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					                                      Loan Fraud and Quality Control

     FBI’s 2008 Mortgage Fraud Report “Year in Review”

     This report is based on FBI, state, and local law enforcement, mortgage
     industry, and open-source reporting. Information also was provided by
     other government agencies, including the US Department of Housing and
     Urban Development-Office of Inspector General (HUD-OIG), Federal
     Housing Administration (FHA), Internal Revenue Service, US Postal
     Inspection Service, and the Federal National Mortgage Association.
     Suspicious Activity Reports (SARs) were obtained from the Financial
     Crimes Enforcement Network (FinCEN).

     Key Findings

         •   Mortgage fraud continued to be an escalating problem in the
 1           United States during 2008. SAR mortgage fraud filings from
             financial institutions increased 36 percent to 63,713 during
             Fiscal Year (FY) 2008 compared to 46,717 filings in FY2007.
             The total dollar loss attributed to mortgage fraud is unknown;
             however, at least 63 percent (1,035) of all pending FBI mortgage
             fraud investigations during FY2008 involved dollar losses
             totaling more than $1 million.
         •   A decrease in loan originations and an increase in defaults and
             foreclosures continued to dominate the downward trend in the
             housing market in 2008. As the housing market continued to
             decline in response to an increase in housing inventories, lack of
             sales, and new foreclosures surface, to include a wave of Alt-A
             and Option ARM loans due to reset beginning in April 2009,
             real estate values softened, and fraud reporting increased
             throughout 2008.
         •   Analysis of available law enforcement and industry information
             indicates the top states for mortgage fraud during 2008 were
             California, Florida, Georgia, Illinois, Michigan, Arizona, Texas,
             Maryland, Missouri, New Jersey, New York, Ohio, Colorado,
             Nevada, Minnesota, Rhode Island, Massachusetts, Pennsylvania,
             Virginia, and the District of Columbia. Rhode Island,
             Massachusetts, Pennsylvania, and the District of Columbia were
             new to the list in 2008, replacing Utah, Indiana, Tennessee and
             Connecticut from 2007.
         •   The downward trend in the housing market during 2008
             provided a favorable climate for mortgage fraud schemes to
             proliferate. Several of these schemes have the potential to
             spread if the current economic downward trend, as expected,
             continues into 2009 and beyond. Increases in foreclosures,
             declining housing prices, and decreased demand place pressure
             on lenders, builders, and home sellers.




FHA Lender Update                                            5-1                  December 2009
                                       Loan Fraud and Quality Control

      A recent trend resulting from the collapse of the sub-prime mortgage
2     market has been the migration of originators and borrowers back to FHA-
      backed mortgages. FHA’s market share has increased from 3 percent in
      2006 to more than 30 percent in 2009, making it an attractive market for
      exploitation by former sub-prime lenders. Further, the number of FHA
      approved lenders increased more than 350 percent from FY 2006 to FY
      2008 (see Figure 5).




      The number of FHA endorsements has also increased more than 193
      percent since FY2006 (see Figure 8). Additionally, FHA reported a 239-
      percent increase in the total dollar amount of annual mortgage loans it
      insured, growing from $75.6 billion in 2007 to $256.3 billion in 2008.




      US Department of Housing and Urban Development - Office of
3     Inspector General

      In FY2008, HUD-OIG had 451 pending single family (SF) residential
      loan investigations, a slight decrease from the 466 pending during
      FY2007. With the increase in FHA originations, HUD anticipates an
      increase in FHA-related fraud claims in the next few years.




    FHA Lender Update                                        5-2                 December 2009
                                        Loan Fraud and Quality Control

      HUD-OIG's top 10 mortgage fraud states based on pending investigations
      opened during FY2008 include California, Illinois, Texas, Georgia, Ohio,
      Colorado, Maryland, Florida, Missouri, and New York .

                                                   Total    %Housing
                                                 Properties  Units
      Rate                                          with (foreclosure
      Rank State     Metropolitan Area            Filings    rate)
       1 California        Stockton                21,127     9.46
       2   Nevada    Las Vegas/Paradise            67,223     8.89
                        Riverside/San
       3 California       Bernardino               112,284       8.02
       4 California       Bakersfield              16,208        6.17
       5 Arizona        Phoenix/Mesa               97,684        6.02
       6   Florida     Fort Lauderdale             47,387        5.95
       7   Florida          Orlando                46,843        5.48
       8   Florida          Miami                  49,697        5.21
       9 California       Sacramento               39,876        5.2
       10 Michigan Detroit/Livonia/Dearborn        38,106        4.52

       Figure 21: Top 10 US Metropolitan Foreclosure Markets by
                         Foreclosure Rate, 2008


      Emerging Schemes

4     Reverse Mortgage Fraud Schemes

      Unscrupulous loan officers, mortgage companies, investors, loan
      counselors, appraisers, builders, developers, and real estate agents are
      exploiting Home Equity Conversion Mortgages (HECMs)—also known
      as reverse mortgages—to defraud senior citizens. They recruit seniors
      through local churches, investment seminars, television, radio, billboard,
      and mailer advertisements, to commit the fraud primarily through equity
      theft, foreclosure rescue, and investment schemes. Equity theft schemes
      are the most common method used by mortgage fraud perpetrators to
      exploit HECMs. Perpetrators, often with the aid of straw buyers, execute
      a scheme designed to withdraw false equity from properties.

      Credit Enhancement Schemes

      Credit enhancement schemes may take various forms. In the most basic
      scheme, a loan officer and home builders are taking measures to
      encourage borrowers to have their names added to the bank accounts of
      friends or family members temporarily to circumvent the underwriting
      process to show that they have sufficient deposits on hand. Additionally,
      some originators and homebuilders are depositing money into the
      accounts of loan applicants who are in the process of trying to qualify for
      a mortgage to be used as an asset. Once the underwriting process
      qualifies the loan and it closes, the builder withdraws the money and uses
      it for the next potential borrower.




    FHA Lender Update                                          5-3                  December 2009
                                     Loan Fraud and Quality Control

  Builder-Bailout Schemes – Modified

  Builders are employing builder-bailout schemes to offset losses, and
  circumvent excessive debt and potential bankruptcy, as home sales suffer
  from escalating foreclosures, rising inventory, and declining demand.
  Builder-bailout schemes are common in any distressed real estate market
  and typically consist of builders offering excessive incentives to buyers,
  which are not disclosed on the mortgage loan documents. Builder-bailout
  schemes often occur when a builder or developer experiences difficulty
  selling their inventory and uses fraudulent means to unload it. In a
  common scenario, the builder has difficulty selling property and offers an
  incentive of a mortgage with no down payment. For example, a builder
  wishes to sell a property for $200,000. He inflates the value of the
  property to $240,000 and finds a buyer. The lender funds a mortgage loan
  of $200,000 believing that $40,000 was paid to the builder, thus creating
  home equity. However, the lender is actually funding 100 percent of the
  home’s value. The builder acquires $200,000 from the sale of the home,
  pays off his building costs, forgives the buyer’s $40,000 down payment,
  and keeps any profits. If the home forecloses, the lender has no equity in
  the home and must pay foreclosure expenses.

  Foreclosure Rescue Schemes

  Foreclosure rescue schemes are often used in association with advance
  fee/loan modification program schemes. The perpetrators convince
  homeowners that they can save their homes from foreclosure through
  deed transfers and the payment of up-front fees. This “foreclosure
  rescue” often involves a manipulated deed process that results in the
  preparation of forged deeds. In extreme instances, perpetrators may sell
  the home or secure a second loan without the homeowners’ knowledge,
  stripping the property’s equity for personal enrichment.

  Serial Property Flipping

  Illegal property flipping continues to be a significant scam identified by
  both industry and law enforcement agencies. Perpetrators are taking
  advantage of the distressed housing market and repeatedly flipping the
  same property numerous times

  Short Sale Schemes – Modified

  Short sale fraud schemes continue to be used in combination with
  foreclosure rescue schemes in an effort to victimize homeowners and
  financial institutions.

  Short-sale schemes are desirable to mortgage fraud perpetrators because
  they do not have to competitively bid on the properties they purchase, as
  they do for foreclosure sales. Perpetrators also use short sales to recycle
  properties for future mortgage fraud schemes. Short-sale fraud schemes
  are difficult to detect since the lender agrees to the transaction, and the
  incident is not reported to internal bank investigators or the authorities.
  As such, the extent of short sale fraud nationwide is unknown. A real
  estate short sale is a type of pre-foreclosure sale in which the lender
  agrees to sell a property for less than the mortgage owed. In a typical
  short sale scheme, the perpetrator uses a straw buyer to purchase a home
  for the purpose of defaulting on the mortgage. The mortgage is secured


FHA Lender Update                                           5-4                 December 2009
                                       Loan Fraud and Quality Control

  with fraudulent documentation and information regarding the straw
  buyer. Payments are not made on the property loan causing the mortgage
  to default. Prior to the foreclosure sale, the perpetrator offers to purchase
  the property from the lender in a short-sale agreement. The lender agrees
  without knowing that the short sale was premeditated. The mortgage
  owed on the property often equals or exceeds 100 percent of the
  property’s equity.

       HUD OIG Reports Issued During Year
                                                                           5

                 • During the 12-15 month period ending in
                   August 2009, HUD OIG had issued 16
                   reports lenders.
                 • Reports can be summarized with 3 main
                   findings.
                     – Underwriting
                          • No controls over underwriting function
                          • Underwriting criteria not being followed
                          • Quality control not properly applied
                     – Improper branch/employee arrangements
                     – No early default monitoring




       HUD OIG Reports Issued During Year
                                                                           6

                 • Reports included
                     –   Supervised lenders
                     –   Correspondent lenders
                     –   Non-supervised lenders
                     –   Discrepancies apply to all programs
                 • Other findings included
                     –   Improper payments
                     –   HECM violations
                     –   Improper branch arrangements
                     –   Improper down payment assistance
                 • See following examples




FHA Lender Update                                               5-5               December 2009
                                        Loan Fraud and Quality Control

         Companies Included in Reports                                        7

                   •   FNB of Gillette, WY         •   CitiMortgage
                   •   A-Plus Mortgage             •   Bank of America – Seattle
                   •   First Source Financial LC   •   Allied Home Mortgage
                   •   First Magnus Financial      •   Midwest Mortgage Capital
                   •   Financial Freedom Senior    •   Peoples Bank of
                       Funding                         Overland, KS
                   •   Eagle Home Mortgage         •   Clarion Mortgage
                   •   Meridian Funding            •   CTX Mortgage
                   •   Heartland Funding
                   •   Security National
                       Mortgage Company




    FIRST NATIONAL BANK OF GILLETTE, WY
8
    First National Bank was audited because of its high default rate and the
    Office of Inspector General’s strategic goal to reduce fraud in single
    family insurance programs.

    First National Bank originated 298 FHA-insured loans, with beginning
    amortization dates from May 1, 2006, through April 30, 2008, with a total
    original mortgage amount of more than $50.1 million. Twenty of these
    loans (6.71 percent) defaulted within the first two years of closing. The
    original mortgage amount of the defaulted loans totaled more than $3.2
    million.

    Underwriting - First National Bank did not follow HUD regulations
    when originating and underwriting 18 FHA loans. The originating and
    underwriting deficiencies occurred because First National Bank
    management did not properly train its originators and underwriters and it
    did not develop effective procedures for monitoring their actions to
    ensure compliance with HUD directives.

    The underwriting deficiencies occurred because First National Bank
    management did not properly train its originators and underwriters and it
    did not develop effective procedures for monitoring their actions to
    ensure compliance with HUD directives. Additionally, there was a high
    turnover in staff, which meant that inexperienced staff originated the
    FHA-insured loans.

    Quality Control - In addition, First National Bank did not have a written
    quality control plan, and its third-party contractor, who performed the
    quality control reviews, did not perform all reviews in accordance with
    HUD requirements. These deficiencies were due to management’s not
    placing a high priority on the quality control process and not adequately
    training new staff.




FHA Lender Update                                               5-6                December 2009
                                      Loan Fraud and Quality Control

    First National Bank did not have a written quality control plan.
    Management officials stated that they believed they had a quality control
    plan at one time but were unable to locate it. They explained that First
    National Bank is in the process of developing and implementing a new
    quality control plan.

    First National Bank used a third-party contractor to perform its quality
    control reviews, but it did not always get loans for review to the
    contractor in a timely manner. Consequently, the contractor could not
    complete the quality control reviews within 90 days of closing as required
    by HUD.

    In addition, First National Bank did not always take action regarding the
    quality control review report findings. Management stated that it
    reviewed the quality control review report findings during the biweekly
    staff meetings. However, it only reviewed 5 of the 23 quality control
    review reports covering our audit period. Further, when management
    conducted staff meetings to discuss the quality control review reports, it
    did not document planned or actual corrective action.

    First National Bank did not ensure that the contractor followed HUD
    requirements. The contractor did not review the FHA-insured loans with
    early defaults and did not perform field reviews of appraisals on 10
    percent of the loans reviewed during the quality control process.


    A PLUS MORTGAGE
9   A Plus disregarded HUD FHA requirements and provisions of RESPA
    and engaged in deceptive lending practices to maximize profits for itself
    and the independent contractors that used A Plus as a conduit for
    submission of loans for FHA insurance. Although it informed borrowers
    that they could receive a lower interest rate on their loans by paying up-
    front points and fees, A Plus charged loan discount fees to borrowers
    without reducing interest rates on the mortgages. This practice allowed A
    Plus to generate high interest rate loans for which A Plus’s sponsor
    lenders paid A Plus a yield spread premium when the loans closed
    escrow. As a result, borrowers paid excessive interest and fees for which
    they received no associated benefit.

    In addition, all 28 FHA-insured A Plus loans reviewed were originated by
    independent contractors, unapproved branches, or other non-FHA-
    approved mortgage broker firms. This condition occurred because A Plus
    ignored FHA origination requirements and submitted FHA loans
    originated by unapproved entities in exchange for a percentage of the
    loan origination fees, loan discount fees, and yield spread premiums
    generated by the loans.

    A Plus Charged Excessive Fees to Borrowers - In Mortgagee Letter
    2001-26, HUD noted that meaningful disclosure of yield spread
    premiums, as early as possible in the mortgage origination process, will
    avoid confusion and enable borrowers to make informed choices.

    Premium pricing occurs when the lender sells a loan to an investor with
    an above-par interest rate and receives a rebate (yield spread premium)
    from the investor. Disclosure of the relationship of loan discount fees and


FHA Lender Update                                            5-7                  December 2009
                                     Loan Fraud and Quality Control

  yield spread premiums was made to the borrowers on all 28 of the insured
  loans reviewed by way of a mortgage loan origination agreement
  (agreement) between A Plus and each borrower.

  In 14 of the 28 loans reviewed, A Plus failed to disclose in its original
  good faith estimates that it would receive yield spread premiums from its
  sponsor lenders at the loan closings. Additionally, the nature and purpose
  of fees paid to A Plus became confusing to borrowers because A Plus
  sometimes used different names or descriptions of a fee in the good faith
  estimates or other disclosure documents than it used in the HUD-1
  settlement statement.

  We interviewed the borrowers of three insured loans. For one A Plus
  loan, the borrowers told us that they had never bought a house before and
  that it was frustrating to see some of the name changes of the yield spread
  premium that occurred from one document to another. The borrowers
  also said that the loan officer did not want to give them time to read all of
  the loan application documents including the A Plus origination
  agreement that they signed.

  Paragraph 1-9 I of HUD Handbook 4155.1, REV-5, relates to the
  disclosure and payment
  of mortgage broker fees and states: “If the borrower must pay a fee
  directly to a mortgage broker, that expense must be included in the total
  of the borrower’s cash settlement requirements and appear on the HUD-1
  Settlement Statement. (This requirement applies to instances in which the
  borrower independently engages a mortgage broker to seek financing and
  pays the broker directly. The payment may not come from the lending
  institution.)”

  All 28 loans reviewed were originated by independent contractors that
  were not employees of A Plus but were employed by other lenders,
  consultants, or real estate firms or owned unapproved independent
  branches (finding 2). Upon loan closing, A Plus received the loan
  origination fee, loan discount, and other fees and the yield spread
  premium from the escrow settlement service in the form of a check. Once
  the escrow check was received by A Plus, its bookkeeper split the total
  amount of those funds between itself and the independent contractor or
  unapproved branches that brokered the
  FHA loans through A Plus. On average, for the 28 FHA loans reviewed,
  A Plus retained nearly 16 percent of the funds with the remainder going
  to the independent contractor or unapproved branch as a brokering
  commission.

  Finding 2: A Plus Allowed Independent Contractors and
  Unapproved Branches to Originate Insured Loans
  Contrary to FHA requirements, A Plus acted as a conduit for insured
  loans originated by independent contractors and unapproved branches.
  All 28 FHA-insured A Plus loans reviewed were originated by
  independent contractors, unapproved branches, or other non-FHA-
  approved mortgage broker firms.

  A Plus entered into a loan originator agreement with each of the loan
  officers involved in the 28 FHA loans reviewed. The agreement stated:
  “A+ Mortgage, Inc. is a Mortgage Broker and Loan Originator is an
  Independent Contractor pursuant to RCW19.146.010(7), and not an


FHA Lender Update                                            5-8                  December 2009
                                   Loan Fraud and Quality Control

  employee.” The A Plus loan officers were paid on a commission-only
  basis as independent contractors and their income was reported at yearend
  using IRS Form 1099.

