‘s housing expense. G. The
borrower has substantial documented cash reserves (at least three months‘ worth)
after closing. In determining if an asset can be included as cash reserves or cash
to close, the lender must judge whether or not the asset is liquid or readily
convertible to cash and can be done so absent retirement or job termination…H.
The borrower has substantial non-taxable income (if no adjustment was made
previously in the ratio computations). I. The borrower has a potential for
increased earnings, as indicated by job training or education in the borrower‘s
profession. J. The home is being purchased as a result of relocation of the
primary wage-earner, and the secondary wage-earner has an established history of
employment, is expected to return to work , and reasonable prospects exist for
securing employment in a similar occupation in the new area. The underwriter
must document the availability of such possible employment.‖

Chapter 3 states, ―The lender is responsible for asking sufficient questions to elicit
a complete picture of the borrower‘s financial situation, source of funds for the
transaction, and the intended use of the property. All information must be
verified and documented.‖

Paragraph 3-1 states, ―The application package must contain all documentation
supporting the lender‘s decision to approve the mortgage loan…All documents
may be up to 120 days old at the time the loan closes (180 days for new
construction) unless this or other applicable HUD instructions specify a different
timeframe, or the nature of the document is such that its validity for underwriting
purposes is not affected by being older than the number of prescribed days (e.g.,
divorce decrees, tax returns). Updated, written verifications must be obtained
when the age of the documents exceed these limits…The following documents


                                 53
                are generally required for mortgage credit analysis in all transactions except for
                certain streamline refinances: …E. Verification of Employment (VOE) and the
                borrower‘s most recent pay stub are to be provided. ‗Most recent‘ means at the
                time the initial loan application is made…As an alternative to obtaining a VOE,
                the lender may obtain the borrower‘s original pay stub(s) covering the most recent
                30-day period, along with original IRS [Internal Revenue Service] W-2 Forms
                from the previous two years…The lender also must verify by telephone all current
                employers…F. VOD and most recent bank statements are to be provided. ‗Most
                recent‘ means at the time the initial loan application is made...As an alternative to
                obtaining a VOD, the lender may obtain from the borrower original bank
                statement(s) covering the most recent three-month period. Provided the bank
                statement shows the previous month‘s balance, this requirement is met by
                obtaining the two most recent, consecutive statements…‖

2. Mortgage Letter 2004-47 states, ―The lender must obtain the single most recent pay stub
   (showing year-to-date earnings of at least one month) and any one of the following to verify
   current employment:
             Written Verification of Employment (VOE)
             Verbal verification of employment (Lender or service provider must document
             individual verifying the employment.)
             Electronic verification acceptable to FHA…

     The lender is required to verify the applicant‘s employment history for the previous two
     years. However, direct verification is not required if all of the following conditions are met:
                The current employer confirms a two-year employment history (this may include
                a paystub indicating a hiring date)
                Only base pay is used to qualify (no overtime or bonuses)
                The borrower signs form IRS 4506 or 8821 for the previous two tax years.‖

3. Mortgagee Letter 2005-16 states, ―for manually underwritten mortgages where the Direct
   Endorsement (DE) underwriter must make the credit decision, the qualifying ratios are raised
   to 31% and 43%...As always, if either or both ratios are exceeded on a manually underwritten
   mortgage, the lender must describe the compensating factors used to justify mortgage
   approval.‖

4. 24 CFR 203.32(a) states, ―…a mortgagor must establish that, after the mortgage offered for
   insurance has been recorded, the mortgaged property will be free and clear of all liens other
   than such mortgage, and that there will not be outstanding any other unpaid obligations
   contracted in connection with the mortgage transaction or the purchase of the mortgaged
   property, except obligations that are secured by property or collateral owned by the
   mortgagor independently of the mortgaged property.‖

5.   24 CFR 203.41

                Paragraph (a)(3) states, ―Legal restrictions on conveyance means any provision in
                any legal instrument, law or regulation applicable to the mortgagor or the


