Issue Date October 9, 2009 Audit Report Number 2010-NY-1002 TO: Vicki Bott, Deputy Assistant Secretary for Single Family Housing, HU FROM: Edgar Moore, Regional Inspector General for Audit, New York/New Jersey, 2AGA SUBJECT: Jersey Mortgage Company, Cranford, New Jersey, Did Not Always Comply with HUD/FHA Loan Underwriting Requirements HIGHLIGHTS What We Audited and Why We audited the Jersey Mortgage Company (Jersey Mortgage), a nonsupervised1 lender located in Cranford, New Jersey. Jersey Mortgage was selected for review because its default rate of 7.40 percent for loans with beginning amortization dates between August 1, 2006, and July 31, 2008, was higher than the state of New Jersey‘s default rate of 5.35 percent. The audit objectives were to determine whether Jersey Mortgage (1) approved Federal Housing Administration (FHA)-insured loans in accordance with the requirements of the U.S. Department of Housing and Urban Development (HUD)/FHA, which include adherence to prudent lending practices, and (2) developed and implemented a quality control plan in compliance with HUD/FHA requirements. What We Found Jersey Mortgage did not always approve FHA-insured loans in accordance with the requirements of the HUD/FHA. Specifically, Jersey Mortgage approved 13 1 A non-supervised lender is a FHA approved non-depository financial entity that has as its principal activity the lending or investing of funds in real estate mortgages. loans in which there were significant underwriting deficiencies such as (1) inadequate verification of borrower‘s credit, (2) inadequate compensating factors for loans with high debt-to-income ratios, (3) inadequate verification of funds to close loans, and (4) improper verification of employment and income information. As a result, loans were approved for potentially ineligible borrowers, which caused HUD/FHA to incur an unnecessary insurance risk. The remaining two loans contained technical deficiencies. These deficiencies occurred because Jersey Mortgage lacked adequate controls to ensure that loans were processed in accordance with HUD requirements. Jersey Mortgage failed to ensure that its quality control plan was implemented in accordance with HUD/FHA‘s requirements. Specifically, (1) quality control reviews were not conducted for the loans that defaulted within the first six payments after closing or for the rejected loans, and (2) management did not provide responses or corrective actions for the deficiencies identified in quality control reviews. Consequently, the effectiveness of its quality control plan, which was designed to ensure accuracy, validity, and completeness in its loan underwriting process, was lessened. What We Recommend We recommend that the Deputy Assistant Secretary for Single Family Housing require Jersey Mortgage to (1) indemnify HUD against future losses on 12 loans with significant underwriting deficiencies, (2) reimburse HUD for the amount of claims and associated fees paid on one loan with significant underwriting deficiencies, and (3) implement quality control procedures to ensure compliance with the requirements to review early defaults and rejected loans. We also recommend that HUD‘s Homeownership Center‘s Quality Assurance Division follow up with Jersey Mortgage within six months to ensure that quality control review procedures were properly implemented. 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 draft report to Jersey Mortgage officials on July 6, 2009 and requested their response by July 22, 2009. We discussed the results of our review during the audit and at an exit conference held on July 29, 2009. Jersey Mortgage officials provided written comments at the exit conference and generally disagreed with the draft report findings. The complete text of Jersey Mortgage‘s response, along with our evaluation of that response, can be found in appendix B of this report. 2 TABLE OF CONTENTS Background and Objectives 4 Results of Audit Finding 1: Jersey Mortgage Did Not Always Comply with HUD/FHA‘s 5 Underwriting Requirements Finding 2: Jersey Mortgage Had Weaknesses in the Implementation 10 of its Quality Control Plan Scope and Methodology 12 Internal Controls 13 Appendixes A. Schedule of Questioned Costs and Funds to Be Put to Better Use 15 B. Auditee Comments and OIG‘s Evaluation 16 C. Summary of Underwriting Deficiencies 53 D. Case Summary Narratives 54 3 BACKGROUND AND OBJECTIVES Jersey Mortgage Company (Jersey Mortgage) became an approved U.S. Department of Housing and Urban Development (HUD) lender in 1986. The company originates loans, which it then sells to investors and other mortgage bankers. Jersey Mortgage is a non-supervised lender that has as its principal activity the lending or investing of funds in real estate mortgages. A non-supervised lender may originate, underwrite, purchase, hold, service and sell FHA insured mortgages and submit applications for mortgage insurance. A non-supervised lender may maintain an FHA approved branch office for the origination of FHA insured mortgages, and must maintain a warehouse line of credit or other mortgage funding program that is acceptable to the Department. For continued approval a non-supervised lender must submit to the Department an acceptable audit report within 90 days of the close of its fiscal year. The main office of Jersey Mortgage is located at 20 Commerce Drive, Suite 340, Cranford, New Jersey, and it has one branch office in Manasquan, New Jersey. Jersey Mortgage has five underwriters and ten loan officers. Between August 1, 2006, and July 31, 2008, Jersey Mortgage underwrote 649 Federal Housing Administration (FHA)-insured mortgages in New Jersey and experienced a default rate of 7.40 percent, which was significantly higher than the New Jersey state average default rate of 5.35 percent. The objectives of this audit were to determine whether Jersey Mortgage (1) approved FHA-insured loans in accordance with the requirements of HUD/FHA, which include adherence to prudent lending practices, and (2) developed and implemented a quality control plan in compliance with HUD/FHA requirements. 4 RESULTS OF AUDIT Finding 1: Jersey Mortgage Did Not Always Comply with HUD/FHA‘s Underwriting Requirements Jersey Mortgage did not always approve FHA-insured loans in accordance with the requirements of HUD/FHA. Specifically, Jersey Mortgage approved 132 loans in which there were significant underwriting deficiencies such as (1) inadequate verification of borrower‘s credit, (2) inadequate compensating factors for loans with high debt-to-income ratios, (3) inadequate verification of funds to close loans, and (4) improper verification of employment and income information. For one of the 13 loans, HUD paid a claim that resulted in a loss of $229,427. There were two loans that contained technical violations. As a result, loans were approved for potentially inelgible borrowers, and contributed to HUD/FHA‘s assuming an unnecessary insurance risk. The deficiencies occurred because Jersey Mortgage did not have adequate controls to ensure that loans were processed in accordance with HUD/FHA requirements. Significant Underwriting Deficiencies Our review of 15 loans with amortization dates between August 1, 2006, and July 31, 2008, disclosed significant underwriting deficiencies in 13 loans. The deficiencies occurred because Jersey Mortgage did not follow prudent lending practices and regulations prescribed by HUD in its origination and underwriting of the loans. HUD Handbook 4155.1, REV-5, ―Mortgage Credit Analysis for Mortgage Insurance,‖ prescribes basic underwriting requirements for FHA-insured single- family mortgage loans. The lender must ensure that the borrower has the ability and willingness to repay the mortgage debt. This assessment must be based on sound underwriting principles in accordance with the guidelines, rules, and regulations described in the handbook and supported by sufficient documentation. In addition, chapter 3-1 of the handbook requires that the application package contain sufficient documentation to support a lender‘s decision to approve a mortgage. While this decision involves some subjectivity, our examination of 15 loans approved by Jersey Mortgage disclosed significant underwriting deficiencies in the approval of 13 loans. Specifically, Jersey Mortgage did not always (1) adequately verify borrowers‘ credit, (2) obtain adequate compensating factors for loans with high debt-to-income ratios, (3) verify that there were 2 We originally reviewed 21 loans for our audit; however, two of the loans had insurance status terminated and two loans that contained deficiencies were cleared when loans were reviewed on-site. In addition, two loans that contained deficiencies were also cleared when we reviewed documentation provided at the exit conference. As a result, we are reporting on 15 loans. 5 sufficient cash reserves to close the loans, and (4) properly verify employment and/or income information. Significant deficiencies are noted in the chart below and in appendix C. The deficiencies noted are not independent of one another, as one loan may have contained more than one deficiency. Areas of deficiencies Number of loans Inadequate credit analysis 3 of 13 loans Excessive debt-to-income ratios without 6 of 13 loans adequate compensating factors Inadequate verification of funds to close 9 of 13 loans on HUD-1 settlement statement Inadequate verification of income and/or 7 of 13 loans employment Specific examples of these significant underwriting deficiencies follow: For FHA case #352-5605932, the lender did not conduct an adequate analysis of the borrower‘s credit history. The credit report in the file contained two judgments in March 2002 and May 2003. However, the lender did not obtain information on the status of the judgments or an explanation from the borrower as required by HUD Handbook 4155.1, REV-5, section 2-3. In addition, the lender did not adequately verify the source of the donor‘s gift. The donor of the gift deposited $9,000 into his own account on July 25, 2007, and then made the gift payment of $8,000 on July 25, 2007, to the coborrower. The assets available on the mortgage credit analysis worksheet were shown as $8,010, and the HUD-1 settlement statement indicated that the borrower would have needed $8,000 to close. If we do not include the gift amount, the borrower would have had $10 available to close and would not have had sufficient funds to close the loan. Also, the monthly employment income on the mortgage credit analysis worksheet was listed as $6,515; however our calculation of the monthly employment income based on the paystubs was $5,958. The employment income was overstated, which resulted in the lender calculating incorrect debt-to-income ratios of 41.24 and 48.44 percent. After adjusting the borrower‘s income, these ratios would increase to 45.09 and 52.97 percent. The lender also did not list compensating factors. Mortgagee Letter 2005-16 states that the lender must describe the compensating factors used to justify mortgage approval when the borrower‗s mortgage payment-to-income ratio (front) and the total fixed payment-to-income ratio (back) exceed 31 and 43 percent. In addition, for one of the coborrowers, there were employment gaps for the months of April 2006, August 2006, and September 2006. The lender did not obtain an explanation for the gaps in employment as required by HUD Handbook 4155.1 REV-5, section 2-6. 