Document:

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================================================================================

                     NOVASTAR MORTGAGE FUNDING CORPORATION,
                                   as Company

                            NOVASTAR MORTGAGE, INC.,
                            as Servicer and as Seller

                        WELLS FARGO BANK MINNESOTA, N.A.,
                   as Certificate Administrator and as Trustee

                                      and

                           FIRST UNION NATIONAL BANK,
                                  as Custodian

                         POOLING AND SERVICING AGREEMENT

                            Dated as of March 1, 2001

                       _____________________________________

                 NovaStar Mortgage Funding Trust, Series 2001-1

       NovaStar Home Equity Loan Asset-Backed Certificates, Series 2001-1
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                                Table of Contents
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ARTICLE I  DEFINITIONS...........................................................................................................  1

Section 1.01  Defined Terms......................................................................................................  1
Section 1.02  Accounting.........................................................................................................  1
Section 1.03  Allocation of Certain Interest Shortfalls..........................................................................  2
Section 1.04  Calculation of Interest............................................................................................  2

ARTICLE II  CONVEYANCE OF MORTGAGE LOANS;ORIGINAL ISSUANCE OF CERTIFICATES.......................................................  2

Section 2.01  Conveyance of Mortgage Loans and MI Policies.......................................................................  2
Section 2.02  Acceptance of Mortgage Loans by the Custodian on behalf of the Trustee.............................................  5
Section 2.03  Repurchase or Substitution of Mortgage Loans by the Seller.........................................................  6
Section 2.04  Acknowledgement of Trustee.........................................................................................  9
Section 2.05  Representations, Warranties and Covenants of the Servicer..........................................................  9
Section 2.06  Representations and Warranties of the Company...................................................................... 10
Section 2.07  Issuance of Certificates........................................................................................... 11
Section 2.08  Conveyance of the Subsequent Mortgage Loans........................................................................ 11
Section 2.09  Miscellaneous REMIC Provisions..................................................................................... 12

ARTICLE III  ADMINISTRATION AND SERVICING OF THE MORTGAGE LOANS.................................................................. 13

Section 3.01  Servicer to Assure Servicing....................................................................................... 13
Section 3.02  Subservicing Agreements Between Servicer and Subservicers.......................................................... 14
Section 3.03  Successor Subservicers............................................................................................. 15
Section 3.04  Liability of the Servicer.......................................................................................... 16
Section 3.05  Assumption or Termination of Subservicing Agreements by the Certificate Administrator.............................. 16
Section 3.06  Collection of Mortgage Loan Payments............................................................................... 17
Section 3.07  Withdrawals from the Collection Account............................................................................ 19
Section 3.08  Collection of Taxes, Assessments and Similar Items; Servicing Accounts............................................. 21
Section 3.09  Access to Certain Documentation and Information Regarding the Mortgage Loans....................................... 21
Section 3.10  [Reserved]......................................................................................................... 22
Section 3.11  Maintenance of Hazard Insurance and Fidelity Coverage.............................................................. 22
Section 3.12  Due-on-Sale Clauses; Assumption Agreements......................................................................... 24
Section 3.13  Realization Upon Defaulted Mortgage Loans.......................................................................... 24
Section 3.14  Certificate Administrator to Cooperate; Release of Mortgage Files.................................................. 26
Section 3.15  Servicing Compensation............................................................................................. 27
Section 3.16  Annual Statements of Compliance.................................................................................... 27
Section 3.17  Annual Independent Public Accountants' Servicing Report............................................................ 28
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Section 3.18  Optional Purchase of Defaulted Mortgage Loans...................................................................... 29
Section 3.19  Information Required by the Internal Revenue Service Generally and Reports of Foreclosures and Abandonments of
 Mortgaged Property.............................................................................................................. 29
Section 3.20  Purchase of Converted Mortgage Loans............................................................................... 29
Section 3.21  [Reserved]......................................................................................................... 29
Section 3.22  Servicing and Administrating of the MI Policies.................................................................... 30
Section 3.23  Determination Date Reports......................................................................................... 31
Section 3.24  Advances........................................................................................................... 31
Section 3.25  Compensating Interest Payments..................................................................................... 32

ARTICLE IV  FLOW OF FUNDS........................................................................................................ 32

Section 4.01  Distributions...................................................................................................... 32
Section 4.02  Payment Account and Distribution Account........................................................................... 35
Section 4.03  Statements......................................................................................................... 37
Section 4.04  Supplemental Interest Account...................................................................................... 39
Section 4.05  Pre-Funding Account................................................................................................ 41
Section 4.06  Interest Coverage Account.......................................................................................... 42
Section 4.07  Allocation of Realized Losses...................................................................................... 43

ARTICLE V  THE CERTIFICATES...................................................................................................... 44

Section 5.01  The Certificates................................................................................................... 44
Section 5.02  Registration of Transfer and Exchange of Certificates.............................................................. 44
Section 5.03  Mutilated, Destroyed, Lost or Stolen Certificates.................................................................. 49
Section 5.04  Persons Deemed Owners.............................................................................................. 49
Section 5.05  Appointment of Paying Agent........................................................................................ 50

ARTICLE VI  THE SERVICER AND THE COMPANY......................................................................................... 50

Section 6.01  Liability of the Servicer and the Company.......................................................................... 50
Section 6.02  Merger or Consolidation of, or Assumption of the Obligations of, the Servicer or the Company....................... 50
Section 6.03  Limitation on Liability of the Servicer and Others................................................................. 51
Section 6.04  Servicer Not to Resign............................................................................................. 51
Section 6.05  Delegation of Duties............................................................................................... 52
Section 6.06  Servicer to Pay Trustee's, and Certificate Administrator's Fees and Expenses; Indemnification...................... 52
                                                                                                                                  54
ARTICLE VII  DEFAULT............................................................................................................. 54

Section 7.01  Servicing Default.................................................................................................. 56
Section 7.02  Certificate Administrator to Act; Appointment of Successor.........................................................
Section 7.03  Waiver of Defaults................................................................................................. 57
Section 7.04  Notification to Certificateholders................................................................................. 57
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Section 7.05  Survivability of Servicer Liabilities.............................................................................. 58

ARTICLE VIII  THE TRUSTEE AND THE CERTIFICATE ADMINISTRATOR...................................................................... 58

Section 8.01  Duties of the Trustee and the Certificate Administrator............................................................ 58
Section 8.02  Rights of Trustee and Certificate Administrator.................................................................... 60
Section 8.03  Individual Rights of Trustee and Certificate Administrator......................................................... 62
Section 8.04  Trustee's and Certificate Administrator's Disclaimer............................................................... 62
Section 8.05  Notice of Servicing Default........................................................................................ 62
Section 8.06  [Reserved]......................................................................................................... 62
Section 8.07  Compensation and Indemnity......................................................................................... 63
Section 8.08  Replacement of Trustee or Certificate Administrator................................................................ 63
Section 8.09  Successor Trustee or Certificate Administrator by Merger........................................................... 64
Section 8.10  Appointment of Co-Trustee or Separate Trustee...................................................................... 65
Section 8.11  Eligibility; Disqualification...................................................................................... 66
Section 8.12  [Reserved]......................................................................................................... 66
Section 8.13  Representations and Warranties..................................................................................... 66
Section 8.14  Directions to Trustee and Certificate Administrator................................................................ 68
Section 8.15  The Agents......................................................................................................... 68
Section 8.16  Reports by the Certificate Administrator; Trust Fiscal Year........................................................ 68

ARTICLE IX  [Reserved]........................................................................................................... 69

ARTICLE X  REMIC ADMINISTRATION.................................................................................................. 69

Section 10.01  REMIC Administration.............................................................................................. 69
Section 10.02  Prohibited Transactions and Activities............................................................................ 71

ARTICLE XI  TERMINATION.......................................................................................................... 71

Section 11.01  Termination....................................................................................................... 71
Section 11.02  Additional Termination Requirements............................................................................... 73

ARTICLE XII  MISCELLANEOUS PROVISIONS............................................................................................ 74

Section 12.01  Amendment......................................................................................................... 74
Section 12.02  Recordation of Agreement; Counterparts............................................................................ 75
Section 12.03  Limitation on Rights of Certificateholders........................................................................ 75
Section 12.04  Governing Law; Jurisdiction....................................................................................... 76
Section 12.05  Notices........................................................................................................... 76
Section 12.06  Severability of Provisions........................................................................................ 78
Section 12.07  Article and Section References.................................................................................... 78
Section 12.08  Further Assurances................................................................................................ 78
Section 12.09  Benefits of Agreement............................................................................................. 78
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Section 12.10  Acts of Certificateholders................................  78

EXHIBITS:
Exhibit A-1    Form of Class A-1 Certificates
Exhibit A-2    Form of Class M-1 Certificates
Exhibit A-3    Form of Class M-2 Certificates
Exhibit A-4    Form of Class M-3 Certificates
Exhibit A-5    Form of Class AIO Certificates
Exhibit A-6    Form of Class O Certificates
Exhibit A-7    Form of Class P Certificates
Exhibit A-8    Form of Class RL Certificates
Exhibit A-9    Form of Class RU Certificates
Exhibit B      Mortgage Loan Schedule
Exhibit C      Form of Addition Notice
Exhibit D      Form of Subsequent Transfer Instrument
Exhibit E      Request for Release
Exhibit F-1    Form of Trustee's Initial Certification
Exhibit F-2    Form of Trustee's Final Certification
Exhibit G      Form of Investment Letter
Exhibit H      Form of Residual Certificate Transfer Affidavit

                                       iv
<PAGE>

                                                                     Exhibit 4.1

                                                                  EXECUTION COPY

          This Pooling and Servicing Agreement is dated as of March 1, 2001 (the
"Agreement"), among NOVASTAR MORTGAGE FUNDING CORPORATION, a Delaware
 ---------
Corporation (the "Company"), NOVASTAR MORTGAGE, INC., as servicer (the
                  -------
"Servicer") and as seller (the "Seller"), WELLS FARGO BANK MINNESOTA, N.A., as
 --------                       ------
certificate administrator (the "Certificate Administrator") and as trustee (the
                                -------------------------
"Trustee"), and FIRST UNION NATIONAL BANK, as custodian (the "Custodian").
 -------                                                      ---------

                                   ARTICLE I

                                   DEFINITIONS

     Section 1.01  Defined Terms.
                   --------------

     Whenever used in this Agreement, except as otherwise expressly provided
herein or unless the context otherwise requires, capitalized terms and phrases
used herein shall have the meanings assigned to such terms and phrases in the
definitions attached hereto as Appendix A, which is incorporated herein by
reference. Unless the context otherwise requires:

     (a) a term has the meaning assigned to it;

     (b) an accounting term not otherwise defined has the meaning assigned to it
in accordance with generally accepted accounting principles as in effect from
time to time;

     (c) "or" is not exclusive;

     (d) "including" means including without limitation;

     (e) words in the singular include the plural and words in the plural
include the singular;

     (f) any agreement, instrument or statute defined or referred to herein or
in any instrument or certificate delivered in connection herewith means such
agreement, instrument or statute as from time to time amended, modified or
supplemented and includes (in the case of agreements or instruments) references
to all attachments thereto and instruments incorporated therein; and

     (g) references to a Person are also to such Person's permitted successors
and assigns.

     Section 1.02  Accounting.
                   -----------

          Unless otherwise specified herein, for the purpose of any definition
or calculation, whenever amounts are required to be netted, subtracted or added
or any distributions are taken into account such definition or calculation and
any related definitions or calculations shall be determined without duplication
of such functions.
<PAGE>

     Section 1.03  Allocation of Certain Interest Shortfalls.
                   ------------------------------------------

     For purposes of calculating the amount of the REMIC Monthly Interest
Distributable Amount for the Class A-1 Certificates, the Mezzanine Certificates
and the Class AIO Certificates for any Distribution Date, (1) the aggregate
amount of any Prepayment Interest Shortfalls and any Relief Act Shortfalls
incurred in respect of the Mortgage Loans for any Distribution Date shall be
allocated on a pro rata basis based on, and to the extent of, the gross REMIC
Monthly Interest Distributable Amount for each such Class, among the Class A-1
Certificates, the Mezzanine Certificates and the Class AIO Certificates and (2)
the aggregate amount of any Available Funds Cap Carryforward Amounts incurred
for any Distribution Date shall be allocated to the Class AIO Certificates to
the extent of the gross REMIC Monthly Interest Distributable Amount for that
Class, after deduction of any Prepayment Interest Shortfalls and any Relief Act
Shortfalls.

     All Prepayment Interest Shortfalls and Relief Act Shortfalls on the
Lower-Tier REMIC Regular Interests shall be allocated on each Distribution Date
among the Lower-Tier REMIC Regular Interests in the proportion that Prepayment
Interest Shortfalls and Relief Act Shortfalls are allocated to the related
Upper-Tier REMIC Regular Interests.

     Section 1.04  Calculation of Interest.
                   ------------------------

     Unless otherwise specified, all calculations in respect of interest on the
Class A-1 Certificates, the Class AIO Certificates and the Mezzanine
Certificates shall be made on the basis of the actual number of days elapsed on
the basis of a 360-day year and all other calculations of interest described
herein shall be made on the basis of a 360-day year consisting of twelve 30-day
months. The Class O Certificates are not entitled to distributions in respect of
interest and, accordingly, will not accrue interest.

   ARTICLE II CONVEYANCE OF MORTGAGE LOANS; ORIGINAL ISSUANCE OF CERTIFICATES

     Section 2.01  Conveyance of Mortgage Loans and MI Policies.
                   ---------------------------------------------

     (a) The Company, concurrently with the execution and delivery hereof, does
hereby transfer, assign, set over and otherwise convey in trust to the Trustee
without recourse for the benefit of the Certificateholders all the right, title
and interest of the Company, including any security interest therein for the
benefit of the Company, in and to (i) each Initial Mortgage Loan identified on
the Mortgage Loan Schedule, including the related Cut- off Date Principal
Balance, all interest accruing thereon on and after the Cut-off Date and all
collections in respect of interest and principal due after the Cut-off Date;
(ii) property which secured each such Mortgage Loan and which has been acquired
by foreclosure or deed in lieu of foreclosure; (iii) its interest in any
insurance policies in respect of the Mortgage Loans; (iv) its interest in the MI
Policies; (v) the rights of the Company under the Purchase Agreement; (vi) all
other assets included or to be included in the Trust Fund; and (vii) all
proceeds of any of the foregoing. Such assignment

                                       2
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includes all interest and principal due to the Company or the Servicer after the
Cut-off Date with respect to the Mortgage Loans.

     In connection with such transfer and assignment, the Seller, on behalf of
the Company, does hereby deliver to, and deposit with the Custodian, as the
Trustee's designated agent, the following documents or instruments with respect
to each Initial Mortgage Loan so transferred and assigned and the Seller, on
behalf of the Company, shall, in accordance with Section 2.09, deliver or caused
to be delivered to the Custodian, as the Trustee's designated agent, with
respect to each Subsequent Mortgage Loan, the following documents or instruments
(with respect to each Mortgage Loan, a "Mortgage File"):
                                        -------------

          (i) the original Mortgage Note endorsed to "Wells Fargo Bank
     Minnesota, N.A., as Trustee pursuant to the Agreement dated as of March 1,
     2001, relating to the NovaStar Home Equity Loan Asset-Backed Certificates,
     Series 2001-1";

          (ii) the original Mortgage with evidence of recording thereon, or, if
     the original Mortgage has not yet been returned from the public recording
     office, a copy of the original Mortgage certified by the Seller or the
     public recording office in which such original Mortgage has been recorded,
     and if the Mortgage Loan is registered on the MERS System, such Mortgage
     shall include thereon a statement that it is a MOM Loan and shall include
     the MIN for such Mortgage Loan;

          (iii) unless the Mortgage Loan is registered on the MERS System, an
     original assignment (which may be included in one or more blanket
     assignments if permitted by applicable law) of the Mortgage endorsed to
     "Wells Fargo Bank Minnesota, N.A., as Trustee pursuant to the Agreement
     dated as of March 1, 2001, relating to the NovaStar Home Equity Loan
     Asset-Backed Certificates, Series 2001-1", and otherwise in recordable
     form;

          (iv) originals of any intervening assignments of the Mortgage showing
     an unbroken chain of title from the originator thereof to the Person
     assigning it to the Trustee (or to MERS, if the Mortgage Loan is registered
     on the MERS System), and noting the presence of a MIN (if the Mortgage Loan
     is registered on the MERS System), with evidence of recording thereon, or,
     if the original of any such intervening assignment has not yet been
     returned from the public recording office, a copy of such original
     intervening assignment certified by the Seller or the public recording
     office in which such original intervening assignment has been recorded;

          (v) the original policy of title insurance (or a commitment for title
     insurance, if the policy is being held by the title insurance company
     pending recordation of the Mortgage);

          (vi) with respect to each Mortgage Loan insured by a MI Policy, a
     certificate of insurance or other evidence of such MI Policy; and

                                       3
<PAGE>

          (vii) a true and correct copy of each assumption, modification,
     consolidation or substitution agreement, if any, relating to the Mortgage
     Loan.

     If a material defect in any Mortgage File is discovered which may
materially and adversely affect the value of the related Mortgage Loan, or the
interests of the Trustee or the Certificateholders in such Mortgage Loan,
including if any document required to be delivered to the Custodian has not been
delivered (provided that a Mortgage File will not be deemed to contain a defect
for an unrecorded assignment under clause (iii) above for 180 days following
submission of the assignment if the Seller has submitted such assignment for
recording pursuant to the terms of the following paragraph), the Seller shall
cure such defect or repurchase the related Mortgage Loan at the Repurchase Price
or substitute an Eligible Substitute Mortgage Loan for the related Mortgage Loan
upon the same terms and conditions set forth in Section 3.01 of the Purchase
Agreement as to the Initial Mortgage Loans and the Subsequent Mortgage Loans and
Section 2.02(c) of the Purchase Agreement as to the Subsequent Mortgage Loans
for breaches of representations and warranties.

     Promptly after the Closing Date in the case of an Initial Mortgage Loan or,
in the case of a Subsequent Mortgage Loan, promptly after the Subsequent
Transfer Date (or after the date of transfer of any Eligible Substitute Mortgage
Loan), the Seller at its own expense shall complete and submit for recording in
the appropriate public office for real property records each of the assignments
referred to in clause (iii) above, with such assignment completed in favor of
the Trustee, excluding any Mortgage Loan that is registered on the MERS System
if MERS is identified on the Mortgage or on a properly recorded assignment of
Mortgage as the mortgagee of record. While such assignment to be recorded is
being recorded, the Custodian shall retain a photocopy of such assignment. If
any assignment is lost or returned unrecorded to the Custodian because of any
defect therein, the Seller is required to prepare a substitute assignment or
cure such defect, as the case may be, and the Seller shall cause such substitute
assignment to be recorded in accordance with this paragraph.

     In instances where an original Mortgage or any original intervening
assignment of Mortgage is not, in accordance with clause (ii) or (iv) above,
delivered by the Seller to the Custodian, on behalf of the Trustee, prior to or
on the Closing Date in the case of an Initial Mortgage Loan or, in the case of a
Subsequent Mortgage Loan, prior to or on the Subsequent Transfer Date, the
Seller will deliver or cause to be delivered the originals of such documents to
the Custodian, on behalf of the Trustee, promptly upon receipt thereof.

     In connection with the assignment of any Mortgage Loan registered on the
MERS System, promptly after the Closing Date in the case of an Initial Mortgage
Loan or, in the case of a Subsequent Mortgage Loan, promptly after the
Subsequent Transfer Date (or after the date of transfer of any Eligible
Substitute Mortgage Loan), the Seller further agrees that it will cause, at the
Seller's own expense, the MERS System to indicate that such Mortgage Loan has
been assigned by the Seller to the Trustee in accordance with this Agreement for
the benefit of the Certificateholders by including (or deleting, in the case of
Mortgage Loans which are repurchased in accordance with this Agreement) in its
computer files (a) the applicable Trustee code in the field "[IDENTIFY THE FIELD
NAME FOR TRUSTEE]" which identifies the Trustee and (b) the code "NovaStar 2001-
1" (or its equivalent) in the field "Pool Field" which

                                       4
<PAGE>

identifies the series of the Certificates issued in connection with such
Mortgage Loans. The Seller further agrees that it will not, and will not permit
the Servicer to, and the Servicer agrees that it will not, alter the codes
referenced in this paragraph with respect to any such Mortgage Loan during the
term of this Agreement unless and until such Mortgage Loan is repurchased in
accordance with the terms of this Agreement.

     Effective on the Closing Date, the Company hereby acknowledges its
acceptance of all right, title and interest to the Initial Mortgage Loans and
other property existing on the Closing Date and thereafter created and conveyed
to it pursuant to this Section 2.01.

     The Trustee, as assignee or transferee of the Company, shall be entitled to
all scheduled principal payments due after the Cut-off Date, all other payments
of principal due and collected after the Cut-off Date, and all payments of
interest on the Initial Mortgage Loans. No scheduled payments of principal due
on or before the Cut-off Date and collected after the Cut-off Date shall belong
to the Company pursuant to the terms of the Purchase Agreement. Any late payment
charges collected in connection with a Mortgage Loan shall be paid to the
Servicer as provided in Section 3.15(b) hereof.

     The parties hereto intend that the transactions set forth herein constitute
a sale by the Company to the Trust on the Closing Date of all the Company's
right, title and interest in and to the Initial Mortgage Loans and other
property as and to the extent described above. In the event the transactions set
forth herein shall be deemed not to be a sale, the Company hereby grants to the
Trustee as of the Closing Date a security interest in all of the Company's
right, title and interest in, to and under the Initial Mortgage Loans and such
other property, to secure all of the Company's obligations hereunder and this
Agreement shall constitute a security agreement under applicable law and in such
event, the parties hereto acknowledge that the Custodian, in addition to holding
the Initial Mortgage Loans on behalf of the Trustee for the benefit of the
Certificateholders, holds the Initial Mortgage Loans as designee of the Company.
The Seller agrees to take or cause to be taken such actions and to execute such
documents, including without limitation the filing of all necessary UCC-1
financing statements in the State of Virginia, the State of Kansas and the State
of Delaware (which shall have been submitted for filing as of the Closing Date
and each Subsequent Transfer Date, as applicable), any continuation statements
with respect thereto and any amendments thereto required to reflect a change in
the name or corporate structure of the Seller or the filing of any additional
UCC-1 financing statements due to the change in the principal office of the
Seller, as are necessary to perfect and protect the interests of the Company and
their respective assignees in each Initial Mortgage Loan and the proceeds
thereof and the interests of the Trust and its assignees in each Subsequent
Mortgage Loan and the proceeds thereof.

     Section 2.02  Acceptance of Mortgage Loans by the Custodian on behalf of
                   ----------------------------------------------------------
the Trustee.
-----------

     (a) The Custodian, on behalf of the Trustee, acknowledges receipt of,
subject to the review described below and any exceptions it notes pursuant to
the procedures described below, the documents (or certified copies thereof)
referred to in Section 2.01 hereof and declares that it holds and will continue
to hold those documents and any amendments, replacements or

                                       5
<PAGE>

supplements thereto and all other assets of the Trust Fund in trust for the use
and benefit of all present and future Certificateholders. No later than 45 days
after the Closing Date and each Subsequent Transfer Date (or, with respect to
any Eligible Substitute Mortgage Loan, within 5 Business Days after the receipt
by the Custodian, on behalf of the Trustee, thereof and, with respect to any
documents received beyond 45 days after the Closing Date, promptly thereafter),
the Custodian, on behalf of the Trustee, agrees, for the benefit of the
Certificateholders, to review each Mortgage File delivered to it and to execute
and deliver, or cause to be executed and delivered, to the Seller and the
Trustee an initial certification in the form annexed hereto as Exhibit F-1. In
conducting such review, the Custodian, on behalf of the Trustee, will ascertain
whether all required documents described in Section 2.01 hereof have been
executed and received and whether those documents relate, determined on the
basis of the Mortgagor name, original principal balance and loan number, to the
Mortgage Loans it has received, as identified in Exhibit B to this Agreement, as
supplemented (provided, however, that with respect to those documents described
              --------  -------
in subclause (vii) of such section, the Custodian's obligations shall extend
only to documents actually delivered pursuant to such subclause). In performing
any such review, the Custodian, on behalf of the Trustee, may conclusively rely
on the purported due execution and genuineness of any such document and on the
purported genuineness of any signature thereon. If the Custodian, on behalf of
the Trustee, finds that any document constituting part of the Mortgage File not
to have been executed or received, or to be unrelated to the Mortgage Loans
identified in Exhibit B or Attachment B to Exhibit 2 of the Purchase Agreement
or to appear to be defective on its face, the Custodian, on behalf of the
Trustee, shall promptly notify the Seller and the Trustee of such finding and
the Seller's obligation to cure such defect or repurchase or substitute for the
related Mortgage Loan.

     (b) No later than 180 days after the Closing Date, the Custodian, on behalf
of the Trustee, will review, for the benefit of the Certificateholders, the
Mortgage Files and will execute and deliver or cause to be executed and
delivered to the Seller and the Trustee, a final certification in the form
annexed hereto as Exhibit F-2. In conducting such review, the Custodian, on
behalf of the Trustee, will ascertain whether an original of each document
described in subclauses (ii)-(iv) of Section 2.01 hereof required to be recorded
has been returned from the recording office with evidence of recording thereon
or a certified copy has been obtained from the recording office. If the
Custodian, on behalf of the Trustee, finds any document constituting part of the
Mortgage File has not been received, or to be unrelated, determined on the basis
of the Mortgagor name, original principal balance and loan number, to the
Mortgage Loans identified in Exhibit B or Attachment B to Exhibit 2 of the
Purchase Agreement or to appear defective on its face, the Custodian, on behalf
of the Trustee, shall promptly notify the Seller and the Trustee of such finding
and the Seller's obligation to cure such defect or repurchase or substitute for
the related Mortgage Loan.

     Section 2.03  Repurchase or Substitution of Mortgage Loans by the Seller.
                   -----------------------------------------------------------

     (a) Upon discovery or receipt of written notice of any materially defective
document in, or that a document is missing from, a Mortgage File or of the
breach by the Seller of any representation, warranty or covenant under the
Purchase Agreement in respect of any Mortgage Loan which materially adversely
affects the value of such Mortgage Loan or the interest therein of the
Certificateholders, the Certificate Administrator shall promptly notify the

                                       6
<PAGE>

Seller and the Servicer of such defect, missing document or breach and request
that the Seller deliver such missing document or cure such defect or breach
within 90 days from the date the Seller was notified of such missing document,
defect or breach, and if the Seller does not deliver such missing document or
cure such defect or breach in all material respects during such period, the
Certificate Administrator shall enforce the Seller's obligation under the
Purchase Agreement and cause the Seller to repurchase such Mortgage Loan from
the Trust Fund at the Repurchase Price on or prior to the Determination Date
following the expiration of such 90 day period; provided that, in connection
with any such breach that could not reasonably have been cured within such 90
day period, if the Seller shall have commenced to cure such breach within such
90 day period, the Seller shall be permitted to proceed thereafter diligently
and expeditiously to cure the same within the additional period provided under
the Purchase Agreement.

     (b) The Repurchase Price for the repurchased Mortgage Loan shall be
deposited in the Collection Account. Upon deposit of the Repurchase Price in the
Collection Account and notification of the Custodian, on behalf of the Trustee,
by a certification signed by a Servicing Officer (which certification shall
include a statement to the effect that the Repurchase Price has been deposited
in the Collection Account), the Custodian, on behalf of the Trustee, shall
release to the Seller the related Mortgage File and the Certificate
Administrator or the Trustee, as applicable, shall execute and deliver such
instruments of transfer or assignment, in each case without recourse, as the
Seller shall furnish to it and as shall be necessary to vest in the Seller any
Mortgage Loan released pursuant hereto and the Custodian shall have no further
responsibility with regard to such Mortgage File (it being understood that none
of the Trustee, the Certificate Administrator or the Custodian shall have any
responsibility for determining the sufficiency of such assignment for its
intended purpose). Such purchase shall be deemed to have occurred on the date on
which certification of the deposit of the Repurchase Price in the Payment
Account was received by the Trustee. The Certificate Administrator, on behalf of
the Trustee, shall amend the applicable Mortgage Loan Schedule to reflect such
repurchase and shall promptly notify the Servicer, the Custodian, and the Rating
Agencies of such amendment. The Trustee agrees to provide the Certificate
Administrator with such power of attorneys as are necessary for the Certificate
Administrator to fulfill its obligations under this Section 2.03 and otherwise
under the Basic Documents provided, however, that the Certificate Administrator
has furnished such form of Power of Attorney to the Trustee.

     In lieu of repurchasing any such Mortgage Loan as provided above, the
Seller may cause such Mortgage Loan to be removed from the Trust Fund (in which
case it shall become a Deleted Mortgage Loan) and substitute one or more
Eligible Substitute Mortgage Loans in the manner and subject to the limitations
set forth in Section 2.03(d). It is understood and agreed that the obligation of
the Seller to cure or to repurchase (or to substitute for) any Mortgage Loan as
to which a document is missing, a material defect in a constituent document
exists or as to which such a breach has occurred and is continuing shall
constitute the sole remedy against the Seller respecting such omission, defect
or breach available to the Trustee or the Certificate Administrator on behalf of
the Certificateholders.

     (c) Within 90 days of the earlier of discovery by the Servicer or receipt
of notice by the Servicer of the breach of any representation, warranty or
covenant of the Servicer set forth in Section 2.05 which materially and
adversely affects the interests of the

                                       7
<PAGE>

Certificateholders in any Mortgage Loan, the Servicer shall cure such breach in
all material respects.

     (d) Any substitution of Eligible Substitute Mortgage Loans for Deleted
Mortgage Loans made pursuant to Section 2.03(a) must be effected prior to the
last Business Day that is within two years after the Closing Date. As to any
Deleted Mortgage Loan for which the Seller substitutes an Eligible Substitute
Mortgage Loan or Loans, such substitution shall be effected by the Seller
delivering to the Custodian, for such Eligible Substitute Mortgage Loan or
Loans, the Mortgage Note, the Mortgage, the Assignment to the Trustee, and such
other documents and agreements, with all necessary endorsements thereon, as are
required by Section 2.01, together with an Officers' Certificate providing that
each such Eligible Substitute Mortgage Loan satisfies the definition thereof and
specifying the Substitution Adjustment Amount (as described below), if any, in
connection with such substitution. The Custodian shall acknowledge receipt for
such Eligible Substitute Mortgage Loan or Loans and, within ten Business Days
thereafter, shall review such documents as specified in Section 2.02 and deliver
to the Servicer, with respect to such Eligible Substitute Mortgage Loan or
Loans, a certification substantially in the form attached hereto as Exhibit F-1,
with any applicable exceptions noted thereon. Within one year of the date of
substitution, the Custodian shall deliver to the Servicer and Trustee a
certification substantially in the form of Exhibit F-2 hereto with respect to
such Eligible Substitute Mortgage Loan or Loans, with any applicable exceptions
noted thereon. Monthly Payments due with respect to Eligible Substitute Mortgage
Loans in the month of substitution are not part of the Trust Fund and will be
retained by the Seller. For the month of substitution, distributions to
Certificateholders will reflect the collections and recoveries in respect of
such Deleted Mortgage Loan in the Due Period preceding the month of substitution
and the Seller shall thereafter be entitled to retain all amounts subsequently
received in respect of such Deleted Mortgage Loan. The Seller shall give or
cause to be given written notice to the Certificateholders that such
substitution has taken place, shall amend the Mortgage Loan Schedule to reflect
the removal of such Deleted Mortgage Loan from the terms of this Agreement and
the substitution of the Eligible Substitute Mortgage Loan or Loans and shall
deliver a copy of such amended Mortgage Loan Schedule to the Custodian. Upon
such substitution by the Seller, such Eligible Substitute Mortgage Loan or Loans
shall constitute part of the Mortgage Pool and shall be subject in all respects
to the terms of this Agreement and the Purchase Agreement, including all
applicable representations and warranties thereof included in the Purchase
Agreement as of the date of substitution.

     For any month in which the Seller substitutes one or more Eligible
Substitute Mortgage Loans for one or more Deleted Mortgage Loans, the Servicer
will determine the amount (the "Substitution Adjustment Amount"), if any, by
                                ------------------------------
which the aggregate Repurchase Price of all such Deleted Mortgage Loans exceeds
the aggregate, as to each such Eligible Substitute Mortgage Loan, of the
principal balance thereof as of the date of substitution, together with one
month's interest on such principal balance at the applicable Net Mortgage Rate.
On the date of such substitution, the Seller will deliver or cause to be
delivered to the Servicer for deposit in the Collection Account an amount equal
to the Substitution Adjustment Amount, if any, and the Custodian, upon receipt
of the related Eligible Substitute Mortgage Loan or Loans and certification by
the Servicer of such deposit, shall release to the Seller the related Mortgage
File or Files and the Custodian or the Trustee, as applicable, shall execute and
deliver such

                                       8
<PAGE>

instruments of transfer or assignment, in each case without recourse, as the
Seller shall deliver to it and as shall be necessary to vest therein any Deleted
Mortgage Loan released pursuant hereto.

     In addition, the Seller shall obtain at its own expense and deliver to the
Certificate Administrator an Opinion of Counsel to the effect that such
substitution will not cause (a) any federal tax to be imposed on the Trust Fund,
including without limitation, any federal tax imposed on "prohibited
transactions" under Section 860F(a)(l) of the Code or on "contributions after
the startup date" under Section 860G(d)(l) of the Code, or (b) any REMIC to fail
to qualify as a REMIC at any time that any Certificate is outstanding. If such
Opinion of Counsel can not be delivered, then such substitution may only be
effected at such time as the required Opinion of Counsel can be given.

     (e) Upon discovery by the Seller, the Servicer, the Certificate
Administrator or the Trustee that any Mortgage Loan does not constitute a
"qualified mortgage" within the meaning of Section 860G(a)(3) of the Code, the
party discovering such fact shall within two Business Days give written notice
thereof to the other parties. In connection therewith, the Seller or the
Company, as the case may be, shall repurchase or, subject to the limitations set
forth in Section 2.03(d), substitute one or more Eligible Substitute Mortgage
Loans for the affected Mortgage Loan within 90 days of the earlier of discovery
or receipt of such notice with respect to such affected Mortgage Loan. Such
repurchase or substitution shall be made by the Seller. Any such repurchase or
substitution shall be made in the same manner as set forth in Section 2.03(a).
The Custodian on behalf of the Trustee shall reconvey to the Seller, the
Mortgage Loan to be released pursuant hereto in the same manner, and on the same
terms and conditions, as it would a Mortgage Loan repurchased for breach of a
representation or warranty.

     Section 2.04  Acknowledgement of Trustee and the Custodian.
                   ---------------------------------------------

     The Trustee and the Custodian acknowledge that in the event that any of (i)
the transfer of the Initial Mortgage Loans and the MI Policies from the Seller
to the Company or from the Company to the Custodian on behalf of the Trustee is
determined to constitute a financing, or (ii) the transfer of the Subsequent
Mortgage Loans from the Seller to the Company or from the Company to the
Custodian on behalf of the Trustee is determined to constitute a financing, then
in each case the Custodian, on behalf of the Trustee, and the Trustee hold the
Initial Mortgage Loans, the MI Policies and the Subsequent Mortgage Loans as the
designee and bailee of the Company, subject, however, in each case, to a prior
lien in favor of the Certificateholders pursuant to the terms of this Agreement.

