Section 203(k) Rehabilitation, Grand Rapids, MI

Published by the Department of Housing and Urban Development, Office of Inspector General on 1998-01-14.

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                                                  U.S. Department of Housing and Urban Development
                                                  Office of Inspector General for Audit, Midwest
                                                  77 West Jackson Boulevard, Room 2646
                                                  Chicago, Illinois 60604-3507

                                                  Phone (312) 353-7832 Fax (312)353-8866
                                                  Internet http//www.hud.gov/oig/oigindex.html

                                                                Audit Related Memorandum

January 14, 1998

Memorandum For: Shirley Bryant, Director of Housing, Grand Rapids Area Office

From: Dale L. Chouteau, District Inspector General for Audit, Midwest

Subject: Hotline Complaint
         Section 203(k) Rehabilitation Home Mortgage Insurance Program
         Grand Rapids, Michigan

We completed a limited review of the Section 203(k) Rehabilitation Home Mortgage Insurance
Program in the Grand Rapids Area. The review was performed in response to a citizen's complaint to
the HUD Hotline. The complainant alleged: (1) lenders in the Grand Rapids area used the same
consultant/inspector for most of their Section 203(k) loans; and (2) the consultant/inspector being used
did not do proper inspections. The objective of our review was to determine if the complaint was valid
and if HUD's rules and regulations were violated.

The 203(k) Program allows a borrower to obtain a single mortgage at a long-term (or adjustable) rate,
to finance both the acquisition and the rehabilitation of a property. To provide funds for the
rehabilitation, the mortgage amount is based on the projected value of the property when the work is
completed, taking into account the cost of the work. A HUD-approved consultant prepares the work
write-ups and cost estimates for the rehabilitation of a property to be insured under the 203(k)
program. A HUD-approved fee inspector inspects the property to verify that the work was properly
completed according to the work write-ups. The lender uses the results of the inspections as the basis
to release funds from the rehabilitation escrow account to pay for the work.

To achieve our objectives, we interviewed HUD personnel and officials from the four lenders with the
highest volume of loans in the Grand Rapids area. The four lenders were: Norwest Mortgage
Company; Mortgage Corporation of America; DMR Mortgage Corporation; and Van Dyk Mortgage
Corporation. We reviewed nine properties whose mortgages were funded by these companies. We
evaluated the work write-ups and cost estimates, and the quality of the inspections. We also
interviewed the owners of all nine properties.
Audit Related Memorandum

We found that the complaint was valid. The lenders used the same consultant/inspector for most of
their Section 203(k) loans. However, this did not violate any HUD rules. The consultant/inspector
who was the subject of the complaint, however, did not always prepare adequate work write-ups and
cost estimates, and did not always perform proper inspections. The consultant/inspector certified that
work was completed when the work either was not done or was unsatisfactory. Additionally, the
HUD Grand Rapids Office was aware that the consultant/inspector was not doing proper inspections,
but HUD did not take any action against him. Details of our review are contained in the attached

Within 60 days, please provide us, for each recommendation made in this report, a status report on: (1)
the corrective action taken; (2) the proposed corrective action and the date to be completed; or (3)
why corrective action is unnecessary. Also, please furnish us copies of any correspondence or
directives issued because of the audit.

Should you or your staff have any questions, please contact me at (312) 353-7832.

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                                     RESULTS OF REVIEW

The consultant/inspector who was the subject of the HUD complaint did not always prepare adequate
work write-ups and cost estimates, and perform proper inspections. The lenders in the Grand Rapids
area used this same consultant/inspector for most of their Section 203(k) loans. HUD did not take any
action against the consultant/inspector although the Chief of Single Family Production was aware that
the consultant/inspector had not performed adequately. As a result, HUD may have insured loans for
excessive amounts and the low or moderate income person who purchased a property may have paid
for rehabilitation work not completed or improperly completed.

                                      Mortgagee Letter 95-40, explains the responsibilities of a
 HUD’s Requirements
                                      consultant. The responsibilities include preparing work write-
                                      ups and cost estimates for the rehabilitation of a property.

                                      HUD Handbook 4240.4 REV-2, 203(k) Handbook, Chapter 1,
                                      Paragraph 1-9 (D), requires a HUD-approved fee inspector to
                                      perform all the inspections during construction and after the
                                      rehabilitation work is completed. The consultant is also
                                      allowed to act as a fee inspector.