6 For FHA case #352-5601063, the lender did not conduct an adequate analysis of the borrower‘s credit history. The credit report in the file contained derogatory items, and a judgment was listed for the coborrower. The file contained a letter written by the coborrower; however, it was inadequate because it did not explain the derogatory items and judgments listed on the credit report as required by HUD Handbook 4155.1, REV-5, section 2-3. The lender also did not obtain an explanation for the source of funds in the file per HUD Handbook 4155.1, REV-5, section 2-10C. The HUD-1 settlement statement showed an earnest money deposit of $10,000. A total of $9,000 of the $10,000 earnest money deposit had been transferred from the borrower‘s checking account as of May 29, 2007. However, on May 29, 2007, an unexplained deposit of $1,170 was made to the borrower‘s checking account, resulting in a pretransfer balance of $9,080. If this deposit had not been made on May 29, 2007, the checking account balance would have been $7,910. The HUD-1 settlement statement for the FHA loan indicated that the borrowers were required to pay $5,044 at closing. Due to the unsupported earnest money deposit of $1,170, the borrowers would have needed $6,214 at closing. Also, the checking account statement contained two non-payroll deposits during the period July 19 through July 20, 2007, totaling $2,230. There was no explanation by the borrower for these excessive deposits. Since the funds to close were not verified, the borrowers did not have sufficient funds to close. Further, employment income was overstated, as the lender used monthly income of $5,388 on the mortgage credit analysis worksheet which resulted in the lender calculating incorrect debt-to-income ratios of 46.29 and 48.53 percent. After adjusting the borrower‘s income to the documented monthly income of $5,328, these ratios would have increased to 46.81 and 49.08 percent. Mortgage Letter 2005-16 states that for manually underwritten mortgages in which the direct endorsement underwriter must make the credit decision, the qualifying ratios are raised to 31 percent and 43 percent and if either or both ratios are exceeded on a manually underwritten mortgage, the lender must describe the compensating factors used to justify mortgage approval. The compensating factors listed on the mortgage credit analysis worksheet that the borrower had an excellent work history and was making the down payment from his own funds were not allowable according to HUD Handbook 4155.1, REV-5, section 2-13. For FHA case #352-5545714, the lender did not conduct an adequate analysis of the borrower‘s credit history. The credit report indicated that several accounts were in collection; however, the lender did not obtain an explanation from the borrower as required by HUD Handbook 4155.1, REV-5, section 2-3. The HUD-1 settlement statement reported an earnest money deposit of $10,000 that exceeded 2 percent of the sale price; the lender did not obtain supporting documentation for the deposit as required 7 by HUD Handbook 4155.1, REV-5, section 2-10 A. The HUD-1 settlement statement also indicated that the borrower was required to pay $12,382 at closing, yet due to the unsupported earnest money deposit of $10,000, the borrower would have needed $22,382 to close. Since the funds to close were not all verified, the borrower did not have sufficient funds to close the loan. Also, the mortgage credit analysis worksheet and the loan application listed $36,011 as assets, which appeared to be the borrower‘s retirement account of $34,612 and the checking account balance of $1,399. The lender obtained a copy of the retirement statement from October 1 through December 31, 2006. However, the lender did not obtain evidence of redemption as required by HUD Handbook 4155.1, REV-5, section 2-10K. For FHA case #351-4900883, the lender did not adequately verify employment income when the lender did not obtain the borrower‘s original pay stubs covering the most recent 30-day period per HUD Handbook 4155.1, REV-5, section 3-1E. The property was later conveyed to the insurer, and HUD paid a claim of $229,427. Technical Underwriting Deficiencies Two of the fifteen cases audited contained technical deficiencies of noncompliance with HUD requirements that were not serious enough to negatively impact approval of the loans. For FHA case #352-5532937, there were missing bank statements in the file. For FHA case #351-4824525, the total fixed payment-to-income ratio was 46 percent, and there were no compensating factors listed on the mortgage credit analysis worksheet Conclusion Jersey Mortgage did not always approve FHA-insured loans in accordance with the requirements of HUD/FHA. These deficiencies occurred because Jersey Mortgage did not have adequate procedures and controls to ensure that all HUD underwriting requirements were properly implemented and documented. As a result, it approved 13 loans for which HUD paid a claim on one loan totaling $229,427 and remains at risk for more than $3 million in potential claims for the other 12 loans (see appendix C). The final loss that HUD will incur depends upon what HUD realizes when it disposes of the property. HUD‘s most recent data disclosed that its loss rate is 42 percent. Net sales proceeds after considering carrying and sales expenses may mitigate the amount of the claim paid. Loans for which HUD remains at risk can be mitigated by requesting that the lender indemnify HUD. In this case, the lender reimburses HUD for any insurance claim, taxes, interest, and other expenses connected with the disposition of the property, reduced by any amount recouped by HUD via sale or other disposition. 8 Appendix C of the report provides a summary of the underwriting deficiencies noted in the 13 cases. Appendix D of this report provides a more detailed description of the deficiencies by case. Recommendations We recommend that the Deputy Assistant Secretary for Single Family Housing require Jersey Mortgage Company to 1A. Indemnify HUD against future losses of $1,281,3143 related to the 12 loans with significant underwriting deficiencies. 1B. Reimburse HUD for the $96,3594 in loss funds resulting from the amount of claims and associated fees paid on one loan with significant underwriting deficiencies (case #351-4900883). 1C. Establish procedures to ensure that all HUD underwriting requirements are properly implemented and documented. 3 The amount of cost savings or funds to be put to better use on the loans for which indemnification is recommended is estimated at $1,281,314 (42 percent of the unpaid principal balance of $3,050,747) 4 Based upon HUD‘s current 42 percent default loss experience, the amount of ineligible costs for one loan for which a claim was paid is estimated at $96,359 (42 percent of the claim paid of $229,427) 9 Finding 2: Jersey Mortgage Had Weaknesses in the Implementation of its Quality Control Plan Jersey Mortgage had weaknesses in the implementation of its quality control plan. It did not always comply with HUD‘s and its own quality control requirements to ensure that (1) HUD- insured FHA loans that went into default within the first six months were reviewed, (2) 10 percent of rejected loans were reviewed, and (3) management addressed the material deficiencies in the quality control findings. These noncompliances occurred because Jersey Mortgage did not establish procedures to ensure that its quality control plan was properly implemented. Consequently, the effectiveness of its quality control plan, which was designed to ensure accuracy, validity, and completeness in its loan underwriting process, was lessened. Loans Defaulting within the First Six Payments Not Reviewed Loans that defaulted within the first six payments (early payment defaults) were not reviewed as required by HUD regulations and the lender‘s own quality control plan. HUD Handbook 4060.1, REV-2, section 7-6D, requires that lenders review all loans going into default within the first six payments. Jersey Mortgage‘s quality control plan, section 3, states that all FHA loans that go into default within the first six months will be reviewed. However, quality control reviews were not conducted for 30 of the 32 early defaulted loans. Further, the two loans reviewed were apparently randomly selected, as opposed to being selected because they defaulted within six months. This condition occurred because Jersey Mortgage did not adequately implement its quality control plan. Quality control reviews of early defaulted loans can provide valuable information about the causes of default that may indicate inadequate underwriting. Jersey Mortgage officials acknowledged this weakness and stated that review of these defaulted loans would be enforced. Rejected Loans Not Reviewed HUD Handbook 4060.1, REV-2, section 7-8A, states that of the total loans rejected, a minimum of 10 percent or a statistical random sampling that provides a 95 percent confidence level with 2 percent precision must be reviewed. Our review disclosed that Jersey Mortgage did not follow this requirement. Jersey Mortgage officials acknowledged this weakness and stated that review of rejected loans would be enforced. Jersey Mortgage officials did not maintain records that permitted identification of the FHA rejected loans so it was impossible to determine how many rejected loans should have been reviewed. 