     Section 2.05  Representations, Warranties and Covenants of the Servicer.
                   ----------------------------------------------------------

     The Servicer hereby represents, warrants and covenants to the Trustee, for
the benefit of each of the Trustee and the Certificateholders and to the Company
that as of the Closing Date or as of such date specifically provided herein:

          (i) The Servicer is a corporation duly organized, validly existing and
     in good standing under the laws of the State of Virginia and has the
     corporate power to own its assets and to transact the business in which it
     is currently engaged. The Servicer is duly

                                       9
<PAGE>

     qualified to do business as a foreign corporation and is in good standing
     in each jurisdiction in which the character of the business transacted by
     it or properties owned or leased by it requires such qualification and in
     which the failure to so qualify would have a material adverse effect on the
     business, properties, assets, or condition (financial or other) of the
     Servicer or the validity or enforceability of the Mortgage Loans;

          (ii) The Servicer has the corporate power and authority to make,
     execute, deliver and perform this Agreement and all of the transactions
     contemplated under this Agreement, and has taken all necessary corporate
     action to authorize the execution, delivery and performance of this
     Agreement. When executed and delivered, this Agreement will constitute the
     legal, valid and binding obligation of the Servicer enforceable in
     accordance with its terms, except as enforcement of such terms may be
     limited by bankruptcy, insolvency or similar laws affecting the enforcement
     of creditors' rights generally and by the availability of equitable
     remedies;

          (iii) The Servicer is not required to obtain the consent of any other
     Person or any consent, license, approval or authorization from, or
     registration or declaration with, any governmental authority, bureau or
     agency in connection with the execution, delivery, performance, validity or
     enforceability of this Agreement, except for such consent, license,
     approval or authorization, or registration or declaration, as shall have
     been obtained or filed, as the case may be;

          (iv) The execution and delivery of this Agreement and the performance
     of the transactions contemplated hereby by the Servicer will not violate
     any provision of any existing law or regulation or any order or decree of
     any court applicable to the Servicer or any provision of the certificate of
     incorporation or bylaws of the Servicer, or constitute a material breach of
     any mortgage, indenture, contract or other agreement to which the Servicer
     is a party or by which the Servicer may be bound; and

          (v) No litigation or administrative proceeding of or before any court,
     tribunal or governmental body is currently pending, or to the knowledge of
     the Servicer threatened, against the Servicer or any of its properties or
     with respect to this Agreement or the Certificates which, to the knowledge
     of the Servicer, has a reasonable likelihood of resulting in a material
     adverse effect on the transactions contemplated by this Agreement.

          (vi) The Servicer is a member of MERS in good standing, and will
     comply in all material respects with the rules and procedures of MERS in
     connection with the servicing of the Mortgage Loans that are registered
     with MERS.

     The foregoing representations and warranties shall survive any termination
of the Servicer hereunder.

     Section 2.06  Representations and Warranties of the Company.
                   ----------------------------------------------

     The Company represents and warrants to the Trust and the Trustee on behalf
of the Certificateholders as follows:

                                       10
<PAGE>

     (a) The Company is duly organized and validly existing as a corporation in
good standing under the laws of the State of Delaware, with power and authority
to own its properties and to conduct its business as such properties are
currently owned and such business is presently conducted.

     (b) The Company is duly qualified to do business as a foreign corporation
in good standing and has obtained all necessary licenses and approvals in all
jurisdictions in which the ownership or lease of its property or the conduct of
its business shall require such qualifications and in which the failure to so
qualify would have a material adverse effect on the business, properties, assets
or condition (financial or other) of the Company and the ability of the Company
to perform hereunder.

     (c) The Company has the power and authority to execute and deliver this
Agreement and to carry out its terms; the Company has full power and authority
to purchase the property to be purchased from the Seller and the Company has
duly authorized such purchase by all necessary corporate action; and the
execution, delivery and performance of this Agreement have been duly authorized
by the Company by all necessary corporate action.

     (d) The consummation of the transactions contemplated by this Agreement and
the fulfillment of the terms hereof do not conflict with, result in any breach
of any of the terms and provisions of, or constitute (with or without notice or
lapse of time) a default under, the articles of incorporation or bylaws of the
Company, or any indenture, agreement or other instrument to which the Company is
a party or by which it is bound; nor result in the creation or imposition of any
Lien upon any of its properties pursuant to the terms of any such indenture,
agreement or other instrument (other than pursuant to the Basic Documents); nor
violate any law or, to the best of the Company's knowledge, any order, rule or
regulation applicable to the Company of any court or of any federal or state
regulatory body, administrative agency or other governmental instrumentality
having jurisdiction over the Company or its properties.

     Section 2.07  Issuance of Certificates.
                   -------------------------

     The Trustee acknowledges the assignment to the Trustee of the Mortgage
Loans and the delivery to the Custodian, on behalf of the Trustee of the
Mortgage Files, subject to the provisions of Sections 2.01 and 2.02, together
with the assignment to it of all other assets included in the Trust Fund,
receipt of which is hereby acknowledged. Concurrently with such assignment and
delivery and in exchange therefor, the Trustee, pursuant to the written request
of the Company executed by an officer of the Company, has executed, and
authenticated and delivered to or upon the order of the Company, the
Certificates in authorized denominations. The interests evidenced by the
Certificates, constitute the entire beneficial ownership interest in the Trust
Fund.

     Section 2.08  Conveyance of the Subsequent Mortgage Loans.
                   --------------------------------------------

     The Trustee shall purchase the Subsequent Mortgage Loans as set forth in
Section 2.02 of the Purchase Agreement.

                                       11
<PAGE>

     Section 2.09  Miscellaneous REMIC Provisions.
                   -------------------------------

     (a) The Certificate Administrator as agent of the Trustee shall elect that
each of the Lower-Tier REMIC and the Upper-Tier REMIC shall be treated as a
REMIC under Section 860D of the Code. Any inconsistencies or ambiguities in this
Agreement or in the administration of this Agreement shall be resolved in a
manner that preserves the validity of such REMIC elections. The assets of the
Lower-Tier REMIC shall include the Mortgage Loans, the Accounts (other than the
Non-REMIC Accounts), any REO Property, and any proceeds of the foregoing. The
Lower-Tier REMIC Regular Interests (as defined below) shall constitute the
assets of the Upper-Tier REMIC.

     (b) The Lower-Tier REMIC will be evidenced by (x) Lower-Tier Interest 1,
Lower- Tier Interest 2, Lower-Tier Interest 3, Lower-Tier Interest 4, Lower-Tier
Interest 5, and Lower-Tier Interest 6 (the "Lower-Tier REMIC Regular
                                            ------------------------
Interests"), which will be uncertificated and non-transferable and are hereby
---------
designated as the "regular interests" in the Lower-Tier REMIC and (y) the Class
RL Certificate, which is hereby designated as the single "residual interest" in
the Lower-Tier REMIC (the Lower-Tier REMIC Regular Interests, together with the
Class RL Certificate, the "Lower-Tier REMIC Interests"). The Lower-Tier REMIC
                           --------------------------
Regular Interests shall be recorded on the records of the Lower-Tier REMIC as
being issued to and held by the Trustee on behalf of the Upper-Tier REMIC.

     The Lower-Tier REMIC Interests will have the following designations and
Lower-Tier Pass-Through Rates, and distributions of principal, interest and
Realized Losses thereon shall be allocated to the Certificates in the following
manner:

<TABLE>
<CAPTION>
    Lower-Tier                                Pass-Through        Allocation of       Allocation of
    Interests         Initial Balance             Rate            Principal (3)        Interest (4)
------------------  -------------------  ----------------------  ----------------  --------------------
<S>                 <C>                  <C>                     <C>               <C>
        1              $   385,950,000     LIBOR + 0.28% (1)           A1                A1, AIO
        2              $     8,300,000     LIBOR + 0.65% (1)           M1                M1, AIO
        3              $     8,300,000     LIBOR + 1.35% (1)           M2                M2, AIO
        4              $     6,225,000     LIBOR + 2.30% (1)           M3                M3, AIO
        5              $415,000,000 (6)             (1)                O                  AIO
        6              $415,000,000 (6)             (2)               (2)                  P
     Class RL                       (5)             (5)               (5)                 (5)
</TABLE>

------------------
(1)  The Lower-Tier Pass-Through Rate on these Lower-Tier REMIC Regular
     Interests shall at any time of determination equal the Weighted Average
     Mortgage Rate of the Mortgage Loans.
(2)  Lower-Tier REMIC Interest 6 is entitled to distributions of all Prepayment
     Charges.  It is not entitled to any other distributions of principal or
     interest.
(3)  Distributions of principal and Realized Losses from the Lower-Tier REMIC
     Interests will be allocated to the related Upper-Tier REMIC Interests in
     the amounts and priorities provided for such Upper-Tier REMIC Interests in
     Section 4.1.
(4)  Distributions of interest from the Lower-Tier REMIC Interests will be
     allocated to the related Upper-Tier REMIC Interests in the amounts and
     priorities provided for such Upper-Tier REMIC Interests in Section 4.1.

                                       12
<PAGE>

(5)  On each Distribution Date, available funds, if any, remaining in the Lower-
     Tier REMIC after payments of interest and principal, as designated above,
     will be distributed to the Class RL Certificate.  It is expected that there
     shall not be any distributions on the Class RL Certificate.
(6)  Notional Principal Amount

     (c) The Class A-1, Class AIO, Class M-1, Class M-2, Class M-3, Class O and
Class P Certificates are hereby designated as "regular interests" with respect
to the Upper-Tier REMIC (the "Upper-Tier REMIC Regular Interests") and the Class
                              ----------------------------------
RU Certificate is hereby designated as the single "residual interest" with
respect to the Upper-Tier REMIC. On each Distribution Date, available funds, if
any, remaining in the Upper-Tier REMIC after payments of interest and principal
as designated herein shall be distributed to the Class RU Certificates.

     (d) For federal income tax purposes, the "latest possible maturity date"
for each of the Lower-Tier REMIC Regular Interests and Upper-Tier REMIC Regular
Interests is hereby set to be the Distribution Date of August, 2031.

                                  ARTICLE III

               ADMINISTRATION AND SERVICING OF THE MORTGAGE LOANS

     Section 3.01  Servicer to Assure Servicing.
                   -----------------------------

     (a) The Servicer shall supervise, or take such actions as are necessary to
ensure, the servicing and administration of the Mortgage Loans and any REO
Property in accordance with this Agreement and its normal servicing practices,
which generally shall conform to the standards of an institution prudently
servicing mortgage loans for its own account and shall have full authority to do
anything it reasonably deems appropriate or desirable in connection with such
servicing and administration. The Servicer may perform its responsibilities
relating to servicing through other agents or independent contractors, but shall
not thereby be released from any of its responsibilities as hereinafter set
forth. Subject to Section 3.06(b), the authority of the Servicer, in its
capacity as Servicer, and any Subservicer acting on its behalf, shall include,
without limitation, the power to (i) consult with and advise any Subservicer
regarding administration of a related Mortgage Loan, (ii) approve any
recommendation by a Subservicer to foreclose on a related Mortgage Loan, (iii)
supervise the filing and collection of insurance claims and take or cause to be
taken such actions on behalf of the insured Person thereunder as shall be
reasonably necessary to prevent the denial of coverage thereunder, and (iv)
effectuate foreclosure or other conversion of the ownership of the Mortgaged
Property securing a related Mortgage Loan, including the employment of
attorneys, the institution of legal proceedings, the collection of deficiency
judgments, the acceptance of compromise proposals and any other matter
pertaining to a delinquent Mortgage Loan. The authority of the Servicer shall
include, in addition, the power on behalf of the Certificateholders, the
Trustee, or any of them to (i) execute and deliver customary consents or waivers
and other instruments and documents, (ii) consent to transfer of any related
Mortgaged Property and assumptions of the related Mortgage Notes and Mortgages
(in the manner provided in this Agreement) and (iii) collect any Insurance
Proceeds and Liquidation Proceeds. Without limiting the generality of the
foregoing, the Servicer and any Subservicer acting on its behalf may, and is
hereby authorized, and empowered

                                       13
<PAGE>

by the Trustee when the Servicer believes it is reasonably necessary in its best
judgment in order to comply with its servicing duties hereunder, to execute and
deliver, on behalf of itself, the Certificateholders, the Trustee, or any of
them, any instruments of satisfaction, cancellation, partial or full release,
discharge and all other comparable instruments, with respect to the related
Mortgage Loans, the insurance policies and the accounts related thereto, and the
Mortgaged Properties. The Servicer may exercise this power in its own name or in
the name of a Subservicer.

     The Servicer, in such capacity, may not consent to the placing of a lien
senior to that of the Mortgage on the related Mortgaged Property.

     The relationship of the Servicer (and of any successor to the Servicer as
servicer under this Agreement) to the Trust and the Trustee under this Agreement
is intended by the parties to be that of an independent contractor and not that
of a joint venturer, partner or agent.

     (b) Notwithstanding the provisions of Subsection 3.01(a), the Servicer
shall not take any action inconsistent with the interests of the Trustee, or the
Certificateholders or with the rights and interests of the Trustee, or the
Certificateholders under this Agreement.

     (c) The Certificate Administrator shall furnish or shall cause the Trustee
to furnish the Servicer on the Closing Date with any powers of attorney and
other documents in form as provided to it necessary or appropriate to enable the
Servicer to service and administer the related Mortgage Loans and REO Property
and the Certificate Administrator and the Trustee shall not be liable for the
actions of the Servicer or any Subservicers under such powers of attorney.

     (d) The Servicer further is authorized and empowered by the Trustee, on
behalf of the Certificateholders and the Trustee, when the Servicer believes it
is appropriate in its best judgment to register any Mortgage Loan on the MERS
System, or cause the removal from the registration of any Mortgage Loan on the
MERS System, to execute and deliver, on behalf of the Trustee and the
Certificateholders or any of them, any and all instruments of assignment and
other comparable instruments with respect to such assignment or rerecording of a
Mortgage in the name of MERS, solely as nominee for the Trustee and its
successors and assigns. Any expenses incurred in connection with the actions
described in the preceding sentence shall be borne by the Servicer with no right
of reimbursement; provided, that if, as a result of MERS discontinuing or
becoming unable to continue operations in connection with the MERS System, it
becomes necessary to remove any Mortgage Loan from registration on the MERS
System and to arrange for the assignment of the related Mortgages to the
Trustee, then any related expenses shall be reimbursable to the Servicer by the
Trust.

     Section 3.02  Subservicing Agreements Between Servicer and Subservicers.
                   ----------------------------------------------------------

     (a) The Servicer may enter into Subservicing Agreements with Subservicers
for the servicing and administration of the Mortgage Loans and for the
performance of any and all other activities of the Servicer hereunder. Each
Subservicer shall be either (i) an institution the accounts of which are insured
by the FDIC or (ii) another entity that engages in the business

                                       14
<PAGE>

of originating or servicing mortgage loans comparable to the Mortgage Loans, and
in either case shall be authorized to transact business in the state or states
in which the related Mortgaged Properties it is to service are situated, if and
to the extent required by applicable law to enable the Subservicer to perform
its obligations hereunder and under the Subservicing Agreement. Any Subservicing
Agreement entered into by the Servicer shall include the provision that such
Agreement may be immediately terminated (i) (x) with cause and without any
termination fee by the Servicer hereunder and/or (y) without cause, in which
case the Servicer shall be solely responsible for any termination fee or penalty
resulting therefrom and (ii) at the option of the Trustee upon the termination
or resignation of the Servicer hereunder, in which case the Servicer shall be
solely responsible for any termination fee or penalty resulting therefrom. In
addition, each Subservicing Agreement shall provide for servicing of the
Mortgage Loans consistent with the terms of this Agreement. The Servicer and the
Subservicers may enter into Subservicing Agreements and make amendments to the
Subservicing Agreements or enter into different forms of Subservicing Agreements
providing for, among other things, the delegation by the Servicer to a
Subservicer of additional duties regarding the administration of the Mortgage
Loans; provided, however, that any such amendments or different forms shall be
consistent with and not violate the provisions of this Agreement, and that no
such amendment or different form shall be made or entered into which could be
reasonably expected to be materially adverse to the interests of the
Certificateholders, without the consent of the Certificateholders holding at
least 51% of the aggregate Voting Rights.

     (b) As part of its servicing activities hereunder, the Servicer, for the
benefit of the Trustee, and the Certificateholders, shall enforce the
obligations of each Subservicer under the related Subservicing Agreement. Such
enforcement, including, without limitation, the legal prosecution of claims,
termination of Subservicing Agreements and the pursuit of other appropriate
remedies, shall be in such form and carried out to such an extent and at such
time as the Servicer, in its good faith business judgment, would require were it
the owner of the related Mortgage Loans. The Servicer shall pay the costs of
such enforcement at its own expense, but shall be reimbursed therefor only (i)
from a general recovery resulting from such enforcement only to the extent, if
any, that such recovery exceeds all amounts due in respect of the related
Mortgage Loan or (ii) from a specific recovery of costs, expenses or attorneys'
fees against the party against whom such enforcement is directed.

     Section 3.03  Successor Subservicers.
                   -----------------------

     The Servicer shall be entitled to terminate any Subservicing Agreement that
may exist in accordance with the terms and conditions of such Subservicing
Agreement and without any limitation by virtue of this Agreement; provided,
however, that upon termination, the Servicer shall either act as servicer of the
related Mortgage Loans or enter into an appropriate contract with a successor
Subservicer reasonably acceptable to the Certificate Administrator on behalf of
the Trustee, pursuant to which such successor Subservicer will be bound by all
relevant terms of the related Subservicing Agreement pertaining to the servicing
of such Mortgage Loans.

                                       15
<PAGE>

     Section 3.04  Liability of the Servicer.
                   --------------------------

     (a) Notwithstanding any Subservicing Agreement, any of the provisions of
this Agreement relating to agreements or arrangements between the Servicer and a
Subservicer or reference to actions taken through a Subservicer or otherwise,
the Servicer shall under all circumstances remain obligated and primarily liable
to the Certificate Administrator, the Trustee, the Certificateholders for the
servicing and administering of the Mortgage Loans and any REO Property in
accordance with this Agreement. The obligations and liability of the Servicer
shall not be diminished by virtue of Subservicing Agreements or by virtue of
indemnification of the Servicer by any Subservicer, or any other Person. The
obligations and liability of the Servicer shall remain of the same nature and
under the same terms and conditions as if the Servicer alone were servicing and
administering the related Mortgage Loans. The Servicer shall, however, be
entitled to enter into indemnification agreements with any Subservicer or other
Person and nothing in this Agreement shall be deemed to limit or modify such
indemnification. For the purposes of this Agreement, the Servicer shall be
deemed to have received any payment on a Mortgage Loan on the date the
Subservicer received such payment.

     (b) Any Subservicing Agreement that may be entered into and any
transactions or services relating to the Mortgage Loans involving a Subservicer
in its capacity as such and not as an originator shall be deemed to be between
the Subservicer and the Servicer alone, and the Certificate Administrator, the
Trustee and the Certificateholders shall not be deemed parties thereto and shall
have no claims, rights, obligations, duties or liabilities with respect to the
Subservicer except as set forth in Section 3.15.

     Section 3.05  Assumption or Termination of Subservicing Agreements by the
                   -----------------------------------------------------------
Certificate Administrator.
--------------------------

     (a) If the Certificate Administrator or its designee as the successor
Servicer, shall assume the servicing obligations of the Servicer in accordance
with Section 7.02 below, the Certificate Administrator, to the extent necessary
to carry out the provisions of Section 7.02 with respect to the Mortgage Loans,
shall succeed to all of the rights and obligations of the Servicer under each of
the Subservicing Agreements. In such event, the Certificate Administrator or its
designee as the successor Servicer shall be deemed to have assumed all of the
Servicer's rights and obligations therein and to have replaced the Servicer as a
party to such Subservicing Agreements to the same extent as if such Subservicing
Agreements had been assigned to the Certificate Administrator or its designee as
a successor Servicer, except that the Certificate Administrator or its designee
as a successor Servicer shall not be deemed to have assumed any obligations or
liabilities of the Servicer arising prior to such assumption or as a result of
the Certificate Administrator's terminating any Subservicer upon the Certificate
Administrator becoming successor Servicer and the Servicer shall not thereby be
relieved of any liability or obligations under such Subservicing Agreements
arising prior to such assumption or as a result of the Certificate
Administrator's terminating any Subservicer upon the Certificate Administrator
becoming successor Servicer.

     (b) The Certificate Administrator may terminate any Subservicer upon
becoming successor Servicer.

                                       16
<PAGE>

     (c) In the event that the Certificate Administrator or its designee as
successor Servicer assumes the servicing obligations of the Servicer under
Section 7.02, upon the request of the Certificate Administrator or such designee
as successor Servicer, the Servicer shall at its own expense deliver to the
Certificate Administrator, or at its written request to such designee, originals
or, if originals are not available, photocopies of all documents, files and
records, electronic or otherwise, relating to the Subservicing Agreements and
the related Mortgage Loans or REO Property then being serviced and an accounting
of amounts collected and held by it, if any, and will otherwise cooperate and
use its reasonable efforts to effect the orderly and efficient transfer of the
Subservicing Agreements, or responsibilities hereunder to the Certificate
Administrator, or at its written request to such designee as successor Servicer.

      Section 3.06  Collection of Mortgage Loan Payments.
                    -------------------------------------

     (a) The Servicer will coordinate and monitor remittances by Subservicers to
it with respect to the Mortgage Loans in accordance with this Agreement.

     (b) The Servicer shall make its best reasonable efforts to collect or cause
to be collected all payments required under the terms and provisions of the
Mortgage Loans and shall follow, and use its best reasonable efforts to cause
Subservicers to follow, collection procedures comparable to the collection
procedures of prudent mortgage lenders servicing mortgage loans for their own
account to the extent such procedures shall be consistent with this Agreement.
Consistent with the foregoing, the Servicer or the related Subservicer may in
its discretion (i) waive or permit to be waived any late payment charge,
prepayment charge, assumption fee, or any penalty interest in connection with
the prepayment of a Mortgage Loan and (ii) suspend or reduce or permit to be
suspended or reduced regular monthly payments for a period of up to six months,
or arrange or permit an arrangement with a Mortgagor for a scheduled liquidation
of delinquencies; provided, however, that the Servicer or the related
Subservicer may permit the foregoing only if it believes, in good faith, that
recoveries of Monthly Payments will be maximized; provided further, however,
with respect to Mortgage Loans insured by an MI Policy, that the Servicer may
not without the prior written consent of the MI Insurer permit any waiver,
modification or variance which would (a) change the loan rate, (b) forgive any
payment of principal or interest, (c) lessen the lien priority or (d) extend the
final maturity date of a Mortgage Loan past 12 months after the original
maturity date on such Mortgage Loan. In the event the Servicer or related
Subservicer shall consent to the deferment of the due dates for payments due on
a Mortgage Note, the Servicer shall nonetheless make an Advance or shall cause
the related Subservicer to make an advance to the same extent as if such
installment were due, owing and delinquent and had not been deferred through
liquidation of the Mortgaged Property; provided, however, that the obligation of
the Servicer or the related Subservicer to make an Advance shall apply only to
the extent that the Servicer believes, in good faith, that such advances are not
Nonrecoverable Advances.

     (c) Within five Business Days after the Servicer has determined that all
amounts which it expects to recover from or on account of a Liquidated Mortgage
Loan have been recovered and that no further Liquidation Proceeds will be
received in connection therewith, the Servicer shall provide to the Certificate
Administrator a certificate of a Servicing Officer that such Mortgage Loan
became a Liquidated Mortgage Loan as of the date of such determination.

                                       17
<PAGE>

     (d) The Servicer shall establish a segregated account in the name of the
Trustee (the "Collection Account"), which shall be an Eligible Account, in which
              ------------------
the Servicer shall deposit or cause to be deposited any amounts representing
payments on and any collections in respect of the Mortgage Loans received by it
after the Cut-Off Date or, with respect to the Subsequent Mortgage Loans, the
Subsequent Cut-off Date (other than in respect of the payments referred to in
the following paragraph) within two Business Days following receipt thereof,
including the following payments and collections received or made by it (without
duplication):

          (i) all payments of principal or interest on the Mortgage Loans
     received by the Servicer directly from Mortgagors or from the respective
     Subservicer;

          (ii) the aggregate Repurchase Price of the Mortgage Loans purchased by
     the Servicer pursuant to Section 3.18 or by the Converted Loan Purchaser,
     pursuant to Section 3.20;

          (iii) Net Liquidation Proceeds;

          (iv) all proceeds of any Mortgage Loans repurchased by the Seller
     pursuant to the Purchase Agreement, and all Substitution Adjustment Amounts
     required to be deposited in connection with the substitution of an Eligible
     Substitute Mortgage Loan pursuant to the Purchase Agreement;

          (v) Insurance Proceeds, other than Net Liquidation Proceeds, and MI
     Insurance Proceeds resulting from any insurance policy maintained on a
     Mortgaged Property;

          (vi) any Advance and any Compensating Interest payments;

          (vii) any other amounts received by the Servicer, including all
     Foreclosure Profits, assumption fees, prepayment penalties and any other
     fees that are required to be deposited in the Collection Account pursuant
     to this Agreement.

provided, however, that with respect to each Due Period, the Servicer shall be
permitted to retain from payments in respect of interest on the Mortgage Loans,
the Servicing Fee for such Due Period.  The foregoing requirements respecting
deposits to the Collection Account are exclusive, it being understood that,
without limiting the generality of the foregoing, the Servicer need not deposit
in the Collection Account late payment charges payable by Mortgagors, as further
described in Section 3.15, or amounts received by the Subservicer for the
accounts of Mortgagors for application towards the payment of taxes, insurance
premiums, assessments and similar items.  In the event any amount not required
to be deposited in the Collection Account is so deposited, the Servicer may at
any time (prior to being terminated under this Agreement) withdraw such amount
from the Collection Account, any provision herein to the contrary
notwithstanding.  The Servicer shall keep records that accurately reflect the
funds on deposit in the Collection Account that have been identified by it as
being attributable to the Mortgage Loans and shall hold all collections in the
Collection Account for the benefit of the Trustee, and the Certificateholders,
as their interests may appear.

                                       18
<PAGE>

     Funds in the Collection Account may be invested in Eligible Investments,
but shall not be commingled with the Servicer's own funds or general assets or
with funds respecting payments on mortgage loans or with any other funds not
related to the Certificates. Income earned on such Eligible Investments shall be
for the account of the Servicer.

     (e) The Servicer will require each Subservicer to hold all funds
constituting collections on the Mortgage Loans, pending remittance thereof to
the Servicer, in one or more accounts in the name of the Trustee meeting the
requirements of an Eligible Account, and such funds shall not be invested. The
Subservicer shall segregate and hold all funds collected and received pursuant
to each Mortgage Loan separate and apart from any of its own funds and general
assets and any other funds. Each Subservicer shall make remittances to the
Servicer no later than one Business Day following receipt thereof and the
Servicer shall deposit any such remittances received from any Subservicer within
one Business Day following receipt by the Servicer into the Collection Account.

     Section 3.07  Withdrawals from the Collection Account.
                   ----------------------------------------

     (a) The Servicer shall, from time to time as provided herein, make
withdrawals from the Collection Account of amounts on deposit therein pursuant
to Section 3.06 that are attributable to the Mortgage Loans for the following
purposes (without duplication):

          (i) to deposit in the Payment Account, by the Servicer Remittance Date
     prior to each Distribution Date, all collections on the Mortgage Loans
     required to be distributed from the Payment Account on a Distribution Date;

          (ii) to the extent deposited to the Collection Account, to reimburse
     itself or the related Subservicer for previously unreimbursed expenses
     incurred in maintaining individual insurance policies pursuant to Section
     3.11, or Liquidation Expenses, paid pursuant to Section 3.13, such
     withdrawal right being limited to amounts received on particular Mortgage
     Loans (other than any Repurchase Price in respect thereof) which represent
     late recoveries of the payments for which such advances were made, or from
     related Liquidation Proceeds;

          (iii) to pay to itself out of each payment received on account of
     interest on a Mortgage Loan as contemplated by Section 3.15, an amount
     equal to the related Servicing Fee (to the extent not retained pursuant to
     Section 3.06);

          (iv) to pay to itself or the Seller, with respect to any Mortgage Loan
     or property acquired in respect thereof that has been purchased by the
     Seller, the Servicer or other entity, all amounts received thereon and not
     required to be distributed to Certificateholders as of the date on which
     the related Repurchase Price is determined;

          (v) to reimburse the Servicer or any Subservicer for any unreimbursed
     Servicing Advance of its own funds or any unreimbursed advance of such
     Subservicer's own funds, the right of the Servicer or a Subservicer to
     reimbursement pursuant to this subclause (v) being limited to amounts
     received on a particular Mortgage Loan

                                       19
<PAGE>

     (including, for this purpose, the Repurchase Price therefor, Insurance
     Proceeds and Liquidation Proceeds) which represent late payments or
     recoveries of the principal of or interest on such Mortgage Loan respecting
     which such Advance or advance was made;

          (vi) to reimburse the Servicer or any Subservicer from Insurance
     Proceeds or Liquidation Proceeds relating to a particular Mortgage Loan for
     amounts expended by the Servicer or such Subservicer pursuant to Section
     3.13 in good faith in connection with the restoration of the related
     Mortgage Property which was damaged by the uninsured cause or in connection
     with the liquidation of such Mortgage Loan;

          (vii) to reimburse the Servicer or any Subservicer for any
     unreimbursed Nonrecoverable Advance previously made, and otherwise not
     reimbursed pursuant to this Subsection 3.07(a);

          (viii) to withdraw any other amount deposited in the Collection
     Account that was not required to be deposited therein pursuant to Section
     3.06;

          (ix) to reimburse the Servicer for costs associated with the
     environmental report specified in Section 3.13(c);

          (x) to clear and terminate the Collection Account upon a termination
     pursuant to Section 7.08;

          (xi) to pay to the Servicer income earned on Eligible Investments in
     the Collection Account;

          (xii) to pay to the MI Insurer the monthly MI Premiums due under each
     MI Policy from payments received (or Advances made) on account of interest
     due on the related Mortgage Loan; and

          (xiii) to make an Advance with respect to a delinquent Mortgage Loan
     from funds held in the Collection Account as contemplated by Section 3.24,
     provided that the amount withdrawn for such an Advance is immediately
     deposited into the Payment Account.

Withdrawals made pursuant to clause (xii) shall be made on a first priority
basis.  In connection with withdrawals pursuant to clauses (ii), (iii), (iv),
and (vi), the Servicer's entitlement thereto is limited to collections or other
recoveries on the related Mortgage Loan, and the Servicer shall keep and
maintain separate accounting, on a Mortgage Loan by Mortgage Loan basis, for the
purpose of justifying any withdrawal from the Collection Account pursuant to
such clauses.

     (b) Notwithstanding the provisions of this Section 3.07, the Servicer may,
but is not required to, allow the Subservicers to deduct from amounts received
by them or from the related account maintained by a Subservicer, prior to
deposit in the Collection Account, any portion to which such Subservicers are
entitled as reimbursement of any reimbursable Advances made by such
Subservicers.

                                       20
<PAGE>

     Section 3.08  Collection of Taxes, Assessments and Similar Items; Servicing
                   -------------------------------------------------------------
Accounts.
---------

     (a) The Servicer shall establish and maintain or cause the related
Subservicer to establish and maintain, one or more Servicing Accounts. The
Servicer or a Subservicer will deposit and retain therein all collections from
the Mortgagors for the payment of taxes, assessments, insurance premiums, or
comparable items as agent of the Mortgagors.

     (b) The deposits in the Servicing Accounts shall be held in trust by the
Servicer or a Subservicer (and its successors and assigns) in the name of the
Trustee. Such Servicing Accounts shall be Eligible Accounts and, if permitted by
applicable law, invested in Eligible Investments held in trust by the Servicer
or a Subservicer as described above and maturing, or be subject to redemption or
withdrawal, no later than the date on which such funds are required to be
withdrawn, and in no event later than 45 days after the date of investment;
withdrawals of amounts from the Servicing Accounts may be made only to effect
timely payment of taxes, assessments, insurance premiums, or comparable items,
to reimburse the Servicer or a Subservicer for any advances made with respect to
such items, to refund to any Mortgagors any sums as may be determined to be
overages, to pay interest, if required, to Mortgagors on balances in the
Servicing Accounts or to clear and terminate the Servicing Accounts at or any
time after the termination of this Agreement. Amounts received from Mortgagors
for deposit into the Servicing Accounts shall be deposited in the Servicing
Accounts by the Servicer within two days of receipt. The Servicer shall advance
from its own funds amounts needed to pay items payable from the Servicing
Accounts if the Servicer reasonably believes that such amounts are recoverable
from the related Mortgagor. The Servicer shall comply with all laws relating to
the Servicing Accounts, including laws relating to payment of interest on the
Servicing Accounts. If interest earned by the Servicer on the Servicing Accounts
is not sufficient to pay required interest on the Servicing Accounts, the
Servicer shall pay the difference from its own funds. The Servicing Accounts
shall not be the property of the Trust.

     Section 3.09  Access to Certain Documentation and Information Regarding the
                   -------------------------------------------------------------
Mortgage Loans.
---------------

     The Servicer shall provide, and shall cause any Subservicer to provide, to
the Certificate Administrator and the Trustee, access to the documentation
regarding the related Mortgage Loans and REO Property and to the
Certificateholders, the FDIC, and the supervisory agents and examiners of the
FDIC (to which the Custodian and the Trustee shall also provide) access to the
documentation regarding the related Mortgage Loans required by applicable
regulations, such access being afforded without charge but only upon reasonable
request and during normal business hours at the offices of the Servicer or the
Subservicers that are designated by these entities; provided, however, that,
unless otherwise required by law, the Custodian and the Trustee shall not be
required to provide access to such documentation if the provision thereof would
violate the legal right to privacy of any Mortgagor; provided, however, that the
Certificate Administrator and the Trustee, shall coordinate their requests for
such access so as not to impose an unreasonable burden on, or cause an
unreasonable interruption of, the business of the Servicer or any Subservicer as
determined by a court of competent jurisdiction. The Servicer, the Subservicers,
the Trustee, the Certificate Administrator and the Custodian shall allow

                                       21
<PAGE>

representatives of the above entities to photocopy any of the documentation and
shall provide equipment for that purpose at a charge that covers their own
actual out-of-pocket costs.

     Section 3.10  [Reserved]
                   ----------

     Section 3.11  Maintenance of Hazard Insurance and Fidelity Coverage.

     (a) The Servicer shall maintain and keep, or cause each Subservicer to
maintain and keep, with respect to each Mortgage Loan and each REO Property, in
full force and effect hazard insurance (fire insurance with extended coverage)
equal to at least the lesser of the Principal Balance of the Mortgage Loan (or
the combined Principal Balance owing on such Mortgage Loan and any mortgage loan
senior to such Mortgage Loan) or the current replacement cost of the Mortgaged
Property, and containing a standard mortgagee clause, provided, however, that
the amount of hazard insurance may not be less than the amount necessary to
prevent loss due to the application of any co- insurance provision of the
related policy. Unless applicable state law requires a higher deductible, the
deductible on such hazard insurance policy may be no more than $1,500 or 1% of
the applicable amount of coverage, whichever is less. In the case of a
condominium unit or a unit in a planned unit development, the required hazard
insurance shall take the form of a multi-peril policy covering the entire
condominium project or planned unit development, in an amount equal to at least
100% of the insurable value based on replacement cost. If the Servicer shall
obtain and maintain a blanket policy consistent with its general mortgage
servicing activities insuring against hazard losses on all of the Mortgage
Loans, it shall conclusively be deemed to have satisfied its obligations as set
forth in this Section 3.11(a), it being understood and agreed that such policy
may contain a deductible clause, in which case the Servicer shall, in the event
that there shall not have been maintained on the related Mortgaged Property a
policy complying with this Section 3.11(a) and there shall have been a loss
which would have been covered by such policy, deposit in the Collection Account
the amount not otherwise payable under the blanket policy because of such
deductible clause without any right of reimbursement. Any such deposit by the
Servicer shall be made on the last Business Day of the Due Period in the month
in which payments under any such policy would have been deposited in the
Collection Account. In connection with its activities as servicer of the
Mortgage Loans, the Servicer agrees to present, on behalf of itself, the Trust,
and the Trustee, claims under any such blanket policy.

