oversight

HUD Paid an Estimated $413 Million for Unnecessary Preforeclosure Claim Interest and Other Costs Due to Lender Servicing Delays

Published by the Department of Housing and Urban Development, Office of Inspector General on 2018-09-27.

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

       Office of Single Family Housing,
               Washington, DC
                       Preforeclosure Claim Costs




Office of Audit, Region 9             Audit Report Number: 2018-LA-0007
Los Angeles, CA                                       September 27, 2018
To:            Gisele G. Roget
               Deputy Assistant Secretary for Single Family Housing, HU

               //SIGNED//
From:          Tanya E. Schulze
               Regional Inspector General for Audit, 9DGA

Subject:       HUD Paid an Estimated $413 Million for Unnecessary Preforeclosure Claim
               Interest and Other Costs Due to Lender Servicing Delays


Attached is the U.S. Department of Housing and Urban Development (HUD), Office of Inspector
General’s (OIG) final results of our review of HUD’s Federal Housing Administration
preforeclosure claim costs.
HUD Handbook 2000.06, REV-4, sets specific timeframes for management decisions on
recommended corrective actions. For each recommendation without a management decision,
please respond and provide status reports in accordance with the HUD Handbook. Please furnish
us copies of any correspondence or directives issued because of the audit.
The Inspector General Act, Title 5 United States Code, section 8M, requires that OIG post its
publicly available reports on the OIG website. Accordingly, this report will be posted at
http://www.hudoig.gov.
If you have any questions or comments about this report, please do not hesitate to call me at
213-534-2471.
                    Audit Report Number: 2018-LA-0007
                    Date: September 27, 2018

                    HUD Paid an Estimated $413 Million for Unnecessary Preforeclosure Claim
                    Interest and Other Costs Due to Lender Servicing Delays



Highlights
What We Audited and Why
We audited the U.S. Department of Housing and Urban Development’s (HUD) Federal Housing
Administration’s (FHA) preforeclosure sale claim process based on an internal Office of
Inspector General audit suggestion noting that existing regulations may allow excessive
preforeclosure claim interest costs. Our audit objective was to determine the amount of
unnecessary preforeclosure claim interest and other costs that resulted from lender
noncompliance with HUD’s loan-servicing timeframe requirements.


What We Found
HUD paid an estimated $413 million in unnecessary interest and other costs for 27,634
preforeclosure claims because lenders failed to complete servicing actions for defaulted loans
within established timeframes. Although the unnecessary amounts were caused by lenders’
inaction, HUD reimbursed lenders for these added costs through FHA insurance claims. This
condition occurred because HUD’s requirements and procedures do not limit unnecessary
preforeclosure claim interest and other costs that result from lenders’ servicing delays. As a
result, the FHA insurance fund incurred unnecessary and unreasonable costs and fewer funds
were available to pay other claims or apply toward reducing FHA borrower mortgage insurance
premiums.


What We Recommend
We recommend that HUD’s Office of Single Family Housing implement a change to regulations
at 24 Code of Federal Regulations Part 203, to require curtailment of preforeclosure interest and
other costs that are caused by lender servicing delays, resulting in $413 million in funds to be put
to better use. This should include updating or seeking statutory authority to update HUD’s
regulations as necessary and coordinating with HUD’s Office of Finance and Budget, well before
any changes go through departmental clearance, to ensure that planned curtailment requirements
can be consistently enforced through the claims process.
Table of Contents
Background and Objective......................................................................................3

Results of Audit ........................................................................................................4
         Finding: HUD Paid an Estimated $413 Million for Unnecessary Preforeclosure
         Claim Costs Due to Lender Servicing Delays ................................................................. 4

Scope and Methodology .........................................................................................10

Internal Controls ....................................................................................................15

Appendixes ..............................................................................................................16
         A. Schedule of Funds To Be Put To Better Use........................................................... 16
         B. Auditee Comments and OIG’s Evaluation ............................................................. 17
         C. Criteria ....................................................................................................................... 19




                                                                     2
Background and Objective
The U.S. Department of Housing and Urban Development’s (HUD) Federal Housing
Administration (FHA) provides mortgage insurance on home loans made by its approved
lenders. This insurance is paid for by borrowers and provides lenders with protection against
losses if the homeowner defaults on the loan. Lenders may submit an insurance claim to HUD
for losses incurred if a property is foreclosed upon, but the lender must first attempt to work with
the homeowner and consider options available as part of HUD’s loss mitigation program, which
can assist the borrower in bringing the loan current or allow the borrower to dispose of the home
without foreclosure. HUD’s single-family preforeclosure sales program is one option under
HUD’s loss mitigation program.

A preforeclosure sale allows an FHA borrower in default to sell his or her home at fair market
value and use the sales proceeds to satisfy the mortgage debt, even if the proceeds are less than
the amount owed. After the property is sold, lenders submit an FHA insurance claim and are
compensated for the difference between the sales proceeds and the amount owed on the
mortgage. Through the insurance claim, lenders are paid interest at a specified debenture interest
rate1 on the outstanding loan principal and claim expenses. Lenders are also reimbursed for other
costs, such as hazard insurance premiums, property taxes, legal fees, and property inspections.
Effective use of the preforeclosure sales can reduce HUD’s losses on certain insurance claims.
However, because the interest and property-related expenses continue to accumulate as a
defaulted loan is being serviced, delays in the servicing process can result in additional FHA
insurance claim costs. HUD’s Office of Single Family Housing administers the FHA mortgage
insurance program for single-family homes and the Office of Finance and Budget is responsible
for processing FHA claim payments.

HUD regulations require lenders to comply with specific deadlines when servicing defaulted
loans.2 For example, lenders generally must institute foreclosure, initiate a preforeclosure sale,
or implement one of several other available loss mitigation actions within 6 months of the loan
default date. Also, once initiated, preforeclosure sales must be completed within 4 to 6 months.
The required loan-servicing deadlines can be extended automatically when certain criteria apply
or when HUD approves a lender’s extension request. Automatic extensions may apply, for
example, if a borrower filed for bankruptcy or was on active duty military service.