                                                  54
mortgaged property, including but not limited to a lease, deed, sales contract,
declaration of covenants, declaration of condominium, option, right of first
refusal, will, or trust agreement, that attempts to cause a conveyance (including a
lease) made by the mortgagor to: …(ii) Be the basis of contractual liability of the
mortgagor for breach of an agreement not to convey, including rights of first
refusal, pre-emptive rights or options related to mortgagor efforts to convey; (iii)
Terminate or subject to termination all or a part of the interest held by the
mortgagor in the mortgaged property if a conveyance is attempted; (iv) Be subject
to the consent of a third party…‖

Paragraph (b) states, ―A mortgage shall not be eligible for insurance if the
mortgaged property is subject to legal restrictions on conveyance, except as
permitted by this part.‖

Paragraph (c) states, ―Legal restrictions on conveyance are acceptable if: (1) The
restrictions are part of an eligible governmental or nonprofit program and are
permitted by paragraph (d) of this section; and (2) The restrictions will
automatically terminate if title to the mortgaged property is transferred by
foreclosure or deed-in-lieu of foreclosure, or if the mortgage is assigned to the
Secretary.‖




                                 55
Appendix D

       NARRATIVE LOAN SUMMARIES FOR SIGNIFICANT
              UNDERWRITING DEFICIENCIES
The following narratives provide the details for the significant underwriting deficiencies noted in
the table contained in finding 1.

1. FHA loan number: 023-2546830              Loan status: Claim
   Requesting indemnification: Yes           Default status: Property conveyed to insurer

       We are seeking indemnification of this loan based on the lender‘s failure to properly
       evaluate the borrower‘s credit.

       Credit
       Both the borrower and coborrower had Chapter 7 bankruptcies that were discharged in
       2003 and 2001, respectively. While a Chapter 7 bankruptcy does not disqualify a
       borrower from obtaining an FHA-insured mortgage if at least 2 years has elapsed, HUD
       Handbook 4155.1, REV-5, paragraph 2-3E, states that the borrower must have
       reestablished good credit or chosen not to incur new credit obligations and the borrower
       also must have demonstrated a documented ability to responsibly manage his or her
       financial affairs. The borrowers did not reestablish good credit and did not demonstrate
       the ability to responsibly manage their affairs as evidenced by the multiple collection
       accounts on their credit report that were originally reported in 2005 through 2007, after
       the bankruptcies were discharged. The loan file contained two letters from vendors
       stating that the borrowers were current on their payments; however, these letters did not
       sufficiently show that the borrowers had reestablished good credit, nor did they
       demonstrate the borrowers‘ ability to responsibly manage their financial affairs.

       In addition, HUD Handbook 4155.1, REV-5, paragraph 2-3, states that if a borrower‘s
       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. The lenders used compensating factors such as
       ―borrowers have had extraordinary medical bills which is causing the FICO (credit score)
       to be low‖ to justify approving the loan; however, none of the compensating factors were
       allowed by HUD Handbook 4155.1, REV-5, paragraph 2-13.

2. FHA loan number: 023-2575560              Loan status: Claim
   Requesting indemnification: Yes           Default status: Preforeclosure sale completed

       We are seeking indemnification of this loan based on the revised total fixed payment-to-
       income ratio, which reflects the allowable qualifying income and liabilities as calculated
       by OIG in accordance with HUD-FHA requirements. After revision, the ratio increased
       from 44.63 to 60.83 percent, which far exceeds HUD‘s total fixed payment-to-income




                                                56
      benchmark ratio of 43 percent as stated in Mortgagee Letter 2005-16. The lender did not
      document compensating factors that could have justified the excessive ratio.

      Income
      The lender calculated the borrower‘s income based on 40 hours per week; however, the
      borrower‘s pay stubs only supported an average of 36.8 hours per week. As a result, the
      lender overstated the borrower‘s income by $243.36 per month.