                                      Chapter 5, Paragraph 5-2 (C) states that the lender who
                                      controls the Rehabilitation Escrow Account should only release
                                      funds to a borrower after the lender has received a properly
                                      executed draw request and inspection report. Permits from the
                                      local or State building authority are required where necessary
                                      and under no circumstances is a draw request to be approved
                                      for work that is not yet complete.

                                      Paragraph 5-2 (C)(2) requires that improvements must be
                                      satisfactorily completed in compliance with industry standards,
                                      local practices and to the satisfaction of the fee inspector.

                                      HUD Handbook 4060.01 REV-1, Mortgagee Approval
                                      Handbook, Chapter 6, requires all lenders to have and maintain
                                      a Quality Control Plan. The Plan must be a prescribed function
                                      of the mortgagee's operations and assure that the mortgagee
                                      maintains compliance with HUD-FHA requirements and its
                                      own policies and procedures.

                                      We randomly selected nine recently rehabilitated properties that
 We Reviewed Nine
 Properties                           had Section 203(k) loans originated by the four lenders with
                                      the biggest volume in the Grand Rapids area, and for which the
                                      consultant/inspector who was the subject of the complaint did

98-CH-184-1805                                 Page 3
Audit Related Memorandum

                             the rehabilitation work write-ups, cost estimates, and
                             inspections. We obtained the services of a HUD inspector to
                             reinspect the properties and evaluate the quality of the original

                             Three of the nine loans were originated by Van Dyk Mortgage
                             Corporation, three by Mortgage Corporation of America, two
                             by DMR Mortgage Corporation, and one by Norwest
                             Mortgage Company.

                             The four lenders used the same consultant/inspector for the
 The Lenders Used The        majority of their loans in the Grand Rapids area. Officials from
 Same Consultant/Inspector   the lenders said they developed a working relationship with the
 For Most Loans
                             consultant/inspector and referred most homebuyers to him.

                             Van Dyk used the consultant/inspector for 22 of 22 loans they
                             processed in 1997, Mortgage Corporation of America used
                             him for 19 of 21 loans, and Norwest used him for 21 of 31
                             loans. DMR Mortgage Corporation was unable to provide the
                             exact number of loans they used him for, but said it was the
                             majority of approximately 100 loans they originated in 1997.

                             Seven of the property owners we interviewed, said the lenders
                             referred them to the consultant/inspector, and two said
                             someone from HUD recommended the consultant/inspector.
                             The Vice President of Van Dyk Mortgage said the
                             consultant/inspector did an acceptable job, and his costs were
                             less than other inspectors.

                             We found that the consultant/inspector charged about $300 to
                             do the work write-ups. We called another consultant who was
                             on HUD's approved list and he said he charged between $400
                             and $700 depending on the amount of work required.

                             HUD regulations do not dictate which consultant/inspector(s) a
                             lender/homebuyer uses.        The regulations also do not
                             specifically require reinspection of a sample of a
                             consultant/inspector's work to assure its quality. However, the
                             regulations require a mortgage company to maintain a quality
                             control plan that assures a mortgagee maintains compliance
                             with HUD-FHA requirements. Proper and accurate work
                             write-ups and inspections are a HUD-FHA requirement.

98-CH-184-1805                        Page 4
Audit Related Memorandum

                             The consultant/inspector did not prepare adequate work write-
 Work Write Ups And          ups for four of the nine properties. Specifically, all health and
 Inspections Were Not        safety and city code violation items requiring correction were
                             not included. Additionally, for three of the nine properties, the
                             cost estimates were excessive. The three properties were
                             owned by two non profits. The Presidents of the non profits
                             said that because of the methods they used to accomplish and
                             pay for the repairs required by the work estimates, they could
                             not provide records that showed the actual cost of completed

                             The consultant/inspector also did not always perform proper
                             inspections of the repairs made under the 203(k) program
                             before he certified the repairs were completed and funds could
                             be released from the rehabilitation escrow account. For five of
                             the properties, the consultant/inspector certified that all repairs
                             were completed. He approved draw requests of funds from the
                             escrow account when the work was either not completed or
                             was unsatisfactorily completed. For example:

                             Inadequate Work Write Up

                             For the dwelling at 1307 Wealthy, the write-ups did not
                             include: a hand rail at the front steps; the replacement of the
                             old unsafe roof on the second story deck; the replacement of an
                             unsecured and unsafe guard rail on the roof deck; replacement
                             of substandard electrical wiring in the basement; and the repair
                             of a porch ceiling. The work write-ups only required the
                             patching of the roof on the second story deck which was not
                             safe to walk on. The porch ceiling had rotted and was sagging
                             in one place.