10 Quality Control Review Findings Not Addressed Management did not provide written responses to the quality control review findings or document what corrective action was taken to address the noted material findings. HUD Handbook 4060.1, REV-2, section 7-3I, requires that management take prompt action to deal appropriately with any material findings. The final report or an addendum must identify actions being taken, the timetable for their completion, and planned follow-up activities. Review of loan files revealed that no management response was provided for the quality control review findings. The quality control liaison stated that management follow-up and corrective action were conducted verbally; however, management officials did not document their actions. Jersey Mortgage officials agreed to implement the required control procedures and stated that written responses to quality control findings would be documented. Conclusion Jersey Mortgage had weaknesses in the implementation of its quality control plan because it did not ensure that (1) all HUD-insured FHA loans that went into default within the first six months were reviewed, (2) 10 percent of rejected loans were reviewed, and (3) management provided follow-up for quality control findings. These noncompliances occurred because Jersey Mortgage did not establish procedures to ensure that its quality control plan was properly implemented. Consequently, the effectiveness of its quality control plan, which was designed to ensure accuracy, validity, and completeness in its loan underwriting process, was lessened. Recommendation We recommend that the Deputy Assistant Secretary for Single Family Housing require 2A. Jersey Mortgage to implement its quality control procedures, to ensure that (1) all loans that default within the first six payments and 10 percent of rejected loans are properly selected and reviewed, and (2) adequate management follow-up is provided for any material findings resulting from quality control reviews. 2B. HUD‘s Homeownership Center‘s Quality Assurance Division to follow up with Jersey Mortgage in six months to ensure that the required quality control procedures were implemented. 11 SCOPE AND METHODOLOGY To achieve our audit objectives, we reviewed applicable laws, regulations, HUD handbooks, mortgagee letters, and reports from HUD‘s Quality Assurance Division. We reviewed the independent audit reports issued by Jersey Mortgage‘s independent auditor and interviewed Jersey Mortgage‘s quality control officials, originators, and underwriters to obtain an understanding of its internal controls. We reviewed 17 defaulted loans from HUD‘s Neighborhood Watch system that were underwritten by Jersey Mortgage with beginning amortization dates between August 1, 2006, and July 31, 2008. Loan selection was based on the following factors: (1) less than six payments were made before the first 90-day default was reported, and (2) the loan was not a streamline refinance. We performed detailed testing and review of Jersey Mortgage‘s underwriting procedures and reviewed documentation from both HUD‘s Homeownership Center endorsement files and loan files provided by Jersey Mortgage officials. Our detail testing and review involved (1) analysis of borrowers‘ income, assets, and liabilities; (2) review of borrowers‘ credit history and savings ability; (3) verification of selected data on the underwriting worksheets and settlement statements; and (4) confirmation of employment and gifts. We communicated compliance issues with HUD and Jersey Mortgage officials. The results of our detailed testing only apply to the 17 loans tested and cannot be projected. We also reviewed Jersey Mortgage‘s quality control plan, as well as its quality control reports and logs. We tested the sufficiency and timeliness of quality control reviews for closed loans. We selected a sample of nine quality control reports to test the adequacy of quality control review procedures and to determine compliance with HUD requirements. We performed the audit fieldwork from January through March 2009 at Jersey Mortgage‘s main office located at 20 Commerce Drive, Suite 340, Cranford, New Jersey. Our audit generally covered the period August 1, 2006, through July 31, 2008, and was expanded as necessary. 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 objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives. 12 INTERNAL CONTROLS Internal control is an integral component of an organization‘s management that provides reasonable assurance that the following controls are achieved: Program operations, Relevance and reliability of information, Compliance with applicable laws and regulations, and 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 objectives: Program operations - Policies and procedures that management has implemented to reasonably ensure that a program meets its objective. Compliance with laws and regulations - Policies and procedures that management has implemented to reasonably ensure that resource use is consistent with laws and regulations. Safeguarding resources - Policies and procedures that management has implemented to reasonably ensure that resources are safeguarded against waste, loss, and misuse. Validity and reliability of data - Policies and procedures that management has implemented to reasonably ensure that valid and reliable data are obtained, maintained, and fairly disclosed in reports. We assessed the relevant controls identified above. A significant weakness exists if management controls do not provide reasonable assurance that the process for planning, organizing, directing, and controlling program operations will meet the organization‘s objectives. 13 Significant Weaknesses Based on our review, we believe that the following items are significant weaknesses: Jersey Mortgage did not ensure that certain loans were processed in accordance with all applicable HUD underwriting requirements (see finding 1). Jersey Mortgage did not adequately implement its quality control plan to ensure compliance with HUD‘s and its own quality control requirements (see finding 2). 14 APPENDIXES Appendix A SCHEDULE OF QUESTIONED COSTS AND FUNDS TO BE PUT TO BETTER USE Recommendation Funds to be put number Ineligible 1/ to better use 2/ 1A $1,281,314 1B $96,359 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 (OIG) 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. In this instance, if HUD implements our recommendations to indemnify the loans that were not originated in accordance with HUD/FHA requirements, it will reduce HUD‘s risk of loss to the insurance fund. The above amount reflects statistics showing that HUD has an average loss experience of 42 percent of the claim amount when it sells a foreclosed property. 15 Appendix B AUDITEE COMMENTS AND OIG’S EVALUATION Ref to OIG Evaluation Auditee Comments 16 17 Comment 1 18 19 Comment 2 Comment 3 20 Comment 3 Comment 4 21 Comment 4 Comment 5 22 Comment 5 Comment 6 23 Comment 7 24 Comment 8 25 Comment 8 Comment 8 Comment 7 26 Comment 7 Comment 9 27 Comment 10 28 Comment 11 29 Comment 12 Comment 13 30 Comment 14 31 Comment 15 Comment 7 32 Comment 7 33 Comment 7 Comment 16 34 Comment 3 35 Comment 3 Comment 17 36 Comment 17 Comment 18 37 Comment 18 Comment 19 38 Comment 20 Comment 21 39 Comment 21 Comment 22 40 Comment 23 Comment 23 41 Comment 23 42 Comment 23 Comment 24 43 Comment 24 Comment 1 Comment 1 44 45 OIG Evaluation of Auditee Comments Comment 1 Jersey Mortgage officials indicate that several of the findings in the report are at variance with the facts and do not constitute violations of HUD/FHA requirements or affect the underlying loans insurability. However, based on evaluation of Jersey Mortgage officials‘ comments and additional documentation provided at the exit conference, we believe the findings in the report are not at variance with the facts and do constitute violations of HUD/FHA requirements. As such, OIG‘s overall conclusions are provided in the below evaluation of auditee comments and were necessary we have revised the report to reflect the additional information provided. Comment 2 Jersey Mortgage officials indicated that borrower‘s with limited recurring expenses are allowed greater latitude on the front end ratio and that the Verification of Rent (VOR) had demonstrated the borrower‘s excellent rental payment history. HUD Handbook 4155.1 REV-5, section 2-13 states that any compensating factor used to justify mortgage approval must be supported by documentation. Present housing expenses paid timely is not an allowable compensating factor. Section 2-13 cites allowable compensating factors and indicates that if 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 this would be an acceptable compensating factor. However, the borrower‘s current housing expense was $2,000 per month and the proposed housing expenses were $3,182 per month, which is significantly higher (59% increase) than the current housing expenses. Also, Jersey Mortgage officials indicated the borrower had been employed in the same line of work for over five years and that the loan was underwritten and approved by the New Jersey Housing & Mortgage Finance Agency with no conditions. However, these are not allowable compensating factors per HUD Handbook 4155.1 REV-5, section 2-13. As such; Jersey Mortgage officials did not have adequate documented compensating factors to justify the high debt to income ratio. Therefore this deficiency will remain in the report and the case is still recommended for indemnification. Comment 3 Jersey Mortgage officials provided documentation to show that the loan had complied with the automated underwriting requirements for Fannie Mae‘s Desktop Underwriter. As such, we revised the report to eliminate this case from the report. Comment 4 Jersey Mortgage officials indicated that the Mortgage Credit Analysis Worksheet (MCAW) and file contained significant compensating factors regarding the high debt to income ratio. The MCAW listed as compensating factors excellent work history and that the down payment came from the borrowers‘ own funds. However, these are not allowable compensating factors per HUD Handbook 4155.1 REV-5, section 2-13. Since, the borrower did not make a large deposit of ten percent or more, the use of his own funds for the deposit is not an allowable 46 compensating factor. Jersey Mortgage officials also stated that $1,600 of monthly income from