  Under HUD regulations, a lender must exercise control and responsible
  management supervision over its home and branch office employees.
  HUD Handbook 4060.1, REV-2, paragraph 2-9(D), requires that control
  and supervision include, at a minimum, regular and ongoing reviews of
  employee performance and work performed. Since the loan officers were
  independent contractors and not employees,

  HUD Handbook 4060.1, REV-2, paragraph 2-14 (A), states that an
  approved lender is prohibited from engaging an existing, separate
  mortgage company or broker to function as a branch of the approved
  lender and allowing that separate entity to originate insured mortgages
  under the approved lender’s FHA number. Such an arrangement
  constitutes a prohibited branch arrangement. Separate entities may not
  operate as branches or dba’s of an FHA-approved lender. Paragraph 2-14
  also prohibits certain employment agreements, including a branch
  compensation plan that includes the payment of operating expenses by
  the branch manager, any other employee, or a third party. This
  prohibition was established in Mortgagee Letter 00-15.

  When our audit began in July of 2007, A Plus listed 50 branch office
  locations and one home office on its Web site. It did not notify HUD of
  the existence of these branch offices and did not receive HUD approval
  for originating and processing insured loans at these branches..

  We recommend that the Assistant Secretary for Housing – Federal
  Housing
  Commissioner require A Plus to

  •   1A. Return unearned and excess yield spread premiums, loan
      discount fees, and other fees, totaling $153,110, to the borrowers of
      the loans shown at appendix C.
  •   1B. Review and analyze all other FHA-insured loans generated by A
      Plus with loan discount points when no interest rate reduction
      occurred and report the results to the Mortgagee Review Board.
      Refunds should be issued to the borrowers.
  •   1C. Discontinue charging loan discount fees when it receives yield
      spread premiums on a loan.
  •   1D. Cease changing the names of fees from the initial disclosure to
      the final HUD-1.
  •   1E. Instruct its loan officers to ensure that the borrowers clearly
      understand the nature of all charges associated with their loans.
  •   2A. Return all loan origination fees, totaling $32,036, to the
      borrowers on all loans that were originated by third-party
      independent contractors, as shown at appendix D.
  •   2B. Only submit loans for FHA insurance that were originated by A
      Plus employees. These employees must not have employment
      elsewhere in the mortgage lending or real estate fields, must be under
      full supervisory control of A Plus, and must be issued IRS Forms W-
      2 for any salary or commission earned on an insured loan.




FHA Lender Update                                         5-9                  December 2009
                                       Loan Fraud and Quality Control

     •   2C. Register all of its branch offices with FHA. Expenses for
         operating these branch offices must be paid by A Plus, not its
         employees or outside parties.

     We also recommend that the Assistant Secretary for Housing – Federal
     Housing Commissioner

     •   2D. Refer A Plus Mortgage to the Mortgagee Review Board for
         consideration of administrative sanctions and/or civil money
         penalties for the violations of HUD requirements disclosed in this
         finding.


     FIRST MAGNUS FINANCIAL CORPORATION
10
     We audited the mortgage origination and business practices of the First
     Magnus Financial Corporation’s (First Magnus) corporate office in
     Tucson, Arizona.

     During the period January 1, 2003, and December 31, 2005, First
     Magnus’ Tucson corporate office paid more than $753,000 in marketing
     fees and non-competition fees to builders and real estate companies in
     exchange for exclusive referrals of more than $937 million in federally
     related mortgages (non-FHA-insured and FHA-insured). Of the payments
     made to builders and real estate companies, over $32,000 in marketing
     fees and noncompetition fees was paid in exchange for the exclusive
     referral of 236 FHA-insured mortgages totaling more than $30 million for
     First Magnus.

     Finding 1: First Magnus Violated the RESPA When Paying Builders
     and Real Estate Companies Marketing Fees and Noncompetition
     Fees in Exchange for Referrals of FHA Mortgage Business
     First Magnus paid builders and real estate companies $32,154 in
     marketing fees and noncompetition fees in exchange for exclusive
     promotion of its mortgage products and programs via terms set out in
     marketing agreements and noncompetition agreements with these entities.
     First Magnus disregarded RESPA and engaged in the practice of paying
     improper marketing referral fees and noncompetition fees to builders and
     real estate companies in exchange for FHA mortgage business referrals.
     First Magnus loan officers were on site at builders’ and real estate
     companies’ offices, and borrowers were directed to these First Magnus
     loan officers by the homebuilder sales agents and real estate agents.
     These arrangements effectively limited affected borrowers’ ability to
     comparison shop with other lenders and violated RESPA.

     The practice of paying real estate companies and builders in exchange for
     exclusive rights to FHA mortgages violates section 8(a) of RESPA,
     which prohibits specified referral fees. Specifically, RESPA regulations
     at 24 CFR (Code of Federal Regulations) 3500.14(b) state, “No person
     shall give and no person shall accept any fee, kickback, or thing of value
     pursuant to any agreement or understanding, oral or otherwise, that
     business incident to or part of a settlement service involving a federally
     related mortgage loan [e.g. FHA-insured] shall be referred to any
     person.” Effectively, RESPA prohibits payments merely for referral of
     business. In this regard, HUD generally has held that when a payment is
     based on the volume or value of business transacted, it is evidence of an


 FHA Lender Update                                           5-10                 December 2009
                                        Loan Fraud and Quality Control

     agreement for the referral of business, unless it is shown that payments
     are for legitimate business reasons unrelated to the value of the referrals.

     For example, First Magnus entered into a marketing agreement with new
     home builder Santa Anna Homes on January 1, 2004. The purpose of the
     agreement was to market various First Magnus mortgage products and
     programs (e.g. FHA, Conventional, etc.) within all Santa Anna Homes
     sales offices in Arizona. The marketing agreement further specified,
     “This shall be an exclusive marketing relationship for Marketing Partner
     (Santa Anna Homes). In exchange for the exclusive referrals at Santa
     Anna Homes sales offices throughout Arizona, First Magnus would pay
     Santa Anna Homes a monthly “marketing” fee of $9,999.

     Santa Anna Homes was paid $76,800 from the first quarter of 2004
     through the first quarter of 2005 to refer mortgage business to First
     Magnus. Of this amount, $14,374 was paid to the homebuilder for the
     referral of 47 FHA mortgages totaling more than $7.1 million. Although
     the agreement indicated that the marketing fees were to be paid in fixed
     monthly sums, the payments were improper referral fees under RESPA.
     Further, three of the four payments made under this agreement differed
     from the amount specified in the agreement and were apparently based on
     the volume of mortgage referrals made during the period.

     We recommend that the Assistant Secretary for Housing-Federal Housing
     Commissioner
     • 1A. Require First Magnus to discontinue the practice of paying
        marketing fees and noncompetition fees to real estate companies and
        builders in exchange for referrals of FHA mortgages on all current
        and/or future transactions.
     • 1B. Remove the active status and approval for First Magnus to
        perform FHA business.
     • 1C. Pursue administrative actions against the principal owners and
        management of First Magnus for allowing the improper practice of
        paying marketing fees and noncompetition fees to real estate
        companies and builders in exchange for FHA mortgage business.


     FINANCIAL FREEDOM SENIOR FUNDING CORPORATION (HECM)
11   We audited Financial Freedom Senior Funding Corporation (Financial
     Freedom) as part of our annual audit plan objective of improving the
     integrity of single family insurance programs.

     Finding: Financial Freedom Did Not Fully Follow HUD’s Reverse
     Mortgage Requirements for Loans in the San Antonio, Texas Area
     Financial Freedom generally complied with HUD’s reverse mortgage
     requirements concerning the borrower’s age and completion of a
     counseling program for the 10 loans reviewed. However, it did not fully
     follow other requirements. It did not follow up on conflicting file
     information; thus, it originated an ineligible $139,500 loan for a home
     that was not the borrower’s primary residence. Also, a $234,000 loan was
     no longer eligible as the borrower no longer occupied the property. An
     additional $111,000 loan may have been ineligible as the repairs had not
     been completed and may not have met local building code. This condition
     occurred because Financial Freedom relied on an improper inspection by
     an inspector. Further, Financial Freedom’s underwriters misinterpreted


 FHA Lender Update                                             5-11                 December 2009
                                       Loan Fraud and Quality Control

     HUD’s Mortgagee Letter 2005-48 and waived repairs that affected the
     soundness of the properties for two loans totaling $388,500.

     Financial Freedom originated a loan with maximum claim amount
     totaling $139,500 for a property that was not the borrower’s principal
     residence. HUD requires that eligible properties for the reverse mortgage
     program be the borrower’s principal residence.4 Financial Freedom did
     not resolve file information showing that the address on the borrower’s
     driver`s license did not match the property address. In addition, the file
     contained a credit report warning of an address mismatch, which also
     indicated that the property was not the borrower’s principal residence.

     We recommend that the Assistant Secretary for Housing-Federal Housing
     Commissioner
     • 1A. Cancel the mortgage insurance totaling $139,500 on the
        ineligible loan.
     • 1B. Require Financial Freedom to contact the borrower and ascertain
        the occupancy status and if the borrower no longer lives in the
        property seek repayment of the ineligible mortgage totaling
        $234,000.
     • 1C. Consider taking administrative action against the inspector for
        the improper inspection.
     • 1D. Require Financial Freedom to ensure that the repairs are
        completed and meet local building code for one loan totaling
        $111,000 or cancel the mortgage insurance.
     • 1E. Require Financial Freedom to ensure that the property exterior
        for the one loan totaling $271,500 is repaired in accordance with
        Mortgage Letter 2005- 48 or cancel the insurance.
     • 1F. Require Financial Freedom to issue guidance to its underwriters
        on Mortgagee Letter 2005-48, clarifying that repairs affecting the
        health and safety of the occupants or the security and the soundness
        of the property cannot be waived.
     • 1G. Require Financial Freedom to provide its files for the 10
        additional loans to HUD’s Quality Assurance Division for review or
        indemnify the loans.


     HEARTLAND FUNDING CORPORATION

12   We audited Heartland Funding Corporation (Heartland Funding) because
     of its high 30-day delinquency rate. From January 2006 through
     December 2007, Heartland Funding originated 420 Federal Housing
     Administration (FHA) loans, valued at $44.5 million. During this same
     period, 97 of the loans (23.1 percent) had been at least 30 days delinquent
     (past due).

     Finding 1: Heartland Funding Violated RESPA When Processing
     FHA Loans That Involved Downpayment Assistance
     Heartland Funding failed to disclose an affiliated business arrangement
     with Midwest, provided instructions to title companies that
     mischaracterized loan transactions, and inappropriately allowed Midwest
     to split a portion of its fee with a nonprofit entity that performed no
     services in downpayment assistance (gift) transactions. This occurred
     because Heartland Funding’s owners/managers incorrectly believed that




 FHA Lender Update                                           5-12                  December 2009
                                     Loan Fraud and Quality Control

  their actions were acceptable and that HUD had approved the
  downpayment assistance program.

  Neither HUD nor Heartland Funding loan files contained evidence that
  Heartland Funding or Midwest disclosed their affiliated business
  arrangement. In addition, we asked five borrowers participating in the
  Midwest/nonprofit downpayment assistance program whether they were
  aware that such a relationship existed between Heartland Funding and
  Midwest. All five borrowers stated that they were not aware of the
  relationship.

  The HUD-1 settlement statements consistently showed that the sellers
  paid Midwest a service fee of 3.75 to 4 percent of the sales price on all 25
  of the loans reviewed that involved the Midwest/nonprofit entity
  downpayment assistance program. The settlement statements also showed
  that the nonprofit entity donated downpayment assistance funds to the 25
  borrowers, equal to 3 percent of the sales price of the home. However, no
  actual transfer of funds, as depicted on the settlement statements, took
  place. The nonprofit entity’s executive director confirmed to us that it did
  not donate the downpayment assistance funds to the borrowers and,
  therefore, no funds were actually transferred from it to the borrowers.

  Heartland Funding violated RESPA when it allowed Midwest (an
  affiliated business entity controlled by Heartland Funding) to split a
  portion of its fee with the nonprofit entity that performed no services in
  the downpayment assistance transactions. Similarly, Midwest also
  violated RESPA by splitting a portion of its fee with the nonprofit entity,
  knowing that the nonprofit entity performed no services to earn the fee.

  Finding 2: Heartland Funding Did Not Always Follow HUD
  Underwriting Requirements on 27 FHA Loans
  For example, in 25 of the 26 loans with improper downpayment
  assistance funds, Heartland Funding did not ensure that there was an
  actual transfer of funds from the nonprofit donor to the borrower, nor did
  it ensure that the funds came from an acceptable source. HUD requires
  lenders to determine that the downpayment assistance funds ultimately
  were not provided from an unacceptable source and were the donor’s own
  funds. HUD rules further state that the donor cannot be a person or entity
  with an interest in the sale of the property, such as the seller, real estate
  agent or broker, builder, or any entity associated with them.

  Finding 3: Heartland Funding Did Not Fully Comply with HUD’s
  Quality Control and Employee Compensation Requirements
  Heartland Funding did not fully comply with HUD’s quality control
  requirements.

  Heartland Funding’s quality control plan lacked 11 required elements.
  For example, the plan did not require the lender to immediately refer
  findings of fraud or other serious violations to HUD or the Office of
  Inspector General (OIG); identify patterns of early defaults by location,
  program, loan characteristic, loan correspondent, or sponsor; and
  determine the method used to establish appraised values.

  In addition, Heartland Funding did not ensure that its quality control
  reviews met HUD requirements. Specifically, it did not




FHA Lender Update                                           5-13                  December 2009
                                    Loan Fraud and Quality Control

  •   Take corrective actions to reduce quality control deficiencies
      identified by the quality control review process.
  •   Ensure that the quality control reviews included all early defaults.
  •   Ensure that it obtained quality control reports on loans within 90
      days of the loan closings. The lender did not obtain reviews within
      the required timeframe for six months of the audit period.
  •   Document on-site quality control reviews of branch offices.
  •   Ensure that its quality control reviews included a review of at least
      10 percent of the FHA loans closed during that review period. The
      lender did not meet this requirement for two months of the audit
      period.

  Heartland Funding violated HUD requirements by using Internal Revenue
  Service Form 1099 to report loan officer compensation, which identified
  the staff members as independent contractors rather than Internal
  Revenue Service Form W-2 employees.

  We recommend that the Assistant Secretary for Housing – Federal
  Housing
  Commissioner and Chairman, Mortgagee Review Board

  •   1A. Take appropriate sanctions against Heartland Funding for
      violating RESPA.
  •   1B. Refer Heartland Funding to HUD’s Mortgagee Review Board for
      review and appropriate actions.
  •   1C. Require Heartland Funding to make a principal reduction
      totaling $83,755 on the 25 loans that used the improper
      downpayment assistance program. See appendix D for details on the
      recommended reduction for each loan.
  •   1D. Require Heartland Funding to adequately train its managers and
      staff on RESPA requirements.
  •   2A. Require Heartland Funding to indemnify HUD for 17 actively
      insured loans with unpaid principal balances of $1,423,881. The
      projected loss is $533,816 based on the FHA insurance fund average
      loss rate of 39 percent for fiscal year 2007 (see appendix D).
  •   2B. Require Heartland Funding to indemnify HUD for future losses
      on nine loans with unpaid principal balances totaling $929,852, for
      which HUD has not yet sold the property. The projected loss is
      $351,475 based on the FHA insurance fund average loss rate of 39
      percent for fiscal year 2007 (see appendix D).
  •   2C. Require Heartland Funding to reimburse HUD for one loan, for
      which HUD has sold the property and incurred a loss of $54,415 (see
      appendix D).
  •   2D. Require Heartland Funding to ensure that it has adequately
      trained its managers and underwriters on HUD underwriting
      requirements, particularly with regard to downpayment assistance
      funds, income, and liabilities.
  •   3A. Verify that Heartland Funding fully implements a quality control
      program that complies with HUD requirements.
  •   3B. Verify that Heartland Funding has ceased reporting staff
      compensation using Internal Revenue Service Form 1099 and is
      reporting earnings using only Internal Revenue Service Form W-2.




FHA Lender Update                                          5-14               December 2009
                                       Loan Fraud and Quality Control

     ALLIED HOME MORTGAGE CAPITAL CORPORATION
13
     We reviewed Allied, a nonsupervised loan correspondent. The objective
     of the review was to determine the validity of a hotline complaint that
     Allied operated its branches in violation of U. S. Department of Housing
     and Urban Development (HUD) requirements. Specifically, the complaint
     alleged that Allied required its branch managers to enter into certain
     contractual relationships, pay branch operating expenses, and provide
     indemnification for losses and damages, all of which were prohibited
     branch arrangements.

     None of the office space lease agreements for the five branches reviewed
     were in Allied’s name. Instead, the branch managers personally entered
     into and signed the lease agreements. Four of the five branch managers
     had signed month-to-month subleases with Allied to show that Allied was
     paying the operating expenses. However, ultimate responsibility for the
     lease payments continued to rest with the branch manager if Allied
     canceled the sublease.

     In two cases, the branch managers submitted equipment leases in Allied’s
     name: one for 36 months and one for 66 months. However, Allied
     instructed the vendors to remove its name from the equipment leases and
     required that the leases be put in the branch managers’ names. One
     branch also had a utility bill in the branch manager’s name.

     Allied requested a former branch manager use his personal funds to cover
     operational expenses when one branch had an extremely high operating
     account deficit.