      Credit
      Both the borrower and the coborrower had payments withheld from their pay checks that
      were not considered by the lender and the automated underwriting system as required by
      the Fannie Mae Underwriting Findings and HUD Handbook 4155.1, REV-5, paragraph
      2-11A. The Fannie Mae Underwriting Findings, item 19, states that when a debt or
      obligation is revealed during the loan process that was not listed on the loan application
      and/or credit report, the lender must verify the actual monthly payment amount and
      resubmit the loan with the liability if it is greater than $100 per month. HUD Handbook
      4155.1, REV-5, paragraph 2-11A, states that in computing the debt-to-income ratios, the
      lender must include the monthly housing expense and all additional recurring charges
      extending 10 months or more. Debts lasting less than 10 months must be counted if the
      amount of the debt affects the borrower‘s ability to make the mortgage payments during
      the months immediately after loan closing. The borrower‘s pay stub revealed a deduction
      for ―Levy – Fed‖ of $100.01 per month, and the coborrower‘s pay stub revealed a
      deduction for ―Company Store‖ of $599.14 per month. These liabilities were not
      included on either the loan application or the credit report, and the loan file did not
      contain documentation showing that these debts would last less than 10 months. As a
      result, the borrowers‘ recurring expenses were understated by $699.15.

      Additionally, the indication that the borrower had a Federal levy deducted from his wages
      requires further consideration by the lender. A Federal levy is usually only enacted after
      an obligor has neglected or refused to pay a Federal debt, indicating that the debt was
      delinquent. HUD Handbook 4155.1, REV-5, paragraph 2-5B, states that if a borrower is
      presently delinquent on any Federal debt or has a lien, including taxes, placed against his
      property for a debt owed to the United States, the borrower is not eligible until the
      delinquent account is brought current, paid, or otherwise satisfied or a satisfactory
      repayment plan is made.

3. FHA loan number: 023-2577611            Loan status: Claim
   Requesting indemnification: Yes         Default status: Preforeclosure sale completed

      We are seeking indemnification of this loan based on the revised mortgage payment-to-
      income and total fixed payment-to-income ratios, which reflect the allowable qualifying
      income as calculated by OIG in accordance with HUD-FHA requirements, and based on
      the lender‘s failure to document adequate compensating factors when the borrower‘s
      ratios exceeded HUD‘s benchmark guidelines. After revision, the ratios were increased
      from 37.07 and 47.70 to 39.25 and 50.51 percent, respectively, which far exceeded
      HUD‘s benchmark ratios of 31 and 43 percent as stated in Mortgagee Letter 2005-16.



                                              57
      Income
      The lender calculated the borrower‘s monthly income based on the $36,000 annual
      income stated on the verification of employment. However, the loan file contained the
      borrower‘s contract, which stated that the annual income for the year was $34,000. The
      amount in the contract was also supported by the borrower‘s pay stubs. As a result, the
      borrower‘s monthly income was overstated by $166.67.

      Compensating Factors
      The lender did not list eligible compensating factors that may be used to justify approval
      of mortgage loans with ratios exceeding HUD‘s benchmark guidelines as required by
      HUD Handbook 4155.1, REV-5, paragraph 2-13, and Mortgagee Letter 2005-16.
      Mortgagee Letter 2005-16 states that if either or both ratios are exceeded on a manually
      underwritten mortgage, the lender must describe the compensating factors used to justify
      mortgage approval. HUD Handbook 4155.1, REV-5, paragraph 2-13, lists compensating
      factors that underwriters must record in the remarks section of the HUD 92900-WS/HUD
      92900-PUR used to support loan approval. The loan was manually approved by the
      lender with mortgage payment-to-income and total fixed payment-to-income ratios that
      exceeded HUD‘s benchmark ratios by 6.07 and 4.70 percent, respectively. The lender
      used ―borrower will have 2 months reserves after closing‖ and ―good employment history
      with very good prospects for future earnings‖ as compensating factors. One of FHA‘s
      eligible compensating factors is that the borrower has at least 3 months of cash reserves
      after closing, not 2 months. Also the lender did not document training or education in the
      borrower‘s profession to support future earnings as required.