From August 1, 2012, through July 31, 2017, FHA paid 100,077 preforeclosure sale claims
totaling more than $8 billion.

Our audit objective was to determine the amount of unnecessary preforeclosure claim interest
and other costs that resulted from lender noncompliance with HUD’s loan-servicing timeframe
requirements.

1
    The debenture interest rate is published by HUD and used for calculating the interest allowance paid to lenders
    for FHA insurance claims.
2
    See appendix D.



                                                          3
Results of Audit
Finding: HUD Paid an Estimated $413 Million for Unnecessary
Preforeclosure Claim Costs Due to Lender Servicing Delays

HUD paid an estimated $413 million in unnecessary interest and other costs for 27,634
preforeclosure claims because lenders failed to complete servicing actions for defaulted FHA
loans within established timeframes. Although these unnecessary costs were due to lenders’
inaction, HUD absorbed the added costs and reimbursed the involved lenders through FHA
insurance claims. This condition occurred because HUD’s requirements and procedures do not
limit unnecessary preforeclosure claim interest and other costs attributable to lender servicing
delays. As a result, the FHA insurance fund incurred unnecessary and unreasonable costs, and
fewer funds were available to pay other claims or apply toward reducing FHA borrower
mortgage insurance premiums.

HUD Reimbursed Lenders for Unnecessary and Unreasonable Interest and Other Costs
HUD paid unnecessary and unreasonable preforeclosure claim interest and other costs that
resulted when lenders failed to comply with HUD’s servicing deadlines. We analyzed available
HUD system data for 100,077 preforeclosure claims paid during the period August 1, 2012,
through July 31, 2017, and identified 30,061 claims that had indications of missed servicing
deadlines.3 We selected and reviewed a statistical
sample of 72 claims from this targeted group.
Lenders missed one or more of HUD’s required             FHA-approved lenders failed to
servicing deadlines in 70 of the 72 (97 percent)         comply with HUD’s servicing
sample preforeclosure claims reviewed4.                  deadlines, causing unnecessary and
Specifically, FHA-approved lenders failed to             unreasonable costs.
comply with HUD’s servicing timeframes and
caused delays as they missed the deadlines to (1)
initiate foreclosure or loss mitigation, (2) complete preforeclosure sales, and (3) complete
foreclosure. The following table shows the number of sample loans identified with each type of
missed servicing deadline.

                                                                  Number of             Percentage of
               Missed HUD servicing deadline
                                                                 sample loans           sample loans
         Initiate foreclosure or loss mitigation                     51                     71%
         Complete preforeclosure                                        24                  33%
         Complete foreclosure                                           51                  71%



3
    See the Scope and Methodology section for details regarding the audit sample testing.
4
    See appendix C.



                                                          4
Lenders Missed the Deadline To Initiate Foreclosure or Loss Mitigation
HUD incurred unnecessary and unreasonable preforeclosure claim costs because lenders missed
the deadline to initiate foreclosure or implement a loss mitigation action. Regulations at 24 CFR
(Code of Federal Regulations) 203.355 generally require that lenders institute foreclosure,
initiate a preforeclosure sale, or implement one of several other available loss mitigation actions
within 6 months of loan default.5 Of the 72 sample claims reviewed 51 (71 percent) missed this
deadline, and interest continued to accumulate for an average of approximately 25 months during
the loan-servicing process after the missed deadline.6 The servicing process was delayed by an
average of approximately 13.5 months until the required action was completed, resulting in
unnecessary other costs, such as property taxes and hazard insurance. In 10 of these 51 cases,
the servicing process was delayed by more than 2 years before the required foreclosure or loss
mitigation action was taken.

For example, sample loan 413-3799157 went into default on July 1, 2010, and the deadline to
commence foreclosure or take a required loss mitigation action was 6 months later on January 1,
2011. However, the lender did not initiate the preforeclosure process until May 30, 2013, 880
days after the deadline, and did not document that an extension applied. The preforeclosure sale
was finalized on November 15, 2013. Based on the unpaid loan balance of $155,161 and the
applicable debenture interest rate of 5.25 percent for this claim, $23,411 in interest accrued from
the missed preforeclosure initiation deadline until the preforeclosure sale closing date, 1,049
days later. Because the servicing process was effectively extended by 880 days, the FHA
insurance claim to HUD also increased by an estimated $11,440 for other unnecessary expenses,
including property maintenance, inspection costs, property taxes, and hazard insurance
premiums. The following chart demonstrates the delayed action for this claim.

          Deadline to initiate                   Lender started                   Preforeclosure sale
          foreclosure or loss                    preforeclosure                         closed
              mitigation

             January 1, 2011                     May 30, 2013                     November 15, 2013


                          880 days late

                      1,049 days of interest accrued past the deadline




5
    See appendix D.
6
    HUD’s criteria and procedures for conveyance type claims require that lenders curtail interest from the first
    missed servicing action forward. Although HUD does not apply these criteria to preforeclosure claims, we
    considered this standard for audit sample testing purposes to estimate the amount of unnecessary interest costs
    when the lenders failed to meet the required deadline to initiate foreclosure or implement an appropriate loss
    mitigation option. Unnecessary other claim expenses were estimated based on the delay that occurred from the
    missed deadline until the applicable action was completed.



                                                          5
Lenders Missed the Deadline To Complete Preforeclosure Sales
HUD incurred unnecessary and unreasonable preforeclosure claim costs because lenders failed to
complete initiated preforeclosure sales within required timeframes. Regulations at 24 CFR
203.355(g)7 require that lenders complete a preforeclosure sale within 4 to 6 months.8 Of the 72
sample claims, 24 (33 percent) missed this deadline and continued to accumulate interest and
other costs for an average of approximately 7.4 months during the period of delay.