a job started by the co-borrower in March 2007 was not included in income, therefore this qualified as a compensating factor. We recalculated the co- borrowers $19,166 paid for ten months as being equal to $1,916 in additional income a month, which results in recomputed ratios of 34.42 and 36.09 percent (front and back respectively). However, the front ratio is still in excess of the HUD limit of 31 percent thus, the additional income is not an adequate compensating factor, per HUD Handbook 4155.1, REV-5, Sec 2-13; therefore, this case will remain in the report. Comment 5 Jersey Mortgage officials indicated that the debt to income ratios were accurately computed and that because the borrowers had made timely rental payments over three years, only had a $300 increase in housing expenses, and had satisfied all outstanding debts before the closing; these were adequate compensating factors. The original debt to income ratios were 37.20 and 45.45 percent and exceeded the HUD limits. The compensating factors cited by Jersey Mortgage officials are not allowable per HUD Handbook 4155.1 REV-5, section 2-13, which requires that any compensating factor used to justify mortgage approval must be supported by documentation. The proposed mortgage payment on the MCAW was $1,890, which was substantially higher (26% increase) than the $1,500 current rental payment. Section 2-13 requires documentation that 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, however the file did not contain such documentation. Therefore, this deficiency will remain in the report and the case is still recommended for indemnification. Comment 6 Jersey Mortgage officials stated that the file contained evidence of additional income from the co-borrower, which was not used to qualify the borrowers and was a compensating factor as was the borrower‘ excellent work history. HUD Handbook 4155.1 REV-5, section 2-13 states that any compensating factor used to justify mortgage approval must be supported by documentation. Excellent work history is not an allowable compensating factor per section 2-13. Jersey Mortgage officials cited additional income from the co-borrower as being a compensating factor, which was supported by the borrowers‘ tax return for 2007. However, the documentation provided included tax transcripts for 2007 that revealed the co- borrower had earned a total of $3,599 in 2007 from two new/different employers. Jersey Mortgage officials did not provide adequate documentation to show what the monthly earnings were, when the employments had started, and proof that the co-borrower was still employed at the time of the closing; thus the additional income was not adequately supported. Furthermore, re-computation of the debt to income ratios using an additional $300 of monthly income resulted in a front end ratio of 36.02 percent, which still exceeded the HUD limit of 31 percent. Therefore, this deficiency will remain in the report and the case is still recommended for indemnification. 47 Comment 7 Jersey Mortgage officials indicated that the income used in underwriting the loan was not overstated. We evaluated Jersey Mortgage official‘s response and supporting documentation and conclude that the borrowers‘ income were not materially overstated; as such, since the ratios were reduced to be within HUD limits we have eliminated this case from the report. Comment 8 Jersey Mortgage officials demonstrated that it had complied with HUD guidelines in analyzing the borrower‘s credit profile and debt for child support; thus they had adequately resolved the cited deficiencies. As such, we have adjusted the report to eliminate the cited credit and debt deficiencies. However, the case is still recommended for indemnification based on the other significant deficiencies that existed. Comment 9 Jersey Mortgage officials acknowledged that they did not obtain an explanation regarding the referenced debts and stated that they obtained a written explanation during the course of the audit. HUD Handbook 4155.1 REV-5, section 2-3 states that major indications of derogatory credit including judgments, collections, and any other recent credit problems require sufficient written explanation from the borrower. As such, since this information was not obtained during the underwriting of the loan the case remains in the report, and is still recommended for indemnification. Comment 10 Jersey Mortgage officials acknowledged that the borrower needed additional funds to close. They state that the underwriter was not informed of the fact and was not provided the opportunity to obtain additional asset verification, but Jersey Mortgage officials indicated that the additional funds could have been provided from the borrower‘s $1,900 biweekly pay. HUD Handbook 4155.1 REV-5, section 2-10 states that all funds for the borrower‘s investment in the property must be verified and documented. The HUD-1 settlement statement indicates that the borrower needed $5,835 to close. However, review of the checking account bank statement revealed that the borrower had $3,043 in available funds. Jersey Mortgage officials did not verify and document all of the sources of the funds to close. As such, at the time of the closing, officials did not document that the borrower had sufficient funds available for closing the loan. Therefore this deficiency will remain in the report and the case is still recommended for indemnification. Comment 11 Jersey Mortgage officials indicated that it had verified all large or excessive increases in account funds used to close the loan. Jersey Mortgage officials indicated that no written explanation for two deposits totaling $3,500 made in December was required because similar deposits were made in August and October 2006. HUD Handbook 4155.1 REV-5, section 2-10 states that all funds for the borrower‘s investment in the property must be verified and documented. Thus, Jersey Mortgage officials did not obtain a credible written explanation for the large deposits before the loan closed. Therefore this deficiency will remain in the report and the case is still recommended for indemnification. 48 Comment 12 Jersey Mortgage officials indicated that the borrower had sufficient verified funds to close because the $900 deposit was not large in relation to the borrower‘s income and could have come from the borrower‘s salary. HUD Handbook 4155.1 REV-5, section 2-10 states that all funds for the borrower‘s investment in the property must be verified and documented at the time of closing. Jersey Mortgage officials did not verify or document the $900 deposit; therefore the borrower did not have sufficient verified funds to close the loan. This deficiency will remain in the report and the case is still recommended for indemnification. Comment 13 Jersey Mortgage officials obtained documentation regarding the withdrawal of $35,000 from the borrower‘s retirement account in response to our audit which provided sufficient funds to pay the earnest money deposit and close the loan. HUD Handbook 4155.1 REV-5, section 2-10 states that all funds for the borrower‘s investment in the property must be verified and documented. When this loan was underwritten the lender did not exercise due diligence to verify and document all funds required to close the loan, as such there was not sufficient verified funds to close the loan. Therefore, this deficiency will remain in the report and the case is still recommended for indemnification. Comment 14 Jersey Mortgage officials indicated that they verified that the borrower had received overtime income over the last three years and that the verification of employment did not state that the overtime was not likely to continue. HUD Handbook 4155.1 REV-5, section 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. The verification of employment form did not indicate whether overtime was likely to continue and officials did not obtain any other statements from the employer regarding overtime. As such, there was a lack of documented assurance that the overtime was likely to continue. Therefore this deficiency will remain in the report and the case is still recommended for indemnification. Comment 15 Jersey Mortgage officials indicated that the co-borrowers income was not overstated and that there were four pay stubs covering the 30 day period prior to closing. HUD Handbook 4155.1 REV-5, section 3-1 E provides that 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 W-2 Forms from the previous two years. However, the lender did not obtain four consecutive pays stubs covering the 30 day period prior to closing. The lender provided copies of checks that were not cashed or processed by the bank, and did not have copies of pay stubs, therefore the co-borrower‘s monthly income was not adequately supported. Therefore, this deficiency will remain in the report and the case is still recommended for indemnification. 