      Credit
      The loan file did not contain an explanation for the three collection accounts on the
      borrower‘s credit report as required by HUD Handbook 4155.1, REV-5, paragraph 2-3C.

4. FHA loan number: 023-2577634             Loan status: Claim
   Requesting indemnification: Yes          Default status: Preforeclosure sale completed

      We are seeking indemnification of this loan based on the lender‘s failure to properly
      determine the borrower‘s liabilities and assets. This loan was approved by the automated
      underwriting system with mortgage payment-to-income and total fixed payment-to-
      income ratios of 27.09 and 46.72 percent, respectively.

      Credit
      The lender calculated the net rental income for the borrower‘s existing rental property but
      did not take into consideration the scheduled increase in the mortgage payment due to the
      interest rate reset. The mortgage for the existing rental property had an adjustable rate
      that was going to reset 5½ months after the close of escrow (November 16, 2007) for the
      FHA-insured property. The interest only adjustable rate rider for the existing rental
      property states that the interest rate was 7.70 percent and would change starting on April
      1, 2008, and every 6 months thereafter. The new rate would be calculated by adding 6.70
      percent to the current index (or LIBOR (London Interbank Offered Rate) index);
      however, the interest rate at the first change date would not be greater than 10.70 percent



                                              58
      or less than 7.70 percent. The LIBOR index at the time of the borrower‘s application on
      November 15, 2007, was 4.8324 percent. Therefore, the interest rate for the existing
      rental property would have increased by 3 percent. An increase of 3 percent would have
      increased the mortgage payment for the existing rental property by $514.66. The
      borrower stated that his payments increased by about $200 to $300.

      Also the lender did not include the homeowners association fee when calculating the net
      rental income for the existing rental property. According to the homeowners association
      management company, the dues were $105.00 per quarter.

      Assets
      The lender did not verify the source of funds that the borrower used for the earnest
      money deposit when the verification of deposit did not support the borrower‘s ability to
      fund the earnest money deposit as required by HUD Handbook 4155.1, REV-5,
      paragraph 2-10A. The borrower‘s earnest money deposit was $3,000, while the
      verification of deposit showed an average monthly balance of only $721. In an interview
      with the borrower, he stated that he borrowed some of the funds for the earnest money
      deposit from his parents.

      In addition, assets in a retirement account that were used to qualify the borrower did not
      meet the requirements of the Fannie Mae Underwriting Findings. The lender used 60
      percent of the retirement account balance without regard for the amount the borrower had
      vested, and the lender did not document that the retirement account allowed for
      withdrawals for conditions other than those related to the borrower‘s employment or
      death and that the borrower qualified for withdrawal and/or borrowing.

5. FHA loan number: 023-2610061            Loan status: Claim
   Requesting indemnification: No          Default status: Property conveyed to insurer

      We are not seeking indemnification of this loan because it was indemnified on August
      14, 2009, by request from the lender. The lender determined that the borrower had been
      working for a placement agency for only 1 month and had no prior history of working
      temporary jobs when the loan was approved. The lender also noted that the borrower‘s
      last day of employment was the day of closing. We identified an additional significant
      underwriting deficiency for this loan regarding the borrower‘s income.

      Income
      The lender did not obtain the borrower‘s most recent year-to-date pay stub documenting
      1 full month‘s earnings as required by item 23 of the Fannie Mae Underwriting Findings.
      The lender obtained only one of the borrower‘s pay stubs, which documented less than 14
      days of earnings. Since the borrower‘s employment start date was April 28, 2008, and
      the lender noted that the borrower‘s last day of employment was the day of closing on
      May 22, 2008, the lender would have known that the borrower was no longer employed if
      it had delayed closing to obtain a pay stub documenting 1 full month‘s earnings.