                             Excessive Cost Estimates

                             For the dwelling at 1050 Dickenson, the HUD inspector
                             determined that the cost estimates were excessive for the
                             following items:

                                                Consultant/Inspector‘s     HUD Inspector’s
                                 Item                 Estimate               Estimate
                           House Roof                  $5,425                 $3,500
                           Garage Roof                  1,920                  1,400
                           Kitchen Cabinets               800                    300
                           Kitchen Floor                  680                    400
                           Paint Windows                  450                    175

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Audit Related Memorandum

                                     Inadequate Inspections

                                     For the dwelling at 1307 Wealthy, the inspector certified the
                                     exterior entry door and storm doors were replaced; the exterior
                                     windows, trim, and garage were painted; a large hole in the
                                     stairwell ceiling was patched; and the heat run in the foyer was
                                     boxed. None of this work was done.

                                     The following chart shows the results of the
                                     consultant/inspector’s work for the nine properties we

                                                          Inadequate      Excessive     Inadequate
                         Lender          Address           Write Up       Estimate      Inspection
                       Mortgage      10785 Lovers Ln          X                             X
                       Mortgage      3908 Milan SW
                       Mortgage      2056 College
                       Van Dyk       544 Westway NW
                       Van Dyk       1135 Benjamin             X                             X
                       Van Dyk       1050 Dickenson            X              X              X
                       DMR           908 Nagold NW                            X              X
                       DMR           131 Rose SW                              X
                       Norwest       1307 Wealthy SE           X                             X

                                     The lenders depended on the consultant/inspector to provide
                                     adequate work write-ups, accurate cost estimates and assure
                                     that the work was properly completed. However, the lenders
                                     did not ensure the consultant/inspector did adequate work. One
                                     of the lenders did not have a quality control plan. The other
                                     three had quality control plans, but the plans were not effective.
                                     Additionally, HUD did not review the adequacy of the
                                     consultant/inspector's work and did not take appropriate action
                                     when it was noted the consultant/inspector’s work was not

                                     The Chief Underwriter at DMR Mortgage Corporation said
 Quality Review Plans Did
 Not Exist Or Were Not               that DMR did not have a quality control plan for Section
 Adequately Implemented              203(k) loans and did not do quality control reviews of these

98-CH-184-1805                                Page 6
Audit Related Memorandum

                           Mortgage Corporation of America had a quality control plan
                           but did not perform any quality control reviews. Its plan did
                           not require reinspection of any rehabilitated properties.

                           Norwest Mortgage Company's quality control plan required
                           reinspections, but it only did file reviews as part of its quality
                           control reviews.

                           Although, Van Dyk Mortgage Corporation's quality plan did
                           not call for reinspections, they did reinspections on 9 properties
                           between December 1995 and January 1997 to verify that the
                           original inspections were adequate and the work was properly
                           completed. Van Dyk found that for 7 of the 9 properties the
                           inspections were not adequate because all the work was not
                           completed as certified on the HUD fee inspector's inspection
                           reports. Van Dyk assured the problems noted during the
                           reinspections were corrected; however, they did not take
                           corrective action against the consultant/inspector, and
                           continued to use him.

                           Van Dyk's Underwriting Manager said he had conversations
                           with the Chief of Single Family in the HUD Grand Rapids
                           Office and told him the consultant/inspector was not doing
                           thorough inspections. He said he and the Chief agreed that all
                           the items on the work write-ups did not need to be corrected as
                           long as the health and safety items were corrected. It is
                           important for all items in the work write-ups to be satisfactorily
                           completed, since the mortgage amount is based on the
                           projected value of the property with these items corrected.

                           The Chief of Single Family Production and Real Estate Owned
 HUD Did Not Take Any      Branch in the Grand Rapids HUD Office told us that his Office
 Action Against The        did not monitor the 203 (k) program because of a lack of staff.
 Inspector                 However, we found that the HUD Office was aware that this
                           consultant/inspector's work was inadequate and should have
                           taken action against him.