     Allied hired an employee who lived in a different state, more than 300
     miles from the HUD approved branch, to initiate loans declined by the
     employee’s husband, who worked at another mortgage company. HUD’s
     policies prohibit taking on an existing, separate mortgage company or
     broker and allowing it to originate insured mortgages under the approved
     lender’s HUD mortgagee number. In addition, this practice is a violation
     of HUD’s rules prohibiting third-party originations of FHA-insured loans.
     The employee also indicated that she would be working for another real
     estate or mortgage company while working for Allied. However, HUD’s
     rules prohibit staff from having outside employment in mortgage lending,
     real estate, or a related field. Allied’s staff determined that the employee
     was ineligible and attempted to stop her from being hired. However,
     Allied’s president overrode internal controls, and she was hired.

     We recommend that HUD’s Assistant Secretary for Single Family
     Housing
     • 1A. Require Allied to immediately discontinue its current practices
        related to office space, utility, and equipment leases/agreements for
        all branch offices, and adopt new practices and controls that require
        Allied to directly enter into those leases and/or agreements.
     • 1B. Require Allied to implement the necessary policies, systems, and
        controls to ensure that it pays all branch operating costs, including
        rental, utility, and telephone expenses.
     • 1C. Require HUD’s Quality Assurance Division to confirm that all
        Allied branch offices have appropriate agreements. For those
        branches that do not comply, take appropriate action to ensure
        compliance including but not limited to prohibiting the branch office


 FHA Lender Update                                            5-15                  December 2009
                                       Loan Fraud and Quality Control

         from originating FHA insured loans, and/or referring Allied to the
         Mortgagee Review Board.
     •   1D. Request the Mortgagee Review Board pursue civil money
         penalties and/or administrative sanctions as appropriate against
         Allied Home Mortgage Capital Corporation for the violations cited in
         this report. We also recommend that the Acting Director of HUD’s
         Departmental Enforcement Center
     •   1E. Pursue civil money penalties and administrative sanctions, as
         appropriate, against the responsible parties for the violations cited in
         this report.


     MIDWEST MORTGAGE CAPITAL
14   Midwest Mortgage Capital (Midwest) is a nonsupervised direct
     endorsement lender based in St. Louis, Missouri. Midwest received
     approval from the Federal Housing Administration (FHA) in November
     of 2001 and currently operates two branch offices in Illinois.

     From January 2007 through December 2008, HUD’s Neighborhood
     Watch system revealed that Midwest approved 867 FHA loans. During
     this same period, 63 of the loans (7.27 percent) were at least 90 days
     delinquent. The national average default rate was 5.23 percent.

     We audited Midwest due to its above-average default rate. During the
     two-year period ending December 2008, Midwest underwrote more than
     860 FHA loans, and 63 of them defaulted.

     Finding 1: Midwest Did Not Adequately Underwrite Seven FHA
     Loans - Underwriting
     Midwest did not adequately underwrite 7 of 29 loans reviewed.

     Credit History/Liabilities
     Midwest did not properly document the credit history and/or liabilities of
     borrowers for five loans. Specifically, the lender failed to obtain
     explanations for derogatory credit, verify the payment of outstanding
     judgments, adequately verify child support obligations, or follow up on
     credit report inquiries. In addition, the lender refinanced a loan when the
     prior month’s payment was outstanding.

     Income
     Midwest did not properly evaluate the income used to compute qualifying
     ratios for one loan. In this case, the lender overstated the borrower’s
     overtime income. When recalculating the overtime income, the
     borrower’s total debt -to-income ratio grossly exceeds HUD’s limit of 43
     percent. This ratio is the total of the mortgage payment and all recurring
     charges divided by the monthly income.

     Qualifying Ratios and Compensating Factors
     Midwest did not provide compensating factors for underwriting a loan
     when the borrower’s total debt-to-income ratio was 51.1 percent and the
     borrower did not have a large amount of assets in reserve or a high
     income level.

     The underwriter did not fully understand HUD’s documentation
     requirements for loan approval. For example, the underwriter did not


 FHA Lender Update                                            5-16                  December 2009
                                    Loan Fraud and Quality Control

  understand that he needed to verify the acceptance of the installment
  agreement by the IRS.

  Finding 2: Midwest’s Quality Control Reviews Were Not Adequate -
  Quality Control
  Midwest’s quality control reviews were inadequate and did not meet
  HUD requirements. Specifically, Midwest did not
  • Perform thorough quality control reviews.
  • Always review 10 percent of loans closed on a monthly basis.
  • Always properly reverify the borrowers’ employment status, income,
      and assets or obtain new credit reports.
  • Document branch site reviews.
  • Semiannually check its employees against the limited denial of
      participation/General Services Administration list.

  Quality Control Reviews Not Thorough
  HUD requires that each loan selected for a quality control review be
  reviewed for compliance with HUD underwriting requirements,
  sufficiency of documentation, and the soundness of underwriting
  judgments. Midwest’s quality control reviews were not thorough and did
  not provide sufficient detail regarding the documents examined and the
  result of the review. The reviewer’s notes on the quality control reports
  primarily concerned differences between the initial and final applications
  and did not analyze the merits of the transaction or draw a conclusion
  about the overall loan quality.

  10 Percent of Loans Closed on a Monthly Basis Not Reviewed
  HUD requires lenders to perform quality control reviews on 10 percent of
  the loans that close in any particular month. Midwest did not always
  perform quality control reviews on 10 percent of the loans that closed on
  a monthly basis. During 2007 and 2008, Midwest closed 1,007 loans and,
  therefore, should have reviewed at least 101 loans. Instead, it reviewed 88
  loans.

  Borrowers’ Employment Status, Income, and Assets Not Always
  Reverified and New Credit Reports Not Always Obtained
  HUD requires Midwest to reverify the employment status, income, assets,
  and credit report of the borrowers selected for quality control reviews.
  During the post closing quality control process, Midwest did not always
  properly reverify the borrowers’ employment status, income, and assets
  or obtain new credit reports. Frequently, Midwest would perform a
  telephone reverification of employment status but could not show
  whether it attempted a written reverification of the borrower’s income
  amount.

  Branch Reviews Not Documented
  HUD requires lenders to periodically review their branch offices for 10
  required elements. Midwest’s president performed these reviews for its
  two branches but was unable to document that he had performed the
  reviews or that the reviews covered the required elements.

  Employee List Not Checked Semiannually
  HUD requires lenders to determine that employees involved in FHA
  transactions are checked against restricted participation lists at least
  semiannually. Midwest only performed this check on an annual basis.
  Midwest also checked some employees, such as loan officers, throughout


FHA Lender Update                                         5-17                  December 2009
                                        Loan Fraud and Quality Control

     the year, but it did not ensure that all employees received a second check
     against the list.

     Midwest did not assign sufficient and knowledgeable staff to the quality
     control function.
     Midwest did not have dedicated quality control staff as loan volumes
     increased.

     Quality control reviews were performed by staff who were not fully
     aware of HUD’s quality control requirements. For example, staff were
     not aware that reverse mortgages should be counted when conducting
     monthly quality control reviews. In addition, contrary to HUD’s stated
     requirements, Midwest did not believe that it was necessary to document
     the branch office reviews. Staff had not received adequate training on
     FHA requirements.

     We recommend that the Assistant Secretary for Housing – Federal
     Housing
     Commissioner require Midwest to:

     •   1A. Indemnify HUD for seven loans with unpaid principal balances
         totaling $1,140,282. The projected loss is $478,918 based on the
         FHA insurance fund average loss rate of 42 percent for fiscal year
         2009. Appendix E lists the seven loans with material underwriting
         deficiencies.
     •   1B. Provide its underwriters with additional training, as approved by
         HUD, that address the deficiencies identified in this finding.
     •   2A. Perform a review of Midwest's quality control function in six
         months to ensure it complies with HUD requirements (including that
         it has reviewed 10 percent of the closed loans) and minimizes the
         risk to HUD's FHA insurance fund.

     HUD’S TOTAL SCORECARD UNDERWRITING
     REQUIREMENTS
15
     FHA’s TOTAL Mortgage Scorecard evaluates the overall
     creditworthiness of the applicants based on a number of credit variables
     and, when combined with the functionalities of the AUS, indicates a
     recommended level of underwriting and documentation to determine a
     loan’s eligibility for insurance by FHA. Taken together, TOTAL and the
     AUS either conclude that the borrowers’ credit and capacity for
     repayment of the mortgage are acceptable or will refer the loan
     application to a Direct Endorsement (DE) underwriter for further
     consideration and review. It is FHA’s policy that no borrower be denied
     a FHA-insured mortgage solely on the basis of a risk assessment
     generated by the TOTAL mortgage scorecard.

     The mortgage credit portion of loan applications that receive an accept or
     approve recommendation (competing AUSs may use either term) need
     not be reviewed by a DE underwriter

     Each AUS using FHA’s Mortgage Scorecard produces a document that
     provides feedback to the lender. The feedback document upon which the
     lender makes its credit decision (typically, the result from the last scoring
     event) must be included in the binder submitted to FHA for insurance
     purposes even if the loan application is referred to a DE underwriter for


 FHA Lender Update                                             5-18                  December 2009
                                       Loan Fraud and Quality Control

     manual underwriting. It is to be placed on the right-hand side of the
     endorsement binder, top sheets.

     Regardless of the risk assessment provided, the lender remains
     accountable for compliance with FHA eligibility requirements, as well as
     for any credit, capacity, and documentation requirements not covered in
     this user guide. A registered DE underwriter must fully underwrite those
     applications where the AUS refers the loan application to an underwriter
     for review and comply with the underwriting requirements described in
     Handbook HUD 4155.1 REV-5, Mortgage Credit Analysis, and
     applicable mortgagee letters and other policy directives.


     LOAN SUBMISSION REQUIREMENTS
16   Please note that although all of the following products and programs are
     eligible for risk assessment using FHA’s TOTAL Mortgage Scorecard, it
     is possible that not all are supported by the AUS. Mortgage lenders will
     need to check the AUS vendor’s user guide for details. The AUS’s
     proprietary user guide will provide the requirements for data input
     specific to that AUS.

     Property and Program Eligibility

     To obtain a credit risk assessment from FHA’s TOTAL Mortgage
     Scorecard, the loan must meet the following FHA eligibility criteria:

     •   Loan Purpose
         - Purchase Money Mortgage
         - Construction-to-Permanent Mortgages
         - Regular Refinance with Credit Qualifying
         - Cash-Out Refinances up to 85 percent of the appraised value
         - Streamline Refinance (both credit qualifying and non-credit
            qualifying, provided sufficient data is entered and verified to
            obtain a risk analysis)
         - Credit Qualifying Assumptions
     •   FHA Insurance Product
         - 203(b)---Standard FHA product for detached dwellings
         - 203(h)---Mortgages for Disaster Victims
         - 234(c)---Unit Mortgages in Condominium Projects
         - 203(k)---Rehabilitation Mortgage Insurance
         - 251---Adjustable Rate Mortgages (ARMs) on single family
            Detached and Condominium Units
         - Energy Efficient Mortgages (EEMs) (see instructions under
            “Income and PITI Information,” below)
         - Section 247---Hawaiian Home Land mortgages
     •   Property Types
         - Single family dwellings of 1- to 4-living units [Note: 3- and 4-
            unit properties have additional underwriting requirements as
            described in Handbook HUD 4155.1 REV-5 which may or may
            not be supported by the AUS]



 FHA Lender Update                                           5-19               December 2009
                                     Loan Fraud and Quality Control

      -   Manufactured homes meeting FHA’s property requirements for
          Title II mortgage insurance
      - Units in Low- and High-Rise Condominium Projects [Note:
          Project must be FHA approved or individual unit must be
          eligible using “spot condo” processing]
  •   Plan Type
      - Fixed Rate Mortgages
      - Adjustable Rate Mortgages, including 1-year ARMs and FHA’s
          hybrid ARMs of 3-, 5-, 7-, and 10-years

  Loan Application Information and Definitions

  The Uniform Residential Loan Application (URLA) captures most of the
  information needed to obtain a risk assessment from an AUS, and a
  completed URLA is required for all FHA insured mortgages. The
  following guidance is to ensure that information entered into the
  LOS/AUS meets FHA eligibility criteria. Income, assets, debts, and other
  credit variables entered into the AUS to obtain a risk assessment
  evaluation using FHA’s TOTAL Mortgage Scorecard must meet FHA’s
  eligibility for that loan application element.

  Type of Mortgage and Terms of Loan

  Section I of the URLA captures data on the Type of Mortgage and Terms
  of the Loan, including interest rate, etc. The interest rate at which the
  loan will close is to be entered in the AUS for qualifying purposes; any
  increase requires a resubmission.

  Property Information/Section II

  This captures information on the property and purpose of the loan.
  Because the maximum insured mortgage is a function of location and the
  number of units, accurately enter the property county and property state
  as listed in the AUS vendor’s Maximum Mortgage Limit Table (if
  provided by the AUS vendor).

  Borrower Information/Section III

  Must include a two-year residency history for each borrower (except for
  streamline refinances of FHA-insured mortgages).


  Employment Information/Section IV

  Must include a two-year employment history for each borrower (except
  for streamline refinances of FHA-insured mortgages).

  Income and Principal, Interest, Taxes and Insurance (PITI)
  Information/Section V

  All income entered into the AUS for risk assessment purposes must meet
  FHA’s requirements for qualifying income (as explained in Handbook



FHA Lender Update                                        5-20                 December 2009
                                     Loan Fraud and Quality Control

  HUD4155.1 REV-5 and applicable mortgagee letters). The lender is
  responsible for ascertaining that the income used in qualifying the
  applicant meets FHA’s criteria for inclusion in the qualifying ratios.

  PITI consists of the items listed below (as well as any other real estate
  owned):
  •   Principal and Interest
  •   Real Estate Taxes (if proposed construction, base estimate on
      property being completed and valued/reassessed by the taxing
      authority)
  •   Hazard Insurance Premiums
  •   Monthly FHA Mortgage Insurance Premiums
  •   Flood Insurance
  •   Ground Rent
  •   Homeowner’s Association Dues/Condominium Fees
  •   Other property related special assessments
  •   Subordinate Financing payments scheduled to begin within three
      years of loan closing

  Assets/Section VI

  Asset documentation must comply with FHA requirements. All asset
  information entered into the AUS must be verifiable and meet FHA
  requirements for eligibility.

  Verified Reserves After Closing are not a requirement for FHA
  underwriting (except on 3- and 4-unit properties), but are nevertheless
  considered in the mortgage evaluation. If not already calculated by the
  LOS, this information should be entered in the appropriate field for the
  automated underwriting database. See Chapter 2 of this User Guide for
  information on what assets may be considered as Reserves for qualifying
  purposes.

  Liabilities Section VI

  Include the following amounts, if applicable, in Total Debt:

  All debts listed on credit report that are not excludable under the
  conditions described below.
  Alimony, child support, separate maintenance agreements. (Note:
  Because of the tax treatment of alimony, the lender may reduce the
  borrower’s monthly gross income by the amount of the alimony payments
  rather than include it as a debt obligation under Total Debt. If this option
  is chosen, do not also include the alimony payment in the data field that
  calculates Total Debt.)
  •   Negative Rent on other real estate owned
  •   Mortgage Debt (PITI) on other real estate owned
  •   Installment debt (Note: Installment debts with fewer than ten
      payments remaining may be excluded from the ratio calculations.
      However, if the AUS indicates that manual underwriting is required,
      then the DE underwriter must determine that short-term debt will not
      negatively affect the borrower’s ability to make mortgage payments



FHA Lender Update                                           5-21                 December 2009
                                    Loan Fraud and Quality Control

      during the early months following loan settlement. See Handbook
      HUD 4155.1 REV-5 for additional information.)
  •   Significant (greater than $100 per month) debt payment not shown
      on the credit report and all debts disclosed by the borrower.
  •   Payment from new debt resulting from material inquiries on credit
      report within 90 days of application. Material inquiries result in
      obligations incurred by the mortgage borrowers and may include
      other mortgages, auto loans and leases, or other installment loans and
      must be considered in the underwriting analysis. Inquiries from
      department stores, credit bureaus, and insurance companies are not
      considered as “material.”
  •   Those debts that must be considered in the qualifying ratios if the
      borrower resides in or the property is located in a community
      property state, per Handbook HUD 4155.1 REV-5.

  Loan Resubmission Requirements
  The lender is responsible for the integrity of the data used to obtain the
  risk assessment, and for resubmitting the loan when material changes are
  discovered or otherwise occur during loan processing. The lender is
  required to resubmit the loan through the automated underwriting system
  for an updated evaluation under any of the conditions described below.
  • Borrowers were either added to or deleted from the loan application.
       Those borrowers shown on the most recent submission into the AUS
       must be the same borrowers who sign the mortgage note/deed of
       trust.
  • Borrower’s income and/or cash assets/reserves decrease.
  • There were changes to the sales price or terms and conditions of the
       mortgage.
  • Any changes are discovered that would negatively affect the
       borrowers’ ability to repay the mortgage.
  • Information about the property valuation changes (e.g., the appraised
       value is determined to be less than the sales price).