     (b) Any amounts collected by the Servicer or a Subservicer under any such
hazard insurance policy (other than amounts to be applied to the restoration or
repair of the Mortgaged Property or amounts released to the Mortgagor in
accordance with the Servicer's or a Subservicer's normal servicing procedures,
the Mortgage Note, the Mortgage or applicable law) shall be deposited in the
Collection Account.

     (c) Any cost incurred by a Servicer or a Subservicer in maintaining any
such individual hazard insurance policies shall not be added to the amount owing
under the Mortgage Loan for the purpose of calculating monthly distributions to
Certificateholders, notwithstanding that the terms of the Mortgage Loan so
permit. Such costs of maintaining individual hazard insurance policies shall be
recoverable by the Servicer or a Subservicer out of related late

                                       22
<PAGE>

payments by the Mortgagor or out of Insurance Proceeds or Liquidation Proceeds
or by the Servicer from the Repurchase Price, to the extent permitted by Section
3.07.

     (d) No earthquake or other additional insurance is to be required of any
Mortgagor or maintained on property acquired with respect to a Mortgage other
than pursuant to such applicable laws and regulations as shall at any time be in
force and shall require such additional insurance. When, at the time of
origination of the Mortgage Loan or at any subsequent time, the Mortgaged
Property is located in a federally designated special flood hazard area, the
Servicer shall use its best reasonable efforts to cause with respect to the
Mortgage Loans and each REO Property flood insurance (to the extent available
and in accordance with mortgage servicing industry practice) to be maintained.
Such flood insurance shall cover the Mortgaged Property, including all items
taken into account in arriving at the Appraised Value on which the Mortgage Loan
was based, and shall be in an amount equal to the lesser of (i) the Principal
Balance of the related Mortgage Loan and (ii) the minimum amount required under
the terms of coverage to compensate for any damage or loss on a replacement cost
basis, but not more than the maximum amount of such insurance available for the
related Mortgaged Property under either the regular or emergency programs of the
National Flood Insurance Program (assuming that the area in which such Mortgaged
Property is located is participating in such program). Unless applicable state
law requires a higher deductible, the deductible on such flood insurance may not
exceed $1,500 or 1% of the applicable amount of coverage, whichever is less.

     (e) If insurance has not been maintained complying with Subsections 3.11
(a) and (d) and there shall have been a loss which would have been covered by
such insurance had it been maintained, the Servicer shall pay, or cause the
related Subservicer to pay, for any necessary repairs without any right of
reimbursement.

     (f) The Servicer shall present, or cause the related Subservicer to
present, claims under any related hazard insurance or flood insurance policy.

     (g) The Servicer shall obtain and maintain at its own expense, and shall
cause each Subservicer to obtain and maintain at its own expense, and for the
duration of this Agreement, a blanket fidelity bond and an errors and omissions
insurance policy covering the Servicer's and such Subservicer's officers,
employees and other persons acting on its behalf in connection with its
activities under this Agreement. The amount of coverage shall be consistent with
industry standards but in an amount not less than presently maintained by the
Servicer. The Servicer shall promptly notify the Certificate Administrator and
the Trustee of any material change in the terms of such bond or policy. The
Servicer shall provide annually to the Certificate Administrator and the Trustee
a certificate of insurance that such bond and policy are in effect. If any such
bond or policy ceases to be in effect, the Servicer shall, to the extent
possible, give the Certificate Administrator and the Trustee ten days' notice
prior to any such cessation and shall use its reasonable best efforts to obtain
a comparable replacement bond or policy, as the case may be. Any amounts
relating to the Mortgage Loans collected under such bond or policy shall be
deposited in the Collection Account.

                                       23
<PAGE>

     Section 3.12  Due-on-Sale Clauses; Assumption Agreements.
                   -------------------------------------------

     (a) In any case in which the Servicer is notified by any Mortgagor or
Subservicer that a Mortgaged Property relating to a Mortgage Loan has been or is
about to be conveyed by the Mortgagor, the Servicer shall enforce, or shall
instruct such Subservicer to enforce, any due-on-sale clause contained in the
related Mortgage to the extent permitted under the terms of the related Mortgage
Note and by applicable law. The Servicer or the related Subservicer may
repurchase a Mortgage Loan at the Repurchase Price when the Servicer requires
acceleration of the Mortgage Loan, but only if the Servicer is satisfied, as
evidenced by an Officer's Certificate delivered to the Certificate Administrator
and the Trustee, that such Mortgage Loan is in default or default is reasonably
foreseeable. If the Servicer reasonably believes that such due-on-sale clause
cannot be enforced under applicable law or if the Mortgage Loan does not contain
a due-on-sale clause, the Servicer is authorized, and may authorize any
Subservicer, to consent to a conveyance subject to the lien of the Mortgage,
and, with the consent of the MI Insurer, if applicable, to take or enter into an
assumption agreement from or with the Person to whom such property has been or
is about to be conveyed, pursuant to which such Person becomes liable under the
related Mortgage Note and unless prohibited by applicable state law, on
condition, however, that the related Mortgage Loan shall continue to be covered
by a hazard policy. In connection with any such assumption, no material term of
the related Mortgage Note may be changed. The Servicer shall notify the
Certificate Administrator and the Trustee in writing, whenever possible, before
the completion of such assumption agreement, and shall forward to the Custodian
the original copy of such assumption agreement, which copy shall be added by the
Custodian to the related Mortgage File and which shall, for all purposes, be
considered a part of such Mortgage File to the same extent as all other
documents and instruments constituting a part thereof.

     (b) Notwithstanding the foregoing paragraph or any other provision of this
Agreement, the Servicer shall not be deemed to be in default, breach or any
other violation of its obligations hereunder by reason of any assumption of a
Mortgage Loan by operation of law or any conveyance by the Mortgagor of the
related Mortgaged Property or assumption of a Mortgage Loan which the Servicer
reasonably believes it may be restricted by law from preventing, for any reason
whatsoever or if the exercise of such right would impair or threaten to impair
any recovery under any applicable insurance policy.

     Section 3.13  Realization Upon Defaulted Mortgage Loans.
                   ------------------------------------------

     (a) The Servicer shall, or shall direct the related Subservicer to,
foreclose upon or otherwise comparably convert the ownership of properties
securing any Mortgage Loans that come into and continue in default and as to
which no satisfactory arrangements can be made for collection of delinquent
payments pursuant to Section 3.06, except that the Servicer shall not, and shall
not direct the related Subservicer to, foreclose upon or otherwise comparably
convert a Mortgaged Property if there is evidence of toxic waste or other
environmental hazards thereon unless the Servicer follows the procedures in
Subsection (c) below. In connection with such foreclosure or other conversion,
the Servicer in conjunction with the related Subservicer, if any, shall use its
best reasonable efforts to preserve REO Property and to realize upon defaulted
Mortgage Loans in such manner as to maximize the receipt of principal and
interest by the

                                       24
<PAGE>

Certificateholders, taking into account, among other things, the timing of
foreclosure and the considerations set forth in Subsection 3.13(b). The
foregoing is subject to the proviso that the Servicer shall not be required to
expend its own funds in connection with any foreclosure or towards the
restoration of any property unless it determines in good faith (i) that such
restoration or foreclosure will increase the proceeds of liquidation of the
Mortgage Loan to Certificateholders after reimbursement to itself for such
expenses and (ii) that such expenses will be recoverable to it either through
Liquidation Proceeds (respecting which it shall have priority for purposes of
reimbursements from the Collection Account pursuant to Section 3.07) or through
Insurance Proceeds (respecting which it shall have similar priority). The
Servicer shall be responsible for all costs and expenses constituting
Liquidation Expenses incurred by it in any such proceedings; provided, however,
that it shall be entitled to reimbursement thereof (as well as its normal
servicing compensation) as set forth in Section 3.07. Any income from or other
funds (net of any income taxes) generated by REO Property shall be deemed for
purposes of this Agreement to be Liquidation Proceeds.

     Any subsequent collections with respect to any Liquidated Mortgage Loan
shall be deposited to the Collection Account. For purposes of determining the
amount of any Liquidation Proceeds or Insurance Proceeds, or other unscheduled
collections, the Servicer may take into account any estimated additional
Liquidation Expenses expected to be incurred in connection with the related
defaulted Mortgage Loan.

     In the event that title to any Mortgaged Property is acquired in
foreclosure or by deed in lieu of foreclosure, the deed or certificate of sale
shall be issued to the Trustee and held by the Custodian, who shall hold the
same on behalf of Trustee and the Trust in accordance with the Agreement.
Notwithstanding any such acquisition of title and cancellation of the related
Mortgage Loan, such Mortgaged Property shall (except as otherwise expressly
provided herein) be considered to be an outstanding Mortgage Loan held as an
asset of the Trust until such time as such property shall be sold.

     (b) The Servicer shall not acquire any real property (or any personal
property incident to such real property) on behalf of the Trust Fund except in
connection with a default or reasonably foreseeable default of a Mortgage Loan.
In the event that the Servicer acquires any real property (or personal property
incident to such real property) on behalf of the Trust Fund in connection with a
default or imminent default of a Mortgage Loan, such property shall be disposed
of by the Servicer on behalf of the Trust Fund within three years after the end
of the calendar year it was acquired on behalf of the Trust Fund.

     (c) With respect to any Mortgage Loan as to which the Servicer or a
Subservicer has received notice of, or has actual knowledge of, the presence of
any toxic or hazardous substance on the Mortgaged Property, the Servicer shall
promptly notify the Certificate Administrator and the Trustee, and shall act in
accordance with any such directions and instructions provided by the Certificate
Administrator on behalf of, and after consulting with the Trustee. If the
Certificate Administrator, on behalf of the Trustee has not provided directions
and instructions to the Servicer in connection with any such Mortgage Loan
within 5 Business Days of a request by the Servicer for such directions and
instructions, then the Servicer shall take such action as it deems to be in the
best economic interest of the Trust Fund (other than

                                       25
<PAGE>

proceeding against the Mortgaged Property) and is hereby authorized at such time
as it deems appropriate to release such Mortgaged Property from the lien of the
related Mortgage. The parties hereto acknowledge that the Servicer shall not
obtain on behalf of the Trust a deed as a result or in lieu of foreclosure, and
shall not otherwise acquire possession of or title to, or commence any
proceedings to acquire possession of or title to, or take any other action with
respect to, any Mortgaged Property, if the Trust could reasonably be considered
to be a responsible party for any liability arising from the presence of any
toxic or hazardous substance on the Mortgaged Property.

     Section 3.14  Custodian to Cooperate; Release of Mortgage Files.
                   --------------------------------------------------

     (a) Upon payment in full of any Mortgage Loan, the Servicer will
immediately notify the Custodian by a certification signed by a Servicing
Officer (which certification shall include a statement to the effect that all
amounts received in connection with such payment which are required to be
deposited in the Collection Account have been so deposited) and shall request
delivery to the Servicer or Subservicer, as the case may be, of the Mortgage
File. Upon receipt of such certification and request, the Custodian on behalf of
the Trustee shall promptly cause to be released the related Mortgage File to the
Servicer or Subservicer and execute and deliver to the Servicer, without
recourse, the request for reconveyance, deed of reconveyance or release or
satisfaction of mortgage or such instrument releasing the lien of the Mortgage
(furnished by the Servicer), together with the Mortgage Note with written
evidence of cancellation thereon.

     (b) From time to time as is appropriate, for the servicing or foreclosure
of any Mortgage Loan or collection under an insurance policy, the Servicer may
deliver to the Custodian a Request for Release signed by a Servicing Officer on
behalf of the Servicer in substantially the form attached as Exhibit E hereto.
Upon receipt of the Request for Release, the Custodian on behalf of the Trustee
shall deliver the Mortgage File or any document therein to the Servicer or
Subservicer, as the case may be, as bailee for the Trustee.

     (c) The Servicer shall cause each Mortgage File or any document therein
released pursuant to Subsection 3.14(b) to be returned to the Custodian when the
need therefor no longer exists, and in any event within 21 days of the
Servicer's receipt thereof, unless the Mortgage Loan has become a Liquidated
Mortgage Loan and the Liquidation Proceeds relating to the Mortgage Loan have
been deposited in the Collection Account or such Mortgage File is being used to
pursue foreclosure or other legal proceedings. Prior to return of a Mortgage
File or any document to the Custodian, the Servicer, the related insurer or
Subservicer to whom such file or document was delivered shall retain such file
or document in its respective control as bailee for the Custodian on behalf of
the Trustee unless the Mortgage File or such document has been delivered to an
attorney, or to a public trustee or other public official as required by law, to
initiate or pursue legal action or other proceedings for the foreclosure of the
Mortgaged Property either judicially or non-judicially, and the Servicer has
delivered to the Custodian and the Trustee, a certificate of a Servicing Officer
certifying as to the name and address of the Person to which such Mortgage File
or such document was delivered and the purpose or purposes of such delivery. If
a Mortgage Loan becomes a Liquidated Mortgage Loan, the Custodian on behalf of

                                       26
<PAGE>

the Trustee shall deliver the Request for Release with respect thereto to the
Servicer upon deposit of the related Liquidation Proceeds in the Collection
Account.

     (d) The Certificate Administrator on behalf of the Trustee shall execute
and deliver or cause to be executed and delivered to the Servicer any court
pleadings, requests for trustee's sale or other documents necessary to (i) the
foreclosure or trustee's sale with respect to a Mortgaged Property; (ii) any
legal action brought to obtain judgment against any Mortgagor on the Mortgage
Note or Mortgage; (iii) obtain a deficiency judgment against the Mortgagor; or
(iv) enforce any other rights or remedies provided by the Mortgage Note or
Mortgage or otherwise available at law or equity. Together with such documents
or pleadings the Servicer shall deliver to the Certificate Administrator and the
Trustee a certificate of a Servicing Officer in which it requests the
Certificate Administrator on behalf of the Trustee to execute or cause to be
executed the pleadings or documents. The certificate shall certify and explain
the reasons for which the pleadings or documents are required. It shall further
certify that the Trustee's or the Certificate Administrator's execution and
delivery of the pleadings or documents will not invalidate any insurance
coverage under the insurance policies or invalidate or otherwise affect the lien
of the Mortgage, except for the termination of such a lien upon completion of
the foreclosure or trustee's sale.

     Section 3.15  Servicing Compensation.
                   -----------------------

     (a) As compensation for its activities hereunder, the Servicer shall be
entitled to receive the Servicing Fee (out of which it will pay the Trustee)
from full payments of accrued interest on each Mortgage Loan. The Servicer shall
be solely responsible for paying any and all fees with respect to a Subservicer,
and the Trustee and the Trust Fund shall not bear any fees, expenses or other
costs directly associated with any Subservicer.

     (b) The Servicer may retain additional servicing compensation in the form
of late payment charges, to the extent such charges are collected from the
related Mortgagors and investment earnings on the Collection Account. The
Servicer shall be required to pay all expenses it incurs in connection with
servicing activities under this Agreement and shall not be entitled in
connection with servicing activities under this Agreement to reimbursement
except as provided in this Agreement. Expenses to be paid by the Servicer
without reimbursement under this Subsection 3.15(b) shall include payment of the
expenses of the accountants retained pursuant to Section 3.17.

     Section 3.16  Annual Statements of Compliance.
                   --------------------------------

     Within 90 days after December 31 of each year, the Servicer at its own
expense shall deliver to the Trustee and the Rating Agencies, an Officer's
Certificate stating, as to the signer thereof, that (i) a review of the
activities of the Servicer during the preceding calendar year and of performance
under this Agreement has been made under such officer's supervision, (ii) to the
best of such officer's knowledge, based on such review, the Servicer has
fulfilled its obligations under this Agreement in all material respects for such
year, or, if there has been a default in the fulfillment of any such obligation,
specifying each such default known to such officer and the nature and status
thereof including the steps being taken by the Servicer to remedy

                                       27
<PAGE>

such default; (iii) a review of the activities of each Subservicer during the
Subservicer's most recently ended calendar year and its performance under its
Subservicing Agreement has been made under such officer's supervision; and (iv)
to the best of the Servicing Officer's knowledge, based on his review and the
certification of an officer of the Subservicer (unless the Servicing Officer has
reason to believe that reliance on such certification is not justified), either
each Subservicer has performed and fulfilled its duties, responsibilities and
obligations under this Agreement and its Subservicing Agreement in all material
respects throughout the year, or, if there has been a default in performance or
fulfillment of any such duties, responsibilities or obligations, specifying the
nature and status of each such default known to the Servicing Officer. Copies of
such statements shall be provided by the Servicer to the Certificateholders upon
request or by the Certificate Administrator at the expense of the Servicer
should the Servicer fail to provide such copies.

     Section 3.17  Annual Independent Public Accountants' Servicing Report.
                   --------------------------------------------------------

     (a) Within 90 days after December 31 of each year, the Servicer, at its
expense, shall cause a firm of independent public accountants who are members of
the American Institute of Certified Public Accountants to furnish a statement to
the Servicer, which will be provided to the Trustee, and the Rating Agencies, to
the effect that, in connection with the firm's examination of the Servicer's
financial statements as of the end of such calendar year, nothing came to their
attention that indicated that the Servicer was not in compliance with Sections
3.06, 3.07 and 3.08 except for (i) such exceptions as such firm believes to be
immaterial and (ii) such other exceptions as are set forth in such statement. In
the event such firm requires the Trustee to agree to the procedures performed by
such firm, the Company shall direct the Trustee in writing to so agree; it being
understood and agreed that the Trustee will deliver such letter of agreement in
conclusive reliance upon the direction of the Servicer, and the Trustee makes no
independent inquiry or investigation as to, and shall have no obligation or
liability in respect of, the sufficiency, validity or correctness of such
procedures.

     (b) Within 90 days after December 31 of each year, the Servicer, at its
expense, shall, and shall cause each Subservicer to cause, a nationally
recognized firm of independent certified public accountants to furnish to the
Servicer or such Subservicer, as the case may be, a report stating that (i) it
has obtained a letter of representation regarding certain matters from the
management of the Servicer or such Subservicer, as the case may be, which
includes an assertion that the Servicer or such Subservicer, as the case may be,
has complied with certain minimum mortgage loan servicing standards identified
in the Uniform Single Attestation Program for Mortgage Bankers established by
the Mortgage Bankers Association of America with respect to the servicing of
first lien conventional single family mortgage loans during the most recently
completed calendar year and (ii) on the basis of an examination conducted by
such firm in accordance with standards established by the American Institute of
Certified Public Accountants, such representation is fairly stated in all
material respects, subject to such exceptions and other qualifications that may
be appropriate. Immediately upon receipt of such report, the Servicer shall or
shall cause each Subservicer to furnish a copy of such report to the Certificate
Administrator, the Trustee and the Rating Agencies.

                                       28
<PAGE>

     Section 3.18  Optional Purchase of Defaulted Mortgage Loans.
                   ----------------------------------------------

     The Servicer may repurchase any Mortgage Loan delinquent in payment for a
period of 90 days or longer for a price equal to the Repurchase Price. The
procedure for such repurchase shall be the same as for repurchase by the Seller
under the Purchase Agreement. Notwithstanding any contrary provision of this
Agreement, with respect to any Mortgage Loan which is not in default or as to
which no default is imminent, no purchase or substitution pursuant to Section
2.03 or this Section 3.18 shall be made unless the Servicer provides to the
Certificate Administrator and the Trustee, an Opinion of Counsel to the effect
that such purchase or substitution would not (i) result in the imposition of
taxes on "prohibited transactions" of the Trust Fund, as defined in Section 860F
of the Code or a tax or contributions to the Trust Fund under the REMIC
Provisions, or (ii) cause the Trust Fund to fail to qualify as a REMIC at any
time that any Certificates are outstanding. Any Mortgage Loan to be purchased or
substituted pursuant to this Section 3.18 shall be purchased or substituted
(subject to compliance with this Section 3.18) upon the earlier of (x) the
occurrence of a default or reasonably foreseeable default with respect to such
Mortgage Loan or (y) receipt by the Certificate Administrator and the Trustee,
of an Opinion of Counsel to the effect that such purchase or substitution will
not result in the events described in clauses (i) and (ii) of the preceding
sentence.

     Section 3.19  Information Required by the Internal Revenue Service
                   ----------------------------------------------------
Generally and Reports of Foreclosures and Abandonments of Mortgaged Property.
-----------------------------------------------------------------------------

     The Servicer shall prepare and deliver all federal and state information
reports when and as required by all applicable state and federal income tax
laws. In particular, with respect to the requirement under Section 6050J of the
Code to the effect that the Servicer or Subservicer shall make reports of
foreclosures and abandonments of any mortgaged property, the Servicer or
Subservicer shall file reports relating to each instance occurring during the
previous calendar year in which the Servicer (i) acquires an interest in any
Mortgaged Property through foreclosure or other comparable conversion in full or
partial satisfaction of a Mortgage Loan, or (ii) knows or has reason to know
that any Mortgaged Property has been abandoned. The reports from the Servicer or
Subservicer shall be in form and substance sufficient to meet the reporting
requirements imposed by Section 6050J, Section 6050H (reports relating to
mortgage interest received) and Section 6050P of the Code (reports relating to
cancellation of indebtedness).

     Section 3.20  Purchase of Converted Mortgage Loans.
                   -------------------------------------

     Pursuant to the Converted Loan Purchase Agreement, the Converted Loan
Purchaser shall be obligated to purchase from the Trust any Converted Mortgage
Loans at the Repurchase Price. The Servicer shall promptly notify the
Certificate Administrator, the Trustee, the Custodian and the Converted Loan
Purchaser of each Mortgage Loan which becomes a Converted Mortgage Loan. If the
Converted Loan Purchaser fails to purchase any Converted Loan, the Servicer
shall be terminated and the Certificate Administrator shall be the Servicer
pursuant to Section 7.02.

     Section 3.21  [Reserved]
                   ----------

                                       29
<PAGE>

     Section 3.22  Servicing and Administrating of the MI Policies.
                   ------------------------------------------------

     (a) The Servicer shall take all such actions on behalf of the Trustee as
are necessary to service, maintain and administer the MI Policies and to perform
the Trustee's obligations and enforce the Trustee's rights under the MI
Policies, which actions shall conform to the standards of an institution
prudently administering MI Policies for its own account. Except as expressly set
forth herein, the Servicer shall have full authority on behalf of the Trust to
do anything it reasonably deems appropriate or desirable in connection with the
servicing, maintenance and administration of the MI Policies. The Servicer shall
make its best reasonable efforts to file all insured claims under the MI
Policies and collect from the MI Insurer all Insurance Proceeds due to the
Trustee under the MI Policies. The Servicer shall not take, or permit any
subservicer to take, any action which would result in non-coverage under any
applicable MI Policy of any loss which, but for the actions of the Servicer or
Subservicer, would have been covered thereunder. To the extent coverage is
available, the Servicer shall keep or cause to be kept in full force and effect
each such MI Policy for the life of the Mortgage Loan; provided, however, that
if a MI Insurer Insolvency Event has occurred and is continuing, the Servicer
may terminate the MI Policy on any Mortgage Loan that is not then past due. The
Servicer shall cooperate with the MI Insurer and shall use its best efforts to
furnish all reasonable aid, evidence and information in the possession of the
Servicer or to which the Servicer has access with respect to any Mortgage Loan.

     (b) The Servicer shall deposit into the Collection Account pursuant to
Section 3.06(d)(v) hereof all MI Insurance Proceeds received from the MI Insurer
under the terms of the MI Policies. The Servicer shall withdraw from the
Collection Account and pay to the MI Insurer pursuant to Section 3.07(a)(xii)
hereof, the monthly MI Premiums due to the MI Insurer in accordance with the
terms of the MI Insurance Agreements.

     (c) Notwithstanding the provisions of Subsection 3.22(a) and (b), the
Servicer shall not take any action in regard to the MI Policies inconsistent
with the interests of the Trustee or the Certificateholders or with the rights
and interests of the Trustee or the Certificateholders under this Agreement;
provided, however, that payments of the monthly MI Premiums to the MI Insurer
pursuant to Subsection 3.22(b) above and Section 3.07(a)(xiii) hereof shall be
deemed not to be inconsistent with such interests.

     (d) The Trustee and the Certificate Administrator on behalf of the Trustee
shall furnish the Servicer with any powers of attorney and other documents in
form as provided to it necessary or appropriate to enable the Servicer to
service and administer the MI Policies; provided, however, that neither the
Certificate Administrator nor the Trustee shall be liable for the actions of the
Servicer under such powers of attorney.

     (e) If at any time during the term of this Agreement, a MI Insurer
Insolvency Event has occurred and is continuing, the Servicer agrees to review,
not less often than monthly, the financial condition of the related MI Insurer
with a view towards determining whether recoveries under the MI Policy are
jeopardized for reasons related to the financial condition of the related MI
Insurer. In such event, the Servicer may obtain an additional MI Policy or a
replacement MI Policy, the MI Premiums on which would be paid by the Servicer
from the

                                       30
<PAGE>

Collection Account pursuant to Section 3.07(a)(xiii) hereof. The Servicer shall
notify the Certificate Administrator of any additional MI Policies and the MI
Premiums.

     (f) The Servicer shall comply with all other terms, conditions and
obligations set forth in the MI Policies.

     Section 3.23  Determination Date Reports.
                   ---------------------------

     On the second Business Day following each Determination Date, the Servicer
shall deliver to the Certificate Administrator a report, prepared as of the
close of business on the Determination Date (the "Determination Date Report"),
                                                  -------------------------
and shall forward to the Certificate Administrator in the form of computer
readable electromagnetic tape or disk or any other electronic media acceptable
to the Certificate Administrator a copy of such report. The Determination Date
Report and any written information supplemental thereto shall include such
information with respect to the Mortgage Loans that is reasonably available to
the Servicer and that is required by the Certificate Administrator for purposes
of making the calculations and providing the reports referred to in this
Agreement, as set forth in written specifications or guidelines issued by the
Certificate Administrator from time to time. Such information shall include the
aggregate amounts required to be withdrawn from the Collection Account and
deposited into the Payment Account pursuant to Section 3.07. Such information
shall also include (a) the number of Mortgage Loans that prepaid in the previous
month; (b) the loan balance of each such Mortgage Loan; (c) whether a prepayment
penalty was applied to such Mortgage Loan; and (d) the amount of prepayment
penalty with respect to each such Mortgage Loan. The Servicer agrees to
cooperate with the Certificate Administrator in providing all information as is
reasonably requested by the Certificate Administrator to prepare the reports
required under the Agreement.

     The determination by the Servicer of such amounts shall, in the absence of
obvious error, be presumptively deemed to be correct for all purposes hereunder
and the Trustee and the Certificate Administrator shall be fully protected in
relying upon the same without any independent check or verification.

     Section 3.24  Advances.
                   ---------

     If any Monthly Payment (together with any advances from the Subservicers)
on a Mortgage Loan that was due on the immediately preceding Due Date and
delinquent on the Determination Date is delinquent other than as a result of
application of the Relief Act, the Servicer will deposit in the Collection
Account not later than the Servicer Remittance Date immediately preceding the
related Distribution Date an amount equal to such deficiency net of the related
Servicing Fee for such Mortgage Loan, except to the extent the Servicer
determines any such advance to be nonrecoverable from Liquidation Proceeds,
Insurance Proceeds or future payments on such Mortgage Loan. Subject to the
foregoing and in the absence of such a determination, the Servicer shall
continue to make such advances through the date that the related Mortgaged
Property has, in the judgment of the Servicer, been completely liquidated.

                                       31
<PAGE>

     The Servicer may fund an Advance from its own corporate funds, advances
made by any subservicer or funds held in the Collection Account for future
payment or withdrawal.

     Advances made from funds held in the Collection Account may be made by the
Servicer from subsequent collections of principal and interest received on other
Mortgage Loans and deposited into the Collection Account. Advances made from the
Collection Account are not limited to subsequent collections of principal and
interest received on the delinquent Mortgage Loan with respect to which an
Advance is made. If on the Servicer Remittance Date prior to any Distribution
Date funds in the Collection Account are less than the amount required to be
paid to the Certificateholders on such Distribution Date, then the Servicer
shall deposit its own funds into the Payment Account in the amount of the lesser
of (i) any unreimbursed Advances previously made by the Servicer with funds held
in the Collection Account or (ii) the shortfall in the Collection Account,
provided, however, that in no event shall the Servicer deposit into the
Collection Account an amount that is less than any shortfall in the Collection
Account attributable to delinquent payments on Mortgage Loans which the Servicer
deems to be recoverable and which has not been covered by an Advance from the
Servicer's own corporate funds or any subservicer's funds. If applicable, on the
Servicer Remittance Date preceding each Distribution Date, the Servicer shall
present an Officer's Certificate to the Certificate Administrator, and the
Trustee (i) stating that the Servicer elects not to make an Advance in a stated
amount and (ii) detailing the reason it deems the advance to be nonrecoverable.

     Section 3.25  Compensating Interest Payments.
                   -------------------------------

     The Servicer shall deposit in the Collection Account not later than the
Servicer Remittance Date preceding the Distribution Date an amount equal to the
Compensating Interest related to the related Determination Date. The Servicer
shall not be entitled to any reimbursement of any Compensating Interest payment.

                                   ARTICLE IV

                                  FLOW OF FUNDS

     Section 4.01  Distributions.
                   --------------

     (a) On each Distribution Date, the Trustee shall (based solely on the
information provided to the Trustee by the Certificate Administrator pursuant to
Section 4.03 hereof) withdraw from the Distribution Account that portion of
REMIC Available Funds for such Distribution Date consisting of the Interest
Remittance Amount for such Distribution Date, and make the following
disbursements and transfers in the order of priority described below, in each
case to the extent of the Interest Remittance Amount remaining for such
Distribution Date:

          (i) On each Distribution Date, the Trustee will first distribute the
     Prepayment Charges collected during the prior Prepayment Period to the
     Holders of the Class P Certificates. After making that distribution, the
     Trustee will distribute the remaining Interest Remittance Amount for that
     Distribution Date, to the Certificate Administrator,

                                       32
<PAGE>

     the Certificate Administrator Fee which is due on that Distribution Date,
     and will then apply the remaining Interest Remittance Amount to the payment
     of interest then due on the certificates in the following order of
     priority:

     (A) first, with respect to the Class AIO Certificates and the Class A-1
         -----
Certificates, the Class AIO Monthly Interest Distributable Amount and the REMIC
Monthly Interest Distributable Amount for the Class A-1 Certificates,
respectively; these payments are of equal priority to those two Classes, and, in
the event that the remaining Interest Remittance Amount is insufficient to pay
both Classes the full amount due, the amount paid to the Holders of each of
these two Classes will be a pro rata portion of the remaining Interest
Remittance Amount, with the allocation based on the relative proportions of the
Class AIO Monthly Interest Distributable Amount and the REMIC Monthly Interest
Distributable Amount for the Class A-1 Certificates; the REMIC Monthly Interest
Distributable Amount for the Class A-1 Certificates shall be paid to the Holders
of the Class A-1 Certificates, and the Class AIO Monthly Interest Distributable
Amount shall be paid as follows:

          (x)  first, to the Holders of the Class AIO Certificates, the Class
               -----
               AIO Unpaid Interest Shortfall Amount; and

          (y)  second, to the Supplemental Interest Account for further
               ------
               application in   accordance with Section 4.04 hereof, the Class
               AIO Current Interest.

               (B) second, to the Holders of the Class M-1 Certificates, the
                   ------
          REMIC Monthly Interest Distributable Amount for Class M-1;

               (C) third, to the Holders of the Class M-2 Certificates, the
                   -----
          REMIC Monthly Interest Distributable Amount for Class M-2;

               (D) fourth, to the Holders of the Class M-3 Certificates, the
                   ------
          REMIC Monthly Interest Distributable Amount for Class M-3; and

               (E) fifth, to the Holders of the Class RU Certificates, any
                   -----
          remainder.

          (ii) On each Distribution Date (a) prior to the Crossover Date or (b)
     on which a Trigger Event is in effect, the Trustee shall (based solely on
     the information provided to the Trustee by the Certificate Administrator
     pursuant to Section 4.03 hereof) withdraw from the Distribution Account
     that portion of the REMIC Available Funds for such Distribution Date
     consisting of the Principal Remittance Amount and make the following
     disbursements and transfers in the order of priority described below:

          (A) first, to the Holders of the Class A-1 Certificates, the entire
              -----
     amount of the Principal Remittance Amount, until the Certificate Principal
     Balance of the Class A-1 Certificates has been reduced to zero;

                                       33
<PAGE>

          (B) second, to the Holders of the Class M-1 Certificates, the entire
              ------
     amount of the Principal Remittance Amount until the certificate principal
     balance of the Class M-1 Certificates has been reduced to zero;

          (C) third, to the Holders of Class M-2 Certificates, the entire amount
              -----
     of the Principal Remittance Amount until the Certificate Principal Balance
     of the Class M-2 Certificates has been reduced to zero;

          (D) fourth, to the Holders of the Class M-3 Certificates, the entire
              ------
     amount of the Principal Remittance Amount until the Certificate Principal
     Balance of the Class M-3 Certificates has been reduced to zero;

          (E) fifth, to the Trustee and the Certificate Administrator, pro rata,
              -----                                                    --- ----
     any amounts owed to them under the Basic Documents remaining unpaid;

          (F) sixth, to the Servicer, the amount of any reimbursement or
              -----
     indemnification owed to it by the Trust pursuant to Section 6.03 hereof;

          (G) seventh, to the Holders of the Class O Certificates, the entire
              -------
     amount of the Principal Distribution Amount until the Certificate Balance
     of the Class O Certificates has been reduced to zero; and

          (H) eighth, to the Holders of the Class RU Certificates, any
              ------
     remainder.

     (iii) On each Distribution Date (a) on or after the Crossover Date and (b)
on which a Trigger Event is not in effect, the Trustee shall (based solely on
the information provided to the Trustee by the Certificate Administrator
pursuant to Section 4.03 hereof) withdraw from the Distribution Account that
portion of the REMIC Available Funds for such Distribution Date consisting of
the Principal Remittance Amount and make the following disbursements and
transfers in the order of priority described below:

          (A) first, to the Holders of the Class A-1 Certificates, the Class A-1
              -----
     Principal Distribution Amount, until the Certificate Principal Balance of
     the A-1 Certificates has been reduced to zero;

          (B) second, to the Holders of the Class M-1 Certificates, the Class
              ------
     M-1 Principal Distribution Amount, until the Certificate Principal Balance
     of the Class M-1 Certificates has been reduced to zero;

          (C) third, to the Holders of the Class M-2 Certificates, the Class M-2
              -----
     Principal Distribution Amount, until the Certificate Principal Balance of
     the Class M-2 Certificates has been reduced to zero;

          (D) fourth, to the Holders of the Class M-3 Certificates, the Class
              ------
     M-3 Principal Distribution Amount, until the Certificate Principal Balance
     of the Class M-3 Certificates has been reduced to zero;

                                       34
<PAGE>

          (E) fifth, to the Trustee and the Certificate Administrator, pro rata,
              -----
     any amounts owed to them under the Basic Documents remaining unpaid;

          (F) sixth, to the Servicer, the amount of any reimbursement or
              -----
     indemnification owed to it by the Trust pursuant to Section 6.03 hereof;

          (G) seventh, to the Holders of the Class O Certificates, the entire
              -------
     amount of the Principal Distribution Amount until the Certificate Balance
     of the Class O Certificates has been reduced to zero; and

          (H) eighth, to the Holders of the Class RU Certificates, any
              ------
     remainder.

