oversight

Prospect Mortgage, LLC, Fairfax, VA, Generally Complied With HUD Requirements Regarding FHA-Insured Single-Family Loans

Published by the Department of Housing and Urban Development, Office of Inspector General on 2010-06-22.

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

                                                               Issue Date
                                                                    June 22, 2010
                                                               Audit Report Number
                                                                    2010-PH-1010




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

           //signed//
FROM:      John P. Buck, Regional Inspector General for Audit, Philadelphia Region,
            3AGA

SUBJECT:   Prospect Mortgage, LLC, Fairfax, VA, Generally Complied With HUD
           Requirements Regarding FHA-Insured Single-Family Loans


                                 HIGHLIGHTS

 What We Audited and Why

           We audited the Fairfax, VA, branch office (branch office) of Prospect Mortgage,
           LLC (Prospect Mortgage), because it had one of the highest default rates for U.S.
           Department of Housing and Urban Development (HUD)-approved lenders for
           loans issued in the State of Maryland. Our objective was to determine whether
           Prospect Mortgage and its branch office complied with HUD regulations,
           procedures, and instructions in the origination and quality control review of
           single-family mortgage loans insured by the Federal Housing Administration
           (FHA).

 What We Found

           Prospect Mortgage generally complied with HUD requirements in its origination
           and quality control review of FHA loans. However, its branch office did not
           underwrite one of five defaulted loans reviewed in accordance with HUD
           requirements. In addition, Prospect Mortgage did not always perform quality
           control reviews of its FHA-insured loans in a reasonably timely manner. These
           deficiencies were caused by a misinterpretation of HUD guidance at the branch
                    office and Prospect Mortgage’s failure to consistently be prudent in the
                    implementation of its quality control process. As a result, the FHA insurance
                    fund was exposed to an unnecessarily increased risk, and the effectiveness of
                    Prospect Mortgage’s quality control process was lessened.

    What We Recommend

                    We recommend that HUD’s Deputy Assistant Secretary for Single Family
                    Housing (1) require Prospect Mortgage to indemnify $193,357 1 for the loan,
                    which it issued contrary to HUD’s loan origination requirements, and (2) direct
                    Prospect Mortgage to improve its quality control process and follow up in 6 months
                    to ensure the lender’s compliance.

                    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 Prospect Mortgage on March 31, 2010. We
                    discussed the audit results with Prospect Mortgage during the audit and at an exit
                    conference on April 14, 2010, and issued a revised draft report on April 28, 2010.
                    Prospect Mortgage provided written comments to our draft report on May 3,
                    2010. It generally disagreed with our report. The complete text of its response,
                    along with our evaluation of that response, can be found in appendix B of this
                    report.




1
    This amount is the unpaid principal balance for the loan. The projected loss to HUD is $116,014 (see appendix C).

                                                           2
                             TABLE OF CONTENTS


Background and Objective                                                      4

Results of Audit
        Finding: Prospect Mortgage Generally Complied With HUD Requirements   5
        Regarding FHA-Insured Single-Family Loans

Scope and Methodology                                                         9

Internal Controls                                                             11

Appendixes
   A.   Schedule of Funds To Be Put to Better Use                             12
   B.   Auditee Comments and OIG’s Evaluation                                 13
   C.   Schedule of Case File Discrepancies                                   34
   D.   Narrative Case Presentations                                          35




                                             3
                      BACKGROUND AND OBJECTIVE

The U.S. Department of Housing and Urban Development’s (HUD) strategic plan states that part
of its mission is to increase homeownership, support community development, and increase
access to affordable housing free from discrimination.

The National Housing Act, as amended, established the Federal Housing Administration (FHA),
an organizational unit within HUD. FHA provides insurance for lenders against loss on single-
family home mortgages.

In 1983, HUD implemented the direct endorsement program, which authorized approved lenders
to underwrite loans without HUD’s prior review and approval. There are two types of approved
direct endorsement lenders—supervised and nonsupervised. A supervised lender is an FHA-
approved financial institution that is a member of the Federal Reserve System or an institution
with accounts insured by the Federal Deposit Insurance Corporation or the National Credit
Union Administration. A nonsupervised lender is an FHA-approved lending institution that has
as its principal activity the lending or investing of funds in real estate mortgages. HUD requires
lenders to use its Neighborhood Watch system to monitor and evaluate their performance and has
many sanctions available for taking actions against lenders that abuse the direct endorsement
program.