FHA Lender Update                                         5-22                 December 2009
                                        Loan Fraud and Quality Control

     UNDERWRITING REQUIREMENTS

     Credit and Capacity to Repay Evaluation
17   FHA’s Mortgage Scorecard evaluates the borrower’s credit history,
     income, cash reserves, and other components of creditworthiness and
     either determines that the borrower is acceptable as a mortgage credit risk
     and may be processed with reduced documentation, or refers the loan
     application to a DE underwriter for his or her personal review and
     evaluation. Items reviewed include:

     •   Adequacy of Income;
     •   Funds to Close and Cash Reserves; and
     •   Credit History

     Risk Classification and Related Responsibilities
     Lenders should also refer to the user guides developed by the AUS
     vendor. However, feedback messages provided by the AUS vendor do
     not supersede the written guidelines issued by FHA in this User Guide.

     “Accept/Approve”
     If the AUS using the TOTAL Mortgage Scorecard rates the mortgage
     loan application as an accept or approve, based on the analysis of the
     credit and capacity to repay and certain other loan characteristics, the loan
     is eligible for FHA’s insurance endorsement provided:
     • The data entered into the AUS are true, complete, properly
           documented, and accurate; and
     • The entire loan package meets all other FHA requirements (except
           for those specifically not required because the loan was evaluated by
           an AUS). FHA requires adherence to all eligibility rules and the
           documentation requirements described elsewhere in this User Guide
           and Handbook HUD 4155.1 REV-5. The DE underwriter need not
           use his or her personal CHUMS identification number on forms
           HUD-92900-WS, 92900-PUR, loan information summary sheet, or
           92900-A and must substitute the CHUMS identifier provided as
           feedback by TOTAL.

     “Approve/Ineligible” Recommendations
     The AUS vendor may also provide “approve/ineligible”
     recommendations. Loans receiving this recommendation have been
     determined to have met FHA’s Mortgage Scorecard threshold but do not
     meet certain FHA eligibility requirements. The vendor will provide
     detailed information advising why the loan did not meet FHA’s eligibility
     requirements. Typical reasons for an “approve/ineligible”
     recommendation include:
     • Loan amount exceeds the FHA maximum;
     • Property type submitted does not correspond to the Section of the
         Act selected in the AUS;
     • Insufficient reserves on a 3- or 4-unit property; and
     • Insufficient funds for closing.

     Loans that receive a recommendation of “approve/ineligible” may still be
     eligible for FHA insurance. To achieve eligibility status, the lender must
     analyze the findings report and determine that the reason for the
     ineligibility is one that can be resolved in a manner complying with FHA
     underwriting requirements. The lender must document the circumstances



 FHA Lender Update                                             5-23                  December 2009
                                       Loan Fraud and Quality Control

     or other reasons that were evaluated in making the decision to approve
     the loan in the remarks section of the mortgage credit analysis worksheet
     (MCAW). The lender is not required to re-underwrite the entire loan, but
     must address each reason the loan received an ineligible recommendation
     and document and explain why it is now eligible for FHA insurance.
     Loans that receive a recommendation of “approve/ineligible” will receive
     the benefit of all other accept or approve documentation and credit policy
     revisions. The CHUMS identifier issued by TOTAL (currently ZFHA)
     may be used as the underwriter on the MCAW for mortgages risk
     classified as “approve/ineligible.”

     The lender may also need to correct the issue(s) that caused the loan to be
     ineligible and resubmit the loan to attempt to obtain an “accept/approve”
     recommendation such as when a mortgage amount exceeds statutory
     limits.

     “Refer”
     The lender using the TOTAL Mortgage Scorecard must conduct a manual
     underwriting review according to FHA requirements for all loan
     applications that generate a “refer” rating. The DE underwriter must
     determine if the borrower is creditworthy in accordance with FHA
     standard credit policies and requirements. It is FHA policy that no
     borrower will be denied a FHA insured mortgage loan solely on the basis
     of a risk assessment generated by the TOTAL Mortgage Scorecard.

     Documentation Requirements
18   All standard FHA documentation requirements must be met, with the
     exception of those described below which may allow for reduced
     documentation sets based upon the risk classification of the loan. The
     lender must also document any situation not addressed in this User Guide
     in accordance with the applicable HUD Handbook or Mortgagee Letter.

     “Faxed” Documents—If income/employment, asset, or other documents
     including various disclosures are “faxed” to and from the lender, the
     documents must clearly identify the employer, depository/investment
     firm’s name, etc., and source of information. The lender is accountable
     for ascertaining the authenticity of the document by examining, among
     other things, the information included at the top or banner portion of the
     fax received by the lender. The document itself must also include a name
     and telephone number of the individual with the employer or financial
     institution that can verify the accuracy of the data.

     Internet Downloads—Income/employment or asset documents
     downloaded from an Internet website must be placed in the case binder in
     paper form. The documents must clearly identify the employer or
     depository/investment firm’s name and source of information. The lender
     is accountable for ascertaining the authenticity of the document by
     examining the information included on any headers, footers, and the
     banner portion of the printouts of the downloaded web page(s). The
     printed web page(s) must also show its Uniform Resource Locator (URL)
     address and the date and time printed.

     Employment /Income
     Specific underwriting requirements for what constitutes acceptable types
19   and sources of income, as well as stability of income requirements are
     described in Chapter 2 of Handbook HUD 4155.1 REV-5. The lender is


 FHA Lender Update                                           5-24                  December 2009
                                   Loan Fraud and Quality Control

  responsible for documenting and verifying the accuracy of the amount of
  income being reported, and for determining if it can be considered as
  effective income in determining the payment-to-income and debt-to-
  income ratios. If any information regarding a borrower’s income or
  employment changes during loan processing, the lender must resubmit
  current, corrected information through the AUS to determine if the risk
  classification changes. Additional documentation may be required for
  borrowers who work for family-owned businesses, as per the mortgage
  credit handbook.


  For loan applications rated as “Accept/Approve”, use      For loan applications rated as “Refer”, use the
  the following to verify employment for employed           following to verify employment for employed
  borrowers:                                                borrowers:

  •   Current Employment---The lender must obtain the       •   Current Employment---The lender must obtain the
      single most recent pay stub (showing year-to-date         single most recent pay stub (showing year-to-date
      earnings of at least one month) and any one of the        earnings of at least one month) and any one of the
      following to verify current employment:                   following to verify current employment:

      •   Written Verification of Employment (VOE)              •   Written Verification of Employment (VOE)
      •   Verbal verification of employment (Lender or          •   Verbal verification of employment (Lender or
          service provider must document individual                 service provider must document individual
          verifying the employment.)                                verifying the employment.)
      •   Electronic verification acceptable to FHA             •   Electronic verification acceptable to FHA

  •   Employment History---The lender is required to        •   Employment History---The lender is required to
      verify the applicant’s employment history for the         verify the applicant’s employment history for the
      previous two years. However, direct verification is       previous two years. Obtain one of the following for
      not required if all of the following conditions are       the most recent two years to verify the applicant’s
      met:                                                      employment history:
      • The current employer confirms a two-year                • W-2(s)
           employment history (this may include a               • VOE(s)
           paystub indicating a hiring date)                    • Electronic verification acceptable to FHA
      • Only base pay is used to qualify (no overtime
           or bonuses)
      • The borrower signs form IRS 4506 or 8821 for
           the previous two tax years.

      If the applicant has not been employed with the
      same employer for the previous two years and/or all
      conditions immediately above cannot be met, then
      the lender must obtain one of the following for the
      most recent two years to verify the applicant’s
      employment history:
      • W-2(s)
      • VOE(s)
      • Electronic verification acceptable to FHA




FHA Lender Update                                        5-25                                      December 2009
                                       Loan Fraud and Quality Control

20       Asset Information

     If the loan application is rated as an                        If the loan application is rated as a “Refer”,
     “Accept/Approve”, document the borrower’s assets to           document the borrower’s assets to close and cash
     close and cash reserves, if any, using the following:         reserves, if any, using the following:


     •   Depository Accounts---If a Verification of Deposit        •   Depository Accounts---If a Verification of Deposit
         (VOD) is not obtained, then provide a statement               (VOD) is not obtained, then provide a statement
         showing the previous month’s ending balance for               showing the previous month’s ending balance for
         the most recent month. If the previous month’s                the most recent two months. If the previous
         balance is not shown, then obtain statement(s) for            month’s balance is not shown, then obtain
         the most recent two months to verify sufficient               statement(s) for the most recent three months to
         funds to close.                                               verify sufficient funds to close.

     •   Cash Reserves---Verify all cash reserves available        •   Cash Reserves---Verify all cash reserves available
         after closing that are submitted to the AUS. Note             after closing that are submitted to the AUS. Note
         that cash reserves after closing are not required on          that cash reserves after closing are not required on
         FHA mortgages (except when purchasing 3- or 4-                FHA mortgages (except when purchasing 3- or 4-
         unit properties) but are evaluated in determining the         unit properties) but are evaluated in determining the
         risk classification of the loan.                              risk classification of the loan.

         Cash reserves may include certain retirement                  Cash reserves may include certain retirement
         accounts. To account for withdrawal penalties and             accounts. To account for withdrawal penalties and
         taxes, only 60% of the vested amount of the account           taxes, only 60% of the vested amount of the account
         may be used. The lender must document the                     may be used. The lender must document the
         existence of the account with the most recent                 existence of the account with the most recent
         depository or brokerage account statement. In                 depository or brokerage account statement. In
         addition, evidence must be provided that the                  addition, evidence must be provided that the
         retirement account allows for withdrawals for                 retirement account allows for withdrawals for
         conditions other than in connection with the                  conditions other than in connection with the
         borrower's employment termination, retirement, or             borrower's employment termination, retirement, or
         death. If withdrawals can only be made under these            death. If withdrawals can only be made under these
         circumstances, the retirement account may not be              circumstances, the retirement account may not be
         included as cash reserves. If any of these funds are          included as cash reserves. If any of these funds are
         also to be used for loan settlement, that amount              also to be used for loan settlement, that amount
         must be subtracted from the amount included as                must be subtracted from the amount included as
         cash reserves.                                                cash reserves. Note: To be considered as a
                                                                       compensating factor when manually underwriting,
                                                                       there must be three months’ worth of such reserves.

     •   Gift Funds---The borrower must list the name,             •   Gift Funds---The borrower must list the name,
         address, telephone number, relationship to the                address, telephone number, relationship to the
         homebuyer, and the dollar amount of the gift on the           homebuyer, and the dollar amount of the gift on the
         loan application or in a gift letter for each cash gift       loan application or in a gift letter for each cash gift
         received. If sufficient funds required for closing are        received. If sufficient funds required for closing are
         not already verified in the borrower’s accounts,              not already verified in the borrower’s accounts,
         document the transfer of the gift funds to the                document the transfer of the gift funds to the
         homebuyer in accordance with instructions                     homebuyer in accordance with instructions
         described in Handbook HUD 4155.1 REV-5.                       described in Handbook HUD 4155.1 REV-5.
         [Note: No form of secondary financing, with or                [Note: No form of secondary financing, with or
         without required payments, is to be shown as “gifts”          without required payments, is to be shown as “gifts”
         in any AUS.]                                                  in any AUS.]




FHA Lender Update                                             5-26                                          December 2009
                                       Loan Fraud and Quality Control

     •   Stock and/or Bond Accounts—Obtain brokerage              •   Stock and/or Bond Accounts—Obtain brokerage
         statement(s) for each account for the most recent            statement(s) for each account for the most recent
         two months. Evidence of liquidation is not                   three months. Evidence of liquidation is required if
         required.                                                    used for cash to close.

     •   Retirement Accounts---Obtain the most recent             •   Retirement Accounts---Obtain the most recent
         statements for each account to verify sufficient             statements for each account to verify sufficient
         funds to close. Document the terms and conditions            funds to close. Document the terms and conditions
         for withdrawal and/or borrowing and that the                 for withdrawal and/or borrowing and that the
         borrower is eligible for these withdrawals. Use only         borrower is eligible for these withdrawals. Use only
         60 percent of the amount in the account unless the           60 percent of the amount in the account unless the
         borrower presents documentation supporting a                 borrower presents documentation supporting a
         greater amount after subtracting any taxes or                greater amount after subtracting any taxes or
         penalties for early withdrawal. Evidence of                  penalties for early withdrawal. Evidence of
         liquidation is not required.                                 liquidation is not required.

     •   Sale of Home---Obtain a HUD-1 or equivalent              •   Sale of Home---Obtain a HUD-1 or equivalent
         closing statement. If the borrower is being                  closing statement. If the borrower is being
         transferred by his or her company under a                    transferred by his or her company under a
         guaranteed sales plan, obtain an executed buyout             guaranteed sales plan, obtain an executed buyout
         agreement and accompanying settlement statement              agreement and accompanying settlement statement
         indicating that the employer or relocation service           indicating that the employer or relocation service
         takes responsibility for the outstanding mortgage            takes responsibility for the outstanding mortgage
         debt.                                                        debt.

     •   Sale of Assets---If an asset other than real estate or   •   Sale of Assets---If an asset other than real estate or
         exchange-traded securities is sold to accumulate             exchange-traded securities is sold to accumulate
         funds to close the mortgage, obtain a bill of sale and       funds to close the mortgage, obtain a bill of sale and
         evidence of proceeds, or document the existence,             evidence of liquidation.
         value, and buyer’s intention to purchase. Evidence
         of liquidation is not required.

     •   Earnest Money and Other Large Deposits---                •   Earnest Money and Other Large Deposits---
         Obtain an explanation and documentation for recent           Obtain an explanation and documentation for recent
         large deposits in excess of 2 percent of the                 large deposits in excess of 2 percent of the
         property’s sales price, including the earnest money          property’s sales price, including the earnest money
         deposit. Also verify that any recent debts were not          deposit. Also verify that any recent debts were not
         incurred to obtain part or all of the required cash          incurred to obtain part or all of the required cash
         investment on the property being purchased.                  investment on the property being purchased.

     Credit Report Processing and Reconciliation Information
21
     The lender is responsible for reviewing all credit reports for all
     borrowers. Lenders may choose to document each borrower’s credit
     history by obtaining credit reports through the AUS vendor, or separately
     through an independent source, depending on the chosen AUS. The
     vendor will determine the options available to the lender, including use of
     in-file credit reports, merged credit reports, and Residential Mortgage
     Credit Reports (RMCRs).

     In the event that derogatory or delinquent credit items are revealed during
     processing that are not reflected on the credit report and, thus, were not
     considered by the scorecard, downgrade to a Refer and manually
     underwrite the loan. Derogatory credit items that could conceivably not
     appear on the credit report and must result in a downgrade include but are
     not limited to:


 FHA Lender Update                                            5-27                                        December 2009
                                        Loan Fraud and Quality Control


     •   Bankruptcy, foreclosure, collection account, charge-off, tax lien, or
         judgment; and
     •   Any mortgage trade line including mortgage line-of-credit payments,
         during the most recent 12 months, consisting of:
             - 3 or more late payments of greater than 30 days, or
             - 1 or more late payments of 60 days plus 1 or more 30-day
                  late payments, or
             - 1 payment greater than 90 days late.

     SYSTEM OVERRIDES AND MANUAL DOWNGRADES

22   A system override occurs when a loan application variable triggers a
     requirement (a “review rule”) that an underwriter review the loan file. A
     manual downgrade becomes necessary if additional information, not
     considered in the AUS decision, affects the overall insurability or
     eligibility of a mortgage otherwise rated as an accept or approve. Both
     system overrides and manual downgrades may be triggered by
     inaccuracies in credit reporting, by eligibility issues, and for other reasons
     including the unlikely failure of the TOTAL Mortgage Scorecard or AUS
     to recognize a derogatory credit variable. Unless specifically permitted to
     continue to use the “accept/approve” documentation class, such as
     following a favorable resolution of a credit issue due to an error in
     reporting, the lender must document as a “refer” risk class and is
     accountable for the credit and ratio warranties on these loans. If the AUS
     the lender is using does not provide for a system override for any of the
     conditions shown below, then the lender is required to manually
     downgrade the loan to a “refer” under any of the following conditions:

     FEDERAL ELIGIBILITY
     Certain individuals may not be eligible for federal benefits due to
     delinquent federally-related obligations or actions taken by a federal
     government agency. If a borrower is discovered to be ineligible due to
     any of the conditions described below, the lender must downgrade the
     loan to a Refer status (if the AUS does not do so) and determine what
     actions—if any—may be taken to allow the borrower to qualify for the
     mortgage. If it is determined that the information originally relied on to
     determine a borrower to be ineligible was erroneous, the lender may
     document the file accordingly and if the loan application is rated as an
     “accept/approve,” use the credit waivers and reduced documentation
     accordingly.

     Delinquent Federal Debt
     If the borrower, as revealed by public records, credit information, or
     HUD’s Credit Alert Interactive Voice Response System (CAIVRS), is
     presently delinquent on any federal debt, the borrower is not eligible for a
     mortgage insured by FHA. See Chapter 2 of Handbook HUD 4155.1
     REV-5 for details.

     CAIVRS
     If CAIVRS indicates a federal delinquency, default, claim payment, or
     lien, the borrower is not eligible for additional federally related credit.
     Exceptions and error resolution are discussed in Chapter 2 of Handbook
     HUD 4155.1 REV-5. A check of CAIVRS is not required for streamline
     refinances.


 FHA Lender Update                                             5-28                   December 2009
                                    Loan Fraud and Quality Control


  We do not require a "clear" CAIVRS access number as a condition for
  mortgage endorsement, but the lender must document and justify its
  approval based on the exceptions described in the handbook or otherwise
  provide documentation proving erroneous or outdated information
  residing in CAIVRS.