     (b) Method of Distribution. The Trustee shall make distributions in respect
         ----------------------
of a Distribution Date to each Certificateholder of record on the related Record
Date (other than as provided in Section 11.01 respecting the final
distribution), in the case of Certificateholders of the Regular Certificates, by
check or money order mailed to such Certificateholder at the address appearing
in the Certificate Register, or by wire transfer. Distributions among
Certificateholders shall be made in proportion to the Percentage Interests
evidenced by the Certificates held by such Certificateholders.

     (c) Distributions on Book-Entry Certificates. Each distribution with
         ----------------------------------------
respect to a Book-Entry Certificate shall be paid to the Depository, which shall
credit the amount of such distribution to the accounts of its Depository
Participants in accordance with its normal procedures. Each Depository
Participant shall be responsible for disbursing such distribution to the
Certificate Owners that it represents and to each indirect participating
brokerage firm (a "brokerage firm" or "indirect participating firm") for which
it acts as agent. Each brokerage firm shall be responsible for disbursing funds
to the Certificate Owners that it represents. All such credits and disbursements
with respect to a Book-Entry Certificate are to be made by the Depository and
the Depository Participants in accordance with the provisions of the
Certificates. None of the Certificate Administrator, the Trustee, the Company,
the Servicer or the Seller shall have any responsibility therefor except as
otherwise provided by applicable law.

     Section 4.02  Payment Account and Distribution Account.
                   -----------------------------------------

     (a) No later than the Closing Date, the Certificate Administrator shall
establish and maintain a segregated trust account that is an Eligible Account,
which shall be titled "Payment Account, Wells Fargo Bank Minnesota, N.A., as
Certificate Administrator for the registered holders of NovaStar Mortgage
Funding Trust 2001-1, Home Equity Loan Asset-Backed Certificates, Series 2001-1"
(the "Payment Account"). The Certificate Administrator shall, promptly upon
      ---------------
receipt, deposit in the Payment Account and retain therein the Interest
Remittance Amount and the Principal Remittance Amount remitted on each Servicer
Remittance Date to the Certificate Administrator by the Servicer, as well as
amounts transferred from the Interest Coverage Account and the Pre-Funding
Account. Funds deposited in the Payment Account shall be held in trust by the
Certificate Administrator for the Certificateholders for the uses and purposes
set forth herein.

                                       35
<PAGE>

     (b) The Certificate Administrator may invest funds deposited in the Payment
Account in Permitted Investments with a maturity date no later than the Business
Day immediately preceding the date on which such funds are required to be
withdrawn from such account pursuant to this Agreement. All income or other gain
from such investments may be released from the Payment Account and paid to the
Certificate Administrator, from time to time as part of its compensation for
acting as Certificate Administrator.

     (c) Amounts on deposit in the Payment Account shall be withdrawn by the
Certificate Administrator as follows:

     (i) To fund the distributions described in Section 4.01 hereof;

     (ii) To withdraw any amount not required to be deposited in the Payment
Account or deposited therein in error; and

     (iii) To clear and terminate the Payment Account upon the termination of
this Agreement, with any amounts remaining on deposit therein being paid to the
Holders of the Class RU Certificates.

     (d)  [RESERVED]

     (e) No later than the Closing Date, the Trustee shall establish and
maintain a segregated trust account that is an Eligible Account, which shall be
titled "Distribution Account, Wells Fargo Bank Minnesota, N.A., as Trustee for
        --------------------
the registered holders of NovaStar Mortgage Funding Trust 2001-1, Home Equity
Loan Asset-Backed Certificates, Series 2001-1" (the "Distribution Account"). The
Certificate Administrator shall, promptly upon receipt, deposit in the
Distribution Account and retain therein amounts transferred from the Payment
Account. Funds deposited in the Distribution Account shall be held in trust by
the Trustee for the Certificateholders for the uses and purposes set forth
herein.

     (f) The Trustee may invest funds deposited in the Distribution Account in
Permitted Investments in its discretion with a maturity date (i) no later than
the Business Day immediately preceding the date on which such funds are required
to be withdrawn from such account pursuant to this Agreement, if a Person other
than the Trustee or an Affiliate manages or advises such investment, and (ii) no
later than the date on which such funds are required to be withdrawn from such
account pursuant to this Agreement, if the Trustee or an Affiliate manages or
advises such investment. All income or other gain from such investments may be
released from the Distribution Account and paid to the Trustee, from time to
time as part of its compensation for acting as Trustee.

     (g) Amounts on deposit in the Distribution Account shall be withdrawn by
the Trustee as follows:

          (i) To fund the distributions described in Section 4.01 hereof;

          (ii) To withdraw any amount not required to be deposited in the
     Distribution Account or deposited therein in error; and

                                       36
<PAGE>

          (iii) To clear and terminate the Distribution Account upon the
     termination of this Agreement, with any amounts remaining on deposit
     therein being paid to the Holders of the Class RU Certificates.

     (h) On each Distribution Date, the Trustee shall distribute all amounts on
deposit in the Distribution Account established by it to Certificateholders in
respect of the Certificates and to such other persons in the order of priority
set forth in Section 4.01 hereof.

     Section 4.03 Statements.
                  -----------

     (a) On each Distribution Date, based, as applicable, on information
provided to it by the Servicer, the Certificate Administrator shall prepare and
make available to each Holder of the Regular Certificates, the Servicer and the
Rating Agencies, a statement as to the distributions made on such Distribution
Date:

          (i) the amount of the distribution made on such Distribution Date to
     the Holders of each Class of Regular Certificates, separately identified,
     allocable to principal and the amount of the distribution made to the
     Holders of the Class P Certificates allocable to Prepayment Charges;

          (ii) the amount of the distribution made on such Distribution Date to
     the Holders of each Class of Regular Certificates (other than the Class P
     Certificates) allocable to interest, separately identified;

          (iii) the Pool Balance at the Close of Business at the end of the
     related Due Period;

          (iv) the number, aggregate principal balance, and weighted average
     Mortgage Rate of the Mortgage Loans as of the related Determination Date
     and the number and aggregate principal balance of all Subsequent Mortgage
     Loans added during the preceding Prepayment Period;

          (v) the number and aggregate unpaid principal balance of Mortgage
     Loans that were (A) Delinquent (exclusive of Mortgage Loans in bankruptcy
     or foreclosure and REO Properties) (1) 30 to 59 days, (2) 60 to 89 days and
     (3) 90 or more days, (B) as to which foreclosure proceedings have been
     commenced and (C) REO Properties;

          (vi) the aggregate amount of Principal Prepayments made during the
     related Prepayment Period;

          (vii) the aggregate amount of Realized Losses incurred during the
     related Prepayment Period and the cumulative amount of Realized Losses;

          (viii) the Certificate Principal Balance of the Class A-1
     Certificates, the Mezzanine Certificates and the Class O Certificates,
     after giving effect to the distributions made on such Distribution Date;

                                       37
<PAGE>

          (ix) the Unpaid Interest Shortfall Amount, if any, with respect to the
     Class A-1 Certificates, the Mezzanine Certificates and the Class AIO
     Certificates for such Distribution Date;

          (x) the aggregate amount of any Prepayment Interest Shortfalls for
     such Distribution Date, to the extent not covered by payments by the
     Servicer pursuant to Section 3.25;

          (xi) the Credit Enhancement Percentage for such Distribution Date;

          (xii) the Available Funds Cap Carryforward Amount for the Class A-1
     Certificates and the Mezzanine Certificates, if any, for such Distribution
     Date and the amount remaining unpaid after reimbursements therefor on such
     Distribution Date;

          (xiii) the respective REMIC Pass-Through Rates applicable to the Class
     A-1 Certificates, the Mezzanine Certificates and the Class AIO Certificates
     for such Distribution Date and the REMIC Pass-Through Rate applicable to
     the Class A-1 Certificates and the Mezzanine Certificates for the
     immediately succeeding Distribution Date;

          (xiv) the Supplemental Interest Payment for each Class on such
     Distribution Date;

     In the case of information furnished pursuant to subclauses (i) and (ii)
above, the amounts shall be expressed in a separate section of the report as a
dollar amount for each Class for each $1,000 original dollar amount as of the
Closing Date.

     The Certificate Administrator may, in the absence of manifest error,
conclusively rely upon the Determination Date Report of the Servicer in its
preparation of the statement to Certificateholders pursuant to this Section
4.03.

     The Trustee will make the Distribution Date statement (and, at its option,
any additional files containing the same information in an alternative format)
available each month to Certificateholders, and other parties to the Agreement
via the Trustee's internet website. The Trustee's internet website shall
initially be located at "www.ctslink.com". Assistance in using the website can
                         ---------------
be obtained by calling the Trustee's customer service desk at (301) 815-6600.
Parties that are unable to use the above distribution options are entitled to
have a paper copy mailed to them via first class mail by calling the customer
service desk and indicating such. The Trustee shall have the right to change the
way Distribution Date statements are distributed in order to make such
distribution more convenient and/or more accessible to the above parties and the
Trustee shall provide timely and adequate notification to all above parties
regarding any such changes.

     (b) Within a reasonable period of time after the end of each calendar year,
the Certificate Administrator shall, upon written request, furnish to each
Person who at any time during the calendar year was a Certificateholder of a
Regular Certificate, if requested in writing by such Person, such information as
is reasonably necessary to provide to such Person a

                                       38
<PAGE>

statement containing the information set forth in subclauses (i) and (ii) above,
aggregated for such calendar year or applicable portion thereof during which
such Person was a Certificateholder. Such obligation of the Certificate
Administrator shall be deemed to have been satisfied to the extent that
substantially comparable information shall be prepared and furnished by the
Certificate Administrator to Certificateholders pursuant to any requirements of
the Code as are in force from time to time.

     (c) On each Distribution Date, the Certificate Administrator shall forward
to the Residual Certificateholders a copy of the reports forwarded to the
Regular Certificateholders in respect of such Distribution Date with such other
information as the Certificate Administrator deems necessary or appropriate.

     (d) Within a reasonable period of time after the end of each calendar year,
the Certificate Administrator shall deliver to each Person who at any time
during the calendar year was a Residual Certificateholder, if requested in
writing by such Person, such information as is reasonably necessary to provide
to such Person a statement containing the information provided pursuant to the
previous paragraph aggregated for such calendar year or applicable portion
thereof during which such Person was a Residual Certificateholder. Such
obligation of the Certificate Administrator shall be deemed to have been
satisfied to the extent that substantially comparable information shall be
prepared and furnished to Certificateholders by the Certificate Administrator
pursuant to any requirements of the Code as from time to time in force.

     (e) In the event that the Certificate Administrator is not the Trustee, no
later than noon on the Business Day prior to each Distribution Date, the
Certificate Administrator shall forward, by facsimile transmission, the
statement prepared pursuant to paragraph (a) of this Section 4.03, together with
all other information reasonably necessary to make the distributions pursuant to
Section 4.01 of this Agreement, to the Trustee. On each Distribution Date, the
Trustee shall make available the information contained in the Distribution Date
statement available to Certificateholders and other parties to the Agreement, in
accordance with paragraph (a) of this Section 4.03. Neither the Trustee nor the
Certificate Administrator shall have any responsibility to (i) verify
information provided by the Servicer to be included in such statement or (ii)
include any information required to be included in such statement if the
Servicer has failed to timely produce such information to the Certificate
Administrator, as required pursuant hereto.

     Section 4.04  Supplemental Interest Account.
                   -----------------------------

     (a) The parties do hereby create and establish a sub-trust of the Trust
Fund, which shall hold an account, which, no later than the Closing Date, the
Certificate Administrator shall establish and maintain, on behalf of the
Trustee, as a segregated trust account that is an Eligible Account, which shall
be titled "Supplemental Interest Account, Wells Fargo Bank Minnesota, N.A., as
Certificate Administrator for the registered holders of NovaStar Mortgage
Funding Trust 2001-1, Home Equity Loan Asset-Backed Certificates, Series 2001-1"
(the "Supplemental Interest Account"). The Certificate Administrator shall,
      -----------------------------
promptly upon receipt, deposit in the Supplemental Interest Account each
distribution of the Class AIO Current Interest pursuant to Section
4.01(a)(i)(A)(ii). Funds deposited in the Supplemental Interest Account shall

                                       39
<PAGE>

be held in trust by the Certificate Administrator for the Certificateholders for
the uses and purposes set forth herein.

     (b) The Certificate Administrator will invest funds deposited in the
Supplemental Interest Account as directed in writing by the Servicer in
Permitted Investments with a maturity date (i) no later than the Business Day
immediately preceding the date on which such funds are required to be withdrawn
from such account pursuant to this Agreement, if a Person other than the
Certificate Administrator or an Affiliate manages or advises such investment,
and (ii) no later than the date on which such funds are required to be withdrawn
from such account pursuant to this Agreement, if the Certificate Administrator
or an Affiliate manages or advises such investment. For federal income tax
purposes, the Holders of the Class AIO Certificates shall be the owners of the
Supplemental Interest Account and shall report all items of income, deduction,
gain or loss arising therefrom. All income and gain realized from investment of
funds deposited in the Supplemental Interest Account shall be credited to such
Account. At no time will the Supplemental Interest Account be an asset of any
REMIC created hereunder. In no event shall the Certificate Administrator be
liable for the selection of Permitted Investments or for investment losses
incurred thereon. The Certificate Administrator shall have no liability in
respect of losses incurred as a result of the liquidation of any Permitted
Investments prior to its stated maturity or failure to provide timely written
direction.

     (c) On each Distribution Date, the Certificate Administrator shall
distribute the funds held in the Supplemental Interest Account as follows:

          (i) first, to pay the Supplemental Interest Payment for the Class A-1
              -----
     Certificates;

          (ii) second, to pay the Supplemental Interest Payment for the Class
               ------
     M-1 Certificates;

          (iii) third, to pay the Supplemental Interest Payment for the Class
                -----
     M-2 Certificates;

          (iv) fourth, to pay the Supplemental Interest Payment for the Class
               ------
     M-3 Certificates; and

          (v) fifth, to pay the Class AIO Monthly Distributable Amount (plus all
              -----
     income and gain realized on investments in the Supplemental Interest
     Account which have not previously been distributed) to the Class AIO
     Certificates.

     (d) The Certificate Administrator shall comply with all requirements of the
Code and applicable state and local law with respect to the withholding from any
distributions made by it to any Person entitled thereto of any applicable
withholding taxes imposed thereon and with respect to any applicable reporting
requirements in connection therewith.

     (e) Notwithstanding any other provision of this Section 4.04, the right to
receive the Supplemental Interest Amount (such right, the "Supplemental Interest
                                                           ---------------------
Right") shall not be separately transferable from the Underwritten Certificates.
-----

                                       40
<PAGE>

     Section 4.05  Pre-Funding Account.
                   --------------------

     (a) No later than the Closing Date, the Certificate Administrator shall
establish and maintain, on behalf of the Trustee, a segregated trust account
that is an Eligible Account, which shall be titled "Pre-Funding Account, Wells
Fargo Bank Minnesota, N.A., as Certificate Administrator for the registered
holders of NovaStar Mortgage Funding Trust 2001-1, Home Equity Loan Asset-Backed
Certificates, Series 2001-1" (the "Pre-Funding Account"). The Certificate
                                   -------------------
Administrator shall, promptly upon receipt, deposit in the Pre-Funding Account
and retain therein the Original Pre- Funded Amount remitted on the Closing Date
to the Certificate Administrator by the Company. Funds deposited in the
Pre-Funding Account shall be held in trust by the Certificate Administrator, on
behalf of the Trustee, for the Certificateholders for the uses and purposes set
forth herein.

     (b) The Certificate Administrator will invest funds deposited in the Pre-
Funding Account as directed by the Servicer in Permitted Investments with a
maturity date (i) no later than the Business Day immediately preceding the date
on which such funds are required to be withdrawn from such account pursuant to
this Agreement, if a Person other than the Certificate Administrator or an
Affiliate manages or advises such investment, and (ii) no later than the date on
which such funds are required to be withdrawn from such account pursuant to this
Agreement, if the Certificate Administrator or an Affiliate manages or advises
such investment. For federal income tax purposes, the Servicer shall be the
owner of the Pre- Funding Account and shall report all items of income,
deduction, gain or loss arising therefrom. All income and gain realized from
investment of funds deposited in the Pre-Funding Account shall be withdrawn and
deposited in the Interest Coverage Account. At no time will the Pre-Funding
Account be an asset of any REMIC created hereunder.

     (c) Amounts on deposit in the Pre-Funding Account shall be withdrawn by the
Certificate Administrator as follows:

          (i) On any Subsequent Transfer Date, the Certificate Administrator
     shall withdraw from the Pre-Funding Account an amount equal to 100% of the
     Principal Balances of the Subsequent Mortgage Loans transferred and
     assigned to the Certificate Administrator for deposit in the Mortgage Pool
     on such Subsequent Transfer Date and pay such amount to or upon the order
     of the Company upon satisfaction of the conditions set forth in Section
     2.08 with respect to such transfer and assignment;

          (ii) If the amount on deposit in the Pre-Funding Account (exclusive of
     investment income) has not been reduced to zero during the Funding Period,
     on the day immediately following the termination of the Funding Period, the
     Certificate Administrator shall deposit into the Payment Account any
     amounts remaining in the Pre-Funding Account (exclusive of investment
     income) for distribution in accordance with the terms hereof;

          (iii) To withdraw investment income as soon as it is realized for
     deposit in the Interest Coverage Account;

                                       41
<PAGE>

          (iv) To withdraw any amount not required to be deposited in the
     Pre-Funding Account or deposited therein in error; and

          (v) To clear and terminate the Pre-Funding Account upon the earlier to
     occur of (A) the Distribution Date immediately following the end of the
     Funding Period and (B) the termination of this Agreement, with any amounts
     remaining on deposit therein being paid to the Holders of the Certificates
     then entitled to distributions in respect of principal.

     Withdrawals from the Pre-Funding Account pursuant to clauses (i), (ii) and
(iv) shall be treated as contributions of cash to the Lower-Tier REMIC on the
date of withdrawal.

     Section 4.06  Interest Coverage Account.
                   --------------------------

     (a) No later than the Closing Date, the Certificate Administrator shall
establish and maintain, on behalf of the Trustee, a segregated trust account
that is an Eligible Account, which shall be titled "Interest Coverage Account,
Wells Fargo Bank Minnesota, N.A., as Certificate Administrator for the
registered holders of NovaStar Mortgage Funding Trust 2001-1, Home Equity Loan
Asset-Backed Certificates, Series 2001-1" (the "Interest Coverage Account"). The
                                                -------------------------
Certificate Administrator shall, promptly upon receipt, deposit in the Interest
Coverage Account and retain therein (i) the Interest Coverage Amount remitted on
the Closing Date to the Certificate Administrator by the Company and (ii) income
and gain realized from investments in the Pre-Funding Account. Funds deposited
in the Interest Coverage Account shall be held in trust by the Certificate
Administrator on behalf of the Trustee for the Certificateholders for the uses
and purposes set forth herein.

     (b) For federal income tax purposes, the Servicer shall be the owner of the
Interest Coverage Account and shall report all items of income, deduction, gain
or loss arising therefrom. At no time will the Interest Coverage Account be an
asset of any REMIC created hereunder. All income and gain realized from
investment of funds deposited in the Interest Coverage Account shall be for the
sole and exclusive benefit of the Servicer and shall be remitted by the
Certificate Administrator to the Servicer no later than the first Business Day
following receipt of such income and gain by the Certificate Administrator. The
Servicer shall deposit in the Interest Coverage Account the amount of any net
loss incurred in respect of any such Permitted Investment immediately upon
realization of such loss.

     (c) On each Distribution Date during the Funding Period and on the
Distribution Date immediately following the end of the Funding Period, the
Certificate Administrator shall withdraw from the Interest Coverage Account, to
the extent funds are available therefore, and deposit in the Payment Account an
amount, as provided in the related Determination Date Report, equal to (i) 30
days' interest on the Original Pre-Funded Amount calculated at an annual rate
equal to the weighted average of the interest rate payable on the Underwritten
Certificates as of the commencement of the related Due Period, minus (ii) the
sum of (1) any interest payments received on Subsequent Mortgage Loans during
the related Due Period and (2) any Advances in respect of interest portions of
delinquent Monthly Payments on the Subsequent Mortgage Loans conveyed to the
Certificate Administrator during the related Due Period. Such withdrawal and
deposit shall be treated as a contribution of cash by the Company

                                       42
<PAGE>

to REMIC 1 on the date thereof. Immediately following any such withdrawal and
deposit, and immediately following the conveyance of any Subsequent Mortgage
Loans to the Trust on any Subsequent Transfer Date, the Certificate
Administrator shall withdraw from the Interest Coverage Account and remit to the
Company or its designee an amount equal to the excess, if any, of the amount
remaining in the Interest Coverage Account over the amount that would be
required to be withdrawn therefrom (assuming sufficient funds therein) pursuant
to the preceding sentence on each subsequent Distribution Date, if any, that
will occur during the Funding Period or that will be the Distribution Date
immediately following the end of the Funding Period, if no Subsequent Mortgage
Loans were acquired by the Trust Fund after the end of the Prepayment Period
relating to the current Distribution Date.

     (d) Upon the earliest of (i) the Distribution Date immediately following
the end of the Funding Period, (ii) the reduction of the Certificate Principal
Balances of the Certificates to zero or (iii) the termination of this Agreement
in accordance with Section 11.01, any amount remaining on deposit in the
Interest Coverage Account after distributions pursuant to paragraph (c) above
shall be withdrawn by the Certificate Administrator and paid to the Servicer or
its designee.

     Section 4.07  Allocation of Realized Losses.
                   ------------------------------

     (a) All Realized Losses on the Mortgage Loans shall be allocated by the
Certificate Administrator on each Distribution Date as follows: first, to the
Class O Certificates, until the Certificate Principal Balance thereof has been
reduced to zero; second, to the Class M-3 Certificates, until the Certificate
Principal Balance thereof has been reduced to zero; third, to the Class M-2
Certificates, until the Certificate Principal Balance thereof has been reduced
to zero; and fourth, to the Class M-1 Certificates, until the Certificate
Principal Balance thereof has been reduced to zero. All Realized Losses to be
allocated to the Certificate Principal Balances of all Classes on any
Distribution Date shall be so allocated after the actual distributions to be
made on such date as provided above. All references above to the Certificate
Principal Balance of any Class of Certificates shall be to the Certificate
Principal Balance of such Class immediately prior to the relevant Distribution
Date, before reduction thereof by any Realized Losses, in each case to be
allocated to such Class of Certificates, on such Distribution Date.

     Any allocation of Realized Losses to a Class O Certificate or to a
Mezzanine Certificate on any Distribution Date shall be made by reducing the
Certificate Principal Balance thereof by the amount so allocated. No allocations
of any Realized Losses shall be made to the Certificate Principal Balances of
the Class A-1 Certificates.

                                       43
<PAGE>

                                   ARTICLE V

                                THE CERTIFICATES

     Section 5.01  The Certificates.
                   -----------------

     Each of the Class A-1 Certificates, the Mezzanine Certificates, the Class
AIO Certificates, the Class P Certificates, the Class O Certificates and the
Residual Certificates shall be substantially in the forms annexed hereto as
exhibits, and shall, on original issue, be executed, authenticated and delivered
by the Trustee or by the Certificate Administrator on behalf of the Trustee to
or upon the order of the Company concurrently with the sale and assignment to
the Trust of the Trust Fund. The Underwritten Certificates shall be initially
evidenced by one or more Certificates representing a Percentage Interest with a
minimum dollar denomination of $25,000 and integral dollar multiples of $1,000
in excess thereof, except that one Certificate of each such Class of
Certificates may be in a different denomination so that the sum of the
denominations of all outstanding Certificates of such Class shall equal the
Certificate Principal Balance of such Class on the Closing Date. The Class AIO
Certificates, the Class P Certificates, the Class O Certificates and the
Residual Certificates are issuable in any Percentage Interests; provided,
however, that the sum of all such percentages for each such Class totals 100%
and no more than ten Certificates of each Class may be issued.

     The Certificates shall be executed on behalf of the Trust by manual or
facsimile signature on behalf of the Trustee by a Responsible Officer.
Certificates bearing the manual or facsimile signatures of individuals who were,
at the time when such signatures were affixed, authorized to sign on behalf of
the Trustee shall bind the Trust, notwithstanding that such individuals or any
of them have ceased to be so authorized prior to the authentication and delivery
of such Certificates or did not hold such offices at the date of such
Certificate. No Certificate shall be entitled to any benefit under this
Agreement or be valid for any purpose, unless such Certificate shall have been
manually authenticated by the Certificate Administrator (or, in the case of the
initial Certificates issued on the Closing Date, by the Trustee) substantially
in the form provided for herein, and such authentication upon any Certificate
shall be conclusive evidence, and the only evidence, that such Certificate has
been duly authenticated and delivered hereunder. All Certificates shall be dated
the date of their authentication. Subject to Section 5.02(c), the Underwritten
Certificates, the Class AIO Certificates and the Class P Certificates shall be
Book-Entry Certificates. The other Classes of Certificates shall be Definitive
Certificates.

     Section 5.02  Registration of Transfer and Exchange of Certificates.
                   ------------------------------------------------------

     (a) The Certificate Registrar shall cause to be kept at the Corporate Trust
Office a Certificate Register in which, subject to such reasonable regulations
as it may prescribe, the Certificate Registrar shall provide for the
registration of Certificates and of transfers and exchanges of Certificates as
herein provided. The Certificate Administrator shall initially serve as
Certificate Registrar for the purpose of registering Certificates and transfers
and exchanges of Certificates as herein provided.

                                       44
<PAGE>

     Upon surrender for registration of transfer of any Certificate at any
office or agency of the Certificate Registrar maintained for such purpose
pursuant to the foregoing paragraph and, in the case of a Residual Certificate,
upon satisfaction of the conditions set forth below, the Certificate
Administrator on behalf of the Trust shall execute, authenticate and deliver, in
the name of the designated transferee or transferees, one or more new
Certificates of the same aggregate Percentage Interest.

     At the option of the Certificateholders, Certificates may be exchanged for
other Certificates in authorized denominations and the same aggregate Percentage
Interests, upon surrender of the Certificates to be exchanged at any such office
or agency. Whenever any Certificates are so surrendered for exchange, the
Certificate Administrator shall execute on behalf of the Trust and authenticate
and deliver the Certificates which the Certificateholder making the exchange is
entitled to receive. Every Certificate presented or surrendered for registration
of transfer or exchange shall (if so required by the Certificate Administrator
or the Certificate Registrar) be duly endorsed by, or be accompanied by a
written instrument of transfer satisfactory to the Certificate Administrator and
the Certificate Registrar duly executed by, the Holder thereof or his attorney
duly authorized in writing.

     (b) Except as provided in paragraph (c) below, the Book-Entry Certificates
shall at all times remain registered in the name of the Depository or its
nominee and at all times: (i) registration of such Certificates may not be
transferred by the Certificate Administrator except to another Depository; (ii)
the Depository shall maintain book-entry records with respect to the Certificate
Owners and with respect to ownership and transfers of such Certificates; (iii)
ownership and transfers of registration of such Certificates on the books of the
Depository shall be governed by applicable rules established by the Depository;
(iv) the Depository may collect its usual and customary fees, charges and
expenses from its Depository Participants; (v) the Certificate Administrator
shall for all purposes deal with the Depository as representative of the
Certificate Owners of the Certificates for purposes of exercising the rights of
Holders under this Agreement, and requests and directions for and votes of such
representative shall not be deemed to be inconsistent if they are made with
respect to different Certificate Owners; (vi) the Certificate Administrator may
rely and shall be fully protected in relying upon information furnished by the
Depository with respect to its Depository Participants and furnished by the
Depository Participants with respect to indirect participating firms and Persons
shown on the books of such indirect participating firms as direct or indirect
Certificate Owners; and (vii) the direct participants of the Depository shall
have no rights under this Agreement under or with respect to any of the
Certificates held on their behalf by the Depository, and the Depository may be
treated by the Trustee, the Certificate Administrator and its agents, employees,
officers and directors as the absolute owner of the Certificates for all
purposes whatsoever.

     All transfers by Certificate Owners of Book-Entry Certificates shall be
made in accordance with the procedures established by the Depository Participant
or brokerage firm representing such Certificate Owners. Each Depository
Participant shall only transfer Book-Entry Certificates of Certificate Owners
that it represents or of brokerage firms for which it acts as agent in
accordance with the Depository's normal procedures. The parties hereto are
hereby authorized to execute a Letter of Representations with the Depository or
take such other action as may be necessary or desirable to register a Book-
Entry Certificate to the Depository. In the event

                                       45
<PAGE>

of any conflict between the terms of any such Letter of Representation and this
Agreement, the terms of this Agreement shall control.

     (c) If (i)(x) the Depository or the Company advises the Certificate
Administrator in writing that the Depository is no longer willing or able to
discharge properly its responsibilities as Depository and (y) the Certificate
Administrator or the Company is unable to locate a qualified successor, (ii) the
Company, at its sole option, with the consent of the Certificate Administrator,
elects to terminate the book-entry system through the Depository or (iii) after
the occurrence of a Servicing Default, the Certificate Owners of the Book-Entry
Certificates representing not less than 51% of the Voting Rights advise the
Certificate Administrator and Depository through the Financial Intermediaries
and the Depository Participants in writing that the continuation of a book-entry
system through the Depository to the exclusion of definitive, fully registered
certificates ("Definitive Certificates") to Certificate Owners is no longer in
               -----------------------
the best interests of the Certificate Owners. Upon surrender to the Certificate
Registrar of the Book-Entry Certificates by the Depository, accompanied by
registration instructions from the Depository for registration, the Trustee or
the Certificate Administrator, on behalf of the Trustee, shall, at the Company's
expense, in the case of (ii) above, or the Seller's expense, in the case of (i)
and (iii) above, execute on behalf of the Trust and authenticate the Definitive
Certificates. None of the Company, the Certificate Administrator nor the Trustee
shall be liable for any delay in delivery of such instructions and may
conclusively rely on, and shall be protected in relying on, such instructions.
Upon the issuance of Definitive Certificates, the Certificate Administrator, the
Trustee, the Certificate Registrar, the Servicer, any Paying Agent and the
Company shall recognize the Holders of the Definitive Certificates as
Certificateholders hereunder.

     (d) No transfer, sale, pledge or other disposition of any Class O
Certificate or Residual Certificate shall be made unless such disposition is
exempt from the registration requirements of the Securities Act of 1933, as
amended (the "1933 Act"), and any applicable state securities laws or is made in
              --------
accordance with the 1933 Act and laws. In the event of any such transfer, except
with respect to the initial transfers of any Class O Certificate or Residual
Certificates by the Company to NFRC, unless (i) such transfer is made in
reliance upon Rule 144A under the 1933 Act and an investment letter, in
substantially the form attached hereto as Exhibit G, is delivered by the
Transferee to the Certificate Administrator) or (ii) a written Opinion of
Counsel (which may be in-house counsel) acceptable to and in form and substance
reasonably satisfactory to the Certificate Administrator and the Company is
delivered to them stating that such transfer may be made pursuant to (x) the
1933 Act, or an exemption thereto, describing the applicable provision or
exemption and the basis therefor, and (y) the Investment Company Act of 1940, or
an exemption thereto, describing the applicable provision or exemption and the
basis therefor, which Opinion of Counsel shall not be an expense of the
Certificate Administrator or the Company. The Holder of a Class O Certificate or
Residual Certificate desiring to effect such transfer shall, and does hereby
agree to, indemnify the Certificate Administrator, the Trustee and the Company
against any liability that may result if the transfer is not so exempt or is not
made in accordance with such federal and state laws.

     No transfer of a Class AIO Certificate, Class O Certificate, Class P
Certificate or Residual Certificate or any interest therein shall be made to any
Plan subject to ERISA or Section

                                       46
<PAGE>

4975 of the Code, any Person acting, directly or indirectly, on behalf of any
such Plan or any Person acquiring such Certificates with "plan assets" of a Plan
within the meaning of the Department of Labor regulation promulgated at 29
C.F.R. (S) 2510.3-101 or otherwise ("Plan Assets"). Each Person who acquires any
                                     ---- ------
Ownership Interest in such classes of Certificates shall be deemed, by the
acceptance or acquisition of such Ownership Interest, to represent that it is
not acquiring such Ownership Interest with Plan Assets.

     Prior to the later of the expiration of the Funding Period and the
publication of final amendments to the Underwriter's exemption from the
Department of Labor to extend exemptive relief to subordinate certificates, no
transfer of Mezzanine Certificates or any interest therein shall be made to a
Person acquiring such Certificates with Plan Assets.

     Each person who acquires any Ownership Interest in such class of
Certificates prior to the later of such dates shall be deemed, by the acceptance
or acquisition of such Ownership Interest, to represent that it is not acquiring
such Ownership Interest with Plan Assets.

     Prior to the expiration of the Funding Period, no transfer of Class A- 1
Certificates or any interest therein shall be made to any Person acquiring such
Certificates with Plan Assets. Each Person who acquires any Ownership Interest
in such class of Certificates prior to the expiration of such Period shall be
deemed, by the acceptance or acquisition of such Ownership Interest, to
represent that it is not acquiring such Ownership Interest with Plan Assets.

     Each Person who has or who acquires any Ownership Interest in a Residual
Certificate shall be deemed by the acceptance or acquisition of such Ownership
Interest to have agreed to be bound by the following provisions and to have
irrevocably appointed the Company or its designee as its attorney-in-fact to
negotiate the terms of any mandatory sale under clause (v) below and to execute
all instruments of transfer and to do all other things necessary in connection
with any such sale, and the rights of each Person acquiring any Ownership
Interest in a Residual Certificate are expressly subject to the following
provisions:

          (i) Each Person holding or acquiring any Ownership Interest in a
     Residual Certificate shall be a Permitted Transferee and shall promptly
     notify the Certificate Administrator of any change or impending change in
     its status as a Permitted Transferee.

          (ii) No Person shall acquire an Ownership Interest in a Residual
     Certificate unless such Ownership Interest is a pro rata undivided
     interest.

          (iii) In connection with any proposed transfer of any Ownership
     Interest in a Residual Certificate, the Certificate Administrator shall as
     a condition to registration of the transfer, require delivery to it, in
     form and substance satisfactory to it, of each of the following:

          (A) an affidavit in the form of Exhibit H hereto from the proposed
     transferee to the effect that such transferee is a Permitted Transferee and
     that it is not acquiring its Ownership Interest in the Residual Certificate
     that is the subject of the

                                       47
<PAGE>

     proposed transfer as a nominee, Certificate Administrator or agent for any
     Person who is not a Permitted Transferee; and

          (B) a covenant of the proposed transferee to the effect that the
     proposed transferee agrees to be bound by and to abide by the transfer
     restrictions applicable to the Residual Certificates.