49 Comment 16 Jersey Mortgage officials stated that it complied with the HUD requirements by obtaining four pay stubs covering a 30 day period prior to closing. HUD Handbook 4155.1 REV-5, section 3-1 E provides that 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 W-2 Forms from the previous two years. The lender did not obtain four consecutive pays stubs covering the 30 day period prior to closing. Therefore, this deficiency will remain in the report and the case is still recommended for indemnification. Comment 17 Jersey Mortgage officials stated that the verification of gift funds met all of HUD‘s requirements. HUD Handbook 4155.1 REV-5, section 2-10C, states that the lender must be able to determine that the gift funds were not ultimately provided from an unacceptable source and were indeed the donor‘s own funds. The donor of the gift deposited $9,000 into his own account on July 25, 2007, and then made the gift payment of $8,000 on July 25, 2007, to the co-borrower. The lender did not adequately verify the source of the donor‘s gift because the documentation on file did not support that the funds were indeed the donor‘s own funds and not provided from an unacceptable source. Therefore, this deficiency will remain in the report and the case is still recommended for indemnification. Comment 18 Jersey Mortgage officials acknowledged that the file did not contain bank statements for the most recent two month consecutive period before the closing. In response to our audit Jersey Mortgage officials subsequently obtained the bank statement covering the four month period before the closing. HUD Handbook 4155.1, Rev-5, section 3-1F, provides that if the bank statement shows the previous month‘s balance, the requirement is met by obtaining the two most recent, consecutive statements. However, the lender did not obtain bank statements for the two most recent consecutive months at the time of the closing. The lender also did not obtain a credible explanation for non-payroll deposits, nor adequately verify the funds to close; as such sufficient verified funds were not available to close the loan. Therefore, this case is still recommended for indemnification. Comment 19 Jersey Mortgage officials indicated that the borrower had enough verified funds to close the loan and that the $3,220 in deposits were not used to close the loan. Upon further review, since the bank statement did show two deposits totaling $7,300 from a gift and a federal tax refund that had been adequately verified and would have provided adequate funds to close; we eliminated the deficiency regarding an inadequate savings pattern or source of funds, pertaining to this case, from the report. Comment 20 Although the lender did not obtain a credible explanation for $5,169 of non- payroll deposits to the borrower‘s checking account Jersey Mortgage officials indicated that the borrower had sufficient verified assets to be able to close the loan and that they had complied with the HUD guidelines. Jersey Mortgage officials indicated that the borrower had at least $14,375 of verified assets that 50 would have covered the $10, 348 of funds needed to close the loan. The documentation provided by Jersey Mortgage officials consisted of a quarterly statement for a mutual fund that had a balance of $14,376. HUD Handbook 4155.1 REV-5, section 2-10L requires the lender to verify that stocks and bonds were redeemed; however this was not done for this case. Further, Jersey Mortgage officials used FHA Total Mortgage Scorecard to underwrite this loan. The FHA Total Mortgage Scorecard User Guide required the lender to obtain the most recent statements for each account to verify that there were sufficient funds to close and to resubmit the loan when material changes are discovered or otherwise occur during loan processing. Jersey Mortgage officials did not resubmit the loan through the automated underwriting system even though there had been a substantial decrease in the borrower‘s assets from $47,219 when underwritten to only $15,014 on the final loan application which included the balance of the mutual fund that had no evidence of redemption. Therefore, this deficiency will remain in the report and the case is still recommended for indemnification. Comment 21 Jersey Mortgage officials indicated that the $800 rental payment by the borrower appears to be a typographical error and that the borrower had provided a June 27, 2007, letter which explained that he lived rent free with his parents and therefore no further verification was needed. HUD Handbook 4155.1 REV-5, section 2-3 A requires the lender 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 the mortgage directly from the mortgage servicer, or through canceled checks covering the most recent 12-month period. The borrower signed the initial and final loan applications that both listed a monthly rental payment of $800 which was used in preparing the mortgage credit analysis worksheet. However, prior to closing the lender failed to obtain a credible explanation for the discrepancy in the rent information provided on loan applications, which had been certified as being true and correct by the borrower. Therefore, this deficiency will remain in the report and the case is still recommended for indemnification. Comment 22 Jersey Mortgage officials acknowledged that the loan file did not contain the required documentation to justify including more than 60 percent of the value of the retirement account in the underwriting analysis. As such, in response to the audit, Jersey Mortgage officials obtained documentation from the borrower to show that the retirement funds had been redeemed and that the higher percentage of funds in the account was available for the closing. HUD Handbook 4155.1 REV-5, section 2-10 states that all funds for the borrower‘s investment in the property must be verified and documented. When this loan was underwritten the lender did not verify all the funds required to close the loan; as such, sufficient verified funds were not available at the closing. This deficiency will remain in the report and the case is still recommended for indemnification. 51 Comment 23 Jersey Mortgage officials disagreed with the amount cited in the report as being the potential loss for the loans with significant underwriting deficiencies. Jersey Mortgage indicated that it is not possible to know the amount of the actual losses and whether there will be any loss on these loans. The amount recommended for indemnification is based on historical experience and represents 42 percent of the unpaid principal balance. The actual loss on individual loans may be higher or lower than the average loss experience. The purpose of indemnification is to protect the government from having to pay claims for loans that were not properly underwritten. The government will not have to absorb the loss for any of the loans recommended for indemnification and if no claim is filed on a loan the lender will not have to make any reimbursement. The recommendations presented in the report are based on an analysis performed by HUD-OIG and does not represent any final decision determined by HUD. Comment 24 The comments made by Jersey Mortgage officials related to our finding 2 are responsive to the finding. 52 Appendix C SUMMARY OF UNDERWRITING DEFICIENCIES Case Unpaid Amount Excessive Inadequate Inadequate Inadequate Inadequate Other number balance requested for debt-to- credit verification support support for deficiencies Appendix amount indemnification income ratios analysis of funds to for income employment 1/ reference without close on calculation adequate HUD-1 compensating settlement factors statement 352- $324,136 $136,137 5568382 X X D-1 352- $212,414 $89,214 5531330 X X X D-2 352- $340,945 $143,197 5516470 X X D-3 352- $255,729 $107,406 5601063 X X X X X D-4 352- $303,594 $127,509 5605932 X X X X X D-5 352- $217,899 $91,518 5526607 X X X X X D-6 352- $283,352 $119,008 5564815 X X X D-7 351- $212,201 $89,124 4842564 X X D-8 351- $225,411 $94,673 4902260 X X D-9 351- $0 $0 2/ 4900883 X D-10 352- $229,938 $96,574 5503273 X D-11 352- $177,120 $74,390 5596824 X X D-12 352- $268,008 $112,563 5545714 X X X D-13 Total $3,050,747 1,281,3143/ 6 3 9 4 3 11 Notes: 1/ The other deficiencies include inadequate evaluation of savings pattern, verification of assets in retirement savings account not verified, inadequate bank account documentation, inadequate gift fund transfer, inadequate earnest money deposit documentation, inadequate support for assets, inaccurate debt-to-income ratios, need to resubmit the loan through the automated underwriting system, incomplete MCAW, and inadequate verification of rent payments. 2/ Based on HUD‘s current 42 percent default loss experience, the amount of ineligible costs for one loan for which a claim was paid is estimated at $96,359 (42 percent of the claim paid of $229,427). 3/ The amount of cost savings or funds to be put to better use on the loans for which indemnification is recommended is estimated at $1,281,314 (42 percent of the unpaid principal balance of $3,050,747) 53 Appendix D CASE SUMMARY NARRATIVES Appendix D-1 Page 1 of 1 Case number: 352-5568382 Loan amount: $324,901 Unpaid balance: $324,136 Closing date: July 12, 2007 Default status: First legal action to commence foreclosure Pertinent Details: A. Inadequate Gift Fund Transfer In the file, there was a gift letter; however, there was no documentation for the gift fund transfer. The amount of the gift was $3,220. The donor made the gift with a cashier‘s check, and the cashier‘s check was dated July 17, 2007; however, the date of the closing for the loan was July 12, 2007. Thus, the gift was provided after the loan closed. Further, HUD Handbook 4155.1, REV-5, section 2-10C, states that if the donor purchased a cashier‘s check, money order, official check, or any other type of bank check as a means of transferring the gift funds, the donor must provide a withdrawal document or canceled check for the amount of the gift, showing that the funds came from the donor‘s personal account. The lender must be able to determine that the gift funds ultimately were not provided from an unacceptable source and were indeed the donor‘s own funds. In the FHA case file, there was no documentation showing that the funds came from the donor‘s personal account. B. Inadequate Verification of Funds to Close on HUD-1 Settlement Statement The lender did not verify or document that the borrower had adequate funds to close. HUD Handbook 4155.1, REV-5, section 2-10, requires that all funds for the borrower‘s investment in the property be verified and documented. The HUD-1 settlement statement indicated that the borrowers were required to pay $11,762. If the gift amount of $3,220 is added back because the lender did not verify and document the source of funds (see in section A), the borrower would have been required to pay $14,982. According to the mortgage credit analysis worksheet, the borrower only had assets of $5,765. Thus, the borrower would have been short of funds to close by $9,217 ($14,982 – $5,765) and did not have sufficient funds to close the loan. 54 Appendix D-2 Page 1 of 1 Case number: 352-5531330 Loan amount: $214,150 Unpaid balance: $212,414 Closing date: November 30, 2006 Default status: Delinquent Pertinent Details: A. Inaccurate Debt-to-Income Ratios B. Excessive Debt-to-Income Ratios without Adequate Compensating Factors The ratios calculated by the lender were incorrect because the borrower‘s and co-borrower‘s monthly income was overstated. On the mortgage credit analysis worksheet, the lender listed the mortgage payment-to-income ratio (front) as 39.36 percent and the total fixed payment-to- income ratio (back) as 51.44 percent. Based on the corrected monthly income of $3,610, we calculated ratios of 50.50 percent and 67.25 percent, respectively. Mortgagee Letter 2005-16 states that the lender must describe