Having an efficient and effective quality control (QC) process is essential for every business—particularly the mortgage lending industry. Recent policy and procedural changes that have already been implemented or are being proposed by the U.S. Department of Housing & Urban Development (HUD), the Federal Housing Administration (FHA), Fannie Mae and Freddie Mac will necessitate substantive changes to a lender’s QC Plans. The oversight and monitoring of third-party originators (TPOs) or loan correspondents, review of condominium project applications under HUD’s Direct Endorsement Lender Approval Process (DELRAP) option, reviews of Early Payment Defaults (EPDs), pre-funding reviews and review of rejected loan applications are just some examples of functions that must be adequately addressed in a lender’s QC Plan. Outlined below is a brief discussion on each of these important components of a lender’s QC Plan:
Oversight of TPOs
Since HUD/FHA no longer “approves” loan correspondents (mortgage brokers) or monitors lenders acting in such capacity for originating FHA loan transactions, the responsibility for performing QC reviews of these entities has been delegated to the FHA-approved mortgagee acting as their sponsor. In this regard, FHA-approved mortgagees must modify their QC Plans to reflect an appropriate sample amount of each of their TPOs based on a variety of factors, such as volume, default rate, experience of staff, past problems, etc. This targeting methodology should be in writing. It is recommended that at least 10 percent of the loans originated by a TPO be targeted for a QC review. If a TPO has less than 10 loans originated in a month’s time, at least one case should be given a QC review.
Condominium project reviews
In HUD’s Condominium Project Approval and Processing Guide (an attachment to Mortgagee Letter 2011-22), it is indicated in Paragraph 4-3 that lenders must select for QC review a minimum of 10 percent of all condo project approval reviews completed by staff reviewers. Therefore, if a lender is processing condo project applications under HUD/FHA’s DELRAP, they will be held accountable by HUD/FHA for the quality of the reviews being performed by their staff. As a result, lenders need to modify their existing QC Plans to adequately address this new requirement and properly document their QC reviews.
Reviews of Early Payment Defaults (EPDs)
All loans that go into default (HUD defines as 60 days past due) within the first six payments must be reviewed on a QC basis. These reviews are in addition to the loans selected for QC review based on the lender’s normal targeting methodology. Also, HUD/FHA requires that the reviews of EPDs must be completed within 45 days from the end of the month the loan is reported as 60 days past due.
The processing of pre-funding reviews should be an important aspect of a lender’s overall QC Plan. Such reviews are utilized to validate the accuracy of the loan information, as well as to identify any additional training needs. The results of these pre-funding reviews (which should be performed by staff other than those who initially obtained the data) should be recorded along with the plans of action taken to address any concerns. Some lenders simply make some phone calls to reverify employment, income and assets and call that a pre-funding review! However, the key elements of a substantive pre-funding QC review process should include confirmation, validation and reverification of the following: Data entered into the AUS system, credit report including checks of CAIVRS and LDP/GSA lists, the Social Security Numbers of each borrower, employment and income information, assets used to meet minimum investment and/or reserve requirements, title vesting, properly completed disclosures, appraisal data (i.e. comp sales, chain of title, GLA, tax and property insurance estimates) and mortgage insurance estimates, etc. One benefit of conducting preclosing reviews is that any written reverification that is received during a pre-funding QC review that has an acceptable response can be utilized in any subsequent post-closing review.
Reviews of rejected loan applications
In order to ensure compliance with the various fair lending regulations, HUD/FHA expects lenders to process QC reviews on rejected loan applications within 90 days from the end of the month in which the decision was made. These reviews should document that the reject reason(s) were valid and that each rejection has the concurrence of an officer or senior staff person. By doing so, the lender is complying with the requirements of the Equal Credit Opportunity Act (ECOA) and that no civil rights violations are committed. Paragraph 7-8(A)(1) of the 4060.1 Handbook states that a minimum of 10 percent of rejected loan applications be given a QC review or a statistical random sampling that provides a 95 percent confidence level with a two percent precision.
Addressing the issues
Upon receipt of the monthly and/or quarterly QC reports, the appropriate senior staff member should make it a priority to carefully read through the reports and identify all substantive issues. More importantly, the cause of each deficiency should be researched and an action plan developed to specifically address each item of concern. Simply stating that training will be conducted at some point in the future is not sufficient. The regulatory agencies will want to see documentation adequately addressing each exception with actual timelines. For example, repeated errors relating to proper gift fund documentation can be addressed by having underwriting personnel produce a Certificate of Completed Training on this topic by one of the various training providers by a specific date. Too many times, senior staffers will perform cursory reviews of the QC reports, file them away in a storage area and make some general statements relative to scheduling training for loan origination staff. When senior staffers begin to implement specific actions based on their review of the QC reports, such as requiring mandatory training, demoting, reassigning or terminating poor performing employees, etc., the message will be heard loud and clear that quality is important and is a priority with senior staffers. The results should be rather dramatic with loan quality greatly improving each month.
Reporting of material deficiecies
One common mistake or omission made by mortgage lenders is that they fail to report instances of fraud or any material deficiencies to HUD/FHA when uncovered as part of their QC reviews on FHA loan transactions. HUD/FHA expects lenders to immediately report all instances of fraud and/or material deficiencies to the Department via the Neighborhood Watch Early Warning system. This requirement is outlined in HUD Handbook 4060.1 REV-2, Para. 7-3(J) and is reiterated on page three of Mortgagee Letter 2011-02. Management staff is required to adequately address each reported instance of fraud or other serious material deficiency and corrective actions should also be reported via the NW Early Warning system.
The use of independent third party firms that specialize in processing QC reviews and that can provide substantive reports that both track and trend underwriting deficiencies is essential in today’s mortgage lending environment. Such QC firms are truly independent from a lender’s loan origination staff. Performing QC reviews on the QC reviews being processed by these third party firms is necessary to assure that the QC reviews being generated are not deficient. Contracting with third party firms to conduct simulated audits from time to time can also contribute to overall improved business processes for a lender. These simulated audits help ensure that a lender has the most up-to-date regulatory criteria built into their QC Plan and that the organization is following its own internal standards and practices.
No matter if a lender’s QC reviews are performed in-house or by a third party firm, it is essential that QC reviews be completed in a timely manner to ensure that any serious deficiencies are identified early on so that corrective actions can be taken to mitigate risk. A reasonable objective is to complete QC reviews on loan transactions within 90 days of closing.
Having an up-to-date QC Plan, accurate QC reviews and a responsive and committed management staff to the importance of quality control will ultimately result in better quality loans for lenders along with reduced numbers of proposed sanctions and repurchase and Indemnification Agreement requests and an overall improved balance sheet.
Gerard Glavey is senior vice president of the East Coast Division for UHS America. He may be reached by phone at (267) 239-0119 or visit UHSAmerica.com.