          (iv) Any attempted or purported transfer of any Ownership Interest in
     a Residual Certificate in violation of the provisions of this Section shall
     be absolutely null and void and shall vest no rights in the purported
     transferee. If any purported transferee shall, in violation of the
     provisions of this Section, become a Holder of a Residual Certificate, then
     the prior Holder of such Residual Certificate that is a Permitted
     Transferee shall, upon discovery that the registration of transfer of such
     Residual Certificate was not in fact permitted by this Section, be restored
     to all rights as Holder thereof retroactive to the date of registration of
     transfer of such Residual Certificate. Neither the Certificate
     Administrator nor the Trustee shall be under no liability to any Person for
     any registration of transfer of a Residual Certificate that is in fact not
     permitted by this Section or for making any distributions due on such
     Residual Certificate to the Holder thereof or taking any other action with
     respect to such Holder under the provisions of this Agreement so long as
     the Certificate Administrator received the documents specified in clause
     (iii). The Certificate Administrator shall be entitled to recover from any
     Holder of a Residual Certificate that was in fact not a Permitted
     Transferee at the time such distributions were made all distributions made
     on such Residual Certificate. Any such distributions so recovered by the
     Certificate Administrator shall be distributed and delivered by the
     Certificate Administrator to the prior Holder of such Residual Certificate
     that is a Permitted Transferee.

          (v) If any Person other than a Permitted Transferee acquires any
     Ownership Interest in a Residual Certificate in violation of the
     restrictions in this Section, then the Certificate Administrator shall have
     the right but not the obligation, without notice to the Holder of such
     Residual Certificate or any other Person having an Ownership Interest
     therein, to notify the Company to arrange for the sale of such Residual
     Certificate. The proceeds of such sale, net of commissions (which may
     include commissions payable to the Company or its affiliates in connection
     with such sale), expenses and taxes due, if any, will be remitted by the
     Certificate Administrator to the previous Holder of such Residual
     Certificate that is a Permitted Transferee, except that in the event that
     the Certificate Administrator determines that the Holder of such Residual
     Certificate may be liable for any amount due under this Section or any
     other provisions of this Agreement, the Certificate Administrator may
     withhold a corresponding amount from such remittance as security for such
     claim. The terms and conditions of any sale under this clause (v) shall be
     determined in the sole discretion of the Certificate Administrator and it
     shall not be liable to any Person having an Ownership Interest in a
     Residual Certificate as a result of its exercise of such discretion.

          (vi) If any Person other than a Permitted Transferee acquires any
     Ownership Interest in a Residual Certificate in violation of the
     restrictions in this Section, then the

                                       48
<PAGE>

     Certificate Administrator upon receipt of reasonable compensation will
     provide to the Internal Revenue Service, and to the persons specified in
     Sections 860E(e)(3) and (6) of the Code, information needed to compute the
     tax imposed under Section 860E(e)(5) of the Code on transfers of residual
     interests to disqualified organizations.

     The foregoing provisions of this Section shall cease to apply to transfers
occurring on or after the date on which there shall have been delivered to the
Certificate Administrator, in form and substance satisfactory to the Certificate
Administrator, (i) written notification from each Rating Agency that the removal
of the restrictions on Transfer set forth in this Section will not cause such
Rating Agency to downgrade its rating of the Certificates and (ii) an Opinion of
Counsel to the effect that such removal will not cause any REMIC created
hereunder to fail to qualify as a REMIC.

     (e) No service charge shall be made for any registration of transfer or
exchange of Certificates of any Class, but the Certificate Registrar may require
payment of a sum sufficient to cover any tax or governmental charge that may be
imposed in connection with any transfer or exchange of Certificates.

     All Certificates surrendered for registration of transfer or exchange shall
be cancelled by the Certificate Registrar and disposed of pursuant to its
standard procedures.

     Section 5.03  Mutilated, Destroyed, Lost or Stolen Certificates.
                   --------------------------------------------------

     If (i) any mutilated Certificate is surrendered to the Certificate
Registrar or the Certificate Registrar receives evidence to its satisfaction of
the destruction, loss or theft of any Certificate and (ii) there is delivered to
the Trustee, the Certificate Administrator, the Company and the Certificate
Registrar such security or indemnity as may be required by them to save each of
them harmless, then, in the absence of notice to the Certificate Administrator
or the Certificate Registrar that such Certificate has been acquired by a bona
fide purchaser, the Trustee or the Certificate Administrator shall execute on
behalf of the Trust, authenticate and deliver, in exchange for or in lieu of any
such mutilated, destroyed, lost or stolen Certificate, a new Certificate of like
tenor and Percentage Interest. Upon the issuance of any new Certificate under
this Section, the Trustee, the Certificate Administrator or the Certificate
Registrar may require the payment of a sum sufficient to cover any tax or other
governmental charge that may be imposed in relation thereto and any other
expenses (including the fees and expenses of the Trustee, the Certificate
Administrator and the Certificate Registrar) in connection therewith. Any
duplicate Certificate issued pursuant to this Section, shall constitute complete
and indefeasible evidence of ownership in the Trust, as if originally issued,
whether or not the lost, stolen or destroyed Certificate shall be found at any
time.

     Section 5.04  Persons Deemed Owners.
                   ----------------------

     The Servicer, the Company, the Trustee, the Certificate Administrator, the
Certificate Registrar, any Paying Agent and any agent of the Servicer, the
Company, the Trustee, the Certificate Administrator, the Certificate Registrar,
any Paying Agent or the Certificate Administrator may treat the Person,
including a Depository, in whose name any Certificate is

                                       49
<PAGE>

registered as the owner of such Certificate for the purpose of receiving
distributions pursuant to Section 4.01 and for all other purposes whatsoever,
and none of the Servicer, the Trust, the Certificate Administrator, the Trustee
nor any agent of any of them shall be affected by notice to the contrary.

     Section 5.05  Appointment of Paying Agent.
                   ----------------------------

     (a) The Paying Agent shall make distributions to Certificateholders from
the Distribution Account pursuant to Section 4.01 and shall report the amounts
of such distributions to the Certificate Administrator. In the event that the
Paying Agent is not the Trustee or Certificate Administrator, the duties of the
Paying Agent may include the obligation to distribute statements prepared by the
Certificate Administrator and delivered to the Trustee pursuant to Section 4.03
and provide information to Certificateholders as required hereunder. The Paying
Agent hereunder shall at all times be an entity duly incorporated and validly
existing under the laws of the United States of America or any state thereof,
authorized under such laws to exercise corporate trust powers and subject to
supervision or examination by federal or state authorities. The Paying Agent
shall initially be the Trustee. The Trustee may appoint a successor to act as
Paying Agent, which appointment shall be reasonably satisfactory to the Company.

     (b) The Trustee shall cause the Paying Agent (if other than the Trustee) to
execute and deliver to the Trustee an instrument in which such Paying Agent
shall agree with the Trustee that such Paying Agent shall hold all sums, if any,
held by it for payment to the Certificateholders in trust for the benefit of the
Certificateholders entitled thereto until such sums shall be paid to such
Certificateholders and shall agree that it shall comply with all requirements of
the Code regarding the withholding of payments in respect of Federal income
taxes due from Certificate Owners and otherwise comply with the provisions of
this Agreement applicable to it.

                                   ARTICLE VI

                          THE SERVICER AND THE COMPANY

     Section 6.01  Liability of the Servicer and the Company.
                   ------------------------------------------

     The Servicer shall be liable in accordance herewith only to the extent of
the obligations specifically imposed upon and undertaken by Servicer herein. The
Company shall be liable in accordance herewith only to the extent of the
obligations specifically imposed upon and undertaken by the Company.

     Section 6.02  Merger or Consolidation of, or Assumption of the Obligations
                   ------------------------------------------------------------
of, the Servicer or the Company.
--------------------------------

     Any entity into which the Servicer or Company may be merged or
consolidated, or any entity resulting from any merger, conversion or
consolidation to which the Servicer or the Company shall be a party, or any
corporation succeeding to the business of the Servicer or the Company, shall be
the successor of the Servicer or the Company, as the case may be, hereunder,
without the execution or filing of any paper or any further act on the part of
any of the parties

                                       50
<PAGE>

hereto, anything herein to the contrary notwithstanding; provided, however, that
the successor Servicer shall satisfy all the requirements of Section 7.02 with
respect to the qualifications of a successor Servicer.

     Section 6.03  Limitation on Liability of the Servicer and Others.
                   ---------------------------------------------------

     Neither the Servicer nor any of the directors or officers or employees or
agents of the Servicer shall be under any liability to the Trust or the
Certificateholders for any action taken or for refraining from the taking of any
action by the Servicer in good faith pursuant to this Agreement, or for errors
in judgment; provided, however, that this provision shall not protect the
Servicer or any such Person against any liability which would otherwise be
imposed by reason of its willful misfeasance, bad faith or negligence in the
performance of duties of the Servicer or by reason of its reckless disregard of
its obligations and duties of the Servicer hereunder.

     The Servicer and any director or officer or employee or agent of the
Servicer may rely in good faith on any document of any kind prima facie properly
executed and submitted by any Person respecting any matters arising hereunder.
The Servicer and any director or officer or employee or agent of the Servicer
shall be indemnified by the Trust and held harmless against any loss, liability
or expense incurred in connection with any legal action relating to this
Agreement or the Certificates, including any amount paid to the Certificate
Administrator on behalf of the Trustee pursuant to Section 6.06(b), other than
any loss, liability or expense related to any specific Mortgage Loan or Mortgage
Loans (except as any such loss, liability or expense shall be otherwise
reimbursable pursuant to this Agreement) and any loss, liability or expense
incurred by reason of its willful misfeasance, bad faith or negligence in the
performance of its duties hereunder or by reason of its reckless disregard of
its obligations and duties hereunder. The Servicer shall not be under any
obligation to appear in, prosecute or defend any legal action which is not
incidental to its duties to service the Mortgage Loans in accordance with this
Agreement, and which in its opinion may involve it in any expense or liability;
provided, however, that the Servicer may in its sole discretion undertake any
such action which it may deem necessary or desirable in respect of this
Agreement, and the rights and duties of the parties hereto and the interests of
the Certificateholders hereunder. In such event, the reasonable legal expenses
and costs of such action and any liability resulting therefrom shall be
expenses, costs and liabilities of the Trust, and the Servicer shall be entitled
to be reimbursed therefor. The Servicer's right to indemnity or reimbursement
pursuant to this Section 6.03 shall survive any resignation or termination of
the Servicer pursuant to Section 6.04 or 7.01 with respect to any losses,
expenses, costs or liabilities arising prior to such resignation or termination
(or arising from events that occurred prior to such resignation or termination).
Any reimbursements or indemnification to the Servicer from the Trust pursuant to
this Section 6.03 shall be payable in the priority set forth in Section 4.01
hereof.

     Section 6.04  Servicer Not to Resign.
                   -----------------------

     Subject to the provisions of Section 6.02, the Servicer shall not resign
from the obligations and duties hereby imposed on it except (i) upon
determination that the performance of its obligations or duties hereunder are no
longer permissible under applicable law or (ii) upon satisfaction of the
following conditions: (a) the Servicer has proposed a successor servicer to the

                                       51
<PAGE>

Trust, the Trustee and the Certificate Administrator in writing and such
proposed successor servicer is reasonably acceptable to the Trustee and the
Certificate Administrator; and (b) each Rating Agency shall have delivered a
letter to the Trust, the Trustee, and the Certificate Administrator prior to the
appointment of the successor servicer stating that the proposed appointment of
such successor servicer as Servicer hereunder will not result in the reduction
or withdrawal of the then current rating of the Certificates; provided, however,
                                                              --------  -------
that no such resignation by the Servicer shall become effective until such
successor servicer or, in the case of (i) above, the Certificate Administrator
or its designee as successor Servicer shall have assumed the Servicer's
responsibilities and obligations hereunder or the Trustee or its designee as
successor Servicer shall have designated a successor servicer in accordance with
Section 7.02. Any such resignation shall not relieve the Servicer of
responsibility for any of the obligations specified in Sections 7.01 and 7.02 as
obligations that survive the resignation or termination of the Servicer. The
Servicer shall have no claim (whether by subrogation or otherwise) or other
action against any Certificateholder for any amounts paid by the Servicer
pursuant to any provision of this Pooling and Agreement. Any such determination
permitting the resignation of the Servicer under clause (i) above shall be
evidenced by an Opinion of Counsel to such effect delivered to the Certificate
Administrator and the Trustee.

     Section 6.05  Delegation of Duties.
                   ---------------------

     In the ordinary course of business, the Servicer at any time may delegate
any of its duties hereunder to any Person, including any of its Affiliates, who
agrees to conduct such duties in accordance with the same standards with which
the Servicer complies pursuant to Section 3.01. Such delegation shall not
relieve the Servicer of its liabilities and responsibilities with respect to
such duties and shall not constitute a resignation within the meaning of Section
6.04.

     Section 6.06  Servicer to Pay Trustee's, Certificate Administrator's and
                   ----------------------------------------------------------
Custodian's Fees and Expenses; Indemnification.
-----------------------------------------------

     (a) The Servicer covenants and agrees to pay to the Certificate
Administrator, the Trustee, any co-trustee of the Trustee and the Custodian from
time to time, and the Certificate Administrator, the Trustee, any such
co-trustee and the Custodian shall be entitled to, reasonable compensation,
including all indemnification payments (which shall not be limited by any
provision of law in regard to the compensation of a trustee of an express trust)
for all services rendered by each of them in the execution of the trusts created
hereunder and in the exercise and performance of any of the powers and duties
and the Servicer will pay or reimburse the Certificate Administrator, the
Trustee, any co-trustee and the Custodian upon request for all reasonable
expenses, disbursements and advances incurred or made by the Certificate
Administrator, the Trustee, any co-trustee of the Trustee or the Custodian in
accordance with any of the provisions of this Agreement except any such expense,
disbursement or advance as may arise from its negligence or bad faith. The
Trustee and Certificate Administrator shall first make a written demand for the
Servicer to pay such expenses, disbursements and advances, and if the Servicer
has not made payment within a reasonable period of time (not to exceed sixty
(60) days), then they may recover such expenses, disbursements and advances as
permitted under Section 3.07 or 4.01 of this Agreement.

                                       52
<PAGE>

     (b) The Servicer agrees to indemnify the Trustee, the Certificate
Administrator and the Custodian, and their officers, directors, agents and
employees, for, and to defend and hold, the Trustee, the Custodian and the
Certificate Administrator, and their officers, directors, agents and employees,
as the case may be, harmless against, any claim, tax, penalty, loss, liability
or expense of any kind whatsoever, incurred without gross negligence or willful
misconduct on the part of the Trustee, the Certificate Administrator or the
Custodian, as such and/or in its individual capacity, arising out of, or in
connection with, the administration of this Agreement and the transactions
contemplated thereby, including the reasonable costs and expenses (including
reasonable legal fees and expenses) of defending itself against any claim in
connection with the exercise or performance of any of its powers or duties
hereunder, provided that:

          (i) with respect to any such claim, the Trustee, the Certificate
     Administrator or the Custodian, as the case may be, shall have given the
     Servicer written notice thereof promptly after the Certificate
     Administrator, the Trustee or the Custodian, as the case may be, shall have
     actual knowledge thereof;

          (ii) while maintaining control over its own defense, the Trustee, the
     Certificate Administrator or the Custodian, as the case may be, shall
     cooperate and consult fully with the Servicer in preparing such defense;
     and

          (iii) notwithstanding anything in this Agreement to the contrary, the
     Servicer shall not be liable for settlement of any claim by the Trustee,
     the Certificate Administrator or the Custodian, as the case may be, entered
     into without the prior consent of the Servicer, which consent shall not be
     unreasonably withheld.

     No termination of this Agreement and resignation and removal of the
Trustee, the Certificate Administrator or the Custodian shall affect the
obligations created by this Section 6.06 of the Servicer to indemnify the
Certificate Administrator, the Trustee and the Custodian under the conditions
and to the extent set forth herein. This section shall survive the termination
of this Agreement and resignation and removal of the Trustee, Certificate
Administrator and the Custodian. Any amounts to be paid by the Servicer pursuant
to this Subsection may not be paid from the Trust Fund except as provided in
Section 6.03.

     Notwithstanding the foregoing, the indemnification provided by the Servicer
in this Section 6.06 shall not pertain to any loss, liability or expense of the
Trustee or the Certificate Administrator, including the costs and expenses of
defending itself against any claim, incurred in connection with any actions
taken by the Trustee or the Certificate Administrator at the direction of the
Certificateholders, as the case may be, pursuant to the terms of this Agreement.

     (c) The Servicer agrees to indemnify the Trust Fund in an amount equal to
the amount of any claim made under a MI Policy for which coverage is denied by
the MI Insurer because (and if the MI Insurer's denial of coverage is contested
by the Servicer, a court or arbitrator finally determines that coverage is not
available under the MI Policy because) of the Servicer's failure to abide by the
terms of the MI Policy or the MI Insurance Agreement or the

                                       53
<PAGE>

Servicer's failure to abide by the NFI Underwriting Guidelines or the NFI
Servicing Guidelines, as attached to the MI Insurance Agreement.

     (d) In the event the Certificate Administrator becomes the Servicer
pursuant to Section 7.02 hereof, neither the Trustee nor the Certificate
Administrator shall be obligated, in its individual capacity, to pay any
obligation of the Servicer under clause (a), (b) or (c) above.

                                  ARTICLE VII

                                     DEFAULT

     Section 7.01  Servicing Default.
                   -----------------

     (a) If any one of the following events (a "Servicing Default") shall occur
                                                -----------------
and be continuing:

          (i) Any failure by the Servicer to deposit in the Collection Account
     or Payment Account (A) any Advances and Compensating Interest or (B) any
     other Deposit required to be made under the terms of this Agreement, which,
     in the case of this clause (B), continues unremedied for a period of three
     Business Days after the date upon which written notice of such failure
     shall have been given to the Servicer by the Trustee or the Certificate
     Administrator or to the Servicer, the Trustee and the Certificate
     Administrator the Holders of Certificates evidencing at least 25% of the
     Voting Rights; or

          (ii) Failure on the part of the Servicer duly to observe or perform in
     any material respect any other covenants or agreements of the Servicer set
     forth in this Agreement, which failure, in each case, materially and
     adversely affects the interests of Certificateholders or the breach of any
     representation or warranty of the Servicer in this Agreement which
     materially and adversely affects the interests of the Certificateholders,
     and which in either case continues unremedied for a period of 30 days after
     the date on which written notice of such failure or breach, requiring the
     same to be remedied, and stating that such notice is a "Notice of Default"
     hereunder, shall have been given to the Servicer by the Certificate
     Administrator or the Trustee or to the Servicer, the Certificate
     Administrator and the Trustee by the Holders of Certificates evidencing at
     least 25% of the Voting Rights; or

          (iii) The entry against the Servicer of a decree or order by a court
     or agency or supervisory authority having jurisdiction in the premises for
     the appointment of a trustee, conservator, receiver or liquidator in any
     insolvency, conservatorship, receivership, readjustment of debt, marshaling
     of assets and liabilities or similar proceedings, or for the winding up or
     liquidation of its affairs, and the continuance of any such decree or order
     unstayed and in effect for a period of 60 consecutive days; or

          (iv) The Servicer shall voluntarily go into liquidation, consent to
     the appointment of a conservator, receiver, liquidator or similar person in
     any insolvency, readjustment of debt, marshaling of assets and liabilities
     or similar proceedings of or

                                       54
<PAGE>

     relating to the Servicer or of or relating to all or substantially all of
     its property, or a decree or order of a court, agency or supervisory
     authority having jurisdiction in the premises for the appointment of a
     conservator, receiver, liquidator or similar person in any insolvency,
     readjustment of debt, marshaling of assets and liabilities or similar
     proceedings, or for the winding-up or liquidation of its affairs, shall
     have been entered against the Servicer and such decree or order shall have
     remained in force undischarged, unbonded or unstayed for a period of 60
     days; or the Servicer shall admit in writing its inability to pay its debts
     generally as they become due, file a petition to take advantage of any
     applicable insolvency or reorganization statute, make an assignment for the
     benefit of its creditors or voluntarily suspend payment of its obligations;
     or

          (v) The Cumulative Loss Percentage exceeds (a) with respect to the
     first 12 Distribution Dates, .70% of the Cut-off Date Aggregate Principal
     Balance, (b) with respect to the next 12 Distribution Dates, 1.05% of the
     Cut-off Date Aggregate Principal Balance, (c) with respect to the next 12
     Distribution Dates, 1.4% of the Cut-off Date Aggregate Principal Balance,
     (d) with respect to the next 12 Distribution Dates, 1.75% of the Cut-off
     Date Aggregate Principal Balance, (e) with respect to the next 12
     Distribution Dates, 2.3% of the Cut-off Date Aggregate Principal Balance,
     (f) and with respect to all Distribution Dates thereafter, 3.5% of the Cut-
     off Date Aggregate Principal Balance; or

          (vi) Realized Losses on the Mortgage Loans over any twelve-month
     period exceeds 1.00% of the sum of the aggregate Principal Balance of the
     Initial Mortgage Loans as of the Cut-off Date and the Original Pre-Funded
     Amount; or

          (vii) The Rolling 90 Day Delinquency Percentage exceeds 14%.

          (b) then, and in each and every such case, so long as a Servicing
     Default shall not have been remedied within the applicable grace period,
     (x) with respect solely to clause (i)(A) above, if such Advance is not made
     by 5:00 P.M., New York time, on the Business Day immediately following the
     Servicer Remittance Date (provided the Certificate Administrator shall give
     the Servicer notice of such failure to advance by 5:00 P.M. New York time
     on the Servicer Remittance Date), the Certificate Administrator shall
     terminate all of the rights and obligations of the Servicer under this
     Agreement and the Certificate Administrator, or a successor servicer
     appointed in accordance with Section 7.02, shall assume, pursuant to
     Section 7.02, the duties of a successor Servicer and (y) in the case of
     (i)(B), (ii), (iii), (iv) and (v) above, the Certificate Administrator
     shall, at the direction of the Holders of Certificates evidencing at least
     51% of the Voters Rights, by notice then given in writing to the Servicer
     (and to the Trustee or the Certificate Administrator if given by Holders of
     Certificates), terminate all of the rights and obligations of the Servicer
     as servicer under this Agreement. Any such notice to the Servicer shall
     also be given to the Certificate Administrator, each Rating Agency, the
     Company and the Seller. On or after the receipt by the Servicer (and by the
     Trustee or the Certificate Administrator if such notice is given by the
     Holders) of such written notice, all authority and power of the Servicer
     under this Agreement, whether with respect to the Certificates or the
     Mortgage Loans or otherwise, shall pass to and be vested in the Certificate
     Administrator or other Successor Servicer appointed in accordance with
     Section 7.02.

                                       55
<PAGE>

     Section 7.02  Certificate Administrator to Act; Appointment of
                   ------------------------------------------------
Successor.
----------

     (a) Within 90 days of the time the Servicer (and the Trustee or the
Certificate Administrator, if notice is sent by the Holders) receives a notice
of termination pursuant to Section 7.01, the Certificate Administrator (or such
other successor Servicer as is approved in accordance with this Agreement) shall
be the successor in all respects to the Servicer in its capacity as servicer
under this Agreement and the transactions set forth or provided for herein and
shall be subject to all the responsibilities, duties and liabilities relating
thereto placed on the Servicer by the terms and provisions hereof arising on and
after its succession. Notwithstanding the foregoing, the parties hereto agree
that the Certificate Administrator, in its capacity as successor Servicer,
immediately will assume all of the obligations of the Servicer to make Advances.
Notwithstanding the foregoing, the Certificate Administrator, in its capacity as
successor Servicer, shall not be responsible for the lack of information and/or
documents that it cannot obtain through reasonable efforts. As compensation
therefor, the Certificate Administrator (or such other successor Servicer) shall
be entitled to such compensation as the Servicer would have been entitled to
hereunder if no such notice of termination had been given. Notwithstanding the
above, (i) if the Certificate Administrator is unwilling to act as successor
Servicer or (ii) if the Certificate Administrator is legally unable so to act,
the Certificate Administrator shall appoint or petition a court of competent
jurisdiction to appoint, any established housing and home finance institution,
bank or other mortgage loan or home equity loan servicer having a net worth of
not less than $10,000,000 as the successor to the Servicer hereunder in the
assumption of all or any part of the responsibilities, duties or liabilities of
the Servicer hereunder; provided, that the appointment of any such successor
Servicer will not result in the qualification, reduction or withdrawal of the
ratings assigned to the Certificates by the Rating Agencies as evidenced by a
letter to such effect from the Rating Agencies. Pending appointment of a
successor to the Servicer hereunder, unless the Certificate Administrator is
prohibited by law from so acting, the Certificate Administrator shall act in
such capacity as hereinabove provided. In connection with such appointment and
assumption, the successor shall be entitled to receive compensation out of
payments on Mortgage Loans in an amount equal to the compensation which the
Servicer would otherwise have received pursuant to Section 3.18 (or such other
compensation as the Certificate Administrator and such successor shall agree,
not to exceed the Servicing Fee). The appointment of a successor Servicer shall
not affect any liability of the predecessor Servicer which may have arisen under
this Agreement prior to its termination as Servicer to pay any deductible under
an insurance policy pursuant to Section 3.14 or to indemnify the Certificate
Administrator and the Trustee pursuant to Section 3.06), nor shall any successor
Servicer be liable for any acts or omissions of the predecessor Servicer or for
any breach by such Servicer of any of its representations or warranties
contained herein or in any related document or agreement. The Certificate
Administrator and such successor shall take such action, consistent with this
Agreement, as shall be necessary to effectuate any such succession. All
Servicing Transfer Costs shall be paid by the predecessor Servicer upon
presentation of reasonable documentation of such costs, and if such predecessor
Servicer defaults in its obligation to pay such costs, such costs shall be paid
by the successor Servicer, the Certificate Administrator or the Trustee (in
which case the successor Servicer, the Certificate Administrator or the Trustee,
as applicable, shall be entitled to reimbursement therefor from the assets of
the Trust).

                                       56
<PAGE>

     (b) Any successor, including the Certificate Administrator, to the Servicer
as servicer shall during the term of its service as servicer continue to service
and administer the Mortgage Loans for the benefit of Certificateholders, and
maintain in force a policy or policies of insurance covering errors and
omissions in the performance of its obligations as Servicer hereunder and a
Fidelity Bond in respect of its officers, employees and agents to the same
extent as the Servicer is so required pursuant to Section 3.14.

     (c) In connection with the termination or resignation of the Servicer
hereunder, either (i) the successor Servicer, shall represent and warrant that
it is a member of MERS in good standing and shall agree to comply in all
material respects with the rules and procedures of MERS in connection with the
servicing of the Mortgage Loans that are registered with MERS, in which case the
predecessor Servicer shall cooperate with the successor Servicer in causing MERS
to revise its records to reflect the transfer of servicing to the successor
Servicer as necessary under MERS' rules and regulations, or (ii) the predecessor
Servicer shall cooperate with the successor Servicer in causing MERS to execute
and deliver an assignment of Mortgage in recordable form to transfer the
Mortgages from MERS to the Trustee and to execute and deliver such other
notices, documents and other instruments as may be necessary or desirable to
effect a transfer of such Mortgage Loans or servicing of such Mortgage Loan on
the MERS System to the successor Servicer. The predecessor Servicer shall file
or cause to be filed any such assignment in the appropriate recording offices.
The predecessor Servicer shall bear any and all fees of MERS, costs of preparing
any assignments of Mortgage, and fees and costs of filing any assignments of
Mortgage that may be required under this subsection (c). The successor Servicer
shall cause such assignment to be delivered to the Trustee promptly upon receipt
of the original with evidence of recording thereon or a copy certified by the
public recording office in which such assignment was recorded.

     Section 7.03  Waiver of Defaults.
                   -------------------

     The Majority Certificateholders may, on behalf of all Certificateholders,
waive any events permitting removal of the Servicer as servicer pursuant to this
Article VII, provided, however, that the Majority Certificateholders may not
waive a default in making a required distribution on a Certificate without the
consent of the Holder of such Certificate. Upon any waiver of a past default,
such default shall cease to exist and any Servicing Default arising therefrom
shall be deemed to have been remedied for every purpose of this Agreement. No
such waiver shall extend to any subsequent or other default or impair any right
consequent thereto except to the extent expressly so waived. Notice of any such
waiver shall be given by the Certificate Administrator to the Rating Agencies.

     Section 7.04  Notification to Certificateholders.
                   -----------------------------------

     (a) Upon any termination or appointment of a successor the Servicer
pursuant to this Article VII, the Certificate Administrator shall give prompt
written notice thereof to the Certificateholders at their respective addresses
appearing in the Certificate Register and each Rating Agency.

                                       57
<PAGE>

     (b) No later than 60 days after the occurrence of any event which
constitutes or which, with notice or a lapse of time or both, would constitute a
Servicing Default for five Business Days after a Responsible Officer of the
Trustee becomes aware of the occurrence of such an event, the Certificate
Administrator shall transmit by mail to all Certificateholders notice of such
occurrence unless such default or Servicing Default shall have been waived or
cured.

     Section 7.05  Survivability of Servicer Liabilities.
                   --------------------------------------

     Notwithstanding anything herein to the contrary, upon termination of the
Servicer hereunder, any liabilities of the Servicer which accrued prior to such
termination shall survive such termination.

                                  ARTICLE VIII

          THE TRUSTEE, THE CERTIFICATE ADMINISTRATOR AND THE CUSTODIAN

     Section 8.01  Duties of the Trustee, the Certificate Administrator and the
                   ------------------------------------------------------------
Custodian.
---------

     If a Servicing Default has occurred and is continuing, each of the Trustee,
the Certificate Administrator and the Custodian shall exercise the rights and
powers vested in each of them by this Agreement and use the same degree of care
and skill in their exercise as a prudent person would exercise or use under the
circumstances in the conduct of such person's own affairs.

     (a) Except during the continuance of a Servicing Default:

          (i) each of the Trustee, the Certificate Administrator and the
     Custodian undertake to perform such duties and only such duties as are
     specifically set forth in this Agreement with respect to the Trustee, the
     Certificate Administrator and the Custodian, respectively, and no implied
     covenants or obligations shall be read into this Agreement against the
     Trustee, the Certificate Administrator or the Custodian; and

          (ii) in the absence of bad faith on its part, each of the Trustee, the
     Certificate Administrator and the Custodian, as the case may be, may
     conclusively rely, as to the truth of the statements and the correctness of
     the opinions expressed therein, upon certificates or opinions furnished to
     the Trustee, the Certificate Administrator and/or the Custodian, as
     applicable, and conforming to the requirements of this Agreement; provided,
     however, that each of the Trustee, the Certificate Administrator and the
     Custodian, as the case may be, shall examine the certificates and opinions
     delivered to it to determine whether or not they conform to the
     requirements of this Agreement, provided, further, however, that the
     Trustee shall have no duty or responsibility to review any document,
     certificate, instrument or opinion delivered solely to the Certificate
     Administrator or the Custodian.

                                       58
<PAGE>

     (b) Neither the Trustee, the Certificate Administrator nor the Custodian
may be relieved from liability for its own negligent action, its own negligent
failure to act or its own willful misconduct, except that:

          (A) this paragraph does not limit the effect of paragraph (b) of this
     Section 8.01;

          (B) the Trustee, the Certificate Administrator and the Custodian shall
     not be liable for any error of judgment made in good faith by its
     respective Responsible Officer unless it is proved that the Trustee, the
     Certificate Administrator or the Custodian, respectively, was negligent in
     ascertaining the pertinent facts; and

          (C) neither the Trustee, the Certificate Administrator nor the
     Custodian shall be liable with respect to any action it takes or omits to
     take in good faith in accordance with a direction received by it from the
     Majority Certificateholders.

     Neither the Trustee nor the Certificate Administrator shall be liable for
interest on any money received by the Trustee or the Certificate Administrator,
as the case may be, except as the Trustee or the Certificate Administrator,
respectively, may agree in writing with the Servicer.

     Money held in trust by the Trustee or the Certificate Administrator need
not be segregated from other trust funds except to the extent required by law or
the terms of this Agreement.

     No provision of this Agreement shall require the Trustee, the Certificate
Administrator or the Custodian to expend or risk its own funds or otherwise
incur financial liability in the performance of any of its duties hereunder or
in the exercise of any of its rights or powers, if it shall have reasonable
grounds to believe that repayment of such funds or indemnity reasonably
satisfactory to it against such risk or liability is not reasonably assured to
it.

     Subject to the other provisions of this Agreement and without limiting the
generality of this Section 8.01, the Trustee, the Certificate Administrator and
the Custodian shall have no duty (A) to see to any recording, filing or
depositing of this Agreement or any agreement referred to herein or any
financing statement or continuation statement evidencing a security interest, or
to see to the maintenance of any such recording or filing or depositing or to
any rerecording, refiling or redepositing of any thereof, (B) to see to any
insurance, (C) to see to the payment or discharge of any tax, assessment, or
other governmental charge or any lien or encumbrance of any kind owing with
respect to, assessed or levied against, any part of the Trust Fund other than
from funds available in the Payment Account, or (D) to confirm or verify the
contents of any reports or certificates of the Servicer delivered to the
Certificate Administrator, the Trustee or the Custodian believed by the
Certificate Administrator, the Trustee or the Custodian to be genuine and to
have been signed or presented by the proper party or parties.

     (c) The Certificate Administrator shall act as successor to the Servicer to
the extent provided in Section 7.02 hereof.

                                       59
<PAGE>

     (d) For all purposes under this Agreement, neither the Trustee, the
Certificate Administrator nor the Custodian shall be deemed to have notice or
knowledge of any Servicing Default unless a Responsible Officer assigned to and
working in the Trustee's, the Certificate Administrator's or the Custodian's,
respectively, corporate trust department has actual knowledge thereof or unless
written notice of any event which is in fact such Servicing Default is received
by the Trustee, the Certificate Administrator or the Custodian, respectively, at
the Corporate Trust Office, and such notice references the Certificates
generally, the Trust, or this Agreement.

     The Trustee and the Certificate Administrator are hereby authorized to
execute and shall execute this Agreement, the Purchase Agreement, and the
Converted Loan Purchase Agreement, and shall perform their respective duties and
satisfy their respective obligations thereunder. The Custodian is hereby
authorized to execute this Agreement and the Purchase Agreement. Every provision
of this Agreement relating to the conduct or affecting the liability of or
affording protection to the Trustee, the Certificate Administrator or the
Custodian shall apply to the Trustee's, the Certificate Administrator's and the
Custodian's execution of this Agreement and the Purchase Agreement, and of the
Trustee's and the Certificate Administrator's execution of the Converted Loan
Purchase Agreement, and the performance of their respective duties and
satisfaction of its obligations hereunder and thereunder.

     Notwithstanding any term or provision in this Agreement to the contrary,
the rights and obligations of the Trustee as trustee under this Agreement shall
not be diminished by the fact that the Trustee may employ the services of the
Certificate Administrator and the Custodian to accomplish the duties of the
Trustee hereunder. Accordingly, any references in this Agreement or the other
Basic Documents alluding to a right or obligation of the Certificate
Administrator or the Custodian (other than the obligation of the Certificate
Administrator to act as successor Servicer pursuant to Section 7.02 hereof in
the event of a Servicing Default) shall be construed to mean such right or
obligation of the Trustee, which right or obligation may be accepted or
performed by the Certificate Administrator or the Custodian on behalf of the
Trustee.