For example, the lender for sample loan 043-7438248 approved the borrower to participate in the
preforeclosure process on January 31, 2011. In accordance with applicable HUD requirements,7
the preforeclosure sale should have been finalized within 6 months, by July 31, 2011. However,
the lender did not complete the preforeclosure sale until December 31, 2012, 519 days after the
deadline. In this case, the lender received approval from HUD to proceed with the transaction
based on an extended program participation date, but the extension request was not submitted
until more than a year after the servicing deadline. Therefore, the unnecessary delay had already
occurred. In this case, the lender also missed the deadline to initiate the preforeclosure sale by
364 days, resulting in a total delay of 883 days. Based on the unpaid loan balance of $274,608
and the applicable debenture interest rate of 3.59 percent, HUD incurred an estimated $28,738 in
unnecessary interest for the 1,064-day period from the missed preforeclosure initiation deadline
until the preforeclosure sale closing. Because the servicing process was effectively extended by
883 days, HUD also incurred $10,011 in unnecessary other claim expenses, including property
taxes, hazard insurance premiums, and a second property appraisal.9 The following chart
demonstrates the delayed action for this claim.


Deadline to initiate             Lender started                  Deadline to                Preforeclosure sale
foreclosure or loss              preforeclosure                   complete                        closed
    mitigation                                                  preforeclosure

    February 1, 2010            January 31, 2011                 July 31, 2011              December 31, 2012


              364 days late                                                519 days late

                       1,064 days of interest accrued past the deadline


Lenders Missed the Deadline To Complete Foreclosure
HUD incurred unnecessary and unreasonable preforeclosure claim costs because lenders failed to
initiate preforeclosure sales until after the deadline for completing foreclosure had expired.

7
     See appendix D.
8
     HUD requirements allow a marketing period of up to 4 months from the borrower’s approval to participate in the
     preforeclosure program. The deadline is automatically extended to 6 months if the borrower has secured an
     acceptable property sale contract or if the involved lender qualified for an extension based on a servicing
     performance rating assigned by HUD.
9
     See the Scope and Methodology section for details regarding the calculation of estimated unnecessary amounts.



                                                          6
Regulations at 24 CFR 203.356(B) require that when foreclosure is necessary, lenders complete
the process to obtain title to and possession of the property within established State-specific
“reasonable diligence” timeframes.10 For 51 of the 72 (71 percent) sample claims, lenders failed
to meet this deadline and delayed the servicing process by an average of approximately 2 years.
Because the servicing process should have already been completed through foreclosure, the
continued loan-servicing period from the related conveyance deadline until the preforeclosure
sale closing was unnecessary.

For example the lender for sample loan 095-0402266 initiated foreclosure on April 21, 2008, and
the foreclosure process should have been completed within the applicable reasonable diligence
period of 7 months, by November 21, 2008. However, the lender missed this deadline and
eventually initiated a preforeclosure sale on February 27, 2014. Because the preforeclosure
process was started years after the foreclosure should have been completed, the 2,019-day period
from the required foreclosure completion date of November 21, 2008, to the preforeclosure sale
closing date of June 2, 2014, was unnecessary. Based on the unpaid loan balance of $176,218
and the applicable debenture interest rate of 4.1 percent for this loan, HUD incurred an estimated
$39,965 in unnecessary interest as a result of the lender’s delayed servicing actions. The delay
also resulted in $20,009 in unnecessary property-related claim expenses, which occurred from
the related conveyance deadline until the property sale closing. The following chart
demonstrates the delayed action for this claim.


               Deadline to                         Lender started                     Preforeclosure sale
                complete                           preforeclosure                           closed
               foreclosure

         November 21 , 2008                      February 27, 2014                        June 2, 2014


                        2,019 days of interest accrued past the deadline


Estimated Unnessary Claim Interest and Other Costs Totaled at Least $413 Million
We projected11 the sample review results to the audit universe of 30,061 claims and determined
that HUD paid at least $413 million in unnecessary interest and other expenses for 27,634
preforeclosure claims because lenders failed to comply with HUD’s servicing deadlines.12 This
amount included $267.8 million for interest costs and $145.6 million for other claim costs, such
as property taxes and hazard insurance. These amounts were not necessary or reasonable
because they resulted from lenders’ noncompliance with HUD requirements and could have been
avoided if the lenders had met the requirements or if HUD had implemented procedures to

10
     See appendix D.
11
     The audit testing was not designed to identify all potential unnecessary claim costs; therefore, the actual number
     of preforeclosure claims paid with unnecessary interest and other costs could be greater than indicated by our
     audit sampling results. See the Scope and Methodology section for more details.
12
     See appendix D.



                                                            7
curtail claim amounts based on missed servicing deadlines.13 As a result, these funds were not
available to pay other claims or apply toward reducing the costs to FHA borrowers whose
mortgage insurance premiums ultimately funded the unnecessary claim amounts paid to lenders.

HUD Did Not Have Adequate Requirements and Procedures To Prevent Unnecessary
Preforeclosure Claim Costs
HUD does not have requirements and procedures to limit unnecessary preforeclosure claim
interest and other costs that result from lender servicing delays.14 When a preforeclosure claim is
submitted, HUD’s claim review and payment process does not include steps to determine
whether lenders met required servicing deadlines or curtail interest or other costs based on
servicing delays.15 Without such curtailment,
HUD effectively absorbs the additional costs and
lenders are not held financially responsible for         HUD’s requirements are not
their delays. Knowing that they will not be held         adequate and do not limit
financially responsible and can simply pass any          unnecessary preforeclosure claim
added costs on to HUD, lenders have little               costs that result from lender
incentive to complete the servicing process in a         servicing delays.
timely manner.