the compensating factors used to justify mortgage approval, when the borrower‘s mortgage payment-to-income ratio (front) and the total fixed payment-to- income ratio (back) exceeds 31 and 43 percent, respectively. However, the mortgage credit analysis worksheet did not list compensating factors. The compensating factors provided later by the lender that there was an 84 percent loan-to-value ratio, the borrower had two months cash reserve, and present housing expenses were paid in a timely manner are not considered to be allowable compensating factors according to HUD Handbook 4155.1, REV-5, section 2-13. C. Inadequate Support for Income Calculation The borrowers‘ monthly income of $4,720, shown on the mortgage credit analysis worksheet and the loan application, was overstated by $1,110. The borrower‘s base pay was listed as $2,397. The coborrower‘s base pay was listed as $1,213. The borrower‘s other earnings were listed as $1,110. In the file, there was a checking statement as of October 16, 2006, which showed monthly Social Security direct deposits of $460 on September 1 and October 3, 2006. It appeared that the lender included the Social Security income. HUD Handbook 4155.1, REV-5, section 2-7E, states that retirement and Social Security income require verification from the source (former employer, Social Security Administration) or federal tax returns. Also, the lender appears to have included income from the borrower‘s son as her other earnings of $650 per month. In the file, there were copies of checks from her son‘s income for September 2, 2006 ($159); September 9, 2006 ($173); October 7, 2006 ($158); October 14, 2006 ($142); and November 25, 2006 ($142). However, these checks did not add up and were not verified. Therefore, we calculated the monthly employment income to be $3,610 ($2,397 + $1,213) because the borrower‘s Social Security income and borrower‘s son‘s income had not been properly verified and documented. Therefore, monthly income was overstated by $1,110. 55 Appendix D-3 Page 1 of 1 Case number: 352-5516470 Loan amount: $345,100 Unpaid balance: $340,945 Closing date: May 14, 2007 Default status: Reinstated by Mortgagor Pertinent Details: A. Excessive Debt-to-Income Ratios without Adequate Compensating Factors The lender calculated the mortgage payment expense-to-income ratio (front) as 41.31 percent, which exceeded HUD‘s threshold; however, no allowable compensating factors were listed. Mortgagee Letter 2005-16 states that if either or both ratios exceed 31 percent and 43 percent, the lender must describe the compensating factors used to justify the mortgage approval. B. Inadequate Verification of Funds to Close on HUD-1 Settlement Statement The HUD-1 settlement statement indicates that the borrower needed $5,835 to close. However, review of the checking account bank statement revealed that the borrower had $3,043 in available funds. It appeared that the borrower did not have sufficient funds to close and was short of funds to close by $2,792 ($5,835 - $3,043). 56 Appendix D-4 Page 1 of 2 Case number: 352-5601063 Loan amount: $256,795 Unpaid balance: $255,729 Closing date: July 23, 2007 Default status: First legal action to commence foreclosure Pertinent Details: A. Inaccurate Debt-to-Income Ratios B. Excessive Debt-to-Income Ratios without Adequate Compensating Factors The ratios calculated by the lender were incorrect because the borrower‘s monthly income was overstated. On the mortgage credit analysis worksheet, the lender listed the mortgage payment expense-to-income ratio (front) as 46.29 percent and the total fixed payment-to-income ratio (back) as 48.53 percent using monthly income of $5,388. Based on the documented monthly income of $5,328, we calculated ratios of 46.81 percent and 49.08 percent, respectively. Mortgagee Letter 2005-16 states that for manually underwritten mortgages in which the direct endorsement underwriter must make the credit decision, the qualifying ratios are raised to 31 percent and 43 percent and if either or both ratios are exceeded on a manually underwritten mortgage, the lender must describe the compensating factors used to justify mortgage approval. The compensating factors listed on the mortgage credit analysis worksheet of excellent work history and that the down payment was made with the borrower‘s own funds were not allowable according to HUD Handbook 4155.1, REV-5, section 2-13. C. Inadequate Evaluation of Savings Pattern The checking account statement indicated that the borrower had made two nonpayroll deposits on July 19 and July 20, 2007, totaling $2,230. The available balance for the checking account statement was $4,001 as of July 20, 2007. There was no explanation in the file by the borrower for these excessive deposits. HUD Handbook 4155.1, REV-5, section 2-10B, states that if there is a large increase in a bank account, the lender must obtain credible explanation of the source of those funds. D. Inadequate Verification of Earnest Money Deposit The HUD-1 settlement statement shows an earnest money deposit of $10,000. A total of $9,000 of the $10,000 earnest money deposit had been transferred from the borrower‘s checking account as of May 29, 2007. However, on May 29, 2007, a deposit of $1,170 was made to the borrower‘s checking account, resulting in a pretransfer balance of $9,080. If this deposit had not been made on May 29, 2007, the checking account balance would have been $7,910. There was no explanation in the file for the source of these funds. HUD Handbook 4155.1, REV-5, section 2-10A, states that 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 accumulated savings, the lender must verify with documentation the deposit amount and source of funds. 57 Appendix D-4 Page 2 of 2 E. Inadequate Verification of Funds to Close on HUD-1 Settlement Statement The lender did not verify or document that the borrower had adequate funds to close. HUD Handbook 4155.1, REV-5, section 2-10, requires that all funds for the borrower‘s investment in the property be verified and documented. The HUD-1 settlement statement for the FHA loan indicated that the borrowers were required to pay $5,044 at closing. Due to the unsupported earnest money deposit of $1,170 (explained in section D), the borrowers would have needed $6,214 at closing. In the checking account statement, the available balance was $4,001; however, if the unexplained nonpayroll deposit of $2,230 (see section C) is not included, the borrower would have had $1,771 ($4,001 - $2,230) in available funds in the checking account. The assets in the savings account were verified as $126, thus total available funds were $1,898. Therefore, the borrower would have had a deficit of $4,316 ($6,214 - $1,898). Since the funds to close were not verified as explained above, the borrower did not have sufficient funds to close. F. Inadequate Support for Income Calculation The file contained documentation of an average monthly overtime income of $305 for 30 months. However, the lender did not verify that overtime income was likely to continue. HUD Handbook 4155.1, REV-5, section 2-7A, states that both overtime and bonus income may be used to quality if the borrower has received such income for the past two years and it is likely to continue. G. Inadequate Credit Analysis The credit report contained derogatory items, and a judgment was listed for the coborrower. The file contained a letter written by the coborrower; however, it was inadequate because it did not explain the derogatory items and judgment listed on the credit report. HUD Handbook 4155.1, REV-5, section 2-3, states that major indications of derogatory credit including judgments, collections, and any other recent credit problems require sufficient written explanation from the borrower. The lender did not obtain a credible explanation for derogatory credit. 58 Appendix D-5 Page 1 of 2 Case number: 352-5605932 Loan amount: $305,210 Unpaid balance: $303,594 Closing date: September 5, 2007 Default status: Special forbearance Pertinent Details: A. Inaccurate Debt-to-Income Ratios B. Excessive Debt-to-Income Ratios without Adequate Compensating Factors The lender listed the mortgage payment-to-income ratio (front) as 41.24 percent and the total fixed payment-to-income ratio (back) as 48.44 percent on the mortgage credit analysis worksheet. The ratios calculated by the lender were incorrect because the borrower‘s monthly income was overstated. Based on a monthly income of $5,958, we calculated ratios of 45.09 percent and 52.97 percent, respectively. Mortgagee Letter 2005-16 states that the lender must describe the compensating factors used to justify mortgage approval when the borrower‘s mortgage payment-to-income ratio (front) and the total fixed payment-to-income ratio (back) exceed 31 and 43 percent, respectively. The lender did not list compensating factors. C. Inadequate Gift Funds Transfer The donor of the gift deposited $9,000 into his own account on July 25, 2007, and then made the gift payment of $8,000 on July 25, 2007, to the coborrower. However, the lender did not adequately verify the source of funds for the gift. The assets available on the mortgage credit analysis worksheet were shown as $8,010. If the gift amount is not included, the borrower would have had $10 available to close. The HUD-1 settlement statement indicated that the borrower would have needed $8,000 to close. HUD Handbook 4155.1, REV-5, section 2-10C, states that the lender must be able to determine that the gift funds were not ultimately provided from an unacceptable source and were indeed the donor‘s own funds. The lender did not adequately verify the source of the donor‘s gift. D. Inadequate Support for Income Calculation The monthly employment income on the mortgage credit analysis worksheet was listed as $6,515; however, our calculation of the monthly employment income based on the pay stubs was $5,958. Therefore, monthly income was overstated by $557. E. Inadequate Support for Employment For one of the coborrowers, there were employment gaps for the months of April 2006, August 2006, and September 2006, with no explanations as to the reason for these gaps. HUD Handbook 4155.1, REV-5, section 2-6, states that the borrower also must explain any gaps in 59 Appendix D-5 Page 2 of 2 employment spanning one month or more. The lender did not obtain an explanation for the gaps in employment. F. Inadequate Credit Analysis The lender did not conduct an adequate analysis of the borrower‘s credit history. The credit report in the file contained two judgments in March 2002 and May 2003. The lender did not obtain information on the status of the judgments or an explanation from the borrower. HUD Handbook 4155.1, REV-5, section 2-3, states that major indications of derogatory credit including judgments, collections, and any other recent credit problems require sufficient written explanation from the borrower. 