Prospect Mortgage, LLC (Prospect Mortgage), is a nonsupervised direct endorsement lender of
FHA loans. The branch office reviewed was located in Fairfax, VA. The branch office issued
51 FHA loans valued at $14.2 million between June 2007 and May 2009 that defaulted within
the first 2 years. Of the 51 loans, 27 remained after terminations and refinances were eliminated.
These loans were valued at more than $7.4 million. We reviewed five of the loans valued at
approximately $1.2 million.

On October 19, 2009, HUD terminated the branch office’s FHA loan origination approval
agreement for the Washington, DC, jurisdiction because of its relatively high default and claim
rate. The termination would have precluded the office from originating single-family loans
within the stated geographic area. However, the branch office was closed down (October 16,
2009) immediately before HUD’s termination.

Our objective was to determine whether Prospect Mortgage and its branch office complied with
HUD regulations, procedures, and instructions in the origination and quality control review of
FHA-insured single-family loans.




                                                4
                                RESULTS OF AUDIT

Finding: Prospect Mortgage Generally Complied With HUD
Requirements Regarding FHA-Insured Single-Family Loans
Prospect Mortgage generally complied with HUD requirements regarding FHA loans. However,
its branch office did not originate one of five loans reviewed in accordance with HUD
requirements. The branch office approved the borrower for a loan originally valued at
approximately $196,900; however, the borrower had debt ratios in excess of HUD guidelines and
the branch office did not justify the approval with adequate compensating factors as required. In
addition, Prospect Mortgage did not always perform quality control reviews of its FHA-insured
loans in a reasonably timely manner. These deficiencies were caused by a misinterpretation of
HUD guidance at the branch office as well as Prospect Mortgage’s failure to consistently be
prudent in the implementation of its quality control process. The improperly underwritten loan
exposed the FHA insurance fund to an unnecessarily increased risk. Therefore, Prospect
Mortgage should indemnify more than $193,300 for the defaulted loan.




 Loan Approved With High
 Ratios and Inadequate
 Compensating Factors


              HUD Handbook 4155.1, REV-5, paragraphs 2-12 and 2-13, specify acceptable
              parameters for debt ratios in the absence of what HUD refers to as “compensating
              factors” for loans that are manually underwritten by the lender (as opposed to
              loans in which an automated underwriting system is used). HUD Mortgagee
              Letter 2005-16 provides that the ratio of the total mortgage payment to effective
              income (front ratio) may not exceed 31 percent and the ratio of total fixed
              payments to effective income (back ratio) may not exceed 43 percent. If either or
              both ratios are exceeded on a manually underwritten mortgage, the lender must
              describe the compensating factors used to justify mortgage approval.
              Compensating factors include but are not limited to the following: (1)
              demonstrated ability to pay housing expenses equal to or greater than the
              proposed new mortgage payment, (2) a downpayment of at least 10 percent, (3)
              demonstrated ability to accumulate savings and conservative use of credit, (4)
              ability to devote a greater portion of income to housing expenses, (5) at least 3
              months worth of documented cash reserves, and (6) a potential for increased
              earnings.

              In one of the cases reviewed, the branch office failed to provide valid or adequate
              compensating factors to justify its approval for a borrower with debt-to-income

                                               5
           ratios in excess of HUD requirements. The borrower’s front and back ratios were
           42.2 and 48.5 percent, respectively. The underwriter indicated the following
           compensating factors: half down from own funds, conservative use of credit,
           satisfactory rental history, and borrower in same line of work (6 years) with new
           employment that offers higher salary and potential for increased earnings. These
           compensating factors were not valid or adequate based on HUD requirements.
           The borrower did not make a downpayment of at least 10 percent. Also, the
           conservative use of credit in and of itself was not an adequate compensating
           factor. In addition, the satisfactory rental history is a requirement and not a
           compensating factor; and in this particular case, the mortgage payment was
           actually about three times the current monthly housing expense. Lastly, the
           borrower obtained a new job in the same line of work before applying for the
           mortgage. The underwriter stated that the borrower had a potential for increased
           earnings as indicated by job training or education in the borrower’s profession.
           However, there was no related rationale or explanation (see appendix D).

Quality Control Reviews Were
Not Always Performed in a
Reasonably Timely Manner



           HUD Handbook 4060.1, paragraph 7-6A, requires lenders to review loans
           routinely selected for quality control reviews within 90 days from the end of the
           month in which the loan closed. This requirement is intended to ensure that
           problems left undetected before closing are identified as early after closing as
           possible. Further, paragraph 7-6D requires lenders to review all early payment
           defaults. HUD defines early payment defaults as loans that become 60 days past
           due within the first 6 payments. HUD does not indicate a timeframe within which
           these loans must be reviewed; however, HUD states that one of the basic
           overriding goals of quality control is to assure swift and appropriate corrective
           action. Therefore, prudence would dictate that these loans be reviewed shortly
           after being identified as early payment defaults.