HUD officials stated that they were aware that delayed preforeclosure claims had resulted in
additional claim costs; however, related claim curtailment procedures were not implemented
because the existing Federal regulations did not explicitly require this. Although HUD
regulations pertaining to conveyance (that is, foreclosure) type claims specifically provide for
interest curtailment when servicing deadlines are missed, there is no corresponding regulatory
requirement applicable to preforeclosure claims. 16 HUD regulations also do not require
curtailment of other preforeclosure claim costs that result from lender servicing delays, such as
property maintenance, taxes, and hazard insurance. HUD initiated a proposed rule in July 2015,
which would have provided for additional interest and other cost curtailment due to
preforeclosure claim servicing delays; however, this rule was canceled after lenders raised
objections to the proposed policy. Without such changes, HUD continues to incur the added
interest and other preforeclosure claim costs caused by lenders’ servicing delays.



13
     See the Scope and Methodology section for details regarding the calculation of estimated unnecessary amounts.
14   HUD Mortgagee Letter 2008-43, issued on December 24, 2008, indicated an intention by HUD to curtail
     preforeclosure claim interest based on servicing delays by stating, “Mortgagees are subject to interest curtailment
     if they do not initiate the PFS [preforeclosure sale] transaction or report the initiation of the PFS transaction to
     HUD via SFDMS [Single Family Default Monitoring System] timely.” However, HUD officials stated that
     claim curtailment procedures were not implemented because Federal regulations did not explicitly require this.
15
     HUD does not curtail interest for delays that occur during the loan-servicing period before the preforeclosure sale
     closing. HUD procedures provide only for preforeclosure interest curtailment when lenders miss the applicable
     claim submission deadline.
16    HUD regulations regarding preforeclosure claim interest curtailment at 24 CFR 203.402(k)(3)(i)(B) cite only the
     deadline to submit a claim (24 CFR 203.365) as a basis for curtailment and do not reference the loan-servicing
     deadlines to initiate foreclosure or loss mitigation actions (24 CFR 203.355(a)), the deadline to complete
     foreclosure within established reasonable diligence timeframes (24 CFR 203.356(b)), or the deadline to complete
     preforeclosure (24 CFR 203.355(g)). See appendix D.



                                                             8
Conclusion
HUD paid an estimated $413 million in unnecessary interest and other costs because lenders
failed to meet required loan-servicing deadlines. This condition occurred because HUD’s
program requirements and controls do not require curtailment of additional claim costs that result
from lender servicing delays. As a result, the FHA insurance fund incurred unnecessary and
unreasonable expenses, and the associated funds were not available to pay other claims or apply
toward reducing FHA borrower mortgage insurance premiums.

Recommendations
We recommend that the Deputy Assistant Secretary for Single Family Housing

1A.       Implement a change to regulations at 24 CFR Part 203 to require curtailment of
          preforeclosure interest and other costs that are caused by lender servicing delays,
          resulting in $413,513,975 in funds to be put to better use.17 This should include updating
          or seeking statutory authority to update HUD’s regulations as necessary18 and
          coordinating with HUD’s Office of Finance and Budget, well before any changes go
          through departmental clearance, to ensure that planned curtailment requirements can be
          consistently enforced through the claims process.




17
     See appendix A and the Scope and Methodology section for details on funds to be put to better use and the $413
     million, respectively.
18
     Because the lack of preforeclosure claim curtailment was the result of HUD’s requirements and procedures, we
     did not make a specific recommendation for HUD to seek repayment of unnecessary or unreasonable costs from
     lenders.



                                                          9
Scope and Methodology
We performed our audit fieldwork from December 2017 to August 2018 remotely at the Office
of Inspector General (OIG), Office of Audit, in Phoenix, AZ. Our audit period covered FHA
preforeclosure claims paid from August 2012 through July 2017.

To accomplish our objective, we

     •    reviewed applicable statutes, regulations, and HUD policies;

     •    interviewed HUD officials;

     •    reviewed available data related to preforeclosure claims; and

     •    reviewed a statistical sample of preforeclosure claims, including loan-servicing and claim
          documentation obtained from servicing lenders.

We analyzed available claim, default, and timeframe extension data from HUD’s Single Family
Housing Enterprise Data Warehouse19 and Extension and Variance Automated Requests System20
for 100,077 preforeclosure claims paid during the period August 1, 2012, through July 31, 2017,
and identified 30,061 claims that had indications of missed FHA loan-servicing deadlines. We
evaluated whether claims appeared late based on reported loan default dates, preforeclosure
program initiation dates, and preforeclosure sale closing dates. We selected claims based on data
reported within the most recent default episode and considered indications that an extension
applied based on lender-reported default codes and HUD extension data.

We initially selected a statistical sample of 85 FHA preforeclosure sale claims from this targeted
group. We reduced the sample size to 72 after additional simulation testing found that a reduced
sample size would yield accurate results and follow a one-sided 95 percent confidence interval.

For projection, we used the survey means procedure in SAS®21 to estimate the dollar amounts.
We reduced the average amount by the margin of error associated with this sample design. For
complex sample designs, such as the stratified technique used for this review, the survey means
procedure in SAS uses the Taylor expansion method to estimate sampling errors (standard
errors). We computed the percentage and number of loans impacted based on the sampling
results, and we extended this result to the population using the survey freq procedure provided by
SAS®. We estimated the upper and lower confidence intervals using a Gaussian sampling
distribution, which is appropriate for error rates in this range.


19
     The Single Family Housing Enterprise Data Warehouse is a large collection of database tables dedicated to
     support analysis, verification, and publication of FHA single-family data.
20
     The Extension and Variance Automated Requests System provides automated request, review, approval, and
     rejection of extensions and variances related to FHA loan programs.
21
     SAS provides data management software and services.