60 Appendix D-6 Page 1 of 2 Case number: 352-5526607 Loan amount: $218,900 Unpaid balance: $217,899 Closing date: January 12, 2007 Default status: Chapter 13 – bankruptcy Pertinent Details: A. Inaccurate Debt-to-Income Ratios B. Excessive Debt-to-Income Ratios without Adequate Compensating Factors The ratios calculated by the lender were incorrect because the borrower‘s monthly income was overstated. The mortgage credit analysis worksheet listed the mortgage payment expense-to- income ratio (front) as 37.20 percent and the total fixed payment-to-income ratio (back) as 45.45 percent. Based on a monthly income of $5,013, we calculated ratios of 37.70 percent and 46.05 percent, respectively. Mortgagee Letter 2005-16 states that the lender must describe the compensating factors used to justify the mortgage approval when the borrower‘s mortgage payment expense-to-income ratio (front) and the total fixed payment-to-income ratio (back) exceeds 31 and 43 percent, respectively. The lender did not list compensating factors. C. Inadequate Support for Assets The mortgage credit analysis worksheet listed $5,807 as assets, which appeared to be a $5,000 grant, $800 (cash on hand), and $7 (credit union account). However, there was no supporting documentation in the file for the $800 in cash on hand. HUD Handbook 4155.1, REV-5, section 2-10M, provides that borrowers who have saved cash at home and are able to demonstrate adequately the ability to do so are permitted to have this money included as an acceptable source of funds to close the mortgage. To include such funds in assessing the home buyer‘s cash assets for closing, the money must be verified—whether deposited in a financial institution or held by the escrow/title company—and the borrower must provide satisfactory evidence of the ability to accumulate such savings. The asset verification process requires the borrower to explain in writing how such funds were accumulated and the amount of time taken to do so. The file did not contain such documents. D. Inadequate Verification of Funds to Close on HUD-1 Settlement Statement The lender did not verify or document that the borrower had adequate funds to close. HUD Handbook 4155.1, REV-5, section 2-10, requires that all funds for the borrower‘s investment in the property be verified and documented. The HUD-1 settlement statement for the FHA loan indicated that the borrowers were required to pay $3,037 in addition to the $5,000 in funds provided by the grant. In the section of the HUD-1 settlement statement, entitled ―Amounts to Be Paid by or on Behalf of Borrower,‖ the $5,000 (grant) was included. Based on the assets 61 Appendix D-6 Page 2 of 2 available of $807, the $800 would be excluded because it was not supported (explained in section C). Thus, the borrowers would only have had $7 according to the verified available assets. Therefore, the borrowers would have had a deficit of $3,030 ($3,037 - $7) at closing. Since the funds to close were not verified as explained above, the borrower did not have sufficient funds to close. E. Inadequate Support for Employment The lender did not obtain the co-borrower‘s original pay stubs covering the most recent 30-day period. In the file, there was documentation indicating a verbal verification of employment and copies of checks dated November 4, 2006, November 14, 2006, November 29, 2006, and December 29, 2006. HUD Handbook 4155.1, REV-5, section 3-1E, requires the lender to obtain a verification of employment and the most recent pay stub showing year-to-date earnings for at least one month; this was not done. F. Inadequate Support for Income Calculation The co-borrower‘s monthly employment income (base pay) on the mortgage credit analysis worksheet was listed as $866; however, our calculation of the monthly employment income based on pay stubs was $800. Therefore, income was overstated by $66. G. Incomplete Mortgage Credit Analysis Worksheet The mortgage credit analysis worksheet was not signed or dated by the underwriter. 62 Appendix D-7 Page 1 of 1 Case number: 352-5564815 Loan amount: $289,430 Unpaid balance: $283,352 Closing date April 10, 2007 Default status: Reinstated after loss mitigation intervention Pertinent Details: A. Excessive Debt-to-Income Ratios without Adequate Compensating Factors The lender calculated the mortgage payment expense-to-income ratio (front) as 37.73 percent and the total fixed payment-to-income ratio (back) as 44.45 percent, which exceeded HUD‘s threshold; however, no compensating factors were listed. Mortgagee Letter 2005-16 states that if either or both ratios exceed 31 percent and 43 percent, respectively, the lender must describe the compensating factors used to justify the mortgage approval. B. Inadequate Evaluation of Savings Pattern The checking account statement indicated that the borrower had a nonpayroll deposit of $3,640 on March 28, 2007. The available balance for the checking account statement was $6,056 as of April 5, 2007. There was no explanation in the file by the borrower for this excessive deposit. HUD Handbook 4155.1, REV-5, section 2-10B, states that if there is a large increase in an account or if the account was opened recently, the lender must obtain a credible explanation of the source of those funds. The lender had not obtained a credible explanation. C. Inadequate Verification of Funds to Close on HUD-1 Settlement Statement The lender did not verify or document that the borrower had adequate funds to close. HUD Handbook 4155.1, REV-5, section 2-10, requires that all funds for the borrower‘s investment in the property be verified and documented. The HUD-1 settlement statement for the FHA loan indicated that the borrowers were required to pay $6,297. The checking account statement available balance was $6,056; however, if we do not include the unexplained nonpayroll deposit of $3,640, the borrower would have $2,416 ($6,056 - $3,640) in available funds. The borrower would have had a deficit of $3,881 ($6,297 - $2,416) at closing. Since the funds to close were not verified as explained above, the borrower did not have sufficient funds to close. 63 Appendix D-8 Page 1 of 2 Case number: 351-4842564 Loan amount: $214,600 Unpaid balance: $212,201 Closing date: December 28, 2006 Default status: Delinquent Pertinent Details: A. Inadequate Bank Account Documentation In the file, there were bank statements from Andrews Federal Credit Union for the periods July 5 to August 4, 2006; September 5 to October 4, 2006; and November 25 to December 20, 2006. We were later provided the bank statements from July 5 through November 4, 2006. The Andrews Federal Credit Union bank documentation for November 5 through November 24, 2006, appeared to be missing. HUD Handbook 4155.1, REV-5, section 3-1F, states that a verification of deposit and most recent bank statement are to be provided. As an alternative to obtaining a verification of deposit, the lender may obtain from the borrower the original bank statements 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. The lender did not obtain bank statements for the two most recent, consecutive months. B. Inadequate Evaluation of Savings Pattern The files contained an Andrews Federal Credit Union bank statement for the period September 5 to October 4, 2006, in which there were two nonpayroll deposits totaling $1,930 ($980 + $950). Also, there was a savings account statement for the period November 25 to December 20, 2006, with an ending balance of $4,207. On December 6 and December 16, 2006, there were nonpayroll deposits for $1,600 and $1,900. The available balance for the savings account was $4,207 as of December 20, 2006. In the file, there was no explanation by the borrower for these excessive nonpayroll deposits. HUD Handbook 4155.1, section 2-10B, states that a verification of deposit, along with the most recent bank statement, may be used to verify savings and checking accounts. If there is a large increase in an account or the account was opened recently, the lender must obtain a credible explanation of the source of those funds. The lender did not obtain a credible explanation of the source of the nonpayroll deposits. C. Inadequate Verification of Funds to Close on HUD-1 Settlement Statement The lender did not verify or document that the borrower had adequate funds to close. HUD Handbook 4155.1, REV-5, section 2-10, requires that all funds for the borrower‘s investment in the property be verified and documented. The HUD-1 settlement statement for the FHA loan indicated that the borrowers were required to pay $6,104. The savings account available balance was $4,207; however, exclusion of the unexplained nonpayroll deposit of $3,500 results in a $707 ($4,207 - $3,500) balance for this account. The assets in the other savings account were 64 Appendix D-8 Page 2 of 2 verified as $3,432, thus leaving available funds of $4,139. Therefore, the borrower would have had a deficit of $1,965 ($6,104 – $4,139) at closing and would not have had sufficient funds to close the loan. 65 Appendix D-9 Page 1 of 2 Case number: 351-4902260 Loan amount: $226,446 Unpaid balance: $225,411 Closing date: June 29, 2007 Default status: First legal action to commence foreclosure – Chapter 13 bankruptcy Pertinent Details: A. No Verification of Retirement Account In the file, there was a 401(k) statement for the period January 1 through March 31, 2007. The statement balance was $29,287; however, the maximum amount that can be used in the underwriting analysis is normally only 60 percent of the statement balance or $17,572. There was no evidence of redemption of the 401(k) account. HUD Handbook 4155.1, REV-5, sections 2-10K, states that assets such as individual retirement accounts, thrift savings plans, and 401(k)s may be included in the underwriting analysis up to only 60 percent of value unless the borrower provides conclusive evidence that a higher percentage may be withdrawn after subtracting