     Section 8.02  Rights of the Trustee, the Certificate Administrator and the
                   ------------------------------------------------------------
Custodian.
----------

     Each of the Trustee, the Certificate Administrator and the Custodian may
conclusively rely and shall be fully protected in acting or refraining from
acting on any resolution, officer's certificate, opinion of counsel, certificate
of auditors or other certificate, statement, instrument, or document believed by
it to be genuine and to have been signed or presented by the proper person. The
Trustee, the Certificate Administrator and the Custodian need not investigate
any fact or matter stated in the document.

     Before either the Trustee, the Certificate Administrator or the Custodian
acts or refrains from acting, it may require an Officer's Certificate or an
Opinion of Counsel reasonably satisfactory in form and substance to the Trustee,
the Certificate Administrator or the Custodian, as the case may be, which
Officer's Certificate or Opinion of Counsel shall not be at the expense of the
Trustee, the Certificate Administrator, the Custodian or the Trust Fund. Neither
the Trustee, the Certificate Administrator, nor the Custodian shall be liable
for any action either of

                                       60
<PAGE>

them takes or omits to take in good faith in reliance on an Officer's
Certificate or Opinion of Counsel.

     The Trustee may execute any of its trusts or powers hereunder and both the
Trustee and the Certificate Administrator may perform any of their respective
duties hereunder either directly or by or through the Custodian, agents,
attorneys or a nominee and the Trustee and Certificate Administrator shall have
no liability for any misconduct or negligence on the part of the Custodian, such
agent, attorney or nominee appointed by the Trustee or Certificate Administrator
with due care.

     Neither the Trustee, the Certificate Administrator nor the Custodian shall
be liable for any action either of them takes or omits to take in good faith
which it believes to be authorized or within its rights or powers; provided,
however, that the Trustee's conduct, the Certificate Administrator's conduct or
the Custodian's conduct, as the case may be, does not constitute willful
misconduct, negligence or bad faith.

     Each of the Trustee, the Certificate Administrator and the Custodian may
consult with counsel chosen by it with due care, and the advice or opinion of
counsel with respect to legal matters relating to this Agreement and the
Certificates shall be full and complete authorization and protection from
liability in respect to any action taken, omitted or suffered by either of them
hereunder in good faith and in accordance with the advice or opinion of such
counsel.

     The Trustee and the Certificate Administrator shall be under no obligation
to exercise any of the trusts or powers vested in it by this Agreement or to
institute, conduct or defend any litigation hereunder or in relation hereto at
the request, order or direction of any of the Certificateholders, pursuant to
the provisions of this Agreement, unless such Certificateholders shall have
offered to the Trustee and the Certificate Administrator security or indemnity
reasonably satisfactory to it against the costs, expenses and liabilities which
may be incurred therein or thereby (which in the case of the Majority
Certificateholders will be deemed to be satisfied by a letter agreement with
respect to such costs from such Majority Certificateholders); nothing contained
herein shall, however, relieve the Trustee or the Certificate Administrator of
the obligation, upon the occurrence of a Servicing Default of which a
Responsible Officer of the Trustee or the Certificate Administrator shall have
actual knowledge (which has not been cured), to exercise such of the rights and
powers vested in it by this Agreement, and to use the same degree of care and
skill in their exercise, as a prudent person would exercise or use under the
circumstances in the conduct of such person's own affairs.

     The Trustee and the Certificate Administrator shall not be bound to make
any investigation into the facts or matters stated in any resolution,
certificate, statement, instrument, opinion, report, notice, request, consent,
order, approval, bond or other paper or document, unless requested in writing to
do by the Majority Certificateholders; provided, however, that if the payment
within a reasonable time to the Trustee and the Certificate Administrator of the
costs, expenses or liabilities likely to be incurred by it in the making of such
investigation is, in the opinion of the Trustee or the Certificate
Administrator, not reasonably assured to the Trustee or the Certificate
Administrator by the security afforded to it by the terms of this Agreement, the

                                       61
<PAGE>

Trustee or the Certificate Administrator may require indemnity reasonably
satisfactory to it against such cost, expense or liability as a condition to
taking any such action. The reasonable expense of every such examination shall
be paid by the Servicer or, if paid by the Trustee or the Certificate
Administrator, shall be repaid by the Servicer upon demand from the Servicer's
own funds.

     The rights of the Trustee, the Certificate Administrator or the Custodian
to perform any discretionary act enumerated in this Agreement shall not be
construed as a duty, and the Trustee, the Certificate Administrator and the
Custodian shall not be answerable for other than its negligence or willful
misconduct in the performance of such act.

     The Trustee, the Certificate Administrator and the Custodian shall not be
required to give any bond or surety in respect of the execution of the Trust
Fund created hereby or the powers granted hereunder.

     Section 8.03  Individual Rights of Trustee and Certificate Administrator.
                   ----------------------------------------------------------

     Each of the Trustee and the Certificate Administrator in its individual or
any other capacity may become the owner or pledgee of Certificates and may
otherwise deal with the Seller or its Affiliates with the same rights it would
have if it were not Trustee or Certificate Administrator, as applicable. Any
Certificates Registrar, co-registrar or co-paying agent may do the same with
like rights. However, the Trustee and the Certificate Administrator must comply
with Section 8.11 hereof.

     Section 8.04  Trustee's, Certificate Administrator's and Custodian's
                   ------------------------------------------------------
Disclaimer.
-----------

     Neither the Trustee, the Certificate Administrator nor the Custodian shall
be responsible for and makes no representation as to the validity or adequacy of
this Agreement or the Certificates, or of any Mortgage Loan or related document,
or of MERS or the MERS System. Neither the Trustee, the Certificate
Administrator nor the Custodian shall be accountable for the use of the proceeds
from the Certificates. Neither the Trustee, the Certificate Administrator nor
the Custodian shall be responsible for any statement of the Trust in this
Agreement or in any document issued in connection with the sale of the
Certificates or in the Certificates other than the Trustee's or the Certificate
Registrar's certificate of authentication.

     Section 8.05  Notice of Servicing Default.
                   ------------------------------

     The Trustee or the Certificate Administrator on behalf of the Trustee shall
mail to each Certificateholder notice of the Servicing Default within 10 days
after a Responsible Officer has actual knowledge thereof unless such Servicing
Default shall have been waived or cured. Except in the case of a Servicing
Default in payment of principal of or interest on any Certificate, the Trustee
and the Certificate Administrator may withhold the notice if and so long as it
in good faith determines that withholding the notice is in the interests of
Certificateholders.

     Section 8.06  [Reserved].
                   -------------

                                       62
<PAGE>

     Section 8.07  Compensation and Indemnity.
                   ---------------------------

     The amount of the Certificate Administrator Fee shall be paid to the
Certificate Administrator on each Distribution Date pursuant to Section
4.01(a)(i) of this Agreement, and all amounts owing to the Trustee and to the
Certificate Administrator hereunder in excess of such amount shall be paid
solely as provided in this Agreement. The Certificate Administrator shall be
responsible for paying the trustee fee out of the Certificate Administrator Fee.
The Trustee's compensation and the Certificate Administrator's compensation
shall not be limited by any law on compensation of a trustee of an express
trust. The Trustee, Certificate Administrator and the Custodian shall be
indemnified pursuant to Section 6.06.

     Section 8.08  Replacement of the Trustee, the Certificate Administrator or
                   ------------------------------------------------------------
the Custodian.
--------------

     No resignation or removal of the Trustee, the Certificate Administrator or
the Custodian and no appointment of a successor Trustee, successor Certificate
Administrator, or successor Custodian shall become effective until the
acceptance of appointment by the successor Trustee, successor Certificate
Administrator or successor Custodian pursuant to this Section 8.08. The Trustee,
the Certificate Administrator or the Custodian may resign at any time by so
notifying the Trustee, the Certificate Administrator, the Custodian and the
Company. The Majority Certificateholders may at any time remove the Trustee, the
Certificate Administrator or the Custodian by so notifying the Company and the
Trustee, the Certificate Administrator or the Custodian, as applicable, and the
Company and may appoint a successor Trustee, successor Certificate Administrator
or successor Custodian. The Company shall remove the Trustee, Certificate
Administrator or the Custodian, as the case may be, if:

     (a) the Trustee, the Certificate Administrator or the Custodian fails to
comply with Section 8.11 hereof;

     (b) the Trustee, the Certificate Administrator or the Custodian is adjudged
a bankrupt or insolvent;

     (c) a receiver or other public officer takes charge of the Trustee, the
Certificate Administrator or the Custodian or its respective property; or

     (d) the Trustee, the Certificate Administrator or the Custodian otherwise
becomes incapable of acting.

     If the Trustee, the Certificate Administrator or the Custodian resigns or
is removed or if a vacancy exists in the office of the Trustee, the Certificate
Administrator or the Custodian for any reason (the Trustee, the Certificate
Administrator or the Custodian, as applicable, in such event being referred to
herein as the retiring Trustee, the retiring Certificate Administrator or the
retiring Custodian), the Company shall promptly appoint a successor Trustee,
successor Certificate Administrator or successor Custodian.

     A successor Trustee, successor Certificate Administrator or successor
Custodian shall deliver a written acceptance of its appointment to the retiring
Trustee, retiring Certificate

                                       63
<PAGE>

Administrator or retiring Custodian, the Company, the Trustee, the Certificate
Administrator, the Custodian and the Servicer. Thereupon, the resignation or
removal of the retiring Trustee, retiring Certificate Administrator or retiring
Custodian shall become effective, and the successor Trustee, successor
Certificate Administrator or successor Custodian shall have all the rights,
powers and duties of the Trustee, the Certificate Administrator or the Custodian
under this Agreement. The successor Trustee, successor Certificate Administrator
or successor Custodian shall mail a notice of its succession to the
Certificateholders. The retiring Trustee, retiring Certificate Administrator or
retiring Custodian shall promptly transfer all property held by it as Trustee,
Certificate Administrator or Custodian, to the successor Trustee, successor
Certificate Administrator or successor Custodian.

     Subject to the foregoing provisions of this Section 8.08, the Trustee may
terminate the Certificate Administrator at any time for failure to perform its
obligations hereunder or under the Basic Documents provided it or a Certificate
Administrator acceptable to the Company assumes the obligations of the
Certificate Administrator.

     If a successor Trustee, successor Certificate Administrator of successor
Custodian does not take office within 60 days after the retiring Trustee,
retiring Certificate Administrator or retiring Custodian resigns or is removed,
the retiring Trustee, retiring Certificate Administrator or retiring Custodian,
as the case may be, the Company, the Trustee, the Certificate Administrator, the
Custodian or the Majority Certificateholders may petition any court of competent
jurisdiction for the appointment of a successor Trustee, successor Certificate
Administrator or successor Custodian.

     Section 8.09  Successor Trustee, Certificate Administrator or Custodian by
                   ------------------------------------------------------------
Merger.
-------

     If the Trustee, the Certificate Administrator or Custodian consolidates
with, merges or converts into, or transfers all or substantially all of its
corporate trust business or assets to, another corporation or banking
association, the resulting, surviving or transferee corporation, without any
further act, shall be the successor Trustee, successor Certificate Administrator
or successor Custodian, as applicable; provided, that such corporation or
banking association shall be otherwise qualified and eligible under Section 8.11
hereof.

     If at the time such successor or successors by merger, conversion or
consolidation to the Trustee or the Certificate Administrator, as the case may
be, shall succeed to the trusts created by this Agreement and any of the
Certificates shall have been authenticated but not delivered, any such successor
to the Trustee or the Certificate Administrator, as the case may be, may adopt
the certificate of authentication of any predecessor trustee and deliver such
Certificates so authenticated; and if at that time any of the Certificates shall
not have been authenticated, any successor to the Trustee or the Certificate
Administrator, as the case may be, may authenticate such Certificates either in
the name of any predecessor hereunder or in the name of the successor to the
Trustee or the Certificate Administrator, as the case may be; and in all such
cases such certificates shall have the full force as the Certificates or this
Agreement provide that such certificates of the Trustee or the Certificate
Administrator, as the case may be, shall have.

                                       64
<PAGE>

     Section 8.10  Appointment of Co-Trustee or Separate Trustee.
                   ----------------------------------------------

     Notwithstanding any other provisions of this Agreement, at any time, for
the purpose of meeting any legal requirement of any jurisdiction in which any
part of the Trust Fund may at the time be located, the Trustee shall have the
power and may execute and deliver all instruments to appoint one or more Persons
to act as a co-trustee or co-trustees, or separate trustee or separate trustees,
of all or any part of the Trust Fund, and to vest in such Person or Persons, in
such capacity and for the benefit of the Certificateholders, such title to the
Trust Fund, or any part hereof, and, subject to the other provisions of this
Section, such powers, duties, obligations, rights and trusts as the Trustee may
consider necessary or desirable. No co-trustee or separate trustee hereunder
shall be required to meet the terms of eligibility as a successor trustee under
Section 8.11 hereof and notice to, and no consent of the Certificateholders of
the appointment of any co-trustee or separate trustee shall be required.

     Every separate trustee and co-trustee shall, to the extent permitted by
law, be appointed and act subject to the following provisions and conditions:

     (a) all rights, powers, duties and obligations conferred or imposed upon
the Trustee shall be conferred or imposed upon and exercised or performed by the
Trustee and such separate trustee or co-trustee jointly (it being understood
that such separate trustee or co-trustee is not authorized to act separately
without the Trustee joining in such act), except to the extent that under any
law of any jurisdiction in which any particular act or acts are to be performed
the Trustee shall be incompetent or unqualified to perform such act or acts, in
which event such rights, powers, duties and obligations (including the holding
of title to the Trust Fund or any portion thereof in any such jurisdiction)
shall be exercised and performed singly by such separate trustee or co-trustee,
but solely at the direction of the Trustee;

     (b) no trustee hereunder shall be personally liable by reason of any act or
omission of any other trustee hereunder; and

     (c) the Trustee may at any time accept the resignation of or remove any
separate trustee or co-trustee.

     Any notice, request or other writing given to the Trustee shall be deemed
to have been given to each of the then separate trustees and co-trustees, as
effectively as if given to each of them. Every instrument appointing any
separate trustee or co-trustee shall refer to this Agreement and the conditions
of this Article VIII. Each separate trustee and co-trustee, upon its acceptance
of the trusts conferred, shall be vested with the estates or property specified
in its instrument of appointment, either jointly with the Trustee or separately,
as may be provided therein, subject to all the provisions of this Agreement,
specifically including every provision of this Agreement relating to the conduct
of, affecting the liability of, or affording protection to, the Trustee. Every
such instrument shall be filed with the Trustee.

     Any separate trustee or co-trustee may at any time constitute the Trustee,
its agent or attorney-in-fact with full power and authority, to the extent not
prohibited by law, to do any lawful act under or in respect of this Agreement on
its behalf and in its name. If any separate

                                       65
<PAGE>

trustee or co-trustee shall die, become incapable of acting, resign or be
removed, all of its estates, properties, rights, remedies and trusts shall vest
in and be exercised by the Trustee, to the extent permitted by law, without the
appointment of a new or successor trustee.

     Section 8.11  Eligibility; Disqualification.
                   ------------------------------

     Each of the Trustee, the Certificate Administrator and the Custodian shall
at all times be reasonably acceptable to the Company and authorized to exercise
corporate trust powers. Each of the Trustee, the Certificate Administrator and
the Custodian shall have a combined capital and surplus of at least $50,000,000
as set forth in its most recent published annual report of condition and it or
its parent shall have a long-term debt rating of Baa3 or better by Moody's and
BBB or better by Standard & Poor's.

     Section 8.12  [Reserved]
                   ----------

     Section 8.13  Representations and Warranties.
                   -------------------------------

     (a) The Trustee hereby represents that:

          (i) The Trustee is duly organized and validly existing as a national
     banking association in good standing under the federal laws of the United
     States with power and authority to own its properties and to conduct its
     business as such properties are currently owned and such business is
     presently conducted;

          (ii) The Trustee has the power and authority to execute and deliver
     this Agreement and to carry out its terms; and the execution, delivery and
     performance of this Agreement have been duly authorized by the Trustee by
     all necessary corporate action;

          (iii) The consummation of the transactions contemplated by this
     Agreement and the fulfillment of the terms hereof do not conflict with,
     result in any breach of any of the terms and provisions of, or constitute
     (with or without notice or lapse of time) a default under, the articles of
     organization or bylaws of the Trustee or any agreement or other instrument
     to which the Trustee is a party or by which it is bound; and

          (iv) To the Trustee's best knowledge, there are no proceedings or
     investigations pending or threatened before any court, regulatory body,
     administrative agency or other governmental instrumentality having
     jurisdiction over the Trustee or its properties: (A) asserting the
     invalidity of this Agreement, (B) seeking to prevent the consummation of
     any of the transactions contemplated by this Agreement or (C) seeking any
     determination or ruling that might materially and adversely affect the
     performance by the Trustee of its obligations under, or the validity or
     enforceability of, this Agreement.

     (b) The Certificate Administrator hereby represents that:

          (i) The Certificate Administrator is duly organized and validly
     existing as a national banking association in good standing under the
     federal laws of the United States

                                       66
<PAGE>

     with power and authority to own its properties and to conduct its business
     as such properties are currently owned and such business is presently
     conducted;

          (ii) The Certificate Administrator has the power and authority to
     execute and deliver this Agreement and to carry out its terms; and the
     execution, delivery and performance of this Agreement have been duly
     authorized by the Certificate Administrator by all necessary corporate
     action;

          (iii) The consummation of the transactions contemplated by this
     Agreement and the fulfillment of the terms hereof do not conflict with,
     result in any breach of any of the terms and provisions of, or constitute
     (with or without notice or lapse of time) a default under, the articles of
     organization or bylaws of the Certificate Administrator or any agreement or
     other instrument to which the Certificate Administrator is a party or by
     which it is bound; and

          (iv) To the Certificate Administrator's best knowledge, there are no
     proceedings or investigations pending or threatened before any court,
     regulatory body, administrative agency or other governmental
     instrumentality having jurisdiction over the Certificate Administrator or
     its properties: (A) asserting the invalidity of this Agreement, (B) seeking
     to prevent the consummation of any of the transactions contemplated by this
     Agreement or (C) seeking any determination or ruling that might materially
     and adversely affect the performance by the Certificate Administrator of
     its obligations under, or the validity or enforceability of, this
     Agreement.

     (c) The Custodian hereby represents that:

          (i) The Custodian is duly organized and validly existing as a national
     banking association in good standing under the laws of the United States
     with power and authority to own its properties and to conduct its business
     as such properties are currently owned and such business is presently
     conducted;

          (ii) The Custodian has the power and authority to execute and deliver
     this Agreement and to carry out its terms; and the execution, delivery and
     performance of this Agreement have been duly authorized by the Custodian by
     all necessary corporate action;

          (iii) The consummation of the transactions contemplated by this
     Agreement and the fulfillment of the terms hereof do not conflict with,
     result in any breach of any of the terms and provisions of, or constitute
     (with or without notice or lapse of time) a default under, the articles of
     organization or bylaws of the Custodian or any agreement or other
     instrument to which the Custodian is a party or by which it is bound; and

          (iv) To the Custodian's best knowledge, there are no proceedings or
     investigations pending or threatened before any court, regulatory body,
     administrative agency or other governmental instrumentality having
     jurisdiction over the Custodian or

                                       67
<PAGE>

     its properties: (A) asserting the invalidity of this Agreement, (B) seeking
     to prevent the consummation of any of the transactions contemplated by this
     Agreement or (C) seeking any determination or ruling that might materially
     and adversely affect the performance by the Custodian of its obligations
     under, or the validity or enforceability of, this Agreement.

     Section 8.14  Directions to Trustee and Certificate Administrator.
                   ----------------------------------------------------

     The Trustee or the Certificate Administrator on behalf of the Trustee, as
the case may be, is hereby directed:

     (a) to accept the Mortgage Loans and hold the assets of the Trust Fund in
trust for the Certificateholders;

     (b) to authenticate and deliver the Certificates of each Class
substantially in the forms prescribed by Exhibits A-1, A-2, A-3, A-4, A-5, A-6,
A-7, A-8 and A-9 in accordance with the terms of this Agreement; and

     (c) to take all other actions as shall be required to be taken by the terms
of this Agreement.

     Section 8.15  The Agents.
                   -----------

     The provisions of this Agreement relating to the limitations of the
Trustee's and the Certificate Administrator's liability and to its indemnity
shall inure also to the Paying Agent, and the Certificate Registrar and their
officers, directors, agents and employees.

     Section 8.16  Reports by the Certificate Administrator; Trust Fiscal Year.
                   ------------------------------------------------------------
The Certificate Administrator, on behalf of the Trust, shall:
-------------------------------------------------------------

     (a) file with the Commission, on behalf of the Trust, the annual reports
and information, documents and other reports (or copies of such portions of any
of the foregoing as the Commission may from time to time by rules and
regulations prescribe) that the Trust may be required to file with the
Commission pursuant to Section 13 or 15(d) of the Exchange Act. Such filings
shall be as follows: within 15 days after each Distribution Date, the
Certificate Administrator, on behalf of the Trust, shall file with the
Commission via the Electronic Data Gathering, Analysis and Retrieval System, a
Form 8-K with a copy of the statement to Certificateholders for such
Distribution Date as an exhibit thereto. Prior to January 31, 2002, the
Certificate Administrator, shall file a Form 15 Suspension Notification with
respect to the Trust Fund, if applicable. Prior to March 31, 2002, the
Certificate Administrator, on behalf of the Trust, shall file a Form 10-K, in
substance conforming to industry standards, with respect to the Trust Fund. The
Trust hereby grants to the Certificate Administrator, a limited power of
attorney to execute and file each such document on behalf of the Trust. Such
power of attorney shall continue until the termination of the Trust Fund. The
Certificate Administrator, on behalf of the Trust, shall deliver to the Seller
and the Trustee within three Business Days after filing any Form

                                       68
<PAGE>

8-K or Form 10-K pursuant to this Section 8.16 a copy of such Form 8-K or Form
10-K, as the case may be; and

     (b) file with the Commission (with copies to the Seller and the Company) in
accordance with rules and regulations prescribed from time to time by the
Commission such additional information, documents and reports with respect to
compliance by the Trust with the conditions and covenants of this Agreement as
may be required from time to time by such rules and regulations.

     The fiscal year of the Trust shall end on December 31 of each year.

                                   ARTICLE IX

                                   [Reserved]

                                   ARTICLE X

                              REMIC ADMINISTRATION

     Section 10.01  REMIC Administration.
                    ---------------------

     (a) [Reserved].

     (b) The Closing Date is hereby designated as the "Startup Day" of each
REMIC within the meaning of section 860G(a)(9) of the Code.

     (c) The Servicer shall pay any and all tax related expenses (not including
taxes) of each REMIC, including but not limited to any professional fees or
expenses related to audits or any administrative or judicial proceedings with
respect to each REMIC that involve the Internal Revenue Service or state tax
authorities, but only to the extent that (i) such expenses are ordinary or
routine expenses, including expenses of a routine audit but not expenses of
litigation (except as described in (ii)); or (ii) such expenses or liabilities
(including taxes and penalties) are attributable to the negligence or willful
misconduct of the Servicer in fulfilling its duties hereunder. The Servicer
shall be entitled to reimbursement of expenses to the extent provided in clause
(i) above from the Collection Account.

     (d) The Certificate Administrator shall (a) maintain (or cause to be
maintained) the books of the Trust on a calendar year basis using the accrual
method of accounting, (b) deliver (or cause to be delivered) to each
Certificateholder as may be required by the Code and applicable Treasury
Regulations, including the REMIC Provisions, such information as may be required
to enable each Certificateholder to prepare its federal and state income tax
returns, (c) prepare and file or cause to be prepared and filed such tax returns
relating to the Trust as may be required by the Code and applicable Treasury
Regulations (including timely making one or more elections to treat the Trust as
a REMIC for federal income tax purposes and any other such elections as may from
time to time be required or appropriate under

                                       69
<PAGE>

any applicable state or federal statutes, rules or regulations), (d) collect or
cause to be collected any required withholding tax with respect to income or
distributions to Certificateholders and prepare or cause to be prepared the
appropriate forms relating thereto and (e) maintain records as required by the
REMIC Provisions.

     (e) The Holder of the Residual Certificate at any time holding the largest
Percentage Interest thereof shall be the "tax matters person" as defined in the
REMIC Provisions (the "Tax Matters Person") with respect to each REMIC and shall
act as Tax Matters Person for each REMIC. The Certificate Administrator, as
agent for the Tax Matters Person, shall perform on behalf of each REMIC all
reporting and other tax compliance duties that are the responsibility of such
REMIC under the Code, the REMIC Provisions, or other compliance guidance issued
by the Internal Revenue Service or any state or local taxing authority. Among
its other duties, if required by the Code, the REMIC Provisions, or other such
guidance, the Certificate Administrator, as agent for the Tax Matters Person,
shall provide (i) to the Treasury or other governmental authority such
information as is necessary for the application of any tax relating to the
transfer of a Residual Certificate to any Disqualified Organization or non-U.S.
Person and (ii) to the Certificateholders such information or reports as are
required by the Code or REMIC Provisions.

     (f) The Trustee, the Servicer, the Certificate Administrator and the
Holders of Certificates shall take any action or cause the REMIC to take any
action necessary to create or maintain the status of each REMIC as a REMIC under
the REMIC Provisions and shall assist each other as necessary to create or
maintain such status. Neither the Trustee, the Certificate Administrator, the
Servicer nor the Holder of any Residual Certificate shall take any action, cause
any REMIC created hereunder to take any action or fail to take (or fail to cause
to be taken) any action that, under the REMIC Provisions, if taken or not taken,
as the case may be, could (i) endanger the status of such REMIC as a REMIC or
(ii) result in the imposition of a tax upon such REMIC (including but not
limited to the tax on prohibited transactions as defined in Code Section
860F(a)(2) and the tax on prohibited contributions set forth on Section 860G(d)
of the Code) (either such event, an "Adverse REMIC Event") unless the Trustee,
                                     -------------------
the Certificate Administrator and the Servicer have received an Opinion of
Counsel (at the expense of the party seeking to take such action) to the effect
that the contemplated action will not endanger such status or result in the
imposition of such a tax. In addition, prior to taking any action with respect
to any REMIC created hereunder or the assets therein, or causing such REMIC to
take any action, which is not expressly permitted under the terms of this
Agreement, any Holder of a Residual Certificate will consult with the Trustee,
the Certificate Administrator and the Servicer, or their respective designees,
in writing, with respect to whether such action could cause an Adverse REMIC
Event to occur with respect to any REMIC, and no such Person shall take any such
action or cause any REMIC to take any such action as to which the Trustee, the
Certificate Administrator or the Servicer has advised it in writing that an
Adverse REMIC Event could occur.

     (g) Each Holder of a Residual Certificate shall pay when due any and all
taxes imposed on each REMIC created hereunder by federal or state governmental
authorities. To the extent that such Trust taxes are not paid by a Residual
Certificateholder, the Certificate Administrator shall pay any remaining REMIC
taxes out of current or future amounts otherwise

                                       70
<PAGE>

distributable to the Holder of the Residual Certificate in the REMICs or, if no
such amounts are available, out of other amounts held in the Payment Account,
and shall reduce amounts otherwise payable to Holders of regular interests in
the related REMIC.

     (h) The Certificate Administrator, as agent for the Tax Matters Person,
shall, for federal income tax purposes, maintain books and records with respect
to each REMIC created hereunder on a calendar year and on an accrual basis.

     (i) After the Pre-Funding Period, no additional contributions of assets
shall be made to any REMIC created hereunder, except as expressly provided in
this Agreement with respect to Qualified Replacement Mortgages.

     (j) None of the Trustee, the Certificate Administrator nor the Servicer
shall enter into any arrangement by which any REMIC created hereunder will
receive a fee or other compensation for services.

     (k) The Certificate Administrator will apply for an Employee Identification
Number from the Internal Revenue Service via a Form SS-4 or other acceptable
method for the Lower-Tier REMIC and the Upper-Tier REMIC and also file a Form
88-11.

     Section 10.02  Prohibited Transactions and Activities.
                    ---------------------------------------

     Neither the Company, the Servicer, the Certificate Administrator nor the
Trustee shall sell, dispose of, or substitute for any of the Mortgage Loans,
except in a disposition pursuant to (i) the foreclosure of a Mortgage Loan, (ii)
the bankruptcy of the Trust Fund, (iii) the termination, pursuant to Article XI
of this Agreement, of any REMIC created hereunder (iv) a substitution pursuant
to Article II of this Agreement or (v) a repurchase of Mortgage Loans pursuant
to Article II of this Agreement, nor acquire any assets for any REMIC, nor sell
or dispose of any investments in the Payment Account for gain, nor accept any
contributions to either REMIC after the Closing Date, unless it has received an
Opinion of Counsel (at the expense of the party causing such sale, disposition,
or substitution) that such disposition, acquisition, substitution, or acceptance
will not (a) affect adversely the status of any REMIC created hereunder as a
REMIC, or (b) cause any REMIC created hereunder to be subject to a tax on
prohibited transactions or prohibited contributions pursuant to the REMIC
Provisions.

                                   ARTICLE XI

                                   TERMINATION

     Section 11.01  Termination.
                    ------------

     (a) The respective obligations and responsibilities of the Seller, the
Servicer, the Company, the Certificate Administrator and the Trustee created
hereby (other than the obligation of the Certificate Administrator to make
certain payments to Certificateholders after the final Distribution Date and the
obligation of the Servicer to send certain notices as hereinafter set forth)
shall terminate upon notice to the Trustee or the Certificate Administrator upon
the

                                       71
<PAGE>

earliest of (i) the Distribution Date on which the Certificate Principal
Balances of the Regular Certificates have been reduced to zero, (ii) the final
payment or other liquidation of the last Mortgage Loan in the Trust, (iii) the
optional purchase by the Servicer of the Mortgage Loans as described below and
(iv) the Distribution Date in January 2031. Notwithstanding the foregoing, in no
event shall the trust created hereby continue beyond the expiration of 21 years
from the death of the last survivor of the descendants of Joseph P. Kennedy, the
late ambassador of the United States to the Court of St. James, living on the
date hereof.

     The Servicer may, at its option, terminate this Agreement on any date on
which the aggregate of the Principal Balances of the Mortgage Loans on such date
is equal to or less than 10% of the Maximum Collateral Amount, by purchasing, on
the next succeeding Distribution Date, all of the outstanding Mortgage Loans and
REO Properties at a price equal to the greater of the Principal Balance of the
Mortgage Loans and REO Properties or the market value of the Mortgage Loans and
REO Properties, in each case plus accrued and unpaid interest thereon at the
weighted average of the Mortgage Rates through the end of the Due Period
preceding the final Distribution Date plus unreimbursed Servicing Advances,
Advances, any unpaid Servicing Fees allocable to such Mortgage Loans and REO
Properties and any unpaid amount due the Trustee and the Certificate
Administrator under this Agreement and any Available Funds Cap Carry-Forward
Amounts (the "Termination Price").
              -----------------

     In connection with any such purchase pursuant to the preceding paragraph,
the Servicer shall deposit in the Payment Account all amounts then on deposit in
the Collection Account, which deposit shall be deemed to have occurred
immediately preceding such purchase.

     Any such purchase shall be accomplished by deposit into the Payment Account
on the Distribution Date of the Termination Price.

     (b) Notice of any termination, specifying the Distribution Date (which
shall be a date that would otherwise be a Distribution Date) upon which the
Certificateholders may surrender their Certificates to the Certificate
Administrator for payment of the final distribution and cancellation, shall be
given promptly by the Certificate Administrator upon the Certificate
Administrator receiving notice of such date from the Servicer, by letter to the
Certificateholders mailed not earlier than the 15th day and not later than the
25th day of the month next preceding the month of such final distribution
specifying (1) the Distribution Date upon which final distribution of the
Certificates will be made upon presentation and surrender of such Certificates
at the office or agency of the Certificate Administrator therein designated, (2)
the amount of any such final distribution and (3) that the Record Date otherwise
applicable to such Distribution Date is not applicable, distributions being made
only upon presentation and surrender of the Certificates at the office or agency
of the Certificate Administrator therein specified.

     (c) Upon presentation and surrender of the Certificates, the Certificate
Administrator shall cause to be distributed to the Holders of the Certificates
on the Distribution Date for such final distribution, in proportion to the
Percentage Interests of their respective Class and to the extent that funds are
available for such purpose, an amount equal to the amount required to be
distributed to such Holders in accordance with the provisions of Section 4.01
for such Distribution Date.

                                       72
<PAGE>

     (d) In the event that all Certificateholders shall not surrender their
Certificates for final payment and cancellation on or before such final
Distribution Date, the Certificate Administrator shall promptly following such
date cause all funds in the Payment Account not distributed in final
distribution to Certificateholders to be withdrawn therefrom and credited to the
remaining Certificateholders by depositing such funds in a separate Servicing
Account for the benefit of such Certificateholders, and the Servicer (if the
Servicer has exercised its right to purchase the Mortgage Loans) or the
Certificate Administrator (in any other case) shall give a second written notice
to the remaining Certificateholders, to surrender their Certificates for
cancellation and receive the final distribution with respect thereto. If within
nine months after the second notice all the Certificates shall not have been
surrendered for cancellation, the Residual Certificateholder shall be entitled
to all unclaimed funds and other assets which remain subject hereto, and the
Certificate Administrator, as agent of the Trustee upon transfer of such funds
shall be discharged of any responsibility for such funds, and the
Certificateholders shall look to the Residual Certificateholder for payment.

     Section 11.02  Additional Termination Requirements.
                    ------------------------------------

     (a) In the event that the Servicer exercises its purchase option as
provided in Section 11.01, each REMIC shall be terminated in accordance with the
following additional requirements, unless the Certificate Administrator shall
have been furnished with an Opinion of Counsel to the effect that the failure of
the Trust to comply with the requirements of this Section will not (i) result in
the imposition of taxes on "prohibited transactions" of the Trust as defined in
Section 860F of the Code or (ii) cause any REMIC constituting part of the Trust
Fund to fail to qualify as a REMIC at any time that any Certificates are
outstanding:

          (i) Within 90 days prior to the final Distribution Date, the Servicer
     shall adopt and the Certificate Administrator shall sign a plan of complete
     liquidation of each REMIC created hereunder meeting the requirements of a
     "Qualified Liquidation" under Section 860F of the Code and any regulations
     thereunder; and

          (ii) At or after the time of adoption of such a plan of complete
     liquidation and at or prior to the final Distribution Date, the Certificate
     Administrator shall sell all of the assets of the Trust Fund to the
     Servicer for cash pursuant to the terms of the plan of complete
     liquidation.

     (b) By their acceptance of Certificates, the Holders thereof hereby agree
to appoint the Certificate Administrator as their attorney in fact to: (i) adopt
such a plan of complete liquidation (and the Certificateholders hereby appoint
the Certificate Administrator as their attorney in fact to sign such plan) as
appropriate and (ii) to take such other action in connection therewith as may be
reasonably required to carry out such plan of complete liquidation all in
accordance with the terms hereof.