           Prospect Mortgage did not always perform quality control reviews of its early
           payment defaults in a reasonably timely manner. It reviewed all 27 of its early
           payment defaults for our review period. However, 6 of the loans were reviewed
           between 250 to 499 days after default, indicating that more than 20 percent of the
           early payment defaults were reviewed more than 8 months after default.
           Therefore, although Prospect Mortgage reviewed the loans, its review process did
           not fully meet the intent of the quality control process as defined by HUD.
           Prospect Mortgage must improve its quality control process to ensure that it
           performs timely assessments of its loan origination process and takes measures as
           appropriate to prevent noncompliance with HUD requirements that could result in
           an unnecessarily increased risk to the FHA insurance fund.



                                            6
    Lender Misinterpreted HUD
    Guidance and Failed To Be
    Consistently Prudent


                      The loan origination deficiencies occurred because an underwriter at Prospect
                      Mortgage’s branch office misinterpreted HUD guidance as indicated by the
                      factors that were used to justify the approval of the loan discussed above.
                      Feedback from HUD indicated that the compensating factors provided by the
                      underwriter were not valid.

                      Prospect Mortgage was not consistently prudent in the implementation of its
                      quality control process. Although it reviewed all early payment defaults that
                      occurred within our review period, approximately 22 percent of the loans were
                      reviewed more than 8 months after default. Therefore, its quality control process
                      did not meet one of the basic goals of quality control which is to assure swift and
                      appropriate corrective action.


    Conclusion


                      Prospect Mortgage generally complied with HUD requirements in its origination
                      and quality control review of FHA loans. However, its branch office did not fully
                      comply with HUD requirements in originating one of five loans reviewed. In
                      addition, Prospect Mortgage did not always perform quality control reviews in a
                      reasonably timely manner. These deficiencies were caused by a misinterpretation
                      of HUD guidance at the branch office and Prospect Mortgage’s failure to
                      consistently be prudent in the implementation of its quality control process. As a
                      result, FHA’s insurance fund was exposed to an unnecessarily increased risk, and
                      the effectiveness of Prospect Mortgage’s quality control process was lessened.
                      Prospect Mortgage should indemnify $193,357 for the defaulted loan which it
                      issued contrary to HUD requirements (see appendixes C and D for more detail).


    Recommendations


                      We recommend that the Deputy Assistant Secretary for Single Family Housing

                      1A.    Require Prospect Mortgage to indemnify $193,357 2 for one loan, which it
                             issued contrary to HUD requirements.




2
    See footnote 1.

                                                       7
1B.   Direct Prospect Mortgage to improve its quality control process to ensure
      that it performs timely assessments of its loan origination process and
      follow up in 6 months to ensure the lender’s compliance.




                                8
                         SCOPE AND METHODOLOGY

We performed our on-site audit work between June and August 2009 at Prospect Mortgage’s
branch office located at 10201 Lee Highway, Suite 570, Fairfax, VA. Our review period was
from June 2007 to May 2009 but was expanded when necessary to include current data through
February 2010.

We queried HUD’s Neighborhood Watch system for information on lenders’ default rates.
HUD’s Neighborhood Watch system is a Web-based software application that displays loan
performance data for lenders and appraisers by loan types and geographic areas, using FHA-
insured single-family loan information. The loan information is displayed for a 2-year
origination period and is updated monthly. HUD requires lenders to use the Neighborhood
Watch system to monitor and evaluate their performance.

Based on the Neighborhood Watch query results, we identified and selected one of Prospect
Mortgage’s two branches located in Fairfax, VA, for review. The branch selected was chosen
because its percentage of defaults by 2 years for loans originated within the State of Maryland
was 15 percent, compared with the State average of 6.77 percent.

Prospect Mortgage originated 51 FHA loans, valued at approximately $14.2 million, between
June 1, 2007, and May 31, 2009, that defaulted within the first 2 years. After eliminating
refinanced and terminated loans, 27 defaulted loans remained. The 27 loans, valued at more than
$7.4 million, defaulted with 12 payments or fewer. We originally selected five of the loans for a
preliminary review. The sample selection was based on the five loans with the highest debt-to-
income ratios as indicated by the Neighborhood Watch system. Due to the closure of the branch
office under review and its loss of HUD approval to originate FHA loans, we did not perform
any additional loan reviews.