                                                         10
       Dollar Projection Results, Unnecessary Interest
       In 70 of 72 loan records reviewed, HUD paid unnecessary interest. This amounts to a
       weighted average of $9,498 per loan. Deducting the statistical margin of error to
       accommodate the uncertainties inherent in statistical sampling, we can say – with a one-
       sided confidence interval of 95 percent – that this amounts to at least $8,911 in
       unnecessary interest payments per loan. In the context of the total universe of 30,061
       loan records, this amounts to a loss to HUD in interest payments of at least $267.8
       million.

       Dollar Projection Results, Unnecessary Expense Costs
       In 70 of 72 loan records reviewed, HUD paid unnecessary expenses. This amounts to a
       weighted average of $5,762 per loan. Deducting the statistical margin of error to
       accommodate the uncertainties inherent in statistical sampling, we can say – with a one-
       sided confidence interval of 95 percent – that this amounts to at least $4,845 in
       unnecessary expense payments per loan. In the context of the total universe of 30,061
       loan records, this amounts to a loss to HUD in expense payments of at least $145.6
       million.

       Percent-Count Projection Results
       In 70 of 72 loan records reviewed, HUD paid unnecessary costs. This amounts to a
       weighted average of 96.45 percent of the loans. Deducting the statistical margin of error
       to accommodate the uncertainties inherent in statistical sampling, we can still say – with
       a one-sided confidence interval of 95 percent – that this amounts to at least 91.93 percent
       of the loans in the universe having this same characteristic. Extending this percentage to
       the total universe count of 30,061 loan records, we can say that HUD paid unnecessary
       costs on at least 27,634 loans.

We obtained loan-servicing and claim documentation from the associated lenders and reviewed
these documents to determine compliance with HUD’s loan-servicing timeframe requirements.
Applicable automatic extensions documented with the lenders’ servicing files or extensions
approved by HUD in accordance with its policies were considered in our analysis.

Our audit testing relied in part on data obtained from HUD’s Single Family Housing Enterprise
Data Warehouse system. Because this system includes information that is manually entered by
lenders, such as claim form submission and default reporting data, it could be subject to errors or
other data quality issues. We determined that the data were adequate for our audit testing
purposes; however, we noted that some preforeclosure claims may have been excluded from our
audit sampling universe and, thus, the audit findings, based on incorrect data. For example, if a
lender mistakenly reported that a property was impacted by a natural disaster or foreclosure
moratorium, such loans may have been excluded from the audit testing if these events were
reported within the most recent default episode and appeared to extend an applicable servicing
deadline. To account for potential data system errors and to better target loans with loan-
servicing delays, our audit sample testing procedures included criteria, such as minimum interest
amount thresholds, that could have excluded some loans from the audit sample universe that had
servicing delays. For these reasons, the actual number of preforeclosure claims paid with



                                                 11
unnecessary interest and other costs could be greater than indicated by our audit sample test
results. The audit testing was intended only to establish an estimate of unnecessary interest and
other costs that resulted from lender servicing delays and was not designed to identify all loans
that may have included such costs.

In some cases, lenders missed multiple servicing deadlines. For example, a lender could have
initiated a preforeclosure sale after the required deadline and also failed to ensure that the
preforeclosure sale was completed in a timely manner after the borrower was approved to
participate in the preforeclosure sales program. Therefore, the total number of deadlines
reported as missed exceeds the number of claims reviewed.

HUD’s criteria and procedures for conveyance-foreclosure type claims require that lenders
curtail interest from the first missed servicing action forward. Although HUD does not apply
these criteria to preforeclosure claims, we considered this standard for audit sample testing
purposes to estimate the amount of unnecessary interest costs when the lenders failed to meet the
required deadline to initiate foreclosure or implement an appropriate loss mitigation option.
Although HUD previously issued guidance indicating an intention to curtail interest for
preforeclosure claims, HUD officials confirmed that such procedures are not in place. HUD
Mortgagee Letter 2008-43, issued on December 24, 2008, stated “Mortgagees [lenders] are
subject to interest curtailment if they do not initiate the PFS [preforeclosure sale] transaction or
report the initiation of the PFS transaction to HUD via SFDMS [Single Family Default
Monitoring System] timely.” For claims that did not miss the deadline to initiate foreclosure or
loss mitigation, we determined the date on which the servicing process should have ended if the
total period of delay had not occurred. For example, if the preforeclosure sale marketing period
deadline was missed by 180 days, our testing estimated that 180 days of interest was
unnecessary. For audit sample testing purposes, if the borrower had not been approved for a loss
mitigation option and the preforeclosure process was initiated after the foreclosure process
should have been completed based on the applicable State-specific reasonable diligence period,
we estimated unnecessary interest for the period from the missed foreclosure completion date to
the preforeclosure sale closing date.

Because HUD has implemented procedures designed to curtail interest based on requirements
specified in 24 CFR 203.402(k)(3)(i)(B) related to the claim submission deadline, we estimated
only unnecessary interest for periods before the preforeclosure sale closing date, effectively
allowing interest applicable to the period from the preforeclosure sale closing to the claim
payment date, regardless of the interest amount paid and whether the lender met the claim
submission deadline. In this way, we excluded from testing the portion of interest paid related to
the claim submission period, although this interest also could have been subject to curtailment
under HUD’s requirements applicable to conveyance type claims. We did not test the
effectiveness of HUD’s procedures for interest curtailment based on the preforeclosure claim
submission deadline.