                                       73
<PAGE>

                                  ARTICLE XII

                            MISCELLANEOUS PROVISIONS

     Section 12.01  Amendment.
                    ----------

     This Agreement may be amended from time to time by the parties hereto, and
without the consent of the Certificateholders (i) to cure any ambiguity, (ii) to
correct or supplement any provisions herein which may be defective or
inconsistent with any other provisions herein or (iii) to make any other
provisions with respect to matters or questions arising under this Agreement
which shall not be inconsistent with the provisions of this Agreement; provided,
however, that any such action listed in clause (i) through (iii) above shall be
deemed not to adversely affect in any respect the interests of any
Certificateholder, if evidenced by (i) written notice to the Company, the
Servicer, the Certificate Administrator, the Trustee and the Custodian from the
Rating Agencies that such action will not result in the reduction or withdrawal
of the rating of any outstanding Class of Certificates with respect to which it
is a Rating Agency or (ii) an Opinion of Counsel delivered to the Servicer, the
Certificate Administrator, the Company, the Custodian and the Trustee.

     In addition, this Agreement may be amended from time to time by the parties
hereto with the consent of the Majority Certificateholders for the purpose of
adding any provisions to or changing in any manner or eliminating any of the
provisions of this Agreement or of modifying in any manner the rights of the
Holders of Certificates; provided, however, that no such amendment or waiver
shall (x) reduce in any manner the amount of, or delay the timing of, payments
on the Certificates or distributions which are required to be made on any
Certificate without the consent of the Holder of such Certificate, (y) adversely
affect in any material respect the interests of the Holders of any Class of
Certificates in a manner other than as described in clause (x) above, without
the consent of the Holders of Certificates of such Class evidencing at least a
66% Percentage Interest in such Class, or (z) reduce the percentage of Voting
Rights required by clause (y) above without the consent of the Holders of all
Certificates of such Class then outstanding. Upon approval of an amendment, a
copy of such amendment shall be sent to the Rating Agencies.

     Notwithstanding any provision of this Agreement to the contrary, the
Trustee shall not consent to any amendment to this Agreement unless it shall
have first received an Opinion of Counsel, delivered by (and at the expense of)
the Person seeking such Amendment, to the effect that such amendment will not
result in the imposition of a tax on any REMIC created hereunder constituting
part of the Trust Fund pursuant to the REMIC Provisions or cause any REMIC
created hereunder constituting part of the Trust to fail to qualify as a REMIC
at any time that any Certificates are outstanding and that the amendment is
being made in accordance with the terms hereof and all conditions precedent to
the execution of such amendment have been met.

     Promptly after the execution of any such amendment the Certificate
Administrator shall furnish, at the expense of the Person that requested the
amendment if such Person is Seller or the Servicer (but in no event at the
expense of the Certificate Administrator), otherwise at the

                                       74
<PAGE>

expense of the Trust, a copy of such amendment and the Opinion of Counsel
referred to in the immediately preceding paragraph to the Servicer and each
Rating Agency.

     It shall not be necessary for the consent of Certificateholders under this
Section 12.01 to approve the particular form of any proposed amendment; instead
it shall be sufficient if such consent shall approve the substance thereof. The
manner of obtaining such consents and of evidencing the authorization of the
execution thereof by Certificateholders shall be subject to such reasonable
regulations as the Trustee may prescribe.

     None of the Certificate Administrator, the Trustee or the Custodian shall
be obligated to enter into any amendment pursuant to this Section 12.01 that
affects its rights, duties, indemnities and immunities under this Agreement or
otherwise.

     Section 12.02  Recordation of Agreement; Counterparts.
                    ---------------------------------------

     To the extent permitted by applicable law, this Agreement is subject to
recordation in all appropriate public offices for real property records in all
the counties or other comparable jurisdictions in which any or all of the
properties subject to the Mortgages are situated, and in any other appropriate
public recording office or elsewhere, such recordation to be effected by the
Servicer at the expense of the Trust, but only upon direction of
Certificateholders accompanied by an Opinion of Counsel to the effect that such
recordation materially and beneficially affects the interests of the
Certificateholders.

     For the purpose of facilitating the recordation of this Agreement as herein
provided and for other purposes, this Agreement may be executed simultaneously
in any number of counterparts, each of which counterparts shall be deemed to be
an original, and such counterparts shall together constitute but one and the
same instrument.

     Section 12.03  Limitation on Rights of Certificateholders.
                    -------------------------------------------

     The death or incapacity of any Certificateholder shall not (i) operate to
terminate this Agreement or the Trust, (ii) entitle such Certificateholder's
legal representatives or heirs to claim an accounting or to take any action or
proceeding in any court for a partition or winding up of the Trust, or (iii)
otherwise affect the rights, obligations and liabilities of the parties hereto
or any of them.

     Except as expressly provided for herein, no Certificateholder shall have
any right to vote or in any manner otherwise control the operation and
management of the Trust, or the obligations of the parties hereto, nor shall
anything herein set forth or contained in the terms of the Certificates be
construed so as to constitute the Certificateholders from time to time as
partners or members of an association; nor shall any Certificateholder be under
any liability to any third person by reason of any action taken by the parties
to this Agreement pursuant to any provision hereof.

     No Certificateholder shall have any right by virtue of any provision of
this Agreement to institute any suit, action or proceeding in equity or at law
upon or under or with respect to this Agreement, unless such Holder previously
shall have given to the Trustee a written

                                       75
<PAGE>

notice of default and of the continuance thereof, as hereinbefore provided, and
unless also the Holders of Certificates entitled to at least 25% of the Voting
Rights shall have made written request upon the Trustee to institute such
action, suit or proceeding in its own name as Trustee hereunder and shall have
offered to the Trustee such reasonable indemnity as it may require against the
costs, expenses and liabilities to be incurred therein or thereby, and the
Trustee for 15 days after its receipt of such notice, request and offer of
indemnity, shall have neglected or refused to institute any such action, suit or
proceeding. It is understood and intended, and expressly covenanted by each
Certificateholder with every other Certificateholder and the Trustee, that no
one or more Holders of Certificates shall have any right in any manner whatever
by virtue of any provision of this Agreement to affect, disturb or prejudice the
rights of the Holders of any other of such Certificates, or to obtain or seek to
obtain priority over or preference to any other such Holder, which priority or
preference is not otherwise provided for herein, or to enforce any right under
this Agreement, except in the manner herein provided and for the equal, ratable
and common benefit of all Certificateholders. For the protection and enforcement
of the provisions of this Section 12.03 each and every Certificateholder and the
Trustee shall be entitled to such relief as can be given either at law or in
equity.

     Section 12.04  Governing Law; Jurisdiction.
                    ----------------------------

     This Agreement shall be construed in accordance with the laws of the State
of New York, and the obligations, rights and remedies of the parties hereunder
shall be determined in accordance with such laws. With respect to any claim
arising out of this Agreement, each party irrevocably submits to the exclusive
jurisdiction of the courts of the State of New York and the United States
District Court located in the Borough of Manhattan in The City of New York, and
each party irrevocably waives any objection which it may have at any time to the
laying of venue of any suit, action or proceeding arising out of or relating
hereto brought in any such courts, irrevocably waives any claim that any such
suit, action or proceeding brought in any such court has been brought in any
inconvenient forum and further irrevocably waives the right to object, with
respect to such claim, suit, action or proceeding brought in any such court,
that such court does not have jurisdiction over such party, provided that
service of process has been made by any lawful means.

     Section 12.05  Notices.
                    --------

     All demands, notices and communications hereunder shall be in writing and
shall be deemed to have been duly given if personally delivered at or mailed by
certified mail, return receipt requested, or sent by reputable overnight courier
service to:

     (a)  in the case of the Company:

          NovaStar Mortgage Funding Corporation
          1900 W. 47th Place
          Westwood, Kansas  66205
          Attention:  Kelly Meinders

                                       76
<PAGE>

     (b)  in the case of the Servicer or the Seller:

          NovaStar Mortgage, Inc.
          1900 W.  47th Place
          Suite 205
          Westwood, Kansas  66205
          Attention: Chris Miller, Senior Vice President

     (c)  in the case of Rating Agencies:

          Moody's Investors Service Inc.
          99 Church Street
          New York, New York  10007
          Attention:  Carole Mortensen

          Standard & Poor's
          26 Broadway
          New York, New York  10004-1064
          Attention:  Scott Mason

     (d)  in the case of the Certificate Administrator or the Trustee:

          Wells Fargo Bank Minnesota, N.A.
          11000 Broken Land Parkway
          Columbia, Maryland  21044
          Attention:  NovaStar 2001-1
          With a copy to:
          Wells Fargo Bank Minnesota, N.A.
          6th Avenue and Marquette
          Minneapolis, Minnesota  55479

     (e)  in the case of the Custodian:

          First Union National Bank
          4527 Metropolitan Court, Suite C
          Frederick, Maryland  21704
          Attention:  Robin Belanger (NovaStar 2001-1)

or, as to each party, at such other address as shall be designated by such party
in a written notice to each other party.  Any notice required or permitted to be
mailed to a Certificateholder shall be given by facsimile or by first class
mail, postage prepaid, at the address of such Certificateholder as shown in the
Certificate Register.  Any notice so mailed within the time prescribed in this
Agreement shall be conclusively presumed to have been duly given, whether or not
the Certificateholder receives such notice.  Any notice or other document
required to be delivered or mailed by the Certificate Administrator to any
Rating Agency shall be given on a reasonable

                                       77
<PAGE>

efforts basis and only as a matter of courtesy and accommodation and the
Certificate Administrator shall have no liability for failure to deliver such
notice or document to any Rating Agency.

     Section 12.06  Severability of Provisions.
                    ---------------------------

     If any one or more of the covenants, agreements, provisions or terms of
this Agreement shall for any reason whatsoever be held invalid, then such
covenants, agreements, provisions or terms shall be deemed severable from the
remaining covenants, agreements, provisions or terms of this Agreement and shall
in no way affect the validity or enforceability of the other provisions of this
Agreement or of the Certificates or the rights of the Holders thereof.

     Section 12.07  Article and Section References.
                    -------------------------------

     All article and section references used in this Agreement, unless otherwise
provided, are to articles and sections in this Agreement.

     Section 12.08  Further Assurances.
                    -------------------

     Notwithstanding any other provision of this Agreement, neither the
Certificate Administrator nor the Trustee shall have any obligation to consent
to any amendment or modification of this Agreement unless they have been
provided security or indemnity reasonably satisfactory to it, as the case may
be, against their out-of-pocket expenses (including reasonable attorneys' fees
and expenses) to be incurred in connection therewith.

     Section 12.09  Benefits of Agreement.
                    ----------------------

     Nothing in this Agreement or in the Certificates, expressed or implied,
shall give to any Person, other than the Certificateholders and the parties
hereto and their successors hereunder, any benefit or any legal or equitable
right, remedy or claim under this Agreement.

     Section 12.10  Acts of Certificateholders.
                    ---------------------------

     (a) Any request, demand, authorization, direction, notice, consent, waiver
or other action provided by this Agreement to be given or taken by the
Certificateholders may be embodied in and evidenced by one or more instruments
of substantially similar tenor signed by such Certificateholders in person or by
agent duly appointed in writing, and such action shall become effective when
such instrument or instruments are delivered to the Trustee, the Certificate
Administrator, the Seller and the Servicer. Such instrument or instruments (and
the action embodied therein and evidenced thereby) are herein sometimes referred
to as the "act" of the Certificateholders signing such instrument or
           ---
instruments. Proof of execution of any such instrument or of a writing
appointing any such agent shall be sufficient for any purpose of this Agreement
and conclusive in favor of the Trustee and the Trust, if made in the manner
provided in this Section 12.10.

     (b) The fact and date of the execution by any Person of any such instrument
or writing may be proved by the affidavit of a witness of such execution or by
the certificate of a

                                       78
<PAGE>

notary public or other officer authorized by law to take acknowledgments of
deeds, certifying that the individual signing such instrument or writing
acknowledged to him the execution thereof. Whenever such execution is by a
signer acting in a capacity other than his or her individual capacity, such
certificate or affidavit shall also constitute sufficient proof of his
authority.

     (c) Any request, demand, authorization, direction, notice, consent, waiver
or other action by any Certificateholder shall bind every future Holder of such
Certificate and the Holder of every Certificate issued upon the registration of
transfer thereof or in exchange therefor or in lieu thereof, in respect of
anything done, omitted or suffered to be done by the Certificate Administrator,
the Trustee or the Trust in reliance thereon, whether or not notation of such
action is made upon such Certificate.

                                       79
<PAGE>

     IN WITNESS WHEREOF, the Company, the Servicer, the Seller, the Certificate
Administrator and the Trustee have caused their names to be signed hereto by
their respective officers thereunto duly authorized, all as of the day and year
first above written.

                              NOVASTAR MORTGAGE FUNDING CORPORATION,
                              as Company

                              By:  /s/ Kelly Meinders
                                 -----------------------------
                                 Name:  Kelly Meinders
                                 Title:   Vice President

                              NOVASTAR MORTGAGE, INC.,
                              as Servicer and as Seller

                              By:  /s/ Kelly Meinders
                                 -----------------------------
                                 Name:  Kelly Meinders
                                 Title:   Vice President

                              WELLS FARGO BANK MINNESOTA, N.A.,
                              as Certificate Administrator and as Trustee

                              By:   /s/ Amy Doyle
                                 -----------------------------
                                 Name:  Amy Doyle
                                 Title:   Assistant Vice President

                              FIRST UNION NATIONAL BANK,
                              as Custodian

                              By:   /s/ Ronald L Fisher
                                 -----------------------------
                                 Name:  Ronald L. Fisher
                                 Title:   Vice President

                [Pooling and Servicing Agreement Signature Page]

                                       80
<PAGE>

STATE OF _______________)
                        ) ss.:
COUNTY OF ______________)

     On the ____ day of March, 2001 before me, a notary public in and for said
State, personally appeared _________________ known to me (or proved to me on the
basis of satisfactory evidence) to be a _________________ of NovaStar Mortgage
Funding Corporation, a Delaware corporation that executed the within instrument,
and also known to me (or proved to me on the basis of satisfactory evidence) to
be the person who executed it on behalf of said corporation, and acknowledged to
me that such corporation executed the within instrument.

     IN WITNESS WHEREOF, I have hereunto set my hand and affixed my official
seal the day and year in this certificate first above written.

                              ___________________________________
          Seal                   Notary Public

                                       81
<PAGE>

STATE OF _______________)
                        ) ss.:
COUNTY OF ______________)

     On the ____ day of March, 2001 before me, a notary public in and for said
State, personally appeared ___________________ known to me (or proved to me on
the basis of satisfactory evidence) to be a _____________________ of NovaStar
Mortgage, Inc., a Virginia corporation that executed the within instrument, and
also known to me (or proved to me on the basis of satisfactory evidence) to be
the person who executed it on behalf of said corporation, and acknowledged to me
that such corporation executed the within instrument.

     IN WITNESS WHEREOF, I have hereunto set my hand and affixed my official
seal the day and year in this certificate first above written.

                              ___________________________________
          Seal                   Notary Public

                                       82
<PAGE>

STATE OF _______________)
                        ) ss.:
COUNTY OF ______________)

     On the ____ day of March, 2001 before me, a notary public in and for said
State, personally appeared ___________________ known to me (or proved to me on
the basis of satisfactory evidence) to be a _____________________ of Wells Fargo
Bank Minnesota, N.A., a national banking association that executed the within
instrument, and also known to me (or proved to me on the basis of satisfactory
evidence) to be the person who executed it on behalf of said corporation, and
acknowledged to me that such corporation executed the within instrument.

     IN WITNESS WHEREOF, I have hereunto set my hand and affixed my official
seal the day and year in this certificate first above written.

                              ___________________________________
          Seal                   Notary Public

                                       83
<PAGE>

STATE OF _______________)
                        ) ss.:
COUNTY OF ______________)

     On the ____ day of March, 2001 before me, a notary public in and for said
State, personally appeared ___________________ known to me (or proved to me on
the basis of satisfactory evidence) to be a _____________________ of First Union
National Bank, a national banking association that executed the within
instrument, and also known to me (or proved to me on the basis of satisfactory
evidence) to be the person who executed it on behalf of said corporation, and
acknowledged to me that such corporation executed the within instrument.

     IN WITNESS WHEREOF, I have hereunto set my hand and affixed my official
seal the day and year in this certificate first above written.

                              ___________________________________
          Seal                   Notary Public

                                       84
<PAGE>

                                                                  EXECUTION COPY

                                   APPENDIX A

                                  DEFINITIONS

          "1933 Act":  The Securities Act of 1933, as amended.
           --------

          "Account": The Collection Account, the Pre-Funding Account, the
           -------
Interest Coverage Account, the Supplemental Interest Account, and the Payment
Account.

          "Accrual Period":  With respect to each Distribution Date, the period
           --------------
commencing on the preceding Distribution Date (or in the case of the first
Accrual Period, commencing on the Closing Date) and ending on the day preceding
the current Distribution Date.

          "Addition Notice":  With respect to the transfer of Subsequent
           ---------------
Mortgage Loans to the Trust Fund pursuant to Section 2.08, a notice of the
Company's designation of the Subsequent Mortgage Loans to be sold to the Trust
Fund and the aggregate principal balance of such Subsequent Mortgage Loans as of
the Subsequent Cut-off Date.  The Addition Notice shall be given not later than
four Business Days prior to the related Subsequent Transfer Date and shall be
substantially in the form attached hereto as Exhibit C.

          "Adjustable Rate Mortgage Loan":  A Mortgage Loan which provides at
           -----------------------------
any period during the life of such loan for the adjustment of the Mortgage Rate
payable in respect thereto.  The Adjustable Rate Mortgage Loans are identified
as such on the Mortgage Loan Schedule.

          "Adjustment Date":  With respect to each Adjustable Rate Mortgage
           ---------------
Loan, each adjustment date, on which the Mortgage Rate of such Mortgage Loan
changes pursuant to the related Mortgage Note.

          "Administrative Fee":  With respect to each Distribution Date, the sum
           ------------------
of the MI Premium, the Servicing Fee and the Certificate Administrator Fee with
respect to such Distribution Date.

          "Administrative Fee Rate":  As to each Distribution Date, the sum of
           -----------------------
(i) the Certificate Administrator Fee Rate, (ii) the Servicing Fee Rate, and
(iii) the total MI Premiums due during the related Due Period, expressed as an
annual percentage rate of the Pool Balance as of the beginning of that Due
Period.

          "Advance":  As to any Mortgage Loan, any advance made by the Servicer
           -------
in respect of any Distribution Date pursuant to Section 3.24.

          "Adverse REMIC Event":  As defined in Section 10.01(f) hereof.
           -------------------

          "Affiliate":  With respect to any Person, any other Person
           ---------
controlling, controlled by or under common control with such Person.  For
purposes of this definition, "control" means the power to direct the management
and policies of a Person, directly or indirectly, whether through ownership of
voting securities, by contract or otherwise and "controlling" and "controlled"
shall have meanings correlative to the foregoing.

                                       85
<PAGE>

          "Agreement":  This Pooling and Servicing Agreement and all amendments
           ---------
hereof and supplements hereto.

          "Allocated Realized Loss Amount":  With respect to any Distribution
           ------------------------------
Date and any Class of Mezzanine Certificates, the Realized Losses allocated to
such Class of Certificates on such Distribution Date pursuant to Section 4.07
hereof.

          "Applicable Regulations":  As to any Mortgage Loan, all federal and
           ----------------------
state laws, statutes, rules and regulations applicable thereto.

          "Appraised Value":  The appraised value of a Mortgaged Property based
           ---------------
upon the appraisal made at the time of the origination of the related Mortgage
Loan.  With respect to a Mortgage Loan the proceeds of which were used to
refinance an existing mortgage loan, the appraised value of the Mortgaged
Property based upon the appraisal (as reviewed and approved by the Seller)
obtained at the time of refinancing.

          "Assignment of Mortgage":  An assignment of Mortgage, notice of
           ----------------------
transfer or equivalent instrument, in recordable form, which is sufficient under
the laws of the jurisdiction wherein the related Mortgaged Property is located
to reflect of record the sale of the Mortgage, which assignment, notice of
transfer or equivalent instrument may be in the form of one or more blanket
assignments covering Mortgages secured by Mortgaged Properties located in the
same county, if permitted by law.

          "Assumed Final Maturity Date":  As to each Class of Certificates, the
           ---------------------------
Distribution Date in August, 2031.

          "Available Funds Cap Carryforward Amount":  With respect to any Class
           ---------------------------------------
of Underwritten Certificates and any Distribution Date, the sum of (i) the
positive excess, if any, of (x) the aggregate, cumulative amount of REMIC
Available Funds Cap Shortfall Amounts for such Class on all prior Distribution
Dates over (y) the aggregate, cumulative amount of Supplemental Interest
Payments actually paid to the Holders of that Class on all prior Distribution
Date pursuant to those clauses of Section 4.04(c) which relate to payments to
that Class, plus (ii) interest on the amount described in clause (i) at a rate
equal to the related Formula Rate for such Class and Distribution Date.

          "Balloon Mortgage Loan":  A Mortgage Loan that provides for the
           ---------------------
payment of the unamortized principal balance of such Mortgage Loan in a single
payment at the maturity of such Mortgage Loan that is substantially greater than
the preceding monthly payment.

          "Balloon Payment":  A payment of the unamortized principal balance of
           ---------------
a Mortgage Loan in a single payment at the maturity of such Mortgage Loan that
is substantially greater than the preceding Monthly Payment.

          "Bankruptcy Code":  The Bankruptcy Reform Act of 1978 (Title 11 of the
           ---------------
United States Code), as amended.

          "Base Prospectus":  The base Prospectus, dated February 16, 2001, with
           ---------------
respect to the Offered Certificates.

                                       86
<PAGE>

          "Basic Documents":  This Agreement, the Purchase Agreement, each
           ---------------
Subsequent Transfer Instrument, the Side Indemnity Letter, the REMIC Interests
Sale Agreement, the Converted Loan Purchase Agreement, the Underwriting
Agreement, and the other documents and certificates delivered in connection with
any of the above.

          "Book-Entry Certificates":  Any of the Certificates that shall be
           -----------------------
registered in the name of the Depository or its nominee, the ownership of which
is reflected on the books of the Depository or on the books of a Person
maintaining an account with the Depository (directly, as a Depository
Participant, or indirectly, as an indirect participant in accordance with the
rules of the Depository and as described in Section 5.02 hereof).  On the
Closing Date, the Class A-1 Certificates, the Class AIO Certificates, the Class
P Certificates and the Mezzanine Certificates shall be Book-Entry Certificates.

          "Business Day":  Any day other than (i) a Saturday or a Sunday or (ii)
           ------------
a day on which banking institutions in the City of New York, or the states of
California or Kansas or in the city in which the corporate trust offices of the
Trustee, the Certificate Administrator and the Custodian are located, are
required or authorized by law to be closed.

          "Cash Liquidation":  As to any defaulted Mortgage Loan other than a
           ----------------
Mortgage Loan as to which an REO Acquisition occurred, a determination by the
Servicer that it has received all  Liquidation Proceeds and other payments or
cash recoveries which the Servicer reasonably and in good faith expects to be
finally recoverable with respect to such Mortgage Loan.

          "Certificate":  Any Regular Certificate, Class RL or Class RU
           -----------
Certificate.

          "Certificate Administrator":  Wells Fargo Bank Minnesota, N.A., a
           -------------------------
national banking association, and any successor thereto.

          "Certificate Administrator Fee":  With respect to each Distribution
           -----------------------------
Date, the product of (i) the Certificate Administrator Fee Rate divided by 12
and (ii) the sum of the Principal Balance of the Mortgage Loans and the Pre-
Funded Amount as of the first day of the related Due Period.

          "Certificate Administrator Fee Rate":  .0065% per annum.
           ----------------------------------

          "Certificateholder" or "Holder":  The Person in whose name a
           -----------------      ------
Certificate is registered in the Certificate Register, except that a
Disqualified Organization or non-U.S. Person shall not be a Holder of a Residual
Certificate for any purpose hereof.

          "Certificate Margin":  With respect to the Class A-1 Certificates on
           ------------------
each Distribution Date (A) on or prior to the Rate Step-Up Date, 0.280% per
annum and (B) after the Rate Step-Up Date, 0.560% per annum.  With respect to
the Class M-1 Certificates on each Distribution Date (A) on or prior to the Rate
Step-Up Date, 0.650% per annum and (B) after the Rate Step-Up Date, 0.975% per
annum.  With respect to the Class M-2 Certificates on each Distribution Date (A)
on or prior to the Rate Step-Up Date, 1.350% per annum and (B) after the Rate
Step-Up Date, 2.025% per annum.  With respect to the Class M-3 Certificates on
each

                                       87
<PAGE>

Distribution Date (A) on or prior to the Rate Step-Up Date, 2.300% per annum and
(B) after the Rate Step-Up Date, 3.450% per annum.

          "Certificate Owner":  With respect to each Book-Entry Certificate, any
           -----------------
beneficial owner thereof.

          "Certificate Principal Balance":  With respect to any Class of Regular
           -----------------------------
Certificates (other than the Class AIO Certificates, the Class O Certificates
and the Class P Certificates) immediately prior to any Distribution Date, will
be equal to the Initial Certificate Principal Balance thereof reduced by the sum
of all amounts actually distributed in respect of principal of such Class and,
in the case of a Mezzanine Certificate, Allocated Realized Loss Amounts applied
with respect to that class on all prior Distribution Dates.  With respect to the
Class  O Certificates as of any date of determination, an amount equal to the
excess, if any, of (A) the Principal Balances of the Mortgage Loans over (B) the
then aggregate Certificate Principal Balances of the Class A-1 Certificates and
the Mezzanine Certificates then outstanding.  The Class AIO Certificates and the
Class P Certificates will not have a Certificate Principal Balance.

          "Certificate Register":  The register maintained by the Certificate
           --------------------
Registrar in which the Certificate Registrar shall provide for the registration
of Certificates and of transfers and exchanges of Certificates.

          "Certificate Registrar":  Initially, the Certificate Administrator, in
           ---------------------
its capacity as Certificate Registrar, or any successor to the Certificate
Administrator in such capacity.

          "Class":  Collectively, Certificates which have the same priority of
           -----
payment and bear the same class designation and the form of which is identical
except for variation in the Percentage Interest evidenced thereby.

          "Class A-1 Certificate":  Any one of the Class A-1 Certificates
           ---------------------
executed, authenticated and delivered pursuant to Section 5.01, substantially in
the form annexed hereto as Exhibit A-1, representing the right to distributions
as set forth herein and therein and evidencing a regular interest in the Upper-
Tier REMIC.

          "Class A-1 Certificateholder":  Any Holder of a Class A-1 Certificate.
           ---------------------------

          "Class A-1 Principal Distribution Amount":  The excess of (x) the
           ---------------------------------------
Certificate Principal Balance of the Class A-1 Certificates immediately prior to
such Distribution Date over (y) the lesser of (A) the product of (i) 86.00% and
(ii) the aggregate Principal Balance of the Mortgage Loans as of the last day of
the related Due Period (after giving effect to scheduled payments of principal
due during the related Due Period, to the extent received or advanced, and
unscheduled collections of principal received during the related Prepayment
Period) and (B) the aggregate Principal Balance of the Mortgage Loans as of the
last day of the related Due Period (after giving effect to scheduled payments of
principal due during the related Due Period, to the extent received or advanced,
and unscheduled collections of principal received during the related Prepayment
Period) minus $2,075,000.

          "Class AIO Certificate":  Any one of the Class AIO Certificates
           ---------------------
executed, authenticated and delivered pursuant to Section 5.01, substantially in
the form annexed hereto as

                                       88
<PAGE>

Exhibit A-5, representing the right to distributions as set forth herein and
therein and evidencing one or more regular interests in the Upper-Tier REMIC.

          "Class AIO Current Interest":  With respect to any Distribution Date
           --------------------------
is equal to the excess of (x) Interest Remittance Formula Amount for that
Distribution Date less (y) the sum of (i) the Administrative Fees, (ii) the
REMIC Current Interest for the Class A-1 Certificates, (iii) the REMIC Current
Interest for the Class M-1 Certificates, (iv) the REMIC Current Interest for the
Class M-2 Certificates, and (v) the REMIC Current Interest for the Class M-3
Certificates.  The "REMIC Current Interest" on each of the Class A-1, Class M-1,
Class M-2 and Class M-3 Certificates will be calculated for this purpose by
using the REMIC Available Funds Cap Rate.

          "Class AIO Monthly Distributable Amount":  As of any Distribution
           --------------------------------------
Date, the excess of (i) the Class AIO Current Interest over (ii) the sum of the
Supplemental Interest Payments for all Classes of Underwritten certificates on
that Distribution Date.

          "Class AIO Monthly Interest Distributable Amount":  As of any
           -----------------------------------------------
Distribution Date, the sum of (1) the Class AIO Unpaid Interest Shortfall Amount
for that Distribution Date and (2) the Class AIO Current Interest for that
Distribution Date.

          "Class AIO Pass-Through Rate":  For any Distribution Date, the
           ---------------------------
percentage equivalent of a fraction, the numerator of which is equal to the
Class AIO Current Interest for that Distribution Date and the denominator of
which is the product of (1) the actual number of days in the related Accrual
Period, divided by 360 and (2) the aggregate Principal Balance of the Mortgage
Loans as of the first day of the preceding Due Period.

          "Class AIO Unpaid Interest Shortfall Amount":  For the first
           ------------------------------------------
Distribution Date, zero and for any Distribution Date after the first
Distribution Date, the amount, if any, by which (a) the Class AIO Monthly
Interest Distributable Amount for the immediately preceding Distribution Date
exceeds (b) the sum of (i) the aggregate amount actually paid to the Holders of
the Class AIO Certificates on such immediately preceding Distribution Date
pursuant to Section 4.01(a)(i)(A)(x) hereof and (ii) the amount actually
transferred to the Supplemental Interest Account on such immediately preceding
Distribution Date pursuant to Section 4.01(a)(i)(A)(y) hereof, plus interest on
such sum, at the Class AIO Pass-Through Rate for the related Accrual Period.

          "Class M-1 Certificate":  Any one of the Class M-1 Certificates
           ---------------------
executed, authenticated and delivered pursuant to Section 5.01, substantially in
the form annexed hereto as Exhibit A-2, representing the right to distributions
as set forth herein and therein and evidencing a regular interest in the Upper-
Tier REMIC.

          "Class M-1 Principal Distribution Amount":  The excess of (x) the sum
           ---------------------------------------
of (i) the Certificate Principal Balance of the Class A-1 Certificates (after
taking into account the payment of the Class A-1 Principal Distribution Amount
on such Distribution Date) and (ii) the Certificate Principal Balance of the
Class M-1 Certificates immediately prior to such Distribution Date over (y) the
lesser of (A) the product of (i) 90.00% and (ii) the aggregate Principal Balance
of the Mortgage Loans as of the last day of the related Due Period (after giving
effect to scheduled payments of principal due during the related Due Period, to
the extent received or

                                       89
<PAGE>

advanced, and unscheduled collections of principal received during the related
Prepayment Period) and (B) the aggregate Principal Balance of the Mortgage Loans
as of the last day of the related Due Period (after giving effect to scheduled
payments of principal due during the related Due Period, to the extent received
or advanced, and unscheduled collections of principal received during the
related Prepayment Period) minus $2,075,000.

          "Class M-2 Certificate":  Any one of the Class M-2 Certificates
           ---------------------
executed, authenticated and delivered pursuant to Section 5.01, substantially in
the form annexed hereto as Exhibit A-3, representing the right to distributions
as set forth herein and therein and evidencing a regular interest in the Upper-
Tier REMIC.

          "Class M-2 Principal Distribution Amount":  The excess of (x) the sum
           ---------------------------------------
of (i) the Certificate Principal Balance of the Class A-1 Certificates (after
taking into account the payment of the Class A-1Principal Distribution Amount on
such Distribution Date), (ii) the Certificate Principal Balance of the Class M-1
Certificates (after taking into account the payment of the Class M-1 Principal
Distribution Amount on such Distribution Date) and (iii) the Certificate
Principal Balance of the Class M-2 Certificates immediately prior to such
Distribution Date over (y) the lesser of (A) the product of (i) 94.00% and (ii)
the aggregate Principal Balance of the Mortgage Loans as of the last day of the
related Due Period (after giving effect to scheduled payments of principal due
during the related Due Period, to the extent received or advanced, and
unscheduled collections of principal received during the related Prepayment
Period) and (B) the aggregate Principal Balance of the Mortgage Loans as of the
last day of the related Due Period (after giving effect to scheduled payments of
principal due during the related Due Period, to the extent received or advanced,
and unscheduled collections of principal received during the related Prepayment
Period) minus $2,075,000.

          "Class M-3 Certificate":  Any one of the Class M-3 Certificates
           ---------------------
executed, authenticated and delivered pursuant to Section 5.01, substantially in
the form annexed hereto as Exhibit A-4, representing the right to distributions
as set forth herein and therein and evidencing a regular interest in the Upper-
Tier REMIC.

          "Class M-3 Principal Distribution Amount":  The excess of (x) the sum
           ---------------------------------------
of (i) the Certificate Principal Balance of the Class A-1 Certificates (after
taking into account the payment of the Class A-1 Principal Distribution Amount
on such Distribution Date), (ii) the Certificate Principal Balance of the Class
M-1 Certificates (after taking into account the payment of the Class M-1
Principal Distribution Amount on such Distribution Date), (iii) the Certificate
Principal Balance of the Class M-2 Certificates (after taking into account the
payment of the Class M-2 Principal Distribution Amount on such Distribution
Date) and (iv) the Certificate Principal Balance of the Class M-3 Certificates
immediately prior to such Distribution Date over (y) the lesser of (A) the
product of (i) 97.00% and (ii) the aggregate Principal Balance of the Mortgage
Loans as of the last day of the related Due Period (after giving effect to
scheduled payments of principal due during the related Due Period, to the extent
received or advanced, and unscheduled collections of principal received during
the related Prepayment Period) and (B) the aggregate Principal Balance of the
Mortgage Loans as of the last day of the related Due Period (after giving effect
to scheduled payments of principal due during the related Due Period, to the
extent received or advanced, and unscheduled collections of principal received
during the related Prepayment Period) minus $2,075,000.

                                       90
<PAGE>

          "Class O Certificate":  Any one of the Class O Certificates executed,
           -------------------
authenticated and delivered pursuant to Section 5.01, substantially in the form
annexed hereto as Exhibit A-6, representing the right to distributions as set
forth herein and therein and evidencing a regular interest in the Upper-Tier
REMIC.

          "Class P Certificate":  Any one of the Class P Certificates executed,
           -------------------
authenticated and delivered pursuant to Section 5.01, substantially in the form
annexed hereto as Exhibit A-7, representing the right to distributions as set
forth herein and therein and evidencing a regular interest in the Upper-Tier
REMIC.

          "Class RL Certificate":  Any one of the Class RL Certificates
           --------------------
executed, authenticated and delivered pursuant to Section 5.01, substantially in
the form annexed hereto as Exhibit A-8, representing the right to distributions
as set forth herein, and evidencing an interest designated as the "residual
interest" in the Lower-Tier REMIC for the purposes of the REMIC Provisions.

          "Class RU Certificate":  Any one of the Class RU Certificates
           --------------------
executed, authenticated and delivered pursuant to Section 5.01, substantially in
the form annexed hereto as Exhibit A-9, representing the right to distributions
as set forth herein, and evidencing an interest designated as the "residual
interest" in the Upper-Tier REMIC for the purposes of the REMIC Provisions.

          "Close of Business":  As used herein, with respect to any Business
           -----------------
Day, 5:00 p.m. (New York time).