To determine whether Prospect Mortgage complied with HUD regulations, procedures, and
instructions in its origination of FHA loans, we performed the following:

   •   Reviewed applicable HUD handbooks and mortgagee letters,
   •   Reviewed case files for the five sample loans,
   •   Examined records and related documents of Prospect Mortgage, and
   •   Conducted interviews with officials and employees of Prospect Mortgage as well as HUD
       employees.

In addition, we relied in part on data maintained by HUD in its Neighborhood Watch system.
Although we did not perform a detailed assessment of the reliability of the data, we performed a
minimal level of testing and found the data to be adequately reliable for our purposes.

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


                                                9
objective. We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.




                                               10
                              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 Control


              We determined that the following internal control was relevant to our audit
              objective:

                  •   Loan origination process – Policies and procedures that management has in
                      place to reasonably ensure that the loan origination process complies with
                      HUD program requirements.

              We assessed the relevant control 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.

 Significant Weakness


              Based our review, we believe that the following item is a significant weakness:

                  •   Prospect Mortgage did not consistently perform quality control reviews in a
                      reasonably timely manner, and therefore, its quality control process did not
                      fully meet the intent of quality control as defined by HUD.




                                               11
                                            APPENDIXES

Appendix A

           SCHEDULE OF FUNDS TO BE PUT TO BETTER USE

                                    Recommendation          Funds to be put
                                           number           to better use 1/

                                                    1A             $116,014



1/        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, implementation of our recommendation
          to indemnify the loan that was not originated in accordance with HUD requirements will
          reduce the risk of loss to the FHA insurance fund. The above amount reflects HUD
          statistics, which show that FHA, on average, lost 60 percent 3 of the unpaid balance as of
          the claim date for each property during 2009 (see appendix C).




3
    Actuarial Review of the FHA Mutual Mortgage Fund for Fiscal Year 2009, dated November 12, 2009.

                                                       12
Appendix B

        AUDITEE COMMENTS AND OIG’S EVALUATION


Ref to OIG Evaluation   Auditee Comments




                         13
Comments 1
and 8




Comment 2




             14
Comment 2

Comment 3




Comment 3




Comment 1




            15
Comment 1




Comment 4




            16
Comment 4




Comment 5




Comment 6




            17
Comment 6




Comment 7




Comment 1



Comment 8




            18
19
20
Comment 9




            21
Comments
9 and 10




Comments
1 and 8



Comments
1 and 8




           22
23
Comment 5




            24
Comment 5




            25
Comment 6




            26
Comment 6




            27
Comment 7




            28
29
30
                         OIG Evaluation of Auditee Comments

Comment 1   We reviewed Prospect Mortgage’s response and the accompanying exhibits and
            determined that it has not provided any information that we did not previously
            review during the audit. Also, we believe our report is appropriate in tone since
            our overall conclusion is that Prospect Mortgage generally complied with HUD
            requirements. Therefore, as outlined in the comments below, we maintain our
            position in regard to our audit conclusion and recommendations.

Comment 2   Prospect Mortgage’s withdrawal of its branch office’s FHA approval does not
            resolve the issue discussed in the report. We continue to recommend that HUD
            require Prospect Mortgage to indemnify HUD against future losses for the loan
            which its branch office improperly originated.

Comment 3   We commend Prospect Mortgage for its efforts to make changes geared toward
            improving loan quality and performance for its FHA-insured loan program.

Comment 4   We recognize that HUD guidelines award lenders the flexibility to exercise
            discretion in the underwriting of home mortgages. However, HUD also expects
            lenders to exercise both sound judgment and due diligence in underwriting. Also,
            as acknowledged by Prospect Mortgage, HUD permits lenders to approve FHA
            financing for a borrower with qualifying ratios in excess of the benchmark
            guidelines when significant compensating factors justify loan approval. We did
            not find adequate evidence of significant compensating factors that would justify
            the approval of the loan cited in the report.

Comment 5   There were four compensating factors listed on the attached mortgage credit
            analysis worksheet (exhibit A-1), which are as follows: conservative use of
            credit, satisfactory rental history since 01/06/1999, half of the downpayment from
            own funds, and borrower with new employer that offers higher salary and
            potential for increased earnings. Based on HUD guidelines and HUD staff
            feedback, these compensating factors were either not valid or inadequately
            supported.

