As an FHA approved lender, you are required to have and implement a Quality Control Plan (QCP). As many lenders have probably figured out, the QC review process is not necessarily intuitive and easily discernible as they would like. For example, are you fully aware of the sampling requirements – how to meet them – and how to do so in a cost efficient manner?
You are probably able to readily identify what it costs for your staff or contractor to complete the monthly QC process, but can you quantify the financial and reputational risk if you fail to implement the Plan or not do so in compliance with FHA requirements?
It can also cost you an audit by the Quality Assurance Division or HUD’s Office of Inspector General, a Credit Watch or Direct Endorsement authority termination. These are all potentially expensive propositions that could seriously impact your operations and production. First, what sampling does FHA require from a loan originator? You can read chapter and verse in the Lender Approval Handbook 4060.1 REV-2 Chapter 7. The short version is that lenders originating less than 3,500 loans are required to do a monthly, 10% sample. If you originate over that number it is either a 10% sample or a statistical random sample providing a 95% confidence level with a 2% precision level.
Regardless of how many loans are originated in a year, all lenders are required to review all loans that go into default (yes, that’s 100%) within the first six payments. I am constantly amazed at how many lenders are unaware of this requirement. These ‘early payment defaults’ (EPD) are defined by FHA as loans that become 60 days past due within the first six payments. In other words, if a borrower does not remit one of the first six payments after loan closing on time, the loan is considered delinquent. If the delinquency remains for 60 days, it must be reviewed as a part of your quality control review. If the loan remains in default, you do not need to QC the file again the next month. But it is critical that you maintain your records in such a way that you can prove that you are doing the 100% sampling of EPDs if asked during an audit.
So if you have originated less than 3,500 loans, does this mean that you are compliant if you select every 10th loan closed last month and all of the EPDs? The short answer is no. Not only is this not compliant with the Handbook, but it is not at all an effective way to do QC sampling.
The FHA Handbook has a listing of the ‘coverage’ that you must attain which includes: your branch offices, loan participants (i.e. loan officers, underwriters etc.), FHA program areas (i.e. in addition to 703 ‘vanilla’ loans, 734 condos, ARMs, 203(k) etc.), new Third Party Originators, soft market areas, 2-4 unit properties etc.).
While you are not required by FHA to ensure this ‘coverage’ on a monthly basis, you are required to do so, “as often as possible”. While this may seem vague on its face, the bottom line is that if your QCP says that you will attain this variety in your sampling, and the results of your review proves that you are making an effort to ensure this coverage, then you will likely pass a review by the OIG or Quality Assurance Division. If need be, develop a spreadsheet with the names of your loan officers, underwriters, TPOs etc. and check off every time you QC their loan (along with the date of that QC review).
Effective sampling also means that you know what to do if a pattern of violation or fraud is detected. If this happens your sampling methodology is not random at all, but it must focus on the problem identified. How many or what percentage of loans you review in this step is not specifically defined in the Handbook. Our suggestion is to review enough files based upon the pattern so that in the end you feel confident you have identified the extent of the problem.
For example, during a regular QC review you discover that a loan officer has teamed with a real estate agent and developed a way to falsify income documents. The next logical step is to pull all of that loan officer’s files and see how many involve that real estate agent. Now you hopefully have properly scoped out the potential population. Your next steps should be to complete an in-depth review of that selected sub-set of files to determine if fraud occurred in those loans.
Most likely you have internal reports to complete the closed loan sampling every month. FHA’s Neighborhood Watch (NW) has a variety of reports you can use to identify other required areas (such as branch office performance, TPO origination and performance etc.) but most importantly, NW has the EPD report of loans that are 60 days delinquent. This report gives you the must have, 100% sampling, list of loans that must be reviewed. If you sell loans servicing released, your servicer may be providing this report, but our recommendation is not to rely upon receipt of that information from the servicer. Staff in FHA and the HUD OIG have access to the NW reports and will use them to identify your EPD loans and when on-site, will expect to see evidence that you have reviewed 100% of them through your QC reviews.
The FHA and all of the other regulators require sound quality control, and you should never treat this requirement casually. Getting it right requires lenders to be proactive in identifying problems and fixing them as soon as possible. At the end of the day, successful lenders will approach these requirements not as costs but as essential tasks, as part of a comprehensive risk management framework that also protects their revenue and reputation.
For more information on FHA compliant QC Plans, their implementation and Neighborhood Watch monitoring and analysis, contact me at The Collingwood Group at firstname.lastname@example.org.