any federal income tax and any withdrawal penalties. Evidence of redemption is required. The lender did not obtain evidence of redemption of the 401(k). B. Inadequate Evaluation of Savings Pattern The checking account transaction history indicated that the borrower had one nonpayroll deposit on March 26, 2007, totaling $4,300. The available balance for the checking account statement was $11,214 as of May 3, 2007. There was no explanation by the borrower for this excessive deposit in the file. HUD Handbook 4155.1, section 2-10B, states that if there are large increases in an account or the account was opened recently, the lender must obtain an explanation of the source of funds. The lender did not obtain a credible explanation for this deposit. C. Inadequate Verification of Funds to Close on HUD-1 Settlement Statement HUD Handbook 4155.1, REV-5, section 2-10, requires that all funds for the borrower‘s investment in the property be verified and documented. The HUD-1 settlement statement indicated that the borrowers were required to pay $10,209. In the checking account transaction history, the available balance was $11,214; however, if we do not include the unexplained nonpayroll deposit of $4,300, the borrower would have had a $6,914 ($11,214 – $4,300) balance in this account. The assets in the savings account were verified as $1,054. Therefore, the borrower would have had a deficit of $2,241 ($10,209 – $7,968) ($6,914 checking balance + $1,054 savings balance) and did not have sufficient funds to close the loan. 66 Appendix D-9 Page 2 of 2 D. Inadequate Bank Account Documentation The lender obtained only one savings account statement for the period March 27 through April 24, 2007. The other savings account statements appeared to be missing. HUD Handbook 4155.1, REV-2, section 3-1F, states that as an alternative to obtaining a verification of deposit, the lender may obtain the borrower‘s original bank statements covering the most recent three- month period, provided the bank statements show that the previous month‘s balance requirement was met by obtaining the two most recent, consecutive statements. The lender did not obtain or maintain bank statements for the two most recent, consecutive months. 67 Appendix D-10 Page 1 of 1 Case number: 351-4900883 Loan amount: $221,523 Unpaid balance: $0 Closing date: May 24, 2007 Default status: Property conveyed to insurer, Claim filed, HUD incurred loss of $229,427 Pertinent Details: A. Inadequate Support for Employment The lender did not obtain the borrower‘s original pay stubs covering the most recent 30-day period. In the file, there were four statements of wages and earnings dated April 13, 2007, April 20, 2007, May 11, 2007, and May 18, 2007. HUD Handbook 4155.1, REV5, section 3-1E, states that as an alternative to obtaining a verification of employment, the lender may obtain the borrower‘s original pay stub(s) covering the most recent 30-day period. The pay stub(s) must show the borrower's name, Social Security number, and year-to-date earnings. The lender did not obtain pay stubs covering the most recent 30-day period. 68 Appendix D-11 Page 1 of 1 Case number: 352-5503273 Loan amount: $232,200 Unpaid balance: $229,938 Closing date: August 4, 2006 Default status: Chapter 13 bankruptcy Pertinent Details: A. Inadequate Evaluation of Savings Pattern The First Bank Americano checking account statement indicated that the borrower had made four nonpayroll deposits from June to July 2007 totaling $5,169. In the file, there was no explanation by the borrower for these excessive deposits. HUD Handbook 4155.1, REV-5, section 2-10B, states that if there was a large increase in an account, the lender must obtain a credible explanation of the source of those deposits. The lender did not obtain a credible explanation for the source of the funds. B. No Verification of Retirement Account The lender did not properly verify the borrower‘s available funds. In the mortgage credit analysis Worksheet, the lender listed assets available as $47,219. The lender used the FHA Total Scorecard to process the loan and included the following assets in determining the available funds: mutual funds ($14,376), checking ($638), and retirement account ($32,205). The lender used the borrower‘s personal retirement benefits statement for December 31, 2004, to obtain the retirement balance of $32,205. The FHA Total Mortgage Scorecard User Guide requires the lender to obtain the most recent statements for each account to verify that there are sufficient funds to close and to document the terms and conditions for withdrawal and/or borrowing and that the borrower is eligible for these withdrawals. We noted that in the final loan application, there were total assets of $15,014 (checking account $638 and investment account $14,376). The FHA Total Mortgage Scorecard User Guide states that the lender is responsible for the integrity of the data used to obtain the risk assessment and for resubmitting the loan when material changes are discovered or otherwise occur during loan processing. The lender is required to resubmit the loan through the automated underwriting system for an updated evaluation if the borrower‘s income and/or cash assets/reserves decrease. However, the lender did not resubmit the loan through the automated underwriting system although there had been a substantial decrease in the borrower‘s assets. 69 Appendix D-12 Page 1 of 1 Case number: 352-5596824 Loan amount: $177,120 Unpaid balance: $177,120 Closing date: June 22, 2007 Default status: Foreclosure sale held Pertinent Details: A. Inadequate Evaluation of Savings Pattern The United Investors Federal Credit Union statement indicated that the borrower had made one nonpayroll deposit on June 21, 2007, totaling $900. The available balance for the checking account statement was $5,865 as of June 21, 2007. The file contained no explanation from the borrower for this excessive deposit. HUD Handbook 4155.1, REV-5, section 2-10B, states that if there was 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. The lender did not obtain a credible explanation as to the source of the funds. B. Inadequate Verification of Funds to Close on HUD-1 Settlement Statement HUD Handbook 4155.1, REV-5, section 2-10, requires that all funds for the borrower‘s investment in the property be verified and documented. The HUD-1 settlement statement indicated that the borrowers were required to pay $5,749. For the savings account, the available balance was $5,865; however, exclusion of the unexplained nonpayroll deposit of $900 results in the borrower having savings of $4,965 ($5,865 - $900) in this account. Therefore, the borrower would have had a deficit of $784 ($5,749 - $4,965) and did not have sufficient funds to close the loan. C. Inadequate Verification of Rent Payments The mortgage credit analysis worksheet and the initial and final loan applications indicated that the borrower paid an $800 monthly rent. However, a June 7, 2007, letter from the borrower stated that he did not pay rent. HUD Handbook 4155.1, REV-5, section 2-3A, states that the payment history of the borrower‘s housing obligation holds significant importance in evaluating credit. The lender must determine the borrower‘s payment history of housing obligation 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. The lender did not obtain a credible explanation regarding the discrepancy in the rental history of the borrower. 70 Appendix D-13 Page 1 of 2 Case number: 352-5545714 Loan amount: $274,800 Unpaid balance: $268,008 Closing date: March 23, 2007 Default status: Delinquent Pertinent Details: A. No Verification of Retirement Account The mortgage credit analysis worksheet and the loan application listed $36,011 as assets, which appeared to be, respectively, the borrower‘s retirement account of $34,612 and an Amboy National checking statement account of $1,399. The lender obtained a copy of the retirement statement for the period October 1 through December 31, 2006. However, the lender did not obtain evidence of redemption. Also, the lender calculated the available assets using 70 percent of the value, yet there was no explanation provided. HUD Handbook 4155.1, REV-5, section 2- 10K, states that assets such as individual retirement accounts, thrift savings plans, and 401(k)s may be included in the underwriting analysis up to only 60 percent of value unless the borrower provides conclusive evidence that a higher percentage may be withdrawn after subtracting any federal income tax and withdrawal penalties. Evidence of redemption is required. B. Inadequate Verification of Funds to Close on HUD-1 Settlement Statement The HUD-1 settlement statement indicated that the borrower was required to pay $12,382 at closing. Due to the unsupported earnest money deposit of $10,000 (explained in paragraph C), the borrower would have needed $22,382 to close. Since the funds to close were not all verified, the borrower did not have sufficient funds to close the loan. C. Inadequate Verification of Earnest Money Deposit The HUD-1 settlement statement reported an earnest money deposit of $10,000 that exceeded 2 percent of the sale price. The lender did not obtain supporting documentation for the deposit. HUD Handbook 4155.1, REV-5, section 2-10A, states that when the amount of the earnest money deposit exceeds 2 percent of sales price or appears excessive based on the borrower‘s history of accumulated savings, the lender must verify with documentation the deposit amount and source of funds. The lender did not obtain evidence of the source of funds including 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. D. Inadequate Credit Analysis The credit report indicated that several accounts were in collection. The FHA file contained no explanations from the borrower. HUD Handbook 4155.1, REV-5, section 2-3, states that major indications of derogatory credit including judgments, collections, and any other recent credit 71 Appendix D-13 Page 2 of 2 problems require sufficient written explanation from the borrower. However, the lender did not obtain an explanation from the borrower. 72
Jersey Mortgage Company, Cranford, New Jersey, Did Not Always Comply with HUD/FHA Loan Underwriting Requirements
Published by the Department of Housing and Urban Development, Office of Inspector General on 2009-10-09.
Below is a raw (and likely hideous) rendition of the original report. (PDF)