FHA Approval RequirementsSome net branch arrangements prohibited

By MIKE DAUGHERTY

August 14, 2003

Most mortgage brokers and lenders are by now familiar with the strict U.S. Department of Housing and Urban Development (HUD) rules regarding so-called “net branches”. These rules, defined in Mortgagee Letter 00-15, prohibit many of the branch arrangements that became common in recent years; arrangements that involved the origination of Federal Housing Administration (FHA) loans by mortgage brokers that were not HUD approved.

The rule has always been that FHA-insured loans may be originated, serviced, purchased, held, or sold only by mortgagees that have been approved by HUD. The government considers the origination of FHA loans by unapproved mortgagees to pose an increased risk to both the FHA insurance fund and to FHA borrowers.

There are three categories 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 directly under the oversight of the FDIC, Federal Reserve, or NCUA. The HUD approval requirements for these institutions are minimal due to their close scrutiny by other governmental agencies. A supervised lender can engage in the same types of lending activities as a non-supervised lender, or can function as a loan correspondent.

A non-supervised lender is a mortgage banker. This category of approval may originate, service, purchase, hold, and sell FHA-insured mortgages. After receiving “direct endorsement” approval, and surviving fifteen pre-closing test cases, non-supervised lenders may close loans and submit them for mortgage insurance without prior underwriting review by HUD.

A loan correspondent is a mortgage broker. This category of approval may only originate FHA loans; it may neither hold nor service such loans. Furthermore, a loan correspondent must have one or more sponsors to underwrite and fund the FHA loans that the correspondent originates. These sponsors must be supervised or non-supervised lenders with direct endorsement approval from HUD. Loans may close in either the name of the correspondent or the sponsor.

Once approved, a broker or lender is issued an exclusive HUD mortgagee identification number that is to be used only by the approved entity. HUD approved branch offices of the mortgagee are given a distinct identification number.

What are the current qualifications for HUD approval? The following is a brief, but complete, summary of the basic requirements. If a mortgagee satisfies these, then, with the proper paperwork, application can confidently be made to HUD for approval.

• An applicant may not be a sole proprietorship. It must be a corporation, a limited liability company, or a partnership. Both C and S corporations qualify for approval. An LLC must meet more detailed requirements. Among other things, it must have at least two members, a term of existence of no less than ten years, and provision for continuance after the withdrawal of a member. HUD will want to see both the LLC operating agreement and articles of organization. Partnership requirements are too complicated to be covered here, and are not recommended unless absolutely necessary.
• The applicant corporation must have an adjusted net worth of at least $63,000 in the case of a loan correspondent or $250,000 in the case of a non-supervised lender. While at least 20 percent of the net worth must be in the form of liquid assets (cash, certificates of deposit, marketable securities), the remainder can consist of furnishings, equipment, and other business items owned by the corporation. The entire net worth must be verified to HUD by an audited financial statement, prepared by a Certified Public Accountant (CPA) in accordance with Generally Accepted Accounting Principals (GAAP). The audited statement must contain the HUD Computation of Adjusted Net Worth, a formula that deletes the value of certain unacceptable assets.
• The corporation must be currently licensed by its state lending regulatory agency, with no sanctions or restrictions. If a state does not require licensing, that is acceptable to HUD.
• At least one senior corporate officer (vice president or above) must have a minimum of three years experience in the origination of mortgage loans, conventional or FHA. This experience need not have been gained at the applicant company.
• The corporation, its major stockholders, and its senior officers must have acceptable credit. There can be no outstanding tax liens or past-due Government loans. Bankruptcies must be discharged and seasoned for the requisite period. Other credit derogatories must be resolved and explained. HUD uses the Mortgage Asset Resource Institute (MARI), as well as its own records, to check the background of applicants for license restrictions, suspensions, debarments, and other negative items which may make individuals or companies ineligible for approval. Applicants may preview the MARI database by going to www.mari-inc.com to determine if there are adverse records.
• The corporation must have a minimum of two employees.
• The corporation must have acceptable main office facilities. This simply means that the office is in a normal business location (not a residence), with exterior and interior signs, and the usual equipment and furnishings needed to run a mortgage lending operation in a responsible and professional manner. The corporation’s main office must be separate from other business entities, but may share a common reception area or lobby.
• A loan correspondent applicant must have a HUD-approved sponsor to underwrite and fund its FHA loan originations. Once a loan correspondent has received its initial HUD approval, additional sponsors may be obtained. The sponsor initiates this process over the internet via the FHA Connection.
• Non-supervised lenders must maintain a warehouse line of credit or other funding program for at least $1,000,000.
• Non-supervised lenders must also provide evidence of a fidelity bond and errors and omissions insurance in the amount of at least $300,000 each.

These constitute the basic requirements for approval to originate FHA loans. The actual application to HUD involves substantial paperwork, but the underlying qualifications are quite reasonable. HUD has attempted to be as inclusive as possible in its approval requirements, while at the same time protecting FHA borrowers and the insurance fund.

To insure that approved mortgagees continue to comply with the net worth requirements, an annual recertification by HUD is required. This involves the submission of an audited financial statement to Washington within 90 days of the end of each mortgagee’s fiscal year. The recertification audit must be conducted in accordance with both GAAP and Government Auditing Standards. Beginning in 2002, HUD began to require that all recertification audits be submitted electronically using the Lender Assessment Sub-System (LASS) via the FHA Connection. (For initial approval submissions, a hard paper copy of the audited financial report is still required.) This new requirement did not receive much publicity, and resulted in widespread confusion among both mortgagees and the CPA community. Information on LASS can be obtained by entering “lender assessment subsystem” on the Google.com search engine.

It is advised that mortgagees familiarize themselves with the new procedures so that they are properly prepared when recertification time rolls around each year. A surprising number of lenders and brokers annually forget or neglect the recertification process, and then face the prospect of losing their HUD approval. In some years, this has resulted in thousands of panicked last minute calls to the HUD approval and recertification staff in Washington, causing an unnecessary burden not only to the staff, but to initial applicants who have their approvals delayed by the diversion of effort.