                                              59
6. FHA loan number: 023-2692048              Loan status: Claim
   Requesting indemnification: No            Default status: Property conveyed to insurer

      We are not seeking indemnification of this loan because it was indemnified on December
      4, 2009, by request from the lender. Before this loan was indemnified, the OIG was
      going to seek indemnification based on the revised total fixed payment-to-income ratio,
      which reflects the allowable qualifying income and liabilities as calculated by OIG in
      accordance with HUD-FHA requirements. After revision, the ratio increased from 48.42
      to 60.86 percent, which far exceeded HUD‘s benchmark ratio of 43 percent as stated in
      Mortgagee Letter 2005-16. The lender did not document compensating factors that could
      have justified the excessive ratio.

      Income
      The lender included the borrower‘s overtime hours in the overtime income calculation as
      well as the base income calculation. The lender calculated the borrower‘s overtime
      income based on the average of the overtime income earned over the past 19.5 months.
      The lender then calculated the borrower‘s base income using 47 hours per week instead
      of 40 hours. As a result, the borrower‘s monthly income was overstated by $424.67.

      In addition, the loan file did not contain the appropriate support to justify the overtime
      pay used in the ratios to qualify the borrower as required by HUD Handbook 4155.1,
      REV-5, paragraph 2-7A. The borrower‘s overtime income was earned for less than 2
      years, and the lender did not document in writing the justification for including the
      borrower‘s overtime income.

      Credit
      The borrower had a payment withheld from his pay check that was not considered by the
      lender and the automated underwriting system. The Fannie Mae Underwriting Findings,
      item 19, states that when a debt or obligation is revealed during the loan process that was
      not listed on the loan application and/or credit report, the lender must verify the actual
      monthly payment amount and resubmit the loan with the liability if it is greater than $100
      per month. The borrower‘s 2-week pay stub revealed a deduction for ―Advance‖ of $93.
      This liability was not included on either the loan application or the credit report. As a
      result, the borrower‘s recurring expenses were understated by $201.50.

      In addition, the credit report contained a civil judgment with an explanation from the loan
      processor that it contacted the appropriate authority and the civil judgment did not reflect
      information identifying the borrower. Also the judgment would be removed in December
      2008 (which was 9 months after the close of escrow). The Fannie Mae Underwriting
      Findings, item 22, requires evidence of payoff of any outstanding judgments shown on
      the credit report. HUD Handbook 4155.1, REV-5, paragraph 2-3, also states that court-
      ordered judgments must be paid off before the mortgage loan is eligible for FHA
      insurance endorsement.




                                               60
7. FHA loan number: 023-2704044            Loan status: Active
   Requesting indemnification: Yes         Default status: Special forbearance

      We are seeking indemnification of this loan based on the lender‘s failure to document
      adequate compensating factors when the borrower‘s ratios exceeded HUD‘s benchmark
      guidelines.

      Compensating Factors
      The lender did not list eligible compensating factors that may be used to justify approval
      of mortgage loans with ratios exceeding HUD‘s benchmark guidelines as required by
      HUD Handbook 4155.1, REV-5, paragraph 2-13, and Mortgagee Letter 2005-16.
      Mortgagee Letter 2005-16 states that if either or both ratios are exceeded on a manually
      underwritten mortgage, the lender must describe the compensating factors used to justify
      mortgage approval. HUD Handbook 4155.1, REV-5, paragraph 2-13, lists compensating
      factors that underwriters must record in the remarks section of the HUD 92900-WS/HUD
      92900-PUR used to support loan approval. The loan was manually approved by the
      lender with mortgage payment-to-income and total fixed payment-to-income ratios that
      exceeded HUD‘s benchmark ratios by 13.12 and 9.71 percent, respectively. The only
      allowable compensating factor listed by the lender was that the borrower had ―potential
      for advancement.‖ This compensating factor was not eligible because, although the
      borrower anticipated graduating with a bachelor‘s degree, this graduation was to occur
      more than 2 years after the close of escrow. Also, the lender did not show that the
      education was in the borrower‘s profession as required.