To estimate unnecessary and unreasonable other claim expenses, such as property taxes and
hazard insurance, we determined the date on which the servicing process should have ended if
the total period of delay had not occurred. For example, if the preforeclosure sale initiation was



                                                  12
180 days late and the preforeclosure sale closing was also 180 days late, we determined that
expenses occurring later than 360 days before the actual preforeclosure sale closing were
unnecessary. Similarly, if a borrower had not been approved for a loss mitigation option and the
preforeclosure process was initiated after the foreclosure process should have been completed,
based on the applicable State-specific reasonable diligence period, we determined that expenses
incurred after the associated conveyance deadline were unnecessary. To determine claim cost
dates for sample testing purposes, we used the date of service if identified in the lender claim file
documentation and, otherwise, the payment dates. If a range of dates was shown in an expense’s
description, the first date of that range was used. Accordingly, some expenses were understated.
For example, if the lender paid hazard insurance covering the period July through December and
we determined that servicing should have been complete by August, our analysis excluded this
entire cost based on the expense start date, although a portion of this expense (from August
through December) was applicable to an identified period of delay. Because the purpose of the
audit test was to provide an estimate and based on the availability of cost information within the
servicing files, we determined that this was the most appropriate method for calculating
estimated unnecessary costs for audit purposes and would provide an appropriate basis for the
audit conclusions.

Other factors could have impacted the cost to HUD associated with lender servicing delays that
were not considered in the audit estimate of unnecessary costs. For example, property values
could have decreased due to inadequate maintenance or changed due to general housing market
conditions during the periods of servicing delay. For this reason, our audit testing may have
underestimated the actual cost associated with lender servicing delays. Recognizing the negative
impact of late claim submissions, HUD previously proposed criteria that would have canceled a
loan’s FHA insurance entirely if a claim was submitted “more than 12 months after expiration of
a period of time from the date of default that is equal to the amount of time provided in the
reasonable diligence timeframe.” Our audit did not estimate unnecessary or unreasonable
amounts based on these proposed criteria. However, because our testing found that the
preforeclosure sale closing date was more than 12 months past the reasonable diligence deadline
for 35 of our sample claims, even including up to 6 additional months for the permitted time
from default to initiate a first action, we note that application of such criteria could have
substantially increased the estimated amount of unnecessary and unreasonable costs. For
example, the total claim amounts for these sample cases were more than four times the estimated
unnecessary claim costs calculated using our audit sample testing methodology. Because the
purpose of the audit test was only to provide an estimate, we determined that the testing used was
sufficient as a basis to support the audit conclusion and recommendations.

Because we estimated unnecessary claim expenses, such as property taxes and hazard insurance,
based on the actual period of delay yet estimated unnecessary interest in some cases based on
HUD’s criteria applicable to conveyance claims, which requires curtailment from the missed
deadline to initiate foreclosure or implement loss mitigation forward, the period associated with
estimated unnecessary interest differed from the period of estimated unnecessary other claim
costs for some loans. For example, if the lender missed the deadline to initiate the preforeclosure
sale by 100 days and the preforeclosure sale closed 100 days after it was initiated, our testing
concluded that 200 days of interest was unnecessary (based on HUD requirements for



                                                  13
conveyance claims), and 100 days of other claim costs, such as property taxes and hazard
insurance, were unnecessary (based on the actual period of delayed action).

HUD requirements allow a marketing period up to 4 months from the borrower’s approval to
participate in the preforeclosure program. This deadline is automatically extended to 6 months if
the borrower has secured an acceptable property sale contract or if the involved lender qualified
for an extension based on a servicing performance rating established by HUD. Also, HUD’s
policy regarding variance requests may allow an extension not to exceed 8 months total. Our
audit testing considered HUD timeframe extensions that were approved in accordance with
HUD’s policy and submitted before expiration of the servicing deadline. In some cases,
timeframe extensions were not documented within the lender-provided files, and we relied on
HUD data to support that an extension applied.

Our audit testing did not classify certain expenses as unnecessary or unreasonable, regardless of
the servicing delays identified. For example, the preforeclosure program borrower incentive
payments and mortgage insurance premium costs were not included in our estimate of
unnecessary costs because we determined that these did not represent an additional expense or
loss to HUD that was attributable servicing delays. Additionally, expenses deducted from the
preforeclosure sale proceeds at settlement (such as prorated property taxes due, past due
homeowner associate fees, etc.) were not included in our calculated estimate of unnecessary
expenses, although these expenses were often incurred as a direct result of servicing delays.
Therefore, the actual amount of unnecessary other claim expenses was greater than indicated by
our audit estimates.
We conducted the audit in accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain sufficient, appropriate
evidence to provide a reasonable basis for our findings and conclusions based on our audit
objective(s). We believe that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objective.




                                                 14
Internal Controls
Internal control is a process adopted by those charged with governance and management,
designed to provide reasonable assurance about the achievement of the organization’s mission,
goals, and objectives with regard to

•   effectiveness and efficiency of operations,

•   reliability of financial reporting, and

•   compliance with applicable laws and regulations.

Internal controls comprise the plans, policies, methods, and procedures used to meet the
organization’s mission, goals, and objectives. Internal controls include the processes and
procedures for planning, organizing, directing, and controlling program operations as well as the
systems for measuring, reporting, and monitoring program performance.

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

•   Program requirements and procedures to ensure that lenders comply with timeframe
    requirements for preforeclosure claims.

We assessed the relevant controls identified above.

A deficiency in internal control exists when the design or operation of a control does not allow
management or employees, in the normal course of performing their assigned functions, the
reasonable opportunity to prevent, detect, or correct (1) impairments to effectiveness or
efficiency of operations, (2) misstatements in financial or performance information, or (3)
violations of laws and regulations on a timely basis.

Significant Deficiency
Based on our review, we believe that the following item is a significant deficiency:

•   HUD did not have adequate requirements and procedures to prevent unnecessary
    preforeclosure claim interest and other costs (finding).