  Suspended and Debarred Individuals
  A borrower suspended, debarred, or otherwise excluded from
  participation in the Department's programs is not eligible for a FHA-
  insured mortgage. Both the General Services Administration (GSA) “List
  of Parties Excluded from Federal Procurement and Non-Procurement
  Programs” and HUD’s Limited Denial of Participation (LDP) list are
  available through the FHA Connection.

  CREDIT ISSUES

  Previous mortgage foreclosure
  A borrower whose previous residence or other real property was
  foreclosed on or has given a deed-in-lieu of foreclosure within the
  previous three years is generally not eligible for an insured mortgage. If
  the lender chooses to continue processing and manually underwrite the
  loan application, it must refer to Handbook HUD 4155.1 REV-5 for
  exceptions and additional underwriting requirements.

  Provided that the foreclosure was completed at least three years
  previously and the risk-classification from TOTAL is an
  “accept/approve,” no further documentation regarding the foreclosure is
  required.

  Bankruptcy
  Both Chapter 7 liquidations and Chapter 13 bankruptcies discharged
  within two years of loan application require a referral to an underwriter
  and compliance with the instructions regarding bankruptcies described in
  Handbook HUD 4155.1 REV-5. A borrower whose bankruptcy has been
  discharged less than one year is not eligible for FHA mortgage insurance
  (except on non-credit qualifying streamline refinances).

  Provided that the bankruptcy was discharged at least two years previously
  and the risk-classification from TOTAL is an “accept/approve,” no
  further documentation regarding the bankruptcy is required.

  Late Mortgage Payments
  If any mortgage trade line including mortgage line-of-credit payments,
  during the most recent 12 months, shows:
       - 3 or more late payments of greater than 30 days; or
       - 1 or more late payments of 60 days plus one or more 30-day late
           payments; or
       - 1 payment greater than 90 days late,
  then loan application must be referred to a DE underwriter for review.

  Disputed Accounts
  If the credit report reveals that the borrower is disputing any credit
  accounts or public records, the mortgage application must be referred to a
  DE underwriter for review.



FHA Lender Update                                          5-29                December 2009
                                       Loan Fraud and Quality Control


     ENDORSEMENT PROCEDURES
23
     The loan is eligible for FHA insurance endorsement if:
     • The TOTAL Mortgage Scorecard rated the mortgage loan
         application as an “accept” or “approve”, or if a “refer”, the DE
         Underwriter manually underwrote and approved the mortgage
         application; and
     • The data entered into the AUS are true, complete, and accurate; and
     • The entire loan package meets all other FHA requirements (except
         for those specifically not required because the loan was evaluated by
         TOTAL).

     Underwriter Responsibilities

                            24                                                          25
     For mortgages receiving an “Accept/Approve”:                For mortgages receiving a “Refer”
     • The DE underwriter is not required to personally          • The DE underwriter is required to underwrite both
         review the credit and/or qualifying ratios;                 credit and capacity according to standard FHA
                                                                     guidelines;
     •   The DE underwriter is not required to certify that      • The DE underwriter is required to certify that the
         the borrower’s credit and capacity meets standard           borrower’s credit and capacity meet standard FHA
         FHA requirements;                                           requirements;

     •   The TOTAL Mortgage Scorecard CHUMS number               •   The CHUMS number of the DE underwriter is to be
         is to be recorded on form HUD-92900-A and the               recorded on form HUD-92900-A and the mortgage
         mortgage credit analysis worksheet; and                     credit analysis worksheet;

     •   The DE underwriter must underwrite the appraisal        •   The DE underwriter must underwrite the appraisal
         according to standard FHA requirements.                     according to standard FHA requirements.


     MANUAL UNDERWRITING REQUIREMENTS OF HANDBOOK
26   4155.1 REV 5
     Occupancy Status - At least one borrower must occupy the property and
     sign the security instrument and the mortgage note for the property to be
     considered owner-occupied. To prevent circumvention of the restrictions
     on FHA-insured mortgages to investors, we generally will not insure
     more than one mortgage for any borrower. We do not object to
     homebuyers using FHA mortgage insurance more than once if compatible
     with the homebuyer’s needs and resources as follows:

     A. Relocations
     B. Increase in family size (pay done current FHA mortgage to 75%
        LTV
     C. Vacating a jointly-owned property (still occupied by a co-borrower)
     D. Non-occupying Co-borrower (joint interest)

     Secondary Residences – Secondary residences are only permitted when
     the appropriate Home Ownership Center (HOC) agrees that an undue
     hardship exists, meaning that affordable rental housing that meets the
     needs of the family is not available for lease in the area or within
     reasonable commuting distance to work, and the maximum loan amount
     is 85 percent of the lesser of the appraised value or sales price. Direct



 FHA Lender Update                                            5-30                                     December 2009
                                       Loan Fraud and Quality Control

     Endorsement (DE) lenders are not authorized to grant hardship
     exceptions.

     A. The secondary residence must not be a vacation home or otherwise
     used primarily for recreational purposes; and

     B. The borrower must obtain the secondary residence because of
     seasonal employment, employment relocation, or other circumstances not
     related to recreational use of the residence; and

     C. There must be a demonstrated lack of affordable rental housing
     meeting the needs of the borrower in the area or within a reasonable
     commuting distance of the borrower's employment. Documentation to
     support this must include:
         1. A satisfactory explanation from the borrower of the need for a
              secondary residence and the lack of available rental housing in
              the area that meets the need.
         2. Written evidence from local real estate professionals who verify
              a lack of acceptable rental housing in the area.

     Maximum Mortgage Amount - The maximum insurable mortgage is the
27   lesser of: (1) the statutory loan limit for the area (typically a county or
     metropolitan statistical area (MSA)) or (2) the applicable loan-to-value
     (LTV) limit.

     Most FHA mortgages require payment of an upfront mortgage insurance
     premium (UFMIP). The statutory loan amount and loan-to-value limits
     described in this Handbook do not include the UFMIP. All descriptions of
     maximum insurable mortgages throughout this Handbook, unless
     otherwise stated, exclude UFMIP.

     Except for certain property and transaction types as described in 1-8
     below, the lower of the adjusted sales price or the appraised value is
     multiplied by the factor shown in the chart below. The resulting amount
     is the maximum loan that FHA will insure provided that the mortgagor
     has made a cash investment of at least three percent of the contract sales
     price.




 FHA Lender Update                                            5-31                 December 2009
                                    Loan Fraud and Quality Control




  TRANSACTIONS THAT AFFECT MAXIMUM MORTGAGE
  CALCULATIONS
  Certain types of loan transactions affect the amount of financing available
  and the calculation of the maximum mortgage.

  A. Identity-of-Interest Transactions. Identity-of-interest transactions on
  principal residences are restricted to a maximum LTV ratio of 85 percent.
  Identity-of-interest is defined as a sales transaction between parties with
  family relationships or business relationships. However, maximum
  financing above 85 percent LTV is permissible under the following
  circumstances:
  1. A family member purchases another family member's home as a
       principal residence. If a property is sold from one family member to
       another and is the seller's investment property, the maximum
       mortgage is the lesser of either:
       a. 85 percent of the appraised value, or
       b. The appropriate LTV ratio percentage applied to the sales price,
            plus or minus required adjustments.
            The 85 percent limit may be waived if the family member has
            been a tenant in the property for at least six month immediately
            predating the sales contract. A lease or other written evidence
            must be submitted to verify occupancy.
  2. An employee of a builder purchases one of the builder's new homes
       or models as a principal residence.
  3. A current tenant purchases the property that he or she has rented for
       at least six months immediately predating the sales contract. (A lease
       or other written evidence must be submitted to verify occupancy.)
  4. A corporation transfers an employee to another location, purchases
       that employee’s home, and then sells the home to another employee.

  B. Non-Occupying Borrowers. When there are two or more borrowers,
  but one or more will not occupy the property as a principal residence, the
  maximum mortgage is limited to a 75 percent LTV.




FHA Lender Update                                         5-32                  December 2009
                                       Loan Fraud and Quality Control

     C. Three- and Four-Unit Properties. Regardless of occupancy status,
     the property must be self-sufficient (i.e., the maximum mortgage is
     limited so that the ratio of the monthly mortgage payment, divided by the
     monthly net rental income, does not exceed 100 percent).

     D. Building on Own Land. If the borrower acts as a general contractor,
     and builds a house on land that the borrower already owns, or acquires
     land separately, maximum financing is available if the borrower receives
     no cash from the settlement.

     E. Paying Off Land Contracts. If the borrower will use the loan to
     complete payment on a land contract, contract for deed, or other similar
     type financing arrangement in which the borrower does not have title to
     the property, the new mortgage may be processed as either a purchase or
     a refinance transaction with maximum FHA-insured financing if the
     borrower receives no cash at closing.

     F. Properties Under Construction or Existing Construction Less than
     One Year Old
     Properties not meeting the criteria shown below are considered as under
     construction or existing construction-less than one year old and are
     limited to 90 percent financing, i.e., 90 percent of the lesser of the
     appraiser’s estimate of value or sales price, plus or minus the adjustments
     required by paragraph 1-7, A-C.


     1-9 SETTLEMENT REQUIREMENTS. For each transaction, the
28   lender must estimate the settlement requirements to determine the cash
     required to close the mortgage transaction.

     A. Closing Costs. These include those FHA-approved non-recurring
     costs associated with the mortgage transaction, including the appraisal
     fee, any inspection fees, the actual cost of credit reports, the loan
     origination fee, settlement fee, deposit verification fees, home inspection
     service fees up to $300, the cost of title examination and title insurance,
     document preparation fees (if performed by a third-party not controlled
     by the lender), property survey fees, attorney's fees, recording fees,
     transfer stamps, and taxes, as well as test and certification fees, such as
     flood-zone determination fees, water tests, and other costs as determined
     by the appropriate HOC.

     B. Prepaid Items. Prepaid items are collected at closing to cover accrued
     and unaccrued hazard insurance and mortgage insurance premiums, taxes
     and per diem interest, and include other similar fees and charges. The
     lender must use a minimum of 15 days of per diem interest in its estimate
     of prepaid items.

     C. Discount Points. Discount points that are being paid by the borrower
     become part of the total cash investment but are not eligible for meeting
     the minimum cash investment requirement.

     D. Non-Realty (Chattel) or Personal Property.

     E. Closing Costs Not Eligible for Meeting the Cash Investment
     Requirement.




 FHA Lender Update                                            5-33                 December 2009
                                    Loan Fraud and Quality Control

  F. UFMIPs.

  G. Repairs and Improvements.

  H. Real Estate Broker Fees. If the borrower is represented by a real
  estate buyer-broker and must pay a fee directly to the broker, that expense
  must be included in the total of the borrower's settlement requirements
  and appear on the HUD-1 Settlement Statement. If the seller pays the
  buyer-broker fee as part of the sales commission, this is not to be
  considered an inducement to purchase or part of the 6 percent seller
  contributions limitation, provided that the seller is paying only the normal
  sales commission typical of that market. The lender must obtain a copy of
  the original listing agreement and compare it with the HUD-1 Settlement
  Statement to determine if the seller paid a buyer-broker fee in addition to
  the normal sales commission for that market. If the seller paid an
  additional commission for the buyer-broker fee, then this is considered an
  inducement to purchase.

  I. Mortgage Broker Fees. If the borrower must pay a fee directly to a
  mortgage broker, that expense must be included in the total of the
  borrower's cash settlement requirements and appear on the HUD-1
  Settlement Statement. (This requirement applies to instances in which the
  borrower independently engages a mortgage broker to seek financing and
  pays the broker directly. The payment may not come from the lending
  institution.)

  J. Premium Pricing on FHA Insured Mortgages. Lenders may pay the
  borrower's allowable closing costs and/or prepaid items by "premium
  pricing”. Closing costs paid in this manner need not be included as part of
  the 6 percent seller contribution limit. The funds derived from a premium
  priced mortgage:
  1. May never be used to pay any portion of the borrower's
       downpayment.
  2. Must be disclosed on the Good-Faith Estimate (GFE) and the HUD-1
       Settlement Statement. The GFE and HUD-1 must include an
       itemized statement indicating which items are being paid on the
       borrower's behalf; disclosing only a lump sum is not acceptable.
       Also, the amount paid on the borrower's behalf for each item may not
       exceed the allowable fee permitted by the jurisdictional HOC.
  3. Must be used to reduce the principal balance if the premium pricing
       agreement establishes a specific dollar amount for closing costs and
       prepaid expenses with any remaining funds, in excess of actual costs,
       reverting to the borrower.
  4. May not be used for payment of debts, collection accounts, escrow
       shortages or missed mortgage payments, or judgments.

  K. Yield Spread Premiums. Yield spread premiums (YSP) are not part
  of the cash required to close but must be disclosed to borrowers on the
  Good Faith Estimate (GFE) and HUD-1 Settlement Statement in
  accordance with the Real Estate Settlement Procedures Act (RESPA)
  requirements.




FHA Lender Update                                          5-34                  December 2009
                                        Loan Fraud and Quality Control

     1-11 MORTGAGE AMOUNTS ON REFINANCES.
     "No Cash-Out" Refinances with Appraisals (Credit Qualifying). The
     maximum mortgage is the lower of the loan-to-value or the existing debt
29
     calculation described below, and may never exceed the statutory limit
     except by the amount of any new upfront MIP:

     1-12 STREAMLINE REFINANCES. Streamline refinances are
     designed to lower the monthly principal and interest payments on a
     current FHA-insured mortgage and must involve no cash back to the
     borrower, except for minor adjustments at closing not to exceed $250.
     Streamline refinances can be made with or without an appraisal. On
     streamline refinances with an appraisal, Form HUD 92564-VC is
     required, but the Homebuyer Summary is not required. FHA does not
     require repairs to be completed (except for lead-based paint repairs) on
     streamline refinances with appraisals; however, the lender may require
     completion of repairs as a condition of the loan.

     MORTGAGE CREDIT ANALYSIS
30   2-1 OVERVIEW. The purpose of underwriting is to determine a
     borrower’s ability and willingness to repay the mortgage debt, thus
     limiting the probability of default and collection difficulties, and to
     examine the property offered as security for the loan to determine if it is
     sufficient collateral. The “Four C’s of Credit” (Credit history, Capacity to
     repay, Cash to close, and the Collateral) are evaluated during the
     underwriting process.

     2-2 MORTGAGE ELIGIBILITY (BORROWERS). Generally, we
     will insure mortgages made to individuals only. Under the conditions
     described in Chapter 1, we will also insure mortgages made to state and
     local government agencies and approved nonprofit organizations.

     A. Borrowers, Co-Borrowers and Co-Signers. Borrowers and
     Coborrowers take title to the property and are obligated on the mortgage
     note and must also sign the security instrument. The co-borrower’s
     income, assets, liabilities, and credit history are considered in determining
     creditworthiness.

     Co-signers do not hold ownership interest in a property, but are liable for
     repaying the obligation and must sign all documents with the exception of
     the security instruments. The co-signer's income, assets, liabilities, and
     credit history are considered in determining creditworthiness for the
     mortgage and the co-signer must complete and sign the loan application.

     The following conditions also apply to co-borrower and co-signer
     eligibility:

     1.   A co-borrower or a co-signer may not be a party that has a financial
          interest in the transaction, such as the seller, builder, real estate
          agent, etc. Exceptions may be granted if the seller and coborrower/
          co-signer is related to the owner by blood, marriage or law.
     2.   An individual signing the loan application must not be otherwise
          ineligible for participation. (See paragraph 2-5).
     3.   Unless otherwise exempted (e.g., military service with overseas
          assignments, U.S. citizens living abroad), any non-occupying




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      coborrowers or co-signers must have a principal residence in the
      United States.

  B. Citizenship and Immigration Status. Citizenship of the United
  States is not required for eligibility. When a mortgage loan applicant
  indicates on the loan application that he or she holds something other than
  U.S. citizenship, the lender must determine residency status from the
  documentation provided by the borrower.

  Lawful Permanent Resident Aliens: For those borrowers with lawful
  permanent resident alien status, FHA will insure the mortgage under the
  same terms and conditions as U.S. citizens. The lender must document
  the mortgage file with evidence of permanent residency and indicate on
  the Uniform Residential Loan Application (URLA) that the borrower is a
  lawful permanent resident alien. Evidence of lawful permanent residency
  is issued by the Bureau of Citizenship and Immigration Services (BCIS)
  (formerly the Immigration and Naturalization Service) within the
  Department of Homeland Security.

  Non-Permanent Resident Aliens: FHA will also insure a mortgage made
  to a non-permanent resident alien provided that the property will be the
  borrower's principal residence, the borrower has a valid SSN, and the
  borrower is eligible to work in the U.S. as evidenced by an Employment
  Authorization Document (EAD) issued by BCIS. If the authorization for
  temporary residency status will expire within one year and a prior history
  of residency status renewals exists, the lender may assume continuation
  will be granted. If there are no prior renewals, the lender must determine
  the likelihood of renewal, based on information from the BCIS.

  C. Borrower's Age. There is no maximum age limit for a borrower. The
  minimum age is the age at which the mortgage note can be enforced
  legally in the state or other jurisdiction in which the property is located.

  D. Non-Purchasing Spouses. If required by state law in order to perfect
  a valid and enforceable first lien, the non-purchasing spouse may be
  required to sign either the security instrument or documentation
  evidencing that he or she is relinquishing all rights to the property. If the
  non-purchasing spouse executes the security instrument for such reasons,
  he or she is not considered a borrower for our purposes and need not sign
  the loan application. In all other cases, the non-purchasing spouse is not
  to appear on the security instrument or otherwise take title to the property
  at loan settlement.

