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Dec 28, 2004

So you want to originate FHA loans? An update on HUD eligibility requirementsMike DaughertyFHA loans, HUD approval, regulatory compliance As most mortgage brokers and lenders are now aware, only mortgagees that have been approved by the U.S. Department of Housing and Urban Development can originate FHA loans. HUD has recently imposed heavy sanctions on mortgagees involved in certain unauthorized forms of net branching and brokering that resulted in increased risks to both the FHA insurance fund and to FHA borrowers. Brokers and lenders interested in originating FHA loans must go through an approval process. There are three classes of HUD approval: supervised lender, non-supervised lender and loan correspondent. A supervised lender is a commercial bank, savings and loan association or credit union under the direct regulation of the FDIC, Federal Reserve or the National Credit Union Administration. The HUD approval requirements for supervised institutions are minimal due to the close scrutiny by other governmental agencies. A supervised lender can participate in the same kinds of lending activities as a non-supervised lender, or they can operate as a loan correspondent. A non-supervised lender is a mortgage banker, the so-called "full eagle." The banker's principal activity must be the lending or investing of funds in real estate mortgages. With this category, mortgage bankers may originate, service, purchase, hold and sell FHA-insured mortgages. After surviving 15 pre-closing test cases, non-supervised lenders may obtain "direct endorsement" (DE) approval and subsequently submit loans for mortgage insurance without prior underwriting review by HUD. Applicants for non-supervised approval should be aware that the DE approval process is far more harrowing than the initial approval itself, and that DE approval is mandatory for this category of lender to originate an FHA loan. You must make sure you have a savvy and experienced DE underwriter on board before beginning the procedure. Keep in mind, however, that it is not necessary for non-supervised lenders to achieve DE status if the main purpose of the HUD approval is for state or investor approval purposes, rather than the origination or underwriting of FHA loans. A loan correspondent is HUD parlance for a mortgage broker, or mini-eagle. With this category of approval, brokers may only originate FHA loans; they may not hold or sell such loans. In addition, the loan correspondent must have one or more registered sponsors to underwrite and fund the FHA loans that it originates. Sponsors must be supervised or non-supervised lenders with DE approval from HUD. When approved, each broker or lender is issued an exclusive HUD mortgagee identification number that is to be used only by the approved entity to order FHA case numbers and deal with HUD on a variety of issues via the FHA connection on the Internet. This identification number will allow the approved mortgagee to order an FHA case number anywhere within the lending area of the mortgagees home office. Lending areas are generally tied to the location of HUD field offices within states, but can often overlap into HUD field office jurisdictions in adjoining states. To originate an FHA loan outside of the home office lending area, the approved mortgagee must apply to HUD for branch office approval. Supervised and non-supervised lenders may add branches over the FHA connection on the Internet for a $300 fee, but loan correspondents must submit a hard copy application to HUD, along with an audited financial statement and the $300 fee. In addition to the initial net worth requirement detailed later in this article, a loan correspondent must maintain an additional net worth of $25,000 for each approved branch office, up to a maximum requirement of $250,000. Current qualifications for HUD approval The following is a concise but complete summary of HUD's requirements. If a mortgagee satisfies these, then with the proper paperwork, application can be confidently made to HUD for approval. "The applicant must be a corporation, a limited liability company (LLC) or a partnership. A sole proprietorship is not acceptable. Both C and S corporations qualify. An LLC must meet more specific requirements; it must have at least two members, its operating agreement must show a term of existence of at least 10 years, and it must also have a provision for continuance after the withdrawal of a member. Both the LLC operating agreement and articles of organization must be submitted for review. Partnership requirements are too complicated to cover here, and are not recommended unless there are compelling tax or legal issues involved. The eligibility requirements that follow will indicate "corporation" for brevity, but also apply to LLCs and partnerships. "The applicant corporation must have an adjusted net worth of at least $63,000 for a loan correspondent or $250,000 for a non-supervised lender. At least 20 percent of the net worth must be in the form of liquid assets, which are defined as cash and cash equivalents, such as readily marketable securities. The remainder of the net worth may consist of furnishings, equipment and other business items owned by the corporation. The entire corporate net worth must be verified to HUD by an audited financial statement, prepared by a certified public accountant in accordance with generally accepted accounting principles. The audited statement must also contain HUD's computation of adjusted net worth, a formula that excludes the value of certain unacceptable assets. "The corporation must be currently licensed by the state regulatory agency where its home office is located. There can be no sanctions or restrictions on the state license. "At least one senior designated corporate officer (president or vice president) must have a minimum three years of mortgage origination experience, either conventional or FHA. A resume must be submitted showing the places and dates where the employment occurred. In the case of an LLC applicant, the designated operating manager-member must have three years of experience. "In companies with joint officers, there must be a duly appointed senior officer (president or vice president), with the required minimum three years of acceptable experience, designated to conduct exclusively the affairs of the approved mortgagee. This is an area of common confusion. For example, you cannot own and operate a HUD-approved mortgage company and have day-to-day management responsibilities at any other mortgage company. Likewise, you cannot own and manage a real estate brokerage and have day-to-day operating responsibilities at a HUD-approved mortgage company. You can have an ownership interest in either of these other entities, as long as you, the designated officer of the HUD-approved mortgage company, have no day-to-day management responsibilities with any other business entity. You will also, of course, need to heed all of the RESPA requirements with respect to conflicts of interest between different entities. "The corporation, its major stockholders and senior officers must have acceptable credit. Recent credit reports, both personal and commercial, must be submitted to HUD. There can be no outstanding tax liens or past-due government loans. Bankruptcies must be discharged and seasoned, and good credit re-established. A default on an FHA-insured loan is cause for application rejection. HUD uses the Mortgage Asset Resource Institute (MARI), as well as its own record base, to check the background of applicants for license restrictions, suspensions, debarments and other negative items that may make individuals or companies ineligible for approval. Applicants may preview the MARI database by visiting to determine if there are adverse records. There is a nominal fee for this service. "The corporation must have acceptable main office facilities. The office must be located in a commercial building, not a residence, with the types of furnishings and equipment required to run a mortgage operation in a responsible and professional manner. There must be permanently affixed business signs to identify the mortgage company to borrowers. The corporation's main office must be separate and apart from any other business entity, but may share a common reception area or lobby. "The corporation must have at least two employees. The employees may include the principals of the corporation, but a shared receptionist cannot be used to meet this requirement. "A loan correspondent applicant is required to have a HUD-approved sponsor (a supervised or non-supervised lender with DE approval) that will underwrite and fund its FHA originations. Once the correspondent has received its initial HUD approval, additional sponsors may be added via the FHA connection on the Internet. "Non-supervised lenders must maintain a warehouse line of credit for at least $1 million. "Non-supervised lenders, but not loan correspondents, must provide evidence of a fidelity bond, and errors and omissions insurance for at least $300,000 each. These are the requirements to originate FHA loans. The actual application package to HUD involves substantial paperwork, but the qualifications themselves are by no means difficult or unreasonable. There is, however, a non-refundable $1,000 application fee to HUD for reviewing and processing the application, so it is important to submit it correctly. Once approved, each mortgagee must be re-certified by HUD on an annual basis. This re-certification requires the submission of an audited financial report and a $500 fee to HUD within 90 days after the end of the company's fiscal year. Failure to meet the strict re-certification deadlines has resulted in approval termination for many mortgagees in recent years. So, mark your calendars! Mike Daugherty was a lender approval official with HUD for many years and is a principal of Mortgagee Approval Services, a provider of consultation and application preparation services to brokers and lenders seeking initial HUD approval. He may be reached at (925) 254-5999 or visit
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