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; 62 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. 63 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. 64 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. 65
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)