  E. Military Personnel. Military personnel are considered occupant-
  owners and are eligible for maximum financing if a member of the
  immediate family will occupy the property as a principal residence, even
  if the service person is stationed elsewhere.

  F. Living Trusts. Property held in a living trust is eligible for FHA
  mortgage insurance for owner-occupied property, as long as an individual
  borrower remains the beneficiary and occupies the property as a principal
  residence. The lender must be satisfied that the trust provides reasonable
  means to assure that the lender will be notified of any subsequent change
  of occupancy (for owner-occupant loans only) or transfer of beneficial
  interest. The trust must appear on the security instrument (i.e., mortgage,
  deed of trust, security deed). The individual borrower must appear on the


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       security instrument when required to create a valid lien under state law;
       otherwise, the individual borrower is not required to appear.


       2-3 ANALYZING THE BORROWER’S CREDIT. Past credit
       performance serves as the most useful guide in determining a borrower’s
31     attitude toward credit obligations and predicting a borrower’s future
       actions. A borrower who has made payments on previous and current
       obligations in a timely manner represents reduced risk. Conversely, if the
       credit history, despite adequate income to support obligations, reflects
       continuous slow payments, judgments, and delinquent accounts, strong
       compensating factors will be necessary to approve the loan.

       When analyzing a borrower's credit history, examine the overall pattern
       of credit behavior, rather than isolated occurrences of unsatisfactory or
       slow payments. A period of financial difficulty in the past does not
       necessarily make the risk unacceptable if the borrower has maintained a
       good payment record for a considerable time period since the difficulty.

       While minor derogatory information occurring two or more years in the
       past does not require explanation, major indications of derogatory credit–
       including judgments, collections, and any other recent credit problems–
       require sufficient written explanation from the borrower.

       Neither the lack of credit history nor the borrower's decision not to use
       credit may be used as a basis for rejecting the loan application.

       When reviewing the borrower's credit and credit report, the lender must
       pay particular attention to the following:

       A. Previous Rental or Mortgage Payment History. The payment
       history of the borrower's housing obligations holds significant importance
       in evaluating credit. The lender must determine the borrower's payment
32     history of housing obligations through either the credit report, verification
       of rent directly from the landlord (with no identity-of-interest with the
       borrower) or verification of mortgage directly from the mortgage
       servicer, or through canceled checks covering the most recent 12-month
       period.

       B. Recent and/or Undisclosed Debts. The lender must ascertain the
       purpose of any recent debts, as the indebtedness may have been incurred
       to obtain part of the required cash investment on the property being
       purchased. Similarly, the borrower must provide a satisfactory
       explanation for any significant debt that is shown on the credit report but
       not listed on the loan application. The borrower must explain in writing
       all inquiries shown on the credit report in the last 90 days.

       C. Collections and Judgments. Court-ordered judgments must be paid
       off before the mortgage loan is eligible for FHA insurance endorsement.
       (An exception may be made if the borrower has agreed with the creditor
       to make regular and timely payments on the judgment and documentation
       is provided that the payments have been made in accordance with the
       agreement.) FHA does not require that collection accounts be paid off as
       a condition of mortgage approval. The borrower must explain in writing
       all collections and judgments.




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     D. Previous Mortgage Foreclosure. A borrower whose previous
     principal residence or other real property was foreclosed or has given a
     deed-in-lieu of foreclosure within the previous three years is generally not
     eligible for a new FHA-insured mortgage. However, if the foreclosure
     was the result of documented extenuating circumstances that were
     beyond the control of the borrower and the borrower has re-established
     good credit since the foreclosure, the lender may grant an exception to the
     three-year requirement. Extenuating circumstances include serious illness
     or death of a wage earner, but do not include the inability to sell the house
     because of a job transfer or relocation to another area.

     E. Bankruptcy. A Chapter 7 bankruptcy (liquidation) does not
     disqualify a borrower from obtaining an FHA-insured mortgage if at least
     two years have elapsed since the date of the discharge of the bankruptcy.
     Additionally, the borrower must have re-established good credit or
     chosen not to incur new credit obligations. The borrower also must have
     demonstrated a documented ability to responsibly manage his or her
     financial affairs. An elapsed period of less than two years, but not less
     than 12 months, may be acceptable if the borrower can show that the
     bankruptcy was caused by extenuating circumstances beyond his or her
     control and has since exhibited a documented ability to manage his or her
     financial affairs in a responsible manner. Additionally, the lender must
     document that the borrower’s current situation indicates that the events
     that led to the bankruptcy are not likely to recur.

     F. Consumer Credit Counseling Payment Plans. Participation in a
     consumer credit counseling payment program does not disqualify a
     borrower from obtaining an FHA-insured mortgage provided the lender
     documents that one year of the pay-out period has elapsed under the plan
     and the borrower’s payment performance has been satisfactory (i.e., all
     required payments made on time). In addition, the borrower must receive
     written permission from the counseling agency to enter into the mortgage
     transaction.



     2-4 CREDIT REPORT REQUIREMENTS.
33   A. Traditional Credit Reports. Credit reports submitted with each loan
     must contain all credit available in the accessed repositories. They also
     must provide an account of all credit, residence history, and public
     records information available in the credit repositories of each borrower
     responsible for the mortgage debt. The minimum credit report required by
     FHA is a "three repository merged" credit report (TRMCR). A
     Residential Mortgage Credit Report (RMCR) from an independent
     consumer-reporting agency also may be used. One report is required for
     each borrower, or a joint report may be obtained for a married couple.

     The following are requirements for traditional credit reports:
     1. The TRMCR submitted must be an original received electronically
         and printed on the lender's printer or delivered by the credit reporting
         agency. The report must not have whiteouts, erasures, or alterations.
         It must indicate the name, address, and telephone number of the
         consumer-reporting agency; and each account listed must show the
         primary repository from which the particular information was pulled.
         The name of the company ordering the report must be shown.




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     2.   The credit report must include all credit and legal information not
          considered obsolete under the Fair Credit Reporting Act, including
          bankruptcies, judgments, law suits, foreclosures, and tax liens that
          have occurred within the last seven years. All inquiries made within
          the last 90 days must also be included on the report.
     3.   The credit report must identify each borrower's name and social
          security number. For each debt listed, the report also must show the
          date the account was opened, the high credit amount, the required
          payment, the unpaid balance, and the payment history, as contained
          in the credit repositories. The report must be in an easy-to-read and
          understandable format, and it should not require code translations.
     4.   The lender must also develop credit information separately for any
          open debt that is listed on the loan application but not referenced on
          the credit report. Accounts listed as "rate by mail only" or "need
          written authorization" require separate written verification.
     5.   While the TRMCR should prove sufficient for processing most loan
          applications, the following circumstances require an RMCR:
          a. The borrower(s) disputes the ownership of accounts on the
               TRMCR; or
          b. The borrower(s) claims that collections, judgments, or liens
               listed as open on the TRMCR have been paid and cannot
               provide separate documentation supporting this claim; or
          c. The borrower claims that certain debts shown on the TRMCR
               have different balances and/or payments and cannot provide
               current statements (less than 30 days old) attesting to this claim;
               or
          d. The lender's underwriter determines that it would be prudent to
               use an RMCR in lieu of a TRMCR to underwrite the loan
               properly.
     6.   RMCRs must access at least two named repositories and meet all the
          requirements for the TRMCR, plus the following:
          a. Provide a detailed account of the borrower's employment
               history.
          b. Verify each borrower's current employment and income (if
               obtainable). It also must include a statement attesting to
               certification of employment and date verified. If this information
               is not obtained through an interview with the employer, the
               credit reporting agency must state why this action was not taken.
          c. Each account with a balance must have been checked with the
               creditor within 90 days of the credit report.


     2-5 ELIGIBILITY FOR FEDERALLY-RELATED CREDIT. A
     borrower must be rejected if any of the following conditions apply:

     HUD Limited Denial of Participation (LDP) and the U.S. General
     A. Services Administration’s “List of Parties Excluded from
     Federal Procurement and Non-Procurement Programs” (GSA List)
     A person suspended, debarred, or otherwise excluded from participation
34   in the Department’s programs is not eligible to participate in FHA-
     insured mortgage transactions. The lender must examine HUD’s LDP list
     and the government-wide General Services Administration’s (GSA) “List
     of Parties Excluded from Federal Procurement or Non-procurement
     Programs” and document this review on the HUD 92900-WS/92900-
     PUR.




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  B. Delinquent Federal Debts. If the borrower, as revealed by public
  records, credit information, or HUD’s Credit Alert Interactive Voice
  Response System (CAIVRS), is presently delinquent on any Federal debt
  (e.g., VA-guaranteed mortgage, Title I loan, Federal student loan, Small
  Business Administration loan, delinquent Federal taxes) or has a lien,
  including taxes, placed against his or her property for a debt owed to the
  U.S., the borrower is not eligible until the delinquent account is brought
  current, paid, otherwise satisfied, or a satisfactory repayment plan is
  made between the borrower and the Federal agency owed and is verified
  in writing. Tax liens may remain unpaid provided the lien holder
  subordinates the tax lien to the FHA-insured mortgage.

  C. CAIVRS. HUD’s CAIVRS is a Federal government-wide repository
  of information on those individuals with delinquent or defaulted Federal
  debt and on those for whom a payment of an insurance claim has
  occurred. Lenders must screen all borrowers, including nonprofit
  agencies acting as a borrower, using CAIVRS (except on streamline
  refinances). Lenders must write the CAIVRS authorization code for each
  borrower on the HUD-92900-WS/92900-PUR. Exceptions to this rule
  may be granted under the following situations:
  1. Assumptions. If the borrower sold the property, with or without a
       release of liability, to an individual who subsequently defaulted, the
       borrower is eligible, provided he or she can prove the loan was not in
       default at the time of assumption.
  2. Divorce. A borrower may be eligible if the divorce decree or legal
       separation agreement awarded the property and responsibility for
       payment to the former spouse. However, if a claim was paid on a
       mortgage in default prior to the divorce, the borrower is not eligible.
  3. Bankruptcy. When the property was included in a bankruptcy that
       was caused by circumstances beyond the borrower's control (such as
       the death of the principal wage earner or serious long-term uninsured
       illness), the borrower may be eligible if the borrower meets the
       requirements in Paragraph 2-3 E.

  D. While FHA may delete erroneous information regarding a borrower
  falsely indicated as having defaulted on a FHA mortgage, such as
  incorrect social security number reporting, it will not remove correct
  CAIVRS information even if the borrower is judged eligible under the
  conditions described above.

  E. Lenders may not rely upon a clear CAIVRS approval when in
  possession of independent evidence of delinquent federal obligations and
  must document the resolution of any conflicting information.

  EFFECTIVE INCOME
  The anticipated amount of income, and the likelihood of its continuance,
  must be established to determine a borrower's capacity to repay mortgage
  debt. Income may not be used in calculating the borrower's income ratios
  if it comes from any source that cannot be verified, is not stable, or will
  not continue.




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     2-6 STABILITY OF INCOME. We do not impose a minimum length of
     time a borrower must have held a position of employment to be eligible.
35   However, the lender must verify the borrower's employment for the most
     recent two full years. If a borrower indicates he or she was in school or
     in the military during any of this time, the borrower must provide
     evidence supporting this claim, such as college transcripts or discharge
     papers. The borrower also must explain any gaps in employment
     spanning one month or more. Allowances for seasonal employment, such
     as is typical in the building trades, etc., may be made if documented by
     the lender.

     To analyze and document the probability of continued employment,
     lenders must examine the borrower’s past employment record,
     qualifications for the position, previous training and education, and the
     employer's confirmation of continued employment. A borrower who
     changes jobs frequently within the same line of work, but continues to
     advance in income or benefits, should be considered favorably. In this
     analysis, income stability takes precedence over job stability. In some
     cases, a borrower may have recently returned to the work force after an
     extended absence. In these circumstances, the borrower's income may be
     considered effective and stable provided the following conditions apply:

     A. The borrower has been employed in the current job for six months or
     more, and

     B. The borrower can document a two-year work history prior to the
     absence from the work force. Acceptable documentation includes
     traditional employment verifications, copies of W-2's or paystubs. An
     example of an acceptable employment situation includes a person that
     took several years off of work to raise children and then returned to the
     workforce. Situations not meeting the criteria listed above may be
     considered as compensating factors only.


     2-7 SALARIES, WAGES, AND OTHER FORMS OF EFFECTIVE
36   INCOME.
     The income of each borrower to be obligated for the mortgage debt must
     be analyzed to determine whether it can reasonably be expected to
     continue through at least the first three years of the mortgage loan. If the
     borrower intends to retire during this period, the effective income must be
     the amount of documented retirement benefits, social security payments,
     or other payments expected to be received in retirement. No inquiry may
     be made regarding possible future maternity leave.

     1. Overtime and Bonus Income. Both overtime and bonus income
     may be used to qualify if the borrower has received such income for the
     past two years and it is likely to continue. The lender must develop an
     average of bonus or overtime income for the past two years, and the
     employment verification must not state that such income is unlikely to
     continue. An earnings trend also must be established and documented for
     overtime and bonus income.

     2. Part-Time Income. Part-time/second job income, including
     employment in seasonal work, may be used in qualifying if the lender
     documents that the borrower has worked the part-time job uninterrupted
     for the past two years and will continue to do so.


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  For qualification purposes, part-time income refers to jobs taken to
  supplement the borrower's income from regular employment (i.e., a
  second job – not meaning primary jobs of less than 40 hours per week.)
  We recognize that many low- and moderate-income families rely on part-
  time and seasonal income for day-to-day needs. Lenders must not restrict
  the consideration of such income sources in qualifying these borrowers.

  C. Military Income. In addition to base pay, military personnel may be
  entitled to additional forms of pay. Income from variable housing
  allowances, clothing allowances, flight or hazard pay, rations, and
  proficiency pay is acceptable, provided its probability of continuance is
  verified in writing.

  D. Commission Income. Commission income must be averaged over
  the previous two years. The borrower must provide copies of signed tax
  returns for the last two years, along with the most recent pay stub.
  (Unreimbursed business expenses must be subtracted from gross income.)
  Individuals whose commission income shows a decrease from one year to
  the next require significant compensating factors to allow for loan
  approval. Borrowers with commission income received for more than one
  but less than two years may be considered favorably provided the
  underwriter is able to make a sound rationalization for acceptance and
  can document the likelihood of continuance. Commissions earned for
  less than one year are not considered effective income.
  E. Retirement and Social Security Income. Retirement and social
  security income require verification from the source (former employer,
  Social Security Administration) or federal tax returns. If any benefits
  expire within the first full three years, the income source may be
  considered only as a compensating factor.

  F. Alimony, Child Support, or Maintenance Income. Income in this
  category may be considered as effective if such payments are likely to be
  consistently received for the first three years of the mortgage. The
  borrower must provide a copy of the final divorce decree, legal separation
  agreement, or voluntary payment agreement, as well as evidence that
  payments have been received during the last twelve months.

  G. Notes Receivable.

  H. Interest and Dividends.

  I.   Mortgage Credit Certificates.

  J.   Employer Differential Payments.

  K. VA Benefits.

  L. Government Assistance Programs.

  M. Rental Income.

  N. Eligible Investment Properties.

  O. Automobile Allowances and Expense Account Payments.




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  P. Trust Income.

  Q. Non-Taxable Income.

  R. Projected Income.


  2-8 EMPLOYMENT BY FAMILY-OWNED BUSINESSES.
  Borrowers employed at businesses owned by their family member(s) are
  required to provide additional income documentation. These borrowers
  must provide the normal verification of employment, pay stubs, and
  evidence that they are not an owner of the business. This evidence may
  include copies of the borrower's signed personal tax returns or a signed
  copy of the corporate tax return showing ownership percentages.


  2-9 SELF-EMPLOYED BORROWERS. A borrower with a 25 percent
  or greater ownership interest in a business is considered self-employed
  for FHA mortgage loan underwriting purposes.
  The following conditions apply to underwriting self-employed borrowers:
  A. Minimum Length of Self-Employment. Income from self-
  employment is considered stable and effective if the borrower has been
  self-employed for two or more years. The high probability of failure
  during the first few years of a business makes the following requirements
  necessary for individuals who have been self-employed less than two
  years:
       1.       Between One and Two Years. An individual self-
                employed between one and two years must have at least two
                years of documented previous successful employment (or a
                combination of one year of employment and formal
                education or training) in the line of work in which the
                borrower is self-employed or in a related occupation to be
                eligible.
       2.       Less than One Year. The income from a borrower self-
                employed less than one year may not be considered
                effective income.

  C. Documentation Requirements. The following documents are
  required from self-employed borrowers:
      1. Signed and dated individual tax returns, plus all applicable
           schedules, for the most recent two years.
      2. Signed copies of federal business income tax returns for the last
           two years, with all applicable schedules, if the business is a
           corporation, an "S" corporation, or a partnership.
      3. A year-to-date profit-and-loss (P&L) statement and balance
           sheet.
      4. A business credit report on corporations and "S" corporations.




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     BORROWER'S CASH INVESTMENT IN THE PROPERTY
37
     2-10 FUNDS TO CLOSE. The cash investment in the property must
     equal the difference between the amount of the insured mortgage,
     excluding any upfront MIP, and the total cost to acquire the property
     including prepaid expenses and closing costs as described in paragraph

     Acceptable sources of these funds include the following:

     A. Earnest Money Deposit. If the amount of the earnest money deposit
     exceeds 2 percent of the sales price or appears excessive based on the
     borrower's history of accumulating savings, the lender must verify with
     documentation the deposit amount and the source of funds. Satisfactory
     documentation includes a copy of the borrower's cancelled check.