            According to HUD, a large downpayment constitutes 10 percent or more paid
            toward the purchase of the property. Although not included in the underwriter’s
            justification on the mortgage credit analysis worksheet, Prospect Mortgage asserts
            that a case could be made that the borrowers demonstrated an ability to
            accumulate savings. We agree that this would be a valid compensating factor if
            accompanied by a conservative use of credit as stipulated by HUD; however, the
            lender did not adequately document the borrowers’ ability to accumulate savings.
            A demonstrated ability to accumulate savings should have been supported by a
            pattern of savings. Prospect Mortgage provided no convincing evidence to
            indicate that the borrowers demonstrated an ability to accumulate savings.
            Prospect Mortgage’s assertion that the borrowers demonstrated the ability to
            accumulate savings is based on bank statements for a 58-day period. The

                                            31
            statements provided did not constitute sufficient evidence that the borrowers
            accumulated or saved the reflected account balances over a period of time.
            Although the attached bank statement (exhibit A-2) reflects ending balances of
            $10,930 and $727, respectively, there were no savings during the 58-day period.
            Contrary to Prospect Mortgage’s assertions, this documentation by itself does not
            demonstrate that the borrowers saved the money, only that the account balance
            was perhaps relatively high.

Comment 6   As stated above, we agree that a demonstrated ability to accumulate savings along
            with a conservative use of credit would constitute a valid compensating factor.
            However, as discussed above, we did not find sufficient evidence to indicate that
            the borrowers demonstrated an ability to accumulate savings. Also, although the
            borrower (coborrower had no credit history) appeared to have conservatively used
            installment and revolving credit based on the credit report excerpt attached
            (exhibit A-3), the full credit report provided during the audit reflected risk scoring
            results from three credit reporting agencies which indicated certain negative
            factors. All three agencies indicated the following negative factors: serious
            delinquency and a relatively high number of accounts with recent delinquency.
            Two of the reporting agencies indicated that there had been too many attempts by
            the borrower to obtain credit in the previous 12 months.

            The borrowers’ rental payment history (exhibit A-4) is not relevant in this
            discussion. As acknowledged by Prospect Mortgage, the satisfactory history of
            paying rent would only be a compensating factor if the borrowers successfully
            demonstrated the ability to pay housing expenses equal to or greater than the
            proposed monthly housing expense for the new mortgage for a period of 12-24
            months. In this case, the borrowers’ proposed monthly housing expense was
            almost three times their rent. Therefore, the satisfactory rental history as a
            compensating factor was invalid. Prospect Mortgage states that the borrowers
            made timely rental payments for 9 years and that they accumulated $10,000 in
            savings during that period. However, Prospect Mortgage did not document
            adequate support to show that the borrowers accumulated the savings over that
            period or over a reasonable period of time. Therefore, we do not agree that the
            lender adequately compensated against the higher ratios.

Comment 7   Based on HUD guidelines, potential for increased earnings as a compensating
            factor must be supported by evidence of job training or education in the
            borrower’s profession. We did not find documentation in the loan file to support
            a potential for increased earnings. Prospect Mortgage provided documentation
            for the borrower’s prior annual earnings and current monthly earnings (exhibits
            A-5 and A-6, respectively). However, since the borrower was qualified for the
            loan based on the current earnings, the potential for increased earnings would
            only be valid if the lender provided adequate documentation to show that there
            was a potential for the current earnings to increase.




                                              32
Comment 8     Our audit conclusions, related recommendations, and associated reporting were
              developed and prepared based on audit work performed in accordance with
              generally accepted government auditing standards, as well as our operations
              policy. It is HUD OIG’s policy to estimate potential savings to HUD from
              indemnifications associated with improperly originated loans using an average
              loss severity rate supported by an actuarial review of the FHA Mutual Mortgage
              Fund. The average loss rate is applied against the unpaid principal balance of the
              loan. The potential savings estimated in this report are based on the Actuarial
              Review of the FHA Mutual Mortgage Fund for Fiscal Year 2009. We did not
              deviate from our standard policy in reporting our audit conclusions and related
              recommendations.