8. FHA loan number: 023-2709195            Loan status: Claim
   Requesting indemnification: Yes         Default status: Property conveyed to insurer

      We are seeking indemnification of this loan based on the lender‘s failure to document
      adequate compensating factors when the borrower‘s ratios exceeded HUD‘s benchmark
      guidelines.

      Compensating Factors
      The lender did not list eligible compensating factors that may be used to justify approval
      of mortgage loans with ratios exceeding HUD‘s benchmark guidelines as required by
      HUD Handbook 4155.1, REV-5, paragraph 2-13, and Mortgagee Letter 2005-16.
      Mortgagee Letter 2005-16 states that if either or both ratios are exceeded on a manually
      underwritten mortgage, the lender must describe the compensating factors used to justify
      mortgage approval. HUD Handbook 4155.1, REV-5, paragraph 2-13, lists compensating
      factors that underwriters must record in the remarks section of the HUD 92900-WS/HUD
      92900-PUR used to support loan approval. The loan was manually approved by the
      lender with mortgage payment-to-income and total fixed payment-to-income ratios that
      exceeded HUD‘s benchmark ratios by 13.95 and 5.34 percent, respectively. The only
      allowable compensating factor listed by the lender was that the borrower had ―potential
      for future earnings.‖ However, this compensating factor was not eligible because it was
      not supported by job training or education in the borrower‘s profession as required.




                                              61
      Assets
      A recent bank statement accompanying the verification of deposit was not provided as
      required by HUD Handbook 4155.1, REV-5, paragraph 3-1F.

9. FHA loan number: 023-2728194             Loan status: Claim
   Requesting indemnification: Yes          Default status: Property conveyed to insurer

      We are seeking indemnification of this loan based on the revised mortgage payment-to-
      income and total fixed payment-to-income ratios, which reflect the allowable qualifying
      income as calculated by OIG in accordance with HUD-FHA requirements. After
      revision, the ratios were increased from 31.57 and 40.26 percent to 40.05 and 51.07
      percent, respectively, which far exceeded HUD‘s benchmark ratios of 31 and 43 percent
      as stated in Mortgagee Letter 2005-16. The lender did not document compensating
      factors that could have justified the excessive ratio.

      Income
      The loan file did not contain the appropriate support to justify the overtime pay used in
      the ratios to qualify the borrower as required by HUD Handbook 4155.1, REV-5,
      paragraph 2-7A. The borrower‘s overtime was in decline, and the lender did not provide
      a sound rationalization in writing for including the overtime income. The average of the
      borrower‘s overtime income was $843.25 and $881.67 per month for 2006 and 2007,
      respectively. However, as shown in the verification of employment, the overtime income
      averaged only $383.50 per month for the first 2 months of 2008. Further, the borrower‘s
      pay stub in the loan file, dated February 9, 2008, stated that the year-to-date overtime
      income was $691.67, and the verification of employment stated that as of March 1, 2008,
      the year-to-date overtime income was $767. This documentation showed that in
      approximately 3 weeks, the borrower earned only $75.33 in overtime income. Therefore,
      the borrower‘s overtime income was inappropriately included, resulting in an
      overstatement of the monthly income by $826.

      Also, the verification of income stated that the continuation of overtime income was
      unknown. HUD Handbook 4155.1, REV-5, paragraph 2-7, states that the income of each
      borrower to be obligated for the mortgage debt must be analyzed to determine whether it
      can be reasonably expected to continue for at least the first 3 years of the mortgage loan.
      It further states that overtime income may be used if it is likely to continue.

      Credit
      The loan file did not contain an explanation for the two credit report inquiries that were
      within 90 days of the completed credit report, as required by HUD Handbook 4155.1,
      REV-5, paragraph 2-3B.