     B. Savings and Checking Accounts. A verification of deposit (VOD),
     along with the most recent bank statement, may be used to verify savings
     and checking accounts. If there is a large increase in an account, or the
     account was opened recently, the lender must obtain a credible
     explanation of the source of those funds.

     C. Gift Funds. An outright gift of the cash investment is acceptable if the
     donor is the borrower’s relative, the borrower's employer or labor union,
     a charitable organization, a governmental agency or public entity that has
     a program to provide homeownership assistance to low- and moderate
     income families or first-time homebuyers, or a close friend with a clearly
     defined and documented interest in the borrower. The gift donor may not
     be a person or entity with an interest in the sale of the property, such as
     the seller, real estate agent or broker, builder, or any entity associated
     with them.

     FHA deems the payment of consumer debt by third parties to be an
     inducement to purchase. While FHA permits sellers and other parties to
     make contributions of up to six percent of the sales price of a property
     toward a buyer's actual closing costs and financing concessions, this
     policy applies exclusively to the provision of mortgage financing. Other
     expenses paid on behalf of the borrower must result in a dollar-for-dollar
     reduction to the sales price.

     Documentation Requirements. The lender must document the gift funds
     by obtaining a gift letter, signed by the donor and borrower, that specifies
38   the dollar amount of the gift, states that no repayment is required, shows
     the donor’s name, address, telephone number and states the nature of the
     donor’s relationship to the borrower. In addition, the lender must
     document the transfer of funds from the donor to the borrower, as
     follows:
      1. If the gift funds are in the homebuyer's bank account, the lender must
          document the transfer of the funds from the donor to the homebuyer
          by obtaining a copy of the canceled check or other withdrawal
          document showing that the withdrawal is from the donor's account.
      2. If the gift funds are to be provided at closing:
          a. If the transfer of the gift funds is by certified check made on the
              donor's account, the lender must obtain a bank statement
              showing the withdrawal from the donor's account, as well as a
              copy of the certified check.


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         b.   If the donor purchased a cashier's check, money order, official
              check, or any other type of bank check as a means of
              transferring the gift funds, the donor must provide a withdrawal
              document or canceled check for the amount of the gift, showing
              that the funds came from the donor's personal account. If the
              donor borrowed the gift funds and cannot provide
              documentation from the bank or other savings account, the
              donor must provide written evidence that those funds were
              borrowed from an acceptable source, i.e., not from a party to the
              transaction, including the lender. "Cash on hand" is not an
              acceptable source of the donor's gift funds.

     O. Sweat Equity. Labor performed or materials furnished by the
39   borrower before closing, on the property being purchased, may be
     considered as the equivalent of a cash investment, to the extent of the
     estimated cost of the work or materials. (Sweat equity may be "gifted"
     subject to the gift requirements and additional requirements shown
     below.) Additionally, the following apply to sweat equity:
     1. On existing construction, only the repairs or improvements listed on
          the appraisal are eligible for sweat equity. Any work completed or
          materials provided before the appraisal is made are not eligible. On
          proposed construction, the sales contract must indicate the tasks to be
          performed by the homebuyer during construction.
     2. The borrower's labor may be considered as the equivalent of cash, if
          the borrower can demonstrate his or her ability to complete the work
          in a satisfactory manner. The lender must document the contributory
          value of the labor through either the appraiser's estimate or a cost
          estimating service.
     3. Delayed work (on-site escrow), clean up, debris removal, and other
          general maintenance cannot be included as sweat equity.
     4. There can be no cash back to the borrower in these transactions.
     5. Sweat equity on a property other than the property being purchased is
          not acceptable. Compensation for work performed on other
          properties must be in cash and be properly documented.
     6. Evidence of the source of funds used to purchase and the market
          value of the materials must be provided if the borrower furnishes
          these.


     LIABILITIES
     2-11 TYPES OF LIABILITIES. The following are types of liabilities
40   that must be considered in qualifying borrowers:

     A. Recurring Obligations. The borrower's liabilities include all
     installment loans, revolving charge accounts, real estate loans, alimony,
     child support, and all other continuing obligations. In computing the debt-
     to-income ratios, the lender must include the monthly housing expense
     and all other additional recurring charges extending ten months or more,
     including payments on installment accounts, child support or separate
     maintenance payments, revolving accounts and alimony, etc.

     The following additional information deals with revolving accounts and
     alimony payments:
     1. Revolving Accounts. If the account shown on the credit report has an
         outstanding balance, monthly payments for qualifying purposes must




 FHA Lender Update                                            5-45                  December 2009
                                     Loan Fraud and Quality Control

       be calculated at the greater of 5 percent of the balance or $10 (unless
       the account shows a specific minimum monthly payment).
  2.   Alimony. Because of the tax consequences of alimony payments, the
       lender may choose to treat the monthly alimony obligation as a
       reduction from the borrower's gross income in calculating qualifying
       ratios, rather than as a monthly obligation.

  B. Contingent Liabilities. A contingent liability exists when an
  individual will be held responsible for payment of a debt, should another
  party, jointly or severally obligated, default on that payment. Unless the
  borrower can provide conclusive evidence from the debt holder that there
  is no possibility the debt holder will pursue debt collection against him or
  her should the other party default, the following rules apply to contingent
  liabilities:
  1. Mortgage Assumptions. When a borrower remains obligated on an
       outstanding FHA-insured, VA-guaranteed, or conventional mortgage
       secured by a property that has been sold or traded within the last
       twelve months without a release of liability, or is to be sold on
       assumption without a release of liability being obtained, contingent
       liability must be considered unless:
               a. The originating lender of the mortgage being underwritten
                   obtains from the servicer of the assumed loan a payment
                   history showing that mortgage has been current during the
                   previous 12 months; or
               b. An appraisal or closing statement from the sale of the
                   property supports a value that results in a 75 percent LTV
                   ratio [i.e., the outstanding balance on the mortgage loan
                   (minus any UFMIP, if applicable) cannot exceed 75
                   percent of the appraised value or sales price].
  2. Co-Signed Obligations. If the individual applying for an FHA-
       insured mortgage is a co-signer–or is otherwise co-obligated on a car
       loan, student loan, mortgage, or any other obligation–contingent
       liability applies unless the lender obtains documented proof that the
       primary obligor has been making payments during the previous 12
       months on a regular basis and does not have a history of delinquent
       payments on the loan.

  C. Projected Obligations. If a debt payment, such as a student loan, is
  scheduled to begin within twelve months of the mortgage loan closing,
  the lender must include the anticipated monthly obligation in the
  underwriting analysis, unless the borrower provides written evidence that
  the debt will be deferred to a period outside this timeframe.

  D. Obligations Not Considered Debt. Obligations not to be considered
  debt (or subtracted from gross income) include federal, state, and local
  taxes; FICA or other retirement contributions such as 401(k) accounts.

  BORROWER QUALIFYING
  The paragraphs below discuss debt-to-income ratios and the
  compensating factors that may be used to exceed the qualifying ratios. As
  evidenced by the description of compensating factors, ratios can be
  exceeded when significant compensating factors exist. We also do not set
  an arbitrary percentage that ratios may never exceed; however, the
  underwriter should judge the overall merits of the loan application and
  determine what compensating factors apply and the extent to which ratios
  may be exceeded.


FHA Lender Update                                          5-46                  December 2009
                                        Loan Fraud and Quality Control

     2-12 DEBT-TO-INCOME RATIOS. Ratios are used to determine
     whether the borrower can reasonably be expected to meet the expenses
41   involved in homeownership, and otherwise provide for the family. The
     lender must compute two ratios:

     A. Mortgage Payment Expense to Effective Income. If the total
     mortgage payment (principal and interest; escrow deposits for real estate
     taxes, hazard insurance, the mortgage insurance premium, homeowners'
     association dues, ground rent, special assessments, and payments for any
     acceptable secondary financing) does not exceed 29 percent of the gross
     effective income, the relationship of the mortgage payment to income is
     considered acceptable. A ratio exceeding 29 percent may be acceptable
     only if significant compensating factors as discussed in paragraph 2-13
     are documented and are recorded on the mortgage credit analysis
     worksheet.

     Typically, for borrowers with limited recurring expense, greater latitude
     is permissible on this ratio than on the total fixed payment ratio described
     below.

     B. Total Fixed Payment to Effective Income. If the total of the
     mortgage payment and all recurring charges does not exceed 41 percent
     of the gross effective income, the relationship of total obligations to
     income is considered acceptable. A ratio exceeding 41 percent may be
     acceptable only if significant compensating factors as discussed in
     paragraph 2-13 are documented and are recorded on the mortgage credit
     analysis worksheet.



     2-13 COMPENSATING FACTORS. Compensating factors that may be
     used to justify approval of mortgage loans with ratios exceeding our
     benchmark guidelines are those listed below. Underwriters must record
     on the "remarks" section of the HUD 92900-WS/HUD 92900-PUR the
     compensating factor(s) used to support loan approval. Any compensating
     factor used to justify mortgage approval must be supported by
     documentation.

     A. The borrower has successfully demonstrated the ability to pay
     housing expenses equal to or greater than the proposed monthly housing
     expense for the new mortgage over the past 12-24 months.

     B. The borrower makes a large downpayment (ten percent or more)
     toward the purchase of the property.

     C. The borrower has demonstrated an ability to accumulate savings and
     a conservative attitude toward the use of credit.

     D. Previous credit history shows that the borrower has the ability to
     devote a greater portion of income to housing expenses.

     E. The borrower receives documented compensation or income not
     reflected in effective income, but directly affecting the ability to pay the
     mortgage, including food stamps and similar public benefits.




 FHA Lender Update                                             5-47                 December 2009
                                        Loan Fraud and Quality Control

     F. There is only a minimal increase in the borrower's housing expense.

     G. The borrower has substantial documented cash reserves (at least
     three months’ worth) after closing. In determining if an asset can be
     included as cash reserves or cash to close, the lender must judge whether
     or not the asset is liquid or readily convertible to cash and can be done so
     absent retirement or job termination. Also see paragraph 2-10K.

     H. Funds borrowed against these accounts may be used for loan closing,
     but are not to be considered as cash reserves. “Assets” such as equity in
     other properties and the proceeds from a cash-out refinance are not to be
     considered as cash reserves. Similarly, funds from gifts from any source
     are not to be included as cash reserves.

     I. The borrower has substantial non-taxable income (if no adjustment
     was made previously in the ratio computations).

     J. The borrower has a potential for increased earnings, as indicated by
     job training or education in the borrower's profession.

     K. The home is being purchased as a result of relocation of the primary
     wage earner, and the secondary wage-earner has an established history of
     employment, is expected to return to work, and reasonable prospects exist
     for securing employment in a similar occupation in the new area. The
     underwriter must document the availability of such possible employment.


     UNDERWRITING DOCUMENTATION
42
     3-1 APPLICATION PACKAGE. The application package must contain
     all documentation supporting the lender's decision to approve the
     mortgage loan.

     When standard documentation does not provide enough information to
     support this decision, the lender must provide additional explanatory
     statements consistent with other information in the application, to clarify
     or to supplement the documentation submitted by the borrower.

     All documents may be up to 120 days old at the time the loan closes (180
     days for new construction) unless this or other applicable HUD
     instructions specify a different timeframe, or the nature of the document
     is such that its validity for underwriting purposes is not affected by being
     older than the number of prescribed days (e.g., divorce decrees, tax
     returns). Updated, written verifications must be obtained when the age of
     the documents exceed these limits.

     The Verification of Deposit (VOD) and Verification of Employment
     (VOE) may
      e faxed documents or printed pages from the Internet if they clearly
     identify their sources (e.g., contain the names of the borrower’s employer
     or depository/investment firm). The lender is accountable for ascertaining
     the authenticity of the document by examining information included in a
     document’s headers and footers.

     Lenders may not accept or use documents relating to the credit,
     employment or income of borrowers that are handled by or transmitted


 FHA Lender Update                                            5-48                  December 2009
                                      Loan Fraud and Quality Control

  from or through interested third parties (e.g., real estate agents, builders,
  sellers) or by using their equipment.

  The following documents are generally required for mortgage credit
  analysis in all transactions except for certain streamline refinances:

  A. Loan Application. Uniform Residential Loan Application (URLA),
  signed and dated by all borrowers and the lender, and the Addendum to
  the URLA (form HUD-92900-A).

  B. Mortgage Credit Analysis Worksheet. Form HUD 92900-WS or
  HUD-92900-PUR, as appropriate.

  C. Social Security Number Evidence. For all borrowers, including US
  citizens, the lender is required to document a valid SSN for each
  borrower, co-borrower, and co-signer on the mortgage. All individuals
  eligible for legal employment in the US must have a SSN.

  D. Credit Report. The lender must obtain a credit report on all
  borrowers who will be obligated on the mortgage note (except for
  streamline refinance transactions).

  E. Verification of Employment (VOE). VOE and the borrower’s most
  recent pay stub are to be provided. “Most recent” means at the time the
  initial loan application is made. If the document is not more than 120
  days old when the loan closes (180 days old on new construction), it does
  not have to be updated.

  Alternative Documentation. As an alternative to obtaining a VOE, the
  lender may obtain the borrower’s original pay stub(s) covering the most
  recent 30-day period, along with original IRS W-2 Forms from the
  previous two years. The pay stub(s) must show the borrower's name,
  social security number, and year-to- date earnings. Any copies of the W-2
  Form not submitted with the borrower's income tax returns are
  considered "original" W-2’s. (These original documents may be
  photocopied and returned to the borrower.) The lender also must verify
  by telephone all current employers. The loan file must include a
  certification from the lender that original documents were examined and
  the name, title, and telephone number of the person with whom
  employment was verified. For all loans processed in this manner, the
  lender also must obtain a signed copy of Form IRS 4506 Request for
  Copy of Tax Form, Form IRS 8821, or a document that is appropriate for
  obtaining tax returns directly from theIRS. The lender also may use an
  electronic retrieval service for obtaining W-2 and tax return information.

  If the employer will not give telephone confirmation of employment or if
  the W-2 indicates inconsistencies (e.g., FICA payments not reflecting
  earnings), standard employment documentation must be used.

  F. VOD. VOD and most recent bank statements are to be provided.
  “Most recent” means at the time the initial loan application is made.
  Provided the document is not more than 120 days old when the loan
  closes (180 days old on new construction), it does not have to be updated.

  Alternative Documentation. As an alternative to obtaining a VOD, the
  lender may obtain from the borrower original bank statement(s) covering


FHA Lender Update                                            5-49                 December 2009
                                    Loan Fraud and Quality Control

  the most recent three-month period. Provided the bank statement shows
  the previous month's balance, this requirement is met by obtaining the
  two most recent, consecutive statements.

  G. Federal Income Tax Returns. Federal income tax returns (both
  individual returns and business returns) for the past two years, including
  all applicable schedules, for self-employed borrowers, are required.
  Commissioned individuals must provide individual federal income tax
  returns for the past two years. The lender must obtain signed Forms IRS
  4506, IRS 8821, or whatever form or electronic retrieval service is
  appropriate for obtaining tax returns directly from the IRS for any loan
  for which the borrower's tax returns are required.

  H. Sales Contract. The sales contract and any amendments or other
  agreements and certifications are to be included in the case binder. Either
  an original or a certified true copy of the sales contract received by the
  lender is required.

  I. Real Estate Certification. Real estate certification, signed by the
  buyer, seller, and selling real estate agent or broker (if not contained
  within the purchase agreement) are required. Also see paragraph 3-3,
  below.

  J. Verification of Rent or Payment History of Present/Previous
  Mortgages. This document must be in the form of a direct verification
  from the landlord or mortgage servicer or through information shown on
  the credit report.

  K. Uniform Residential Appraisal Report (URAR). The URAR and
  Valuation package must be included in the endorsement binder except for
  streamline refinances made without appraisals.

  L. Explanatory Statements. Explanatory statements or additional
  documentation necessary to make a sound underwriting decision are to be
  included in the case binder.


  3-2 DOCUMENTATION STANDARDS.
  A. Application Forms. Application forms must be signed and dated by
  all borrowers applying for the mortgage and assuming responsibility for
  the mortgage debt.

  B. Verifications. Rather than requiring borrowers to sign multiple
  verification forms, the lender may ask the borrower to sign a general
  authorization form that gives the lender blanket authority to verify
  information needed to process the mortgage loan application, such as past
  and present employment records, bank accounts, stock holdings, etc. If
  the lender uses such an authorization, he or she must attach a copy of the
  authorization to each verification sent. Additionally, lenders may use self-
  adhesive signature labels for laser printed verifications. Each label must
  completely and clearly indicate its use and must contain the Privacy Act
  notification.

  C. Documents Signed in Blank. Lenders may not have borrowers sign
  documents in blank, or on blank sheets of paper.




FHA Lender Update                                          5-50                  December 2009
                                     Loan Fraud and Quality Control


  3-3 REAL ESTATE CERTIFICATION. The borrower, seller, and the
  selling real estate agent or broker involved in the sales transaction must
  certify that the terms and conditions of the sales contract are true to the
  best of their knowledge and belief and that any other agreement entered
  into by any of the parties in connection with the real estate transaction is
  part of, or attached to, the sales agreement.