Comment 9     We did not state that Prospect Mortgage did not comply with FHA quality control
              requirements. We only seek for Prospect Mortgage to improve its quality control
              process as indicated in recommendation 1B of the report. Although Prospect
              Mortgage complied with the requirement to review all early payment default
              loans, it did not review the loans in a reasonably timely manner. According to
              HUD, early payment defaults are typically indicative of significant underwriting
              deficiencies. Therefore, the review of these loans must be a priority for lenders,
              especially since HUD also states that one of the basic overriding goals of quality
              control is to assure swift and appropriate corrective action. HUD agreed that
              Prospect Mortgage should not have waited as long as it did to perform quality
              control reviews of the six loans cited in the report. We have revised the report to
              reflect calculations based on the default date of the loans instead of the closing
              date of the loans. Even with this revision, our results indicate that the loans in
              question were reviewed more than 8 months after default. The quality control
              review dates we used were based on quality control review reports that Prospect
              Mortgage provided during the audit. Although Prospect Mortgage states that the
              loans were previously reviewed by a third-party vendor, it did not provide
              supporting documentation to substantiate its statement.

Comment 10 We concluded that the underwriting staff misinterpreted the requirements related
           to compensating factors because several compensating factors provided were
           either not valid or inadequately supported. We found this to be the case with the
           loan cited and with another loan reviewed. The other loan was not recommended
           for indemnification because one of four compensating factors used by the
           underwriter to justify approval of the loan was valid and adequately supported.
           Nevertheless, three of the compensating factors were either not valid or
           inadequately supported, and in the case of the loan cited in this report, none of the
           compensating factors used by the underwriter was valid and/or adequately
           supported. HUD confirmed that the compensating factors, as indicated on the
           mortgage credit analysis worksheet, were either not valid or not adequately
           supported. Therefore, as stated above, we maintain our position in regard to our
           conclusion and recommendations.




                                               33
Appendix C

                  SCHEDULE OF CASE FILE DISCREPANCIES




                                                  compensating factors
                          Excessive debt ratios

                                                     Unsupported
                                                                                     Unpaid
                                                                         Mortgage
           Case number                                                              principal   60% loss rate *
                                                                         amount
                                                                                     balance




            241-7969493   X                            X                 $196,910   $193,357       $116,014
                Totals                                                   $196,910   $193,357       $116,014

* This amount was calculated by taking 60 percent of the unpaid principal balance for the loan as
of February 1, 2010. HUD statistics show that FHA, on average, lost 60 percent 4 of the unpaid
balance as of the claim date for each property during 2009.




4
    See footnote 1.

                                                                              34
Appendix D

                     NARRATIVE CASE PRESENTATIONS

Case number: 241-7969493                      Payments before first default reported: Six

Mortgage amount: $196,910                     Unpaid principal balance: $193,357

Date of loan closing: December 5, 2007

Summary:

The borrower had high debt ratios with unsupported compensating factors and improper
transmittal of documentation from third parties

Pertinent Details:

HUD Handbook 4155.1, REV-5, paragraphs 2-12 and 2-13, specify acceptable parameters for
debt ratios in the absence of what HUD refers to as “compensating factors” for loans that are
manually underwritten by the lender. HUD Mortgagee Letter 2005-16 states that the ratio of the
total mortgage payment to effective income (front ratio) may not exceed 31 percent and the ratio
of total fixed payments to effective income (back ratio) may not exceed 43 percent unless
significant and valid compensating factors are provided. Compensating factors include but are
not limited to the following: (1) demonstrated ability to pay housing expenses equal to or greater
than the proposed new mortgage payment, (2) a downpayment of at least 10 percent, (3)
demonstrated ability to accumulate savings and conservative use of credit, (4) ability to devote a
greater portion of income to housing expenses, (5) borrower’s documented compensation or
income not reflected in effective income but directly affecting the ability to pay the mortgage, (6)
at least 3 months worth of documented cash reserves, and (7) a potential for increased earnings.

The borrower had high front and back ratios (approximately 42 and 49 percent, respectively).
The lender indicated the following compensating factors: “half down from own funds,
conservative use of credit, satisfactory rental history, and borrower in same line of work (6
years) with new employment that offers higher salary and potential for increased earnings.”
These compensating factors were not valid based on HUD requirements. The borrower did not
make a downpayment of at least 10 percent. Also, the conservative use of credit in and of itself
was not an adequate compensating factor. In addition, the satisfactory rental history is a
requirement and not a compensating factor; and in this particular case, the mortgage payment
was actually about three times the current monthly housing expense. Lastly, the borrower
obtained a new job in the same line of work before applying for the mortgage. The underwriter
stated that the borrower had a potential for increased earnings, as indicated by job training or
education in the borrower’s profession. However, there was no related rationale or explanation.

Recommendation: Indemnify HUD $116,014 for this loan.

                                                35