      In addition, the borrower had a court-ordered judgment on his credit report that may not
      have been paid. HUD Handbook 4155.1, REV-5, paragraph 2-3C, requires that court-
      ordered judgments be paid off before the mortgage loan is eligible for FHA insurance
      endorsement. Chapter 3 of the handbook also requires that all information be verified
      and documented. The HUD-1 settlement statement showed a disbursement to the court;



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      however, the check was given to the borrower rather than directly to the court. The
      lender should have obtained documentation showing that the judgment had been paid.

10. FHA loan number: 023-2836293           Loan status: Active
    Requesting indemnification: Yes        Default status: Special forbearance

      We are seeking indemnification of this loan based on the lender‘s inability to determine
      the borrower‘s liabilities and failure to document adequate compensating factors when
      the borrower‘s ratios exceeded HUD‘s benchmark guidelines.

      Income
      The loan file did not contain the appropriate support to justify the overtime pay used in
      the ratios to qualify the borrower as required by HUD Handbook 4155.1, REV-5,
      paragraph 2-7A. The borrower‘s overtime income was earned for less than 2 years, and
      the lender did not document in writing the justification for including the borrower‘s
      overtime income.

      Credit
      The lender did not obtain a credit history report for the borrower‘s nonpurchasing spouse
      as required by HUD Handbook 4155.1, REV-5, paragraph 2-2D, which requires a credit
      report for a nonpurchasing spouse in a community property State such as Arizona. Based
      on the documentation in the file, specifically the uniform residential loan application,
      dated June 10, 2008, and the pay stub, dated April 11, 2008, it appeared that the borrower
      was married. There was another name listed on the borrower‘s bank statement. Without
      obtaining the nonpurchasing spouse‘s credit report or establishing alternative credit, the
      lender was unable to determine the coborrower‘s liabilities.

      Compensating Factors
      The lender did not list eligible compensating factors that may be used to justify approval
      of mortgage loans with ratios exceeding HUD‘s benchmark guidelines as required by
      HUD Handbook 4155.1, REV-5, paragraph 2-13, and Mortgagee Letter 2005-16.
      Mortgagee Letter 2005-16 states that if either or both ratios are exceeded on a manually
      underwritten mortgage, the lender must describe the compensating factors used to justify
      mortgage approval. HUD Handbook 4155.1, REV-5, paragraph 2-13, lists compensating
      factors that underwriters must record in the remarks section of the HUD 92900-WS/HUD
      92900-PUR to support loan approval. The loan was manually approved by the lender
      with mortgage payment-to-income and total fixed payment-to-income ratios that
      exceeded HUD‘s benchmark ratios by 16.83 and 6.14 percent, respectively. The only
      allowable compensating factor listed by the lender was that the borrower had ―reserves
      for 3 months.‖ However, this was not an eligible compensating factor because the
      borrower‘s reserves were $422.72 less than the amount required.




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11. FHA loan number: 023-2866499                    Loan status: Claim
    Requesting indemnification: Yes                 Default status: Property conveyed to insurer

        We are seeking indemnification of this loan based on the lender‘s failure to document the
        transfer of gift funds that were used as the borrower‘s cash investment in the property.

        Assets
        The loan file did not contain the required documentation supporting the transfer of a
        $20,000 gift from the nonpurchasing spouse. The borrower had a downpayment of
        $19,132 that was derived from the gift, and at the closing, the funds were wired from the
        borrower‘s checking account. However, the loan file contained neither a withdrawal
        document showing that the withdrawal was from the donor‘s account nor the home
        buyer‘s deposit slip or bank statement that showed the deposit. HUD Handbook 4155.1,
        REV-5, paragraph 2-10C, states that all funds for the borrower‘s investment in the
        property must be verified and documented. Paragraph 2-10A further states that if the gift
        funds are in the home buyer‘s bank account, the lender must document the transfer of the
        funds from the donor to the home buyer by obtaining a copy of the canceled check or
        other withdrawal document showing that the withdrawal is from the donor‘s account.
        The home buyer‘s deposit slip and bank statement that show the deposit are also required.
        The gift funds were not documented as required, and without the gift, the borrower did
        not have sufficient funds to close19.