  If the sales contract contains a provision that there are no other
  agreements between parties and that the terms of the sales contract
  constitute the entire agreement between the parties, the certification
  specified in the above paragraph is not needed if all parties are signatories
  to the sales contract submitted at the time of underwriting.




FHA Lender Update                                           5-51                  December 2009
                               Loan Fraud and Quality Control

           Mike's Best Mortgage
   43      12/31/2008
            Audit Planning

           CLIENT INFORMATION

           Client Name                                                     Mike's Best Mortgage
           TAX ID No.                                                      90-9999999
           FHA ID No.                                                      18444000002

           Address                                                         999 Main St
                                                                           Kaysville, MN
           Is this address current in FHA Connection                       Yes
           Legal Structure                                                 Sub S Corp
           Are there related entities?
           Is FIN 46 an issue?
           Owners/Partners                                                 Mike Olsen
                                                                           Les Sparks
                                                                           Title II Loan
           Type of Entity Per HUD                                          Correspondent
           Number of approved branches                                     0
           Unapproved branches (satellite offices)                         0
           Are branch arrangements appropriate (expense & compensation)?

           Do you have a copy of the client annual verification report?    Yes

           Types of Loans Originated                                       HUD
                                                                           Conventional
                                                                           Interest Only

           HUD Mortgage(s) Originated - No.                                                    95
           HUD Mortgage(s) Orignated Value                                            10,000,000
           Conventional Loans Originated - No.                                             1,113
           Conventional Loans Originated - Value                                     114,179,168
           Total Loans                                                                     1,208
           Branches
           Number of Branches                                              0
           Branch Locations

           Sponsor
           Wells Fargo, N.A.
           Bank of America
           Significant employee turnover?                                  No




FHA Lender Update                                5-52                            December 2009
                                   Loan Fraud and Quality Control

   ENGAGEMENT INFORMATION
   Services to be provided                                              Audited financial
                                                                        statements in HUD
                                                                        format per Uniform
                                                                        Financial Reporting
                                                                        Standards
                                                                        Agreed-upon procedures for LASSC filing
                                                                        Input of the LASS templates
                                                                        Tax Return
   If you are preparing the financial statements, see GAGAS Checklist
   attached                                                             Yes

   List engagement team                                                 Jim Smith
                                                                        John James
                                                                        Martha Walters


   Are the new pronouncements affecting the engagement?                 Yes, FAS 157 & 159

   Are specialists required?                                            No

   Planning Materiality                                                               94,749
   Tolerable Misstatement                                                             71,250
   What is current net worth                                                       2,300,768
   Will net worth be affected by this calculation?                      No
   What is current liquidity                                                      $2,105,632
   Is it HUD compliant?


   Tolerable Noncompliance Program 1                                                     500000

   Number of years in business                                          10
   Number of employees                                                  6
   Significant employee turnover
   Alternative employment arrangements                                  NO
       This usually involves the use of independent
       for loan officer or processor duties. Such transactions
   are considered high risk due to HUD, IRS and DOL regulations

   Distributions/dividends or significant owner compensation?           Yes
   Investment in loans?                                                 No
   Warehouse Line?                                                      Yes
   Are any warehouse loans older than 30 days?                          No
   Has the MIP been remitted on those loans?                            No
   Revenue on pipeline loans?                                           No
   Service Loans?                                                       No




FHA Lender Update                                     5-53                                     December 2009
                                  Loan Fraud and Quality Control

   Repurchase Agreements? If yes, document the
   arrangement including the frame of risk for each loan.

   Lease or other financing agreements affecting net worth?
   Legal or other issues to address?

   Does the client have an appropriate Quality Control Program? If yes,
   please attach                                                          Yes
   Does the plan contain all required elements?                           Yes
   Does it cover all officers, appraisers, underwriters and branches?     No
   Is ther evidence of management follow-up on QC findings                No
   Does the client outsource its QC program to a third party?             No
   Do you have a copy of the third party agreement?
   Does the client have a significant default rate?listed in HUD
   Neighborhood Watch. Attach output                                      No
   Is client monitoring early default rates? Attach output                Yes
   Is client monitoring all branches, loan , officers, underwriters and
   appraisers? Attach output                                              Yes
   Significant employee turnover?                                         No
   Were there prior year findings? The HUD Audit Guide requires
   followup on prior year findings.                                       No
   Are GAGAS Yellowbook requirements met? See GAGAS Checklist             Yes

   IS the CPA provinding Non-audit services? If yes, see GAGAS checklist Yes
   Is the client paying marketing, or referral fees? If yes, examine for
   complaince with RESPA and other HUD requirements                      No
   Does the client underwrite? If, yes follow-up with checklist




FHA Lender Update                                      5-54                     December 2009
                                               HUD Audit Guide

  ASSESSING AUDIT RISK IN HUD-APPROVED LENDER
  AUDITS


    44   Is the auditor in compliance with Yellowbook
         requirements?

         With Regard to Independence:

         For any nonaudit services provided to the audited entity, has the
         audit organization identified, evaluated, and documented the
         independence considerations regarding compliance with the
         following overarching principles? [GAS par. 1.34, 3.20-.24; AAG-
         SLA 2.09-.10]
         •    The audit organization does not provide nonaudit services
              that involve performing management functions or making
              management decisions.
         •    The audit organization does not audit their own work or
              provide nonaudit services in situations where the nonaudit
              services are significant or material to the audit subject
              matter.

         For nonaudit services that would not impair independence if
         supplemental safeguards are implemented, have the following
         safeguards been implemented and documented by the audit
         organization? [GASpar. 3.28-.30; AAG-SLA 2.09-.10]
         •   The audit organization excludes personnel who provided the
             nonaudit services from planning, conducting, or reviewing
             the audit work in the subject matter of the nonaudit service.

         Note: GAS Q&A question 30 provides a waiver of the above re-
         quirement when the audit organization provides 40 or fewer
         hours of nonaudit services to the audited entity.

   45    •   The nonaudit service does not result in a reduction of the
             audit scope or extent of work below a level appropriate had
             the services been done by an unrelated party.

         A written understanding as been established with the party
         contracting for the nonaudit service as to the objectives, scope of
         work, and nonaudit product or deliverables, and management's
         responsibility for
         —     the subject matter of the nonaudit service;
         —     the substantive outcomes of the work; and
         —     making any decisions that involve management functions
               related to the nonaudit service and accepting responsibility
               for such decisions.

  AHACPA COMMENT

         From: YellowBook [mailto:YellowBook@gao.gov]
         Sent: Tuesday, September 02, 2008 8:11 PM
         To: les@ahacpa.org; Gail Vallieres
         Subject: Re: YB Independence question

         Mr. Sparks,




FHA Lender Update                                        5-55                  December 2009
                                         HUD Audit Guide

        The 2007 revision of government auditing standards moved the discussion of nonaudit
        services to the section of the GAGAS independence standard on organizational
        independence; previously, in the 2003 revision, nonaudit services were discussed in the
        personal impairment section. This relocation, however, did not change the substance of the
        standards with regards to nonaudit services.

        Footnote 27 to paragraph 3.20 of the 2007 revision refers to the independence Q&A, which
        is still applicable guidance. With regards to permitting the same staff to draft/compile
        financial statements and perform the audit, the relevant question in the Q&A document is
        question 46 rather question 30. Question 46 provides an exemption from the safeguard of
        having separate staff provide the nonaudit service of drafting/compiling financial statements
        and conduct the audit, provided that the audit organization/firm is able to meet all the other
        safeguards and that the two overarching principles are not violated.

        GAO is currently beginning a comprehensive process of considering potential revisions to
        the independence standard and related guidance.

        Please feel free to call me at 202-512-9535 if you have any additional questions or would
        like to discuss this matter further.

        Michael C. Hrapsky
        Specialist, Auditing Standards
        Financial Management and Assurance
        U.S. Government Accountability Office
        202-512-9535
        yellowbook@gao.gov

        Here is the question in point.

        46. Can an audit organization be involved in preparing a trial balance and draft financial
        statements and notes without impairing its independence to audit the financial statements?
        Can audit engagement team members perform these activities? Maintaining the audited
        entity’s books and records is the responsibility of its management. Accordingly,
        management is responsible for ensuring that these books and records adequately support
        the preparation of financial statements in accordance with generally accepted accounting
        principles and that records are current and in balance.

        If an audit organization were asked to prepare a trial balance, the audit organization would
        not impair its audit independence if the preparation of the trial balance was purely
        technical in nature. The trial balance should be based on management’s chart of accounts,
        and the audited entity’s management must take responsibility for the trial balance. In other
        words, the preparation of the trial balance is a matter of formatting the chart of accounts
        into a trial balance. Work involving more than the technical formatting of the trial balance
        would impair independence because the audit organization would be performing a
        management function, which would violate an overarching principle.




FHA Lender Update                              5-56                                 December 2009
                                              HUD Audit Guide

         The audit organization’s preparation of draft financial statements and note disclosures from
         a trial balance provided by entity management (or prepared by the audit organization as
         described above), which the management of the audited entity then reviews and approves,
         would not impair the auditor’s independence (see paragraphs 3.26 and 3.26a). This work is
         considered technical assistance and as part of the audit. The audit organization must be
         careful not to make management decisions, and management of the audited entity must have
         the knowledge to evaluate and approve the draft financial statements and notes and take
         responsibility for them.

         Further, the audit engagement team that prepared the trial balance and draft financial
         statements and notes could also perform the financial statement audit. The audit
         organization must comply with all other safeguards in paragraph 3.25. Also, the
         management representation letter, required by auditing standards, should acknowledge the
         audit organization’s role in preparing the trial balance and draft financial statements and
         related notes, and management’s review, approval, and responsibility for the financial
         statements and related notes.

         Likewise, auditors can convert cash-based financial statements to accrual-based financial
         statements, as long as management is in the position to make informed judgments to review,
         approve, and take responsibility for the appropriateness of the conversion. In providing this
         service, the audit team that proposed the accruals could also perform the financial
         statement audit since this service is in substance the same as proposing adjusting or
         correcting entries as long as management makes the decision on accepting the entries.
         Similarly, as stated above, the management representation letter should also acknowledge
         the audit organization’s role in reflecting accruals and management’s review, approval,
         and responsibility for the accrual adjustments.

         It is important to reiterate that the answer to this question is conditioned on the audit
         organization starting with appropriate books and records that balance and the audited
         entity having knowledgeable management. Where this is not the case, the audit organization
         must be careful not to cross the line of making management’s decisions or performing
         management functions and find itself in a position where reasonable third parties with
         knowledge of the relevant facts and circumstances could conclude that the auditor has, in
         effect, maintained the audited entity’s books or records and, therefore, has impaired its
         independence to conduct the financial statement audit.




  With Regard to Competence:
         Does the audit organization have a quality control policies and
    46   procedures for recruitment, hiring, continuous development,
         meeting CPE requirements, assignment, and evaluation of
         staff and does management assess and match the skills
         necessary to accomplish audit objectives?

         Does the audit team collectively possess adequate professional
         competence (the blending of education and experience) for the
         tasks required?



FHA Lender Update                                       5-57                         December 2009
                                                HUD Audit Guide

          Do the audit team members appear knowledgeable or to have
          accessed appropriate knowledge in GAAP and GAAS and
          have sufficient skills appropriate for the work being performed

          Did the audit organization assess and document the
          professional qualifications of any external specialists assisting
          in the audit?

          Do the audit team members, including internal specialists,
          meet the 24 and 80 hour continuing professional education
          (CPE) requirements of Government Auditing Standards, as
          applicable?


  With Regard to Quality Control and Assurance:

          Has the audit organization established a system of quality
    47    control that is designed to provide reasonable assurance of
          compliance with professional standards and any applicable legal
          and regulatory requirements? [GAS par. 3.50-.51

          Has the audit organization documented its quality control policies
          and procedures and communicated them to organization
          personnel? [GAS par. 3.52]

          Has the audit organization documented compliance with its
          quality control policies and procedures and maintained such
          documentation for a period of time sufficient to enable monitoring
          and peer review? [GAS par. 3.52]

          Does the audit organization's system of quality control
          collectively address the following? [GAS par. 3.53]
          •    Leadership responsibilities for quality within the organization
          •    Independence, legal, and ethical responsibilities
          •    Initiation, acceptance, and continuance of audit
               engagements
          •    Human resources
          •    Engagement performance, documentation, and reporting
          •    Monitoring of quality

          Has the audit organization at least annually performed
          monitoring of system quality and analyzed and summarized the
          results of that monitoring to identify any systemic
          improvements needed?

          Has the organization met the external peer review
          requirements of GAS through an independent peer review once
          every three years, sufficient in scope to meet the GAGAS
          requirements?

          HUD Audit Guide Requirements
    48    Does the audit report cover clearly indicate the HUD-assisted
          activities and period which was audited?
          Did the auditor include in the audit report or an accompanying
          transmittal letter
          •   the auditor's Federal Employer ID Number?
          •   identification of the name, office address, and telephone
              of the audit partner?



FHA Lender Update                                          5-58                  December 2009
                                               HUD Audit Guide


         Does the auditor's report on the financial statements
         and required supplemental schedules
         •   include reference to generally accepted auditing
             standards (GAAS) and to GAS issued by the
             comptroller general of the United States?
         •   describe or make reference to separate reports that
             describe the scope of the auditor's testing of compliance
             with laws and regulations, and of internal controls?
         •   include a separate paragraph or a separate report on
             accompanying supplemental information required by
             HUD?
         Does the separate paragraph or separate report on
         accompanying supplemental information include a
         statement that the supplementary information (financial
         data templates) is reported on in relation to the audited
         basic financial statements in accordance with SAS No.
         29?

         Do the auditor's reports use language that conforms
         with professional standards including reference to
         GAAS, GAS issued by the comptroller general of the
         United States, and, as applicable, the Consolidated
         Audit Guide for Audits of HUD Programs (the HUD audit
         guide), issued by HUD's Office of the Inspector General?

         Did the auditor promptly prepare a separate written report and
         submit it to the HUD District Inspector General for Audit as the
         designated over sight official concerning illegal acts or fraud that
         have occurred or are likely to occur and include all questioned
         costs as the result of the acts?

         Did the auditor's report on Title II nonsupervised
    49   mortgagees and loan correspondents, worded in
         accordance with professional standards, include
         •    The auditor's report on the basic financial statements
              together with the auditor's report on accompanying
              supplemental information required by HUD?
         •    a report on the computation of the mortgagee's
              adjusted net worth?
         •    a report on the fair presentation of the LASS
              Financial Data
              Templates in relation to the basic financial
              statements?
         •    a report on internal controls and compliance with
              specific requirements that have a direct and material
              effect on HUD-insured loans?
         •    a report on the compliance with requirements
              applicable to each major HUD-assisted program
              or a report on compliance with requirements
              applicable to nonmajor HUD-assisted program
              transactions?
         •    an agreed-upon procedures report on the
              electronic submission (LASS Templates) in



FHA Lender Update                                         5-59                  December 2009
                                              HUD Audit Guide

             accordance with SSAE No. 10?


  HUD Workpaper Requirements

         General
         Does the engagement letter required by HUD specify
   50    •   that the audit was to be performed in accordance with
             GAAS GAS, and the Consolidated Audit Guide for Audits
             of HUD Programs?
         •   that the scope of the audit and contents of the financial
             report to be issued will meet the requirements of the
             Consolidated Audit Guide for Audits of HUD Programs?
         •   that the secretary of HUD, the HUD Inspector General,
             and GAO or their representatives have access to the
             working papers and, upon request, photocopies will be
             provided to them?
         •   the auditor provided his or her most recent external peer
             review report and letter of comment to the audit client?


         Does the auditor's documentation indicate compliance with out-
         of-state licensing requirements, if necessary?

         Does the auditor's documentation include evidence that tests of
   51    controls were performed to evaluate effectiveness of design and
         operation of internal control policies and procedures in
         preventing or detecting material noncompliance with the
         requirements of HUD programs regardless of whether or not the
         auditor assesses internal control risk below the maximum? In
         instances where controls were not tested, was the report properly
         modified to report a significant deficiency or material weakness?

         Did the auditor obtain a representation letter from management
         that
         •   represented that they identified all laws and regulations
   52        that have a direct and material effect on the determination
             of financial statement amounts and the requirements of
             each HUD program?
         •   represented that management is responsible for the
             organization's compliance with the laws and regulations
             applicable to the organization and the requirements of each
             HUD program and that they have complied with them?

         Did the auditor review the auditee's comments on the status
         of corrective actions taken on prior findings as well as review
         and consider findings from audits conducted by HUD-OIG
         and other HUD program reviews and, where applicable,
         include a current finding?
         Have the following specific compliance requirements been
   53    tested in accordance with the procedures in the HUD audit guide
         or have alternative procedures been justified?
         •    Quality control plan
         •    Sponsor responsibility over Title II loan correspondents



FHA Lender Update                                       5-60                 December 2009
                                            HUD Audit Guide

        •   Branch office operations
        •   Loan origination
        •   Loan settlement
        •   Loan servicing
        •   Escrow accounts
        •   Section 235 assistance payments
        •   Federal financial and activity reports
        •   Kickbacks
        •   Mortgagee approval requirements: Net Worth
            Requirement, Liquidity Requirement, Fidelity Bond and
            Errors and Omission Insurance Policy, Verification Report, &
            Renewal Fee




FHA Lender Update                                     5-61                 December 2009

				
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