                           In September 1996, in response to concerns about the
                           properties being rehabilitated nationwide by Faith Housing Inc.,
                           a HUD inspector inspected three properties in the Grand
                           Rapids area that were owned and rehabilitated by Faith
                           Housing.       For each of the three properties, the
                           consultant/inspector who is the subject of the Hotline
                           complaint did the inspections. The HUD inspector found that
                           the repairs that had been certified as complete were either not

98-CH-184-1805                      Page 7
Audit Related Memorandum

                           completed or unsatisfactorily completed for all of the
                           properties. For example for the dwelling at 2017 Melita:

                           .     Damaged siding was supposed to have been replaced but
                                 was not.

                           .     The crawl space to the rear addition was supposed to have
                                 been ventilated but no ventilation was installed.

                           .     No interior doors were replaced as required by the work

                           .     The entire house was to have been scraped, primed and
                                 repainted. The HUD inspector found the property was
                                 only spray painted with no scraping or priming, and work
                                 was of poor quality.

                           We asked the Chief of Single Family Production and Real
                           Estate Owned Branch about what actions HUD took as a
                           result of the Faith Housing reinspections. He said Faith
                           Housing was suspended as a non-profit organization; however,
                           he could not remember if any action was taken against the
                           consultant/inspector. We could not find any evidence of any
                           action. We believe, at a minimum to protect HUD’s interests
                           both Faith Housing and the consultant/inspector should have
                           been suspended or debarred from further participation in
                           HUD's programs.

                           We recommend that the Director of Housing, Grand Rapids
 Recommendations           Area Office:

                           1A.      Issue a Limited Denial of Participation against the
                                    consultant/inspector  and    initiate    debarment

                           1B.      Require all mortgage companies doing business under
                                    Section 203(k) to reinspect each property for which
                                    they used the services of the subject
                                    consultant/inspector and ensure all items that were not
                                    completed or were not properly completed are

                           1C.      Require DMR Mortgage Corporation, Mortgage
                                    Corporation of America, Norwest Mortgage Company,
                                    and Van Dyk Mortgage to demonstrate that they have

98-CH-184-1805                        Page 8
Audit Related Memorandum

                                 implemented an effective quality control plan within six
                                 months. For the entities that can not show they have
                                 an effective plan, take action to prevent them from
                                 participating in HUD’s programs.

                           1D.   Take action deemed appropriate against any HUD
                                 employee who did not adequately fulfill his/her
                                 responsibility to protect HUD's interests.

98-CH-184-1805                    Page 9
Secretary’s Representative, Midwest District
State Coordinator, Michigan State Office
Assistant General Counsel for the Midwest
Field Controller, Midwest
Director Field Accounting Division, Midwest
Director, Office of Housing, Michigan State Office (2)
Director, Administrative Service Center 1
Assistant to the Deputy Secretary for Field Management, SDF (Room 7106)
Chief Financial Officer, F (Room 10164) (2)
Deputy Chief Financial Officer for Finance FF (Room 10164) (2)
Acquisitions Librarian, Library, AS (Room 8141)
Director, Participation and Compliance Division, HSLP (Room 9164)
Director, Housing Finance Analysis Division, REF (Room 8204)
Comptroller/Audit Liaison Officer, HF (Room 5132) (5)
General Counsel, C (Room 10214)
Deputy Secretary (Room 10100)
Assistant Secretary for Congressional and Intergovernmental Relations, J (Room 10120)
Deputy Assistant Secretary for Public Affairs, W (Room 10220)
Chief of Staff, S (Room 10000)
Counselor to the Secretary, S (Room 10234)
Senior Advisor to the Secretary for Communication Policy, S (Room 10222)
Assistant Secretary for Housing, H (Room 9100)
Assistant to the Secretary for Labor Relations, (Acting), SL (Room 7118)
Director, Housing and Community Development Issue Area, U.S. GAO, 441 G Street,
  NW, Room 2474, Washington, DC 20548 (2)
The Honorable John Glenn, Ranking Member, Committee on Governmental Affairs,
  United States Senate, Washington, DC 20515-4305
The Honorable Fred Thompson, Chairman, Committee on Governmental Affairs,
  United States Senate, Washington, DC 20515-4305
Ms. Cindy Sprunger, Subcommittee on General Oversight and Investigations,
  Room 212, O’Neill House Office Building, Washington, DC 20515
Mr. Pete sessions, Government Reform and Oversight Committee, Congress of the
  U.S. House of Representatives, Washington, DC 20510-6250
The Honorable Dan Burton, Chairman, Committee on Government Reform and Oversight,
  U.S. House of Representatives, Washington, DC 20515-6143

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