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Thursday, March 6, 2014

Prefunding Quality Control Audits

Our company recently commenced requiring prefunding quality control audits which requires substantial manpower. I have heard conflicting views on whether prefunding quality control audits are required by Fannie Mae and/or HUD. Can you clarify the prefunding requirement for me?

HUD does not specifically require that prefunding audits be performed on FHA loans but it strongly suggests that prefunding reviews should be done. HUD's Handbook 4060.1 Rev-2 Section 7-5-B says, "mortgagees may want to sample cases prior to closing to evaluate the quality of processing and underwriting. Using such reviews, mortgagees may detect problems prior to closing while problems can still be corrected.”

As we all know, Fannie Mae requires prefunding reviews and they list the specific elements or audit steps that should be conducted. (And so does Freddie Mac.)

Even if your firm does not sell directly to Fannie Mae, it is still required to perform prefunding audits because its investors sell to Fannie Mae and the investors want their lenders to follow Fannie Mae guidelines. This is mandated because all the investors want the loans to be considered secondary marketable. Please check with your investors to confirm this requirement.

Lenders should perform prefunding audits, not just because it is a regulatory requirement, but because it is Best Practice. All lenders must have a strong system of internal controls to protect themselves. In any internal control system, there are primary control points and secondary control points. Primary control points are designed to prevent the problems or, in other words, find the problems before they occur. Prefunding Quality Control is an important primary control point. Secondary control points are designed to find the problems after they have occurred. Post-Closing Quality Control is a secondary control point. Any internal control system for any company in any industry should have a combination of primary and secondary controls.

Our quality control division has audited many Early Payment Default (EPD) loans through the years, and approximately one out of every 25 EPD loans audited, resulted in a finding that a borrower lost his or her job one to two weeks prior to loan closing. And of course the borrower failed to mention this to the lender, and therefore at closing, when the borrower signed the Final Application, s/he committed fraud - because by signing the Final Application the borrower is affirming that the information to originate the loan was true and correct. Approximately, 75% of the time these files did not have any evidence that a verbal verification of employment (VOE) was conducted a few days prior to closing. Had a verbal VOE been done, these EPDs would have been prevented.

Prefunding audits are important. If your firm is having trouble performing prefunding audits due to manpower, I would suggest that they consider outsourcing this task to us, Lenders Compliance Group.

Bruce Culp
Director/Loan Analytics & Quality Control
Lenders Compliance Group