        Compensating Factors
        The lender did not list eligible compensating factors that may be used to justify approval
        of mortgage loans with ratios exceeding HUD‘s benchmark guidelines as required by
        HUD Handbook 4155.1, REV-5, paragraph 2-13, and Mortgagee Letter 2005-16.
        Mortgagee Letter 2005-16 states that if either or both ratios are exceeded on a manually
        underwritten mortgage, the lender must describe the compensating factors used to justify
        mortgage approval. HUD Handbook 4155.1, REV-5, paragraph 2-13, lists compensating
        factors that underwriters must record on the remarks section of the HUD 92900-
        WS/HUD 92900-PUR to support loan approval. The loan was manually approved by the
        lender with mortgage payment-to-income and total fixed payment-to-income ratios that
        exceeded HUD‘s benchmark ratios by 10.9 and 2.68 percent, respectively. The only
        allowable compensating factor listed by the lender was that the borrower was ―putting
        9% down payment into transaction.‖ However, this compensating factor was not eligible
        because the handbook requires a 10 percent or more downpayment.

12. FHA loan number: 023-2880511                    Loan status: Active
    Requesting indemnification: Yes                 Default status: Delinquent

        We are seeking indemnification of this loan based on the lender‘s failure to properly
        determine the borrower‘s liabilities. This loan was approved by the automated
        underwriting system with mortgage payment-to-income and total fixed payment-to-
        income ratios of 36.95 and 51.88 percent, respectively.

19
  HUD Handbook 4155.1, paragraph 1-7, states that the borrower must make a cash investment at least equal to the
difference between the sales price and the resulting maximum mortgage amount.


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Assets
The borrower received an $8,000 gift from his brother; however, the automated
underwriting system did not show the funds segregated as gift funds, which may have
affected the decision to approve the loan. Also, the loan file did not contain the required
documentation supporting the transfer of the gift funds. A deposit slip was in the file;
however, there was no canceled check or other withdrawal document showing that the
withdrawal was from the donor‘s account. HUD Handbook 4155.1, REV-5, paragraph 2-
10, states that all funds for the borrower‘s investment in the property must be verified and
documented. Paragraph 2-10C further states if the gift funds are in the home buyer‘s
bank account, the lender must document the transfer of the funds from the donor to the
home buyer by obtaining a copy of the canceled check or other withdrawal document
showing that the withdrawal is from the donor‘s account. The home buyer‘s deposit slip
and bank statement that show the deposit are also required.

Credit
The lender calculated the net rental income for the borrower‘s existing rental property but
did not take into consideration the increase in the mortgage payment due to the interest
rate reset. The existing rental property had two mortgages, with one having an adjustable
rate that reset before the borrower‘s loan application for the FHA-insured property. The
adjustable rate rider for the existing rental property stated that the interest rate was 6.75
percent and would change starting on June 1, 2008, and every 6 months thereafter. The
new rate would be calculated by adding 6.50 percent to the current index (or LIBOR
index) but the interest rate at the first change date would not be greater than 9.75 percent
or less than 6.75 percent. The borrower‘s loan application was dated June 30, 2008 (after
the change date); however, the mortgage payment used in calculating the net rental
income did not reflect a change based on the rate reset. The LIBOR index at the time of
the change date was 2.8544 percent. Therefore, the interest rate for the existing rental
property would have increased by 2.6044 percent ([6.50 plus 2.8544] minus 6.75).
Conservatively, if we assume that the payment was interest only, an increase of 2.6044
percent would have increased the mortgage payment for the existing rental property by
approximately $282.




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