          "Closing Date":   March 29, 2001.
           ------------

          "Code":  The Internal Revenue Code of 1986 as it may be amended from
           ----
time to time.

          "Collection Account":  The account or accounts created and maintained
           ------------------
by the Servicer pursuant to Section 3.06(d) hereof, which must be an Eligible
Account.

          "Commission":  The Securities and Exchange Commission.
           ----------

          "Company":  NovaStar Mortgage Funding Corporation, a Delaware
           --------
corporation, and its successors and assigns.

          "Compensating Interest":  With respect to any Determination Date, an
           ---------------------
amount equal to the lesser of (i) the aggregate amount of Prepayment Interest
Shortfall for the related Prepayment Period and (ii) the Servicing Fee for the
related Distribution Date.

          "Conversion Date":  The date on which a Convertible Mortgage Loan
           ---------------
becomes a Converted Mortgage Loan according to the terms of the related Mortgage
Note.

          "Converted Loan Purchase Agreement":  The Converted Loan Purchase
           ---------------------------------
Agreement, dated as of  March 1, 2001, among the Converted Loan Purchaser, the
Certificate Administrator, the Trustee and the Servicer.

                                       91
<PAGE>

          "Converted Loan Purchaser":  NovaStar Capital, Inc., a Delaware
           ------------------------
corporation, and any successor thereto.

          "Converted Mortgage Loan":  Any Convertible Mortgage Loan as to which
           -----------------------
the Mortgagor has exercised the option to convert to a fixed Mortgage Rate and
satisfied all of the conditions to conversion set forth in the Mortgage Note.

          "Convertible Mortgage Loans":  Any Mortgage Loan evidenced by a
           --------------------------
Mortgage Note that according to its terms is convertible at the option of the
Mortgagor from a variable Mortgage Rate to a fixed Mortgage Rate, subject to
satisfaction of the conditions set forth in such note.

          "Corporate Trust Office":  With respect to the Trustee, the Paying
           ----------------------
Agent, the Certificate Administrator and the Certificate Registrar, the
principal corporate trust office at which at any particular time its corporation
trust business shall be administered, which office at the date of execution of
this Agreement is located at Wells Fargo Bank Minnesota, N.A., 11000 Broken Land
Parkway, Columbia, Maryland  21049 Attention: NovaStar 2001-1.  With respect to
Certificate Transfers, such address shall be:  Wells Fargo Bank Minnesota, N.A.,
6th Avenue and Marquette, Minneapolis, Minnesota  55479.

          "Credit Enhancement Percentage":  For any Distribution Date, the
           -----------------------------
percentage equivalent of a fraction, (x) the numerator of which is the sum of
the aggregate Certificate Principal Balances of the Mezzanine Certificates and
the Class O Certificates, and (y) the denominator of which is the sum of (i) the
aggregate Principal Balance of the Mortgage Loans and (ii) the Pre-Funded
Amount, in each case calculated prior to taking into account the distribution of
the Principal Distribution Amount to the Holders of the Certificates then
entitled to distributions of principal on such Distribution Date.

          "Crossover Date":  The later to occur of (i) the Distribution Date
           --------------
occurring in October 2003 and (ii) the first Distribution Date on which the
Credit Enhancement Percentage (calculated for this purpose only prior to taking
into account the distribution of the Principal Distribution Amount to the
Certificates then entitled to distributions of principal on such Distribution
Date) is equal to or greater than 14%.

          "Cumulative Loss Percentage":  As to any Distribution Date, the
           --------------------------
percentage equivalent of the fraction obtained by dividing (i) the aggregate
amount of Realized Losses on the Mortgage Loans (after giving effect to coverage
provided by any MI Policy) from the Cut-off Date through such Distribution Date
by (ii) the sum of the aggregate Principal Balance of the Initial Mortgage Loans
as of the Cut-off Date plus the Original Pre-Funded Amount.

          "Custodian":  First Union National Bank, a national banking
           ---------
association, and its successors and assigns.

          "Cut-off Date":  With respect to each Initial Mortgage Loan, the later
           ------------
of (i) the date of origination of such Mortgage Loan or (ii) March 1, 2001.

          "Cut-off Date Aggregate Principal Balance":  With respect to the
           ----------------------------------------
Mortgage Pool, the aggregate of the Cut-off Date Principal Balances of the
Initial Mortgage Loans.

                                       92
<PAGE>

          "Cut-off Date Principal Balance":  With respect to any Mortgage Loan,
           ------------------------------
the unpaid principal balance thereof as of the Cut-off Date or Subsequent Cut-
off Date, as the case may be (or as of the applicable date of substitution with
respect to an Eligible Substitute Mortgage Loan).

          "Debt Service Reduction":  With respect to any Mortgage Loan, a
           ----------------------
reduction in the scheduled Monthly Payment for such Mortgage Loan by a court of
competent jurisdiction in a proceeding under the Bankruptcy Code, except such a
reduction resulting from a Deficient Valuation.

          "Deficient Valuation":  With respect to any Mortgage Loan, a valuation
           -------------------
of the related Mortgaged Property by a court of competent jurisdiction in an
amount less than the then outstanding principal balance of the Mortgage Loan,
which valuation results from a proceeding initiated under the Bankruptcy Code.

          "Definitive Certificates":  The Class O, Class RU and Class RL
           -----------------------
Certificates, and such other classes of certificates as become definitive
certificates pursuant to Section 5.02(c) hereof.

          "Deleted Mortgage Loan":  A Mortgage Loan replaced or to be replaced
           ---------------------
by one or more Eligible Substitute Mortgage Loans.

          "60-Day Delinquency Percentage":  As of the last day of any Due
           -----------------------------
Period, the percentage equivalent of a fraction, (i) the numerator of which
equals the aggregate Principal Balance of the Mortgage Loans that are 60 or more
days delinquent, in foreclosure or converted to REO Properties as of such last
day of such Due Period, and (ii) the denominator of which is the aggregate
Principal Balance of the Mortgage Loans as of the last day of such Due Period.

          "90-Day Delinquency Percentage":  As of the last day of any Due
           -----------------------------
Period, the percentage equivalent of a fraction, (i) the numerator of which
equals the aggregate Principal Balance of the Mortgage Loans that are 90 or more
days delinquent, in foreclosure or converted to REO Properties as of such last
day of such Due Period, and (ii) the denominator of which is the aggregate
Principal Balance of the Mortgage Loans as of the last day of such Due Period.

          "Delinquent":  Any Mortgage Loan, the Monthly Payment due on a Due
           ----------
Date which is not made by the Close of Business on the next scheduled Due Date
for such Mortgage Loan.

          "Depository":  The initial Depository shall be The Depository Trust
           ----------
Company, whose nominee is Cede & Co., or any other organization registered as a
"clearing agency" pursuant to Section 17A of the Securities Exchange Act of
1934, as amended.  The Depository shall initially be the registered Holder of
the Book-Entry Certificates.  The Depository shall at all times be a "clearing
corporation" as defined in Section 8-102(3) of the Uniform Commercial Code of
the State of New York.

          "Depository Participant":  A broker, dealer, bank or other financial
           ----------------------
institution or other person for whom from time to time a Depository effects
book-entry transfers and pledges of securities deposited with the Depository.

                                       93
<PAGE>

          "Determination Date":  With respect to any Distribution Date, the 15th
           ------------------
day of the calendar month in which such Distribution Date occurs or, if such
15th day is not a Business Day, the Business Day immediately preceding such 15th
day.

          "Determination Date Report": The meaning specified in Section 3.23
           -------------------------
hereof.

          "Disqualified Organization":  "Disqualified Organization" shall have
           -------------------------
the meaning set forth from time to time in the definition thereof at Section
860E(e)(5) of the Code and applicable to the Trust.

          "Distribution Date":  The 25th day of any calendar month, or if such
           -----------------
25th day is not a Business Day, the Business Day immediately following such 25th
day, commencing in April 2001.

          "Due Date":  The first day of the month of the related Distribution
           --------
Date.

          "Due Period":  With respect to any Mortgage Loan and Due Date, the
           ----------
period commencing on the second day of the month preceding the month of such
Distribution Date and ending on the related Due Date.

          "Eligible Account":  An account that is either:  (A) a segregated
           ----------------
account or accounts maintained with an institution whose deposits are insured by
the FDIC, the unsecured and uncollateralized long-term debt obligations of which
institution shall be rated AA or higher by Standard & Poor's and Aa2 or higher
by Moody's and in the highest short-term rating category by each of the Rating
Agencies, and which is (i) a federal savings and loan association duly
organized, validly existing and in good standing under the federal banking laws,
(ii) an institution duly organized, validly existing and in good standing under
the applicable banking laws of any state, (iii) a national banking association
duly organized, validly existing and in good standing under the federal banking
laws, (iv) a principal subsidiary of a bank holding company or (v) approved in
writing by each Rating Agency or (B) a segregated trust account or accounts
maintained with the trust department of a federal or state chartered depository
institution acceptable to each Rating Agency, having capital and surplus of not
less than $100,000,000, acting in its fiduciary capacity.

          "Eligible Investments":  One or more of the following:
           --------------------

          (i) direct obligations of, and obligations fully guaranteed by, the
United States of America, any of the Federal Home Mortgage Corporation, the
Federal National Mortgage Association, the Federal Home Loan Banks or any agency
or instrumentality of the United States of America the obligations of which are
backed by the full faith and credit of the United States of America;

          (ii) (A) demand and time deposits in, certificates of deposit of,
banker's acceptances issued by or federal funds sold by any depository
institution or trust company (including the Trustee, the Certificate
Administrator or their agents acting in their respective commercial capacities)
incorporated under the laws of the United States of America or any State thereof
and subject to supervision and examination by federal and/or state authorities,
so long as at the time of such investment or contractual commitment providing
for such investment, such

                                       94
<PAGE>

depository institution or trust company has a short- term unsecured debt rating
in the highest available rating category of each of the Rating Agencies and
provided that each such investment has an original maturity of no more than 365
days, and (B) any other demand or time deposit or deposit which is fully insured
by the Federal Deposit Insurance Corporation;

          (iii)  repurchase obligations with a term not to exceed 30 days with
respect to any security described in clause (i) above and entered into with a
depository institution or trust company (acting as a principal) rated "A" or
higher by S&P and A2 or higher by Moody's; provided, however, that collateral
transferred pursuant to such repurchase obligation must (A) be valued daily at
current market price plus accrued interest, (B) pursuant to such valuation,
equal, at all times, 105% of the cash transferred in exchange for such
collateral and (C) be delivered in such a manner as to accomplish perfection of
a security interest in the collateral by possession of certificated securities.

          (iv) securities bearing interest or sold at a discount issued by any
corporation incorporated under the laws of the United States of America or any
State thereof which has a long-term unsecured debt rating in the highest
available rating category of each of the Rating Agencies at the time of such
investment;

          (v) commercial paper having an original maturity of less than 365 days
and issued by an institution having a short-term unsecured debt rating in the
highest available rating category of each of the Rating Agencies at the time of
such investment;

          (vi) a guaranteed investment contract approved by each of the Rating
Agencies and issued by an insurance company or other corporation having a long-
term unsecured debt rating in the highest available rating category of each of
the Rating Agencies at the time of such investment;

          (vii)  money market funds having ratings in the highest available
long-term rating category of each of the Rating Agencies at the time of such
investment; any such money market funds which provide for demand withdrawals
being conclusively deemed to satisfy any maturity requirement for Eligible
Investments set forth in the Agreement (including those funds for which the
Trustee or Certificate Administrator is investment manager or investment
advisor); and

          (viii)  any investment approved in writing by each of the Rating
Agencies;

          provided, however, that each such instrument shall be acquired in an
          --------  -------
arm's-length transaction and no such instrument shall be an Eligible Investment
if it represents, either (1) the right to receive only interest payments with
respect to the underlying debt instrument or (2) the right to receive both
principal and interest payments derived from obligations underlying such
instrument and the principal and interest payments with respect to such
instrument provide a yield to maturity greater than 120% of the yield to
maturity at par of such underlying obligations; provided, further, however, that
each such instrument acquired shall not be acquired at a price in excess of par.
The Trustee or Certificate Administrator may purchase from or sell to itself or
an affiliate, as principal or agent, the Eligible Investments listed above.

                                       95
<PAGE>

          "Eligible Substitute Mortgage Loan":  A Mortgage Loan substituted by
           ---------------------------------
the Seller for a Deleted Mortgage Loan which must, on the date of such
substitution, as confirmed in an Officer's Certificate delivered to the
Certificate Administrator, (i) have an outstanding principal balance, after
deduction of the principal portion of the monthly payment due in the month of
substitution (or in the case of a substitution of more than one Mortgage Loan
for a Deleted Mortgage Loan, an aggregate outstanding principal balance, after
such deduction), not in excess of the outstanding principal balance of the
Deleted Mortgage Loan (the amount of any shortfall to be deposited by the Seller
in the Collection Account in the month of substitution); (ii) comply in all
material respects with each representation and warranty set forth in clauses
(ii) through (lxviii) of Section 3.01(b) of the Purchase Agreement other than
clauses (iii), (v)-(xiv), (xli), (lv) and (lvi); (iii) have a Mortgage Rate and,
with respect to an Adjustable Rate Mortgage Loan, a Gross Margin no lower than
and not more than 1% per annum higher than the Mortgage Rate and Gross Margin,
respectively, of the Deleted Mortgage Loan as of the date of substitution; (iv)
have a Loan-to-Value Ratio, at the time of substitution no higher than that of
the Deleted Mortgage Loan at the time of substitution; (v) have a remaining term
to stated maturity not greater than (and not more than one year less than) that
of the Deleted Mortgage Loan; (vi) not be 30 days or more delinquent; (vii) not
be a negative amortization loan; (viii) have a lien priority equal to or
superior to the lien priority of the Deleted Mortgage Loan; and (ix) be a
Qualified Replacement Mortgage.

          "ERISA":  The Employee Retirement Income Security Act of 1974, as
           -----
amended.

          "Expense Adjusted Mortgage Rate":  With respect to any Mortgage Loan,
           ------------------------------
as of any date of determination, a per annum rate of interest equal to the then
applicable Mortgage Rate for such Mortgage Loan minus the Administrative Fee
Rate.

          "Fannie Mae":  Federal National Mortgage Association or any successor
           ----------
thereto.

          "FDIC":  Federal Deposit Insurance Corporation or any successor
           ----
thereto.

          "Fixed Rate Mortgage Loan":  A first lien Mortgage Loan which provides
           ------------------------
for a fixed Mortgage Rate payable with respect thereto.  The Fixed Rate Mortgage
Loans are identified as such on the Mortgage Loan Schedule.

          "Foreclosure Profit":  With respect to a Liquidated Mortgage Loan, the
           ------------------
amount, if any, by which (i) the aggregate of its Net Liquidation Proceeds
exceeds (ii) the related Principal Balance (plus accrued and unpaid interest
thereon at the applicable Mortgage Rate from the date interest was last paid
through the date of receipt of the final Liquidation Proceeds) of such
Liquidated Mortgage Loan immediately prior to the final recovery of its
Liquidation Proceeds.

          "Formula Rate":  For any Distribution Date and the Class A-1
           ------------
Certificates and the Mezzanine Certificates, LIBOR plus the related Certificate
Margin.

          "Freddie Mac":  The Federal Home Loan Mortgage Corporation, or any
           -----------
successor thereto.

                                       96
<PAGE>

          "Funding Period":  The period beginning on the Closing Date and ending
           --------------
on the earlier to occur of the date upon which (a) the amount on deposit in the
Pre-Funding Account (exclusive of investment income) has been reduced to less
than $10,000 or (b) June 25, 2001.

          "Gross Margin":  With respect to each Adjustable Rate Mortgage Loan,
           ------------
the fixed percentage set forth in the related Mortgage Note that is added to the
Index on each Adjustment Date in accordance with the terms of the related
Mortgage Note used to determine the Mortgage Rate for such Mortgage Loan.

          "Independent":  When used with respect to any specified Person, any
           -----------
such Person who (a) is in fact independent of the Company, the Servicer and
their respective Affiliates, (b) does not have any direct financial interest in
or any material indirect financial interest in the Company or the Servicer or
any Affiliate thereof, and (c) is not connected with the Company or the Servicer
or any Affiliate thereof as an officer, employee, promoter, underwriter,
trustee, partner, director or Person performing similar functions; provided,
however, that a Person shall not fail to be Independent of the Company or the
Servicer or any Affiliate thereof merely because such Person is the beneficial
owner of 1% or less of any class of securities issued by the Company or the
Servicer or any Affiliate thereof, as the case may be.

          "Index":  With respect to each Adjustable Rate Mortgage Loan and with
           -----
respect to each related Adjustment Date, the index as specified in the related
Mortgage Note.

          "Initial Certificate Principal Balance":  With respect to any Regular
           -------------------------------------
Certificate (other than a Class AIO or a Class P Certificate), the amount
designated "Initial Certificate Principal Balance" on the face thereof.

          "Initial Mortgage Loan":  Any of the Mortgage Loans included in the
           ---------------------
Trust Fund as of the Closing Date.  The aggregate principal balance of the
Initial Mortgage Loans as of the Closing Date is equal to $211,419,715.44.

          "Insurance Proceeds":  Proceeds paid by any insurer pursuant to any
           ------------------
insurance policy covering a Mortgage Loan which are required to be remitted to
the Servicer, including MI Insurance Proceeds in the case of Mortgage Loans
covered under a MI Policy, or amounts required to be paid by the Servicer
hereunder, net of any component thereof (i) covering any expenses incurred by or
on behalf of the Servicer in connection with obtaining such proceeds, (ii) that
is applied to the restoration or repair of the related Mortgaged Property or
(iii) released to the Mortgagor in accordance with the Servicer's normal
servicing procedures.

          "Interest Coverage Account":  The account established and maintained
           -------------------------
pursuant to Section 4.06 , as defined therein, which must be an Eligible
Account.

          "Interest Coverage Amount":  The amount to be paid by the Company to
           ------------------------
the Certificate Administrator for deposit in the Interest Coverage Account on
the Closing Date pursuant to Section 4.06, which amount is $250,000.

          "Interest Determination Date":  With respect to each Accrual Period,
           ---------------------------
the second LIBOR Business Day preceding the commencement of such Accrual Period.

                                       97
<PAGE>

          "Interest Remittance Amount":  With respect to any Distribution Date,
           --------------------------
that portion of the REMIC Available Funds for such Distribution Date allocable
to interest and Prepayment Charges.

          "Interest Remittance Formula Amount":  As of any Distribution Date is
           ----------------------------------
an amount equal to (1) the product of (x) 1/12 of the Weighted Average Mortgage
Rate of the Mortgage Pool as of the beginning of the prior Due Period and (y)
the aggregate Principal Balances of the Mortgage Loans as of the beginning of
the prior Due Period minus (2) the aggregate amount of Relief Act Shortfalls and
                     -----
Prepayment Interest Shortfalls for the prior period.

          "LIBOR":  With respect to any Accrual Period, the rate determined by
           -----
the Certificate Administrator on the related Interest Determination Date on the
basis of the offered rates of the Reference Banks for one-month United States
dollar deposits, as such rates appear on the Telerate Page 3750, as of 11:00
a.m. (London time) on such Interest Determination Date.  If such rate does not
appear on Telerate Page 3750, the rate for that day will be determined on the
basis of the rates at which deposits in United States dollars are offered by the
Reference Banks at approximately 11:00 a.m., London time, on that day to prime
banks in the London interbank market for a period equal to the relevant Accrual
Period (commencing on the first day of such Accrual Period).  The Certificate
Administrator will request the principal London office of each of the Reference
Banks to provide a quotation of its rate.  If at least two such quotations are
provided, the rate for that day will be the arithmetic mean of the quotations.
If fewer than two quotations are provided as requested, the rate for that day
will be the arithmetic mean of the rates quoted by major banks in New York City,
selected by the Certificate Administrator, at approximately 11:00 a.m., New York
City time, on that day for loans in United States dollars to leading European
banks for a period equal to the relevant Accrual Period (commencing on the first
day of such Accrual Period).

          The establishment of LIBOR on each Interest Determination Date by the
Certificate Administrator and the Certificate Administrator's calculation of the
rate of interest applicable to the Certificates for the related Accrual Period
shall (in the absence of manifest error) be final and binding.

          "LIBOR Business Day":  Any day other than (i) a Saturday or a Sunday
           ------------------
or (ii) a day on which banking institutions in the State of New York or in the
city of London, England are required or authorized by law to be closed.

          "Lifetime Rate Cap":  With respect to each Adjustable Rate Mortgage
           -----------------
Loan with respect to which the related Mortgage Note provides for a lifetime
rate cap, the maximum Mortgage Rate permitted over the life of such Mortgage
Loan under the terms of such Mortgage Note, as set forth on the Mortgage Loan
Schedule.

          "Liquidated Mortgage Loan":  With respect to any Distribution Date,
           ------------------------
any Mortgage Loan in respect of which the Servicer has determined, in accordance
with the servicing procedures specified in Article III hereof, as of the end of
the related Prepayment Period that substantially all Liquidation Proceeds which
it reasonably expects to recover with respect to the disposition of the related
Mortgaged Property or REO Property have been recovered.

                                       98
<PAGE>

          "Liquidation Expenses":  Out-of-pocket expenses (exclusive of
           --------------------
overhead) which are incurred by or on behalf of the Servicer in connection with
the liquidation of any Mortgage Loan and not recovered under any insurance
policy, such expenses, including, without limitation, legal fees and expenses,
any unreimbursed amount expended respecting the related Mortgage Loan and any
related and unreimbursed expenditures for real estate property taxes or for
property restoration, preservation or insurance against casualty loss or damage.

          "Liquidation Proceeds":  Proceeds (including Insurance Proceeds)
           --------------------
received in connection with the liquidation of any Mortgage Loan or related REO
Property.

          "Loan-to-Value Ratio":  With respect to any Mortgage Loan, as of any
           -------------------
date of determination, a fraction expressed as a percentage, the numerator of
which is the then current principal amount of the Mortgage Loan, and the
denominator of which is the lesser of the purchase price or the Appraised Value
of the related Mortgaged Property.

          "Loan Year":  With respect to any Mortgage Loan, the one year period
           ---------
commencing on the day succeeding the origination of such Mortgage Loan and
ending on the anniversary date of such Mortgage Loan, and each annual period
thereafter.

          "Lower-Tier Balance":  As to each Class of Lower-Tier Interests and
           ------------------
any Distribution Date, the Initial Lower-Tier Balance as set forth in Section
2.09(b) minus all amounts distributed as principal of such Class on previous
Distribution Dates.

          "Lower-Tier Interest 1":  The interest of that name established
           ---------------------
pursuant to Section 2.09(b) hereof.

          "Lower-Tier Interest 2":  The interest of that name established
           ---------------------
pursuant to Section 2.09(b) hereof.

          "Lower-Tier Interest 3":  The interest of that name established
           ---------------------
pursuant to Section 2.09(b) hereof.

          "Lower-Tier Interest 4":  The interest of that name established
           ---------------------
pursuant to Section 2.09(b) hereof.

          "Lower-Tier Interest 5":  The interest of that name established
           ---------------------
pursuant to Section 2.09(b) hereof.

          "Lower-Tier Interest 6":  The interest of that name established
           ---------------------
pursuant to Section 2.09(b) hereof.

          "Lower-Tier Pass-Through Rate":  As to each of the respective Lower-
           ----------------------------
Tier Interests, the applicable "Lower-Tier Pass-Through Rate" set forth in
Section 2.09(b) hereof.

          "Lower-Tier REMIC":  The segregated pool of assets consisting of the
           ----------------
Mortgage Loans, the Accounts (other than the Non-REMIC Accounts), any REO
Property and any proceeds of the foregoing.

                                       99
<PAGE>

          "Lower-Tier REMIC Interests":  As defined in Section 2.09(b) hereof.
           --------------------------

          "Lower-Tier REMIC Regular Interests":  As defined in Section 2.09(b)
           ----------------------------------
hereof.

          "Majority Certificateholders":  The Holders of Certificates evidencing
           ---------------------------
at least 51% of the Voting Rights.

          "Maximum Collateral Amount": The sum of the Principal Balance as of
           -------------------------
the Cut-off Date of the Initial Mortgage Loans and the Principal Balance of each
Subsequent Mortgage Loan as of its respective Subsequent Cut-Off Date.

          "Maximum Mortgage Rate":  With respect to each Adjustable Rate
           ---------------------
Mortgage Loan, the percentage set forth in the related Mortgage Note as the
maximum Mortgage Rate thereunder.

          "MERS":  Mortgage Electronic Registration Systems, Inc., a corporation
           ----
organized and existing under the laws of the State of Delaware, or any successor
thereto.

          "MERS System":  The system of recording transfers of Mortgages
           -----------
electronically maintained by MERS.

          "Mezzanine Certificate":  Any Class M-1 Certificate, Class M-2
           ---------------------
Certificate or Class M-3 Certificate.

          "MI Insurance Agreement":  A private mortgage insurance agreement
           ----------------------
issued by the MI Insurer pursuant to which MI Policies are issued on individual
Mortgage Loans.

          "MI Insurance Proceeds":  Proceeds paid by the MI Insurer pursuant to
           ---------------------
an MI Policy.

          "MI Insurer":  Each of (i) PMI Mortgage Insurance Co., an Arizona
           ----------
mortgage insurance company, (ii) Radian Guaranty, Inc., a Pennsylvania mortgage
insurance company, and (iii) Mortgage Guaranty Insurance Corporation, a
Wisconsin private mortgage insurance company, and their successors and assigns.

          "MI Insurer Insolvency Event":  (A) The determination by the
           ---------------------------
applicable regulatory or supervisory agency having jurisdiction over the MI
Insurer that such MI Insurer is insolvent or unable to pay its obligations as
they mature, (B) following the failure of the MI Insurer to pay any claim under
the related MI Policy, the determination by the Servicer that such MI Insurer is
insolvent or unable to pay its obligations as they become due, (C) the long-term
rating on the claims paying ability of the MI Insurer shall be lowered by
Moody's below A-2, if such MI Insurer is then rated by Moody's, or shall be
lowered by S&P below AA, if such MI Insurer is then rated by S&P.

          "MI Policy": A private mortgage insurance policy underwritten by the
           ---------
MI Insurer with respect to an individual Mortgage Loan, issued pursuant to the
MI Insurance Agreement.

                                      100
<PAGE>

          "MI Premium":  The primary mortgage insurance premium for each MI
           ----------
Policy, payable annually to an MI Insurer, as specified in the MI Insurance
Agreement, and with respect to each monthly premium payment, 1/12 of the annual
premium.

          "MIN":  The Mortgage Identification Number for Mortgage Loans
           ---
registered with MERS on the MERS System

          "Minimum Mortgage Rate":  With respect to each Adjustable Rate
           ---------------------
Mortgage Loan, the percentage set forth in the related Mortgage Note as the
minimum Mortgage Rate thereunder.

          "MOM Loan":  With respect to any Mortgage Loan, MERS acting as the
           --------
mortgagee of such Mortgage Loan, solely as nominee for the originator of such
Mortgage Loan and its successors and assigns, at the origination thereof.

          "Monthly Payment":  With respect to any Mortgage Loan (including any
           ---------------
REO Property) and any Due Date, the payment of principal and interest due
thereon in accordance with the amortization schedule at the time applicable
thereto (after adjustment, if any, for partial Principal Prepayments and for
Deficient Valuations occurring prior to such Due Date but before any adjustment
to such amortization schedule by reason of any bankruptcy, other than a
Deficient Valuation, or similar proceeding or any moratorium or similar waiver
or grace period).

          "Moody's":  Moody's Investors Service, Inc. or its successor in
           -------
interest.

          "Mortgage":  The mortgage, deed of trust or other instrument creating
           --------
a first lien on an estate or fee simple interest in real property securing a
Mortgage Note.

          "Mortgage File":  The mortgage documents listed in Section 2.01
           -------------
pertaining to a particular Mortgage Loan and any additional documents required
to be added to the Mortgage File pursuant to this Agreement.

          "Mortgage Loan Schedule":  With respect to any date, the schedule of
           ----------------------
Mortgage Loans subject to this Agreement on such date.  The schedule of Initial
Mortgage Loans as of the Cut-off Date is the schedule set forth in Exhibit B
hereto and the schedule or schedules of Subsequent Mortgage Loans, if any, as of
the Subsequent Cut-off Date, which schedules set forth as to each Mortgage Loan

          (i) the loan number and name of the Mortgagor;

          (ii) the street address, city, state and zip code of the Mortgaged
Property;

          (iii)  the Mortgage Rate at origination;

          (iv) with respect to an Adjustable Rate Mortgage Loan, the Maximum
Rate and the Minimum Rate;

          (v)  the maturity date;

                                      101
<PAGE>

          (vi) the original principal balance;

          (vii)  the first Distribution Date;

          (viii)  the type of Mortgaged Property;

          (ix) the Monthly Payment in effect as of the Cut-off Date (with
respect to an Initial Mortgage Loan) or Subsequent Cut-off Date (with respect to
a Subsequent Mortgage Loan);

          (x) the Principal Balance as of the Cut-off Date (with respect to an
Initial Mortgage Loan) or Subsequent Cut-off Date (with respect to a Subsequent
Mortgage Loan);

          (xi) with respect to an Adjustable Rate Mortgage Loan, the Index, the
Gross Margin; the Lifetime Rate Cap and the Periodic Rate Cap;

          (xii)  with respect to an Adjustable Rate Mortgage Loan, the first
Adjustment Date and next Adjustment Date, if any;

          (xiii)  with respect to an Adjustable Rate Mortgage Loan, the
Adjustment Date frequency and Distribution Date frequency;

          (xiv)  the occupancy status;

          (xv) the purpose of the Mortgage Loan;

          (xvi)  the Appraised Value of the Mortgaged Property;

          (xvii)  the original term to maturity;

          (xviii)  the paid-through date of the Mortgage Loan;

          (xix)  the Loan-to-Value Ratio;

          (xx) whether the Mortgage Loan is an Adjustable Rate Mortgage Loan or
a Fixed Rate Mortgage Loan;

          (xxi)  whether or not the Mortgage Loan was underwritten pursuant to a
limited documentation program;

          (xxii)  whether or not the Mortgage Loan is a Convertible Mortgage
Loan;

          (xxiii)  whether the Mortgage Loan is covered by an MI Policy; and

          (xxiv)  if the Mortgage Loan is registered with MERS on the MERS
System, the MIN.

          The Mortgage Loan Schedule shall set forth the total of the amounts
described under (x) above for all of the Mortgage Loans.

                                      102
<PAGE>

          "Mortgage Loans":  At any time, collectively, all Mortgage Loans that
           --------------
have been transferred and conveyed to the Trust, in each case together with the
Related Documents, and that remain subject to the terms of the Agreement.  As
applicable, Mortgage Loan shall be deemed to refer to the related REO Property
and both Initial Mortgage Loans and Subsequent Mortgage Loans.

          "Mortgage Note":  The original executed note or other evidence of
           -------------
indebtedness evidencing the indebtedness of a Mortgagor under a Mortgage Loan.

          "Mortgage Rate":  With respect to any Mortgage Loan, the annual rate
           -------------
at which interest accrues on such Mortgage Loan.

          "Mortgage Pool":  The pool of Mortgage Loans, identified on Exhibit B
           -------------
from time to time, and any REO Properties acquired in respect thereof and as
supplemented by any Subsequent Mortgage Loans identified on each schedule of
Subsequent Mortgage Loans attached to a Subsequent Transfer Instrument.

          "Mortgaged Property":  The underlying property, including real
           ------------------
property and improvements thereon, securing a Mortgage Loan.

          "Mortgagor":  The obligor on a Mortgage Note.
           ---------

          "Net Liquidation Proceeds":  With respect to any Liquidated Mortgage
           ------------------------
Loan, Liquidation Proceeds net of Liquidation Expenses.

          "Net Mortgage Rate":  With respect to any Mortgage Loan and any day,
           -----------------
the related Mortgage Rate less the Administrative Fee Rate.

          "NFI":  NovaStar Financial, Inc., a Maryland corporation, and its
           ---
successors and assigns.

          "Non-REMIC Accounts" The Supplemental Interest Account, the Pre-
           ------------------
Funding Account and the Interest Coverage Account.

          "Nonrecoverable Advance": With respect to any Mortgage Loan, any
           ----------------------
Advance (i) which was previously made or is proposed to be made by the Servicer;
and (ii) which, in the good faith judgment of the Servicer, will not or, in the
case of a proposed Advance, would not, be ultimately recoverable by the Servicer
from Liquidation Proceeds, Repurchase Price or future payments on such Mortgage
Loan.

          "Notional Principal Amount":  For purposes of calculating original
           -------------------------
issue discount ("OID"), with respect to the Class AIO Certificates, initially
$415,000,000, and with respect to the Class P Certificates, initially
$415,000,000.

          "NRFC":  NovaStar REMIC Financing Corporation, a Delaware corporation,
           ----
and its successors and assigns.

                                      103
<PAGE>

          "Offered Certificates":  Collectively, the Class A-1 Certificates, the
           --------------------
Class AIO Certificates, the Mezzanine Certificates and the Class P Certificates.

          "Officers' Certificate":  A certificate signed by the Chairman of the
           ---------------------
Board, the Vice Chairman of the Board, the President or any vice president
(however denominated), and by the Treasurer, the Secretary, or any assistant
treasurer or assistant secretary of the applicable Person.

          "Opinion of Counsel":  A written opinion of counsel, who may, without
           ------------------
limitation, be a salaried counsel for the Company or the Servicer, acceptable to
the Certificate Administrator and the Trustee, except that any opinion of
counsel relating to (a) the qualification of any REMIC as a REMIC or (b)
compliance with the REMIC Provisions which must be an opinion of Independent
counsel.

          "Optional Termination Date":  The first Distribution Date on which the
           -------------------------
Servicer may opt to terminate the Trust Fund pursuant to Section 11.01.

          "Original Pre-Funded Amount":  The amount deposited by the Company in
           --------------------------
the Pre-Funding Account on the Closing Date, which amount is $203,580,284.56.

          "Original Value":  Except in the case of a refinanced Mortgage Loan,
           --------------
the lesser of the Appraised Value or sales price of Mortgaged Property at the
time a Mortgage Loan is closed, and for a refinanced Mortgage Loan, the Original
Value is the value of such property set forth in an appraisal acceptable to the
Servicer.

          "Ownership Interest":  As to any Certificate, any ownership or
           ------------------
security interest in such Certificate, including any interest in such
Certificate as the Holder thereof and any other interest therein, whether direct
or indirect, legal or beneficial, as owner or as pledgee.

          "Paying Agent":  Any paying agent appointed pursuant to Section 5.05.
           ------------

          "Payment Account":  The trust account or accounts created and
           ---------------
maintained by the Trustee or the Certificate Administrator pursuant to Section
4.02 hereof, which must be an Eligible Account.

          "Percentage Interest":  With respect to any Underwritten Certificate,
           -------------------
a fraction, expressed as a percentage, the numerator of which is the Initial
Certificate Principal Balance represented by such Certificate and the
denominator of which is the Initial Certificate Principal Balance of the related
Class.  With respect to a Class AIO Certificate, Class P Certificate, Class O
Certificate or Residual Certificate, the portion of the Class evidenced thereby,
expressed as a percentage, as stated on the face of such Certificate; provided,
however, that the sum of all such percentages for each such Class totals 100%.

          "Periodic Rate Cap":  With respect to each Adjustable Rate Mortgage
           -----------