                                                  15
Appendixes

Appendix A
                       Schedule of Funds To Be Put To Better Use

                                                      Funds to be put to
                  Recommendation number
                                                        better use 1/
                               1A                         $ 413,513,975
                              Total                          413,513,975


1/   Recommendations that funds be put to better use are estimates of amounts that could be
     used more efficiently if an 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 recommendation 1A will reduce the risk that HUD will
     continue unnecessary and unreasonable interest and other cost payments. We determined
     that the payments made from the FHA insurance fund for costs incurred due to lender
     servicing delays were unreasonable and unnecessary and could have been avoided if
     lenders had complied with required servicing deadlines or if HUD had adequate
     procedures to curtail interest and other costs that resulted from lender servicing delays.
     We estimated these payments to be $413 million. (See the Scope and Methodology
     section for details on the statistical sample and related projections.)




                                              16
Appendix B
             Auditee Comments and OIG’s Evaluation




Ref to OIG    Auditee Comments
Evaluation




Comment 1




                               17
                         OIG Evaluation of Auditee Comments

Comment 1   HUD’s response did not state any concerns with the audit finding and generally
            indicated agreement with the audit report recommendation. We look forward to
            continued cooperation during the audit resolution process.




                                              18
   Appendix C
                     Schedule of Unnecessary Preforeclosure Claim Costs


                                                                         Missed
                                              Missed deadline to      deadline to
                                                                                      Missed deadline
              Unnecessary     Unnecessary     initiate foreclosure     complete
 FHA loan                                                                              to complete
                interest       claim costs     or implement loss     preforeclosure
                                                                                       foreclosure
                                                   mitigation          marketing
                                                                         period
023-4216431   $    1,796.22   $      946.64                                X
043-7438248       29,115.28       12,044.49            X                   X                X
045-6613412       25,079.89        9,448.48            X                                    X
045-7012788        6,909.07        2,628.39            X
048-4840276       14,698.68        9,035.86            X                                    X
048-5489589        3,022.79        1,471.41            X
052-2719268        6,995.30          703.99            X                   X
052-4357481       13,859.58        5,798.65            X                   X                X
052-5978398       10,266.48        5,356.30            X                                    X
093-6196726       10,516.96        4,182.31            X                                    X
094-5328164        3,292.93        3,585.54            X                                    X
094-5540150       14,034.78        4,746.51            X                                    X
095-0334347       21,911.61        7,080.28                                X                X
095-0402266       39,964.86       15,942.24                                                 X
095-0465555       18,889.83        7,016.80            X                                    X
095-0815359       35,733.44       54,948.61            X                                    X
105-1206113        3,510.98        6,743.79            X                                    X
121-2380996       15,211.05       10,041.44            X                                    X
249-5109790       26,273.35       11,580.93            X                   X                X
249-5335366       26,317.59       11,643.13                                X                X
249-5512236       17,046.81        6,834.40            X                   X                X
292-4725554        3,398.63        2,920.59            X                   X
331-1361238       11,535.08        2,710.83            X                                    X
332-5072219       10,856.96        4,251.09            X                   X
351-5355343       28,156.21       16,320.20                                X                X
351-5386459       24,216.54       26,000.64                                X                X
352-5550606       41,804.43       21,426.46            X                   X                X
352-6939912       16,404.51       16,865.71            X                                    X
413-3799157       24,936.29       11,440.42            X                                    X
431-4510342       24,463.43       10,374.62            X                   X                X
482-3878257        2,687.46        1,411.95            X


                                                 19
                                                                       Missed
                                            Missed deadline to      deadline to
                                                                                    Missed deadline
              Unnecessary    Unnecessary    initiate foreclosure     complete
 FHA loan                                                                            to complete
                interest      claim costs    or implement loss     preforeclosure
                                                                                     foreclosure
                                                 mitigation          marketing
                                                                       period
483-4103908       5,764.83         505.00                                X
495-7710269      10,853.42       1,720.73            X                                    X
521-7030605       5,010.12       3,124.80            X
521-7462000       9,571.67       2,298.31                                                 X
581-3455058       8,214.64       4,734.28            X                                    X
381-7105218      15,298.48       8,405.63            X                                    X
548-4383543      45,113.96      24,752.66            X                                    X
331-1306333      32,933.92       8,748.19            X                                    X
052-5525487       7,485.03         793.52            X                                    X
052-5526873       6,762.70       7,241.27            X                                    X
095-0404504      39,771.77      19,292.28            X                                    X
105-1368364       6,492.25       3,733.44            X                                    X
156-0106482      11,839.09       3,354.00            X                                    X
197-3769467      25,792.75      10,676.44                                                 X
241-8238648      26,188.02      14,163.69            X                                    X
561-8517951      16,055.06       7,373.01            X                                    X
561-8919405      10,605.49       5,798.78            X                                    X
351-5165089      24,875.02      21,751.55            X                   X
561-9489437      15,763.80       8,168.18            X                                    X
048-5276344       2,867.74       1,070.86            X                                    X
105-4874698       1,225.23         550.00                                X
092-9477113       6,446.52       4,743.43                                                 X
491-9022928         973.38         500.00                                X
332-4876619       3,074.13         592.30            X                                    X
332-4917686      35,187.07      20,275.39                                                 X
095-0093103      21,847.04      25,068.49                                                 X
137-3711731       3,272.60      13,912.28                                X
137-4719970       3,359.78       3,217.54                                X
332-4512423       7,154.04       2,467.32            X                   X                X
413-4650177       4,983.29       9,257.68            X                   X
052-3663273       2,838.73       1,239.95            X                                    X
332-4553513       2,522.11         129.07            X
095-0431204      25,604.42      15,741.01                                                 X
023-3200572              -              -
045-7000368              -              -


                                               20
                                                                        Missed
                                             Missed deadline to      deadline to
                                                                                     Missed deadline
              Unnecessary     Unnecessary    initiate foreclosure     complete
 FHA loan                                                                             to complete
                interest       claim costs    or implement loss     preforeclosure
                                                                                      foreclosure
                                                  mitigation          marketing
                                                                        period
052-7222967        8,196.30       3,232.50                                X
137-5235771       28,695.75      19,005.90                                                 X
241-8788372        2,744.48       1,411.58            X                   X
412-4545733       14,771.54      15,561.68            X                                    X
541-8485641        6,863.25       8,366.09            X                                    X
561-9707322        5,552.31       3,084.84            X
              Claim count                            51                  24                51




                                                21
Appendix D
                                             Criteria


24 Code of Federal Regulations (CFR) 203.355(a) – generally require that lenders initiate
foreclosure or loss mitigation action within 6 months of loan default.

   “… the mortgagee [lender] shall take one or a combination of the following actions within
   six months of the date of default or within such additional time approved by HUD or
   authorized by §203.345 or 203.346:

           1. Obtain a deed-in-lieu of foreclosure (see §§203.357, 203.389 and 203.402(f) of
              this part) with title being taken in the name of the mortgagee or the [HUD]
              Secretary;
           2. Commence foreclosure;
           3. Enter into a special forbearance agreement under §203.614;
           4. Complete a modification of the mortgage under §203.616;
           5. Complete a refinance of the mortgage under §203.43(c);
           6. Complete an assumption under §203.512;
           7. File a partial claim under §203.371; or
           8. Initiate a pre-foreclosure sale under §203.370.”

24 Code of Federal Regulations (CFR) 203.355(b), Vacant or abandoned property. “With
respect to defaulted mortgages on vacant or abandoned property, if the mortgagee discovers, or
should have discovered, that the property is vacant or abandoned, the mortgagee must commence
foreclosure within the later of 120 days after the date the property became vacant, or 60 days
after the date the property is discovered, or should have been discovered, to be vacant or
abandoned; but no later than the number of months from the date of default as provided in
paragraph (a) of this section. The mortgagee must not delay foreclosure on vacant or abandoned
property because of the requirements of §203.606.”

24 CFR 203.356(b) – provide that mortgagees “must exercise reasonable diligence in
prosecuting the foreclosure proceedings to completion and in acquiring title to and possession of
the property. A time frame that is determined by the Secretary to constitute ‘reasonable
diligence’ for each State is made available to mortgagees.”

24 CFR 203.355(g) – generally require that lenders complete a preforeclosure sale within 4 to 6
months.

“Within 90 days of the end of a mortgagor’s [borrower] participation in the pre-foreclosure sale
procedure, or within the time limit described in paragraph (a) of this section, whichever is later,
if no closing of an approved pre-foreclosure sale has occurred, the mortgagee must obtain a deed
in lieu of foreclosure, with title being taken in the name of the mortgagee or the Secretary, or
undertake one of the actions listed at §203.355(a). The end-of-participation date is defined as:




                                                 22
       1. Four months after the date of commencement of participation, if there is no signed
          Contract of Sale at that time, unless extended by the [Federal Housing]
          Commissioner;
       2. Six months after the date of commencement of participation, if there is a signed
          contract but settlement has not occurred by that date, unless extended by the
          Commissioner;
       3. The date the mortgagee is notified of the mortgagor’s withdrawal from the Pre-
          foreclosure Sale procedure; or
       4. The date of the letter sent by the mortgagee to the mortgagor prior to the expiration of
          the customary participation period, terminating the mortgagor’s opportunity to
          participate in the Pre-foreclosure Sale procedure.”

Mortgagee Letter 2008-43 (and updated guidance in HUD Handbook 4000.1) allows a
marketing period between 4 to 6 months from the borrower’s approval to participate in the
preforeclosure program.

“K. Duration of the Pre-Foreclosure Sale Period. Unless an extension has been approved by
NSC [National Servicing Center], mortgagees have 4 months from the date of the mortgagor’s
approval to participate in the PFS Program. Mortgagees have a pre-approved extension of 2
additional months to complete the PFS if one of the following exists:

   •   The mortgagee is in the Tier 1 category under the Department’s [HUD] Tier Ranking
       System (TRS); or
   •   There is a signed Contract of Sale, but settlement has not occurred by the end of the
       fourth month following the date of the mortgagor’s approval to participate in the PFS
       Program.”

24 CFR 203.359(b) – require conveyance to HUD within 30 days.

   1. “Conveyance by the mortgagee. The mortgagee must acquire good marketable title and
      transfer the property to the Secretary within 30 days of the later of:

          i.   Filing for record the foreclosure deed;
         ii.   Recording date of deed in lieu of foreclosure;
        iii.   Acquiring possession of the property;
        iv.    Expiration of the redemption period; or
         v.    Such further time as the Secretary may approve in writing.

   2. Direct conveyance. In cases where the mortgagee arranges for a direct conveyance of the
      property to the Secretary, the mortgagee must ensure that the property is transferred to
      the Secretary within 30 days of the reasonable diligence time frame specified in §
      203.356 of this part.”




                                                23
24 CFR 203.365 (a) – require that lenders submit preforeclosure claims within 30 days after the
closing of the pre-foreclosure sale:

   “… unless extended by the Commissioner, the mortgagee must forward to the Secretary: (1)
   A copy of the deed… (2) Fiscal data pertaining to the mortgage transaction. (3) Any
   additional information or data that the Secretary may require.”

24 CFR 203.402(k)(3)(i)(B) – require preforeclosure claim interest curtailment, based only on
the claim submission deadline created by 24 CFR 203.365, not the PFS initiation and completion
deadlines of the following: 24 CFR 203.355(a) and (g) or the reasonable diligence deadline of
24 CFR 203.356(b).

   “...except that if the mortgagee fails to meet any of the applicable requirements of § 203.365
   within the specified time and in a manner satisfactory to the Commissioner (or within such
   further time as the Commissioner may approve in writing), the interest allowance in such
   cash payment shall be computed only to the date on which the particular required action
   should have been taken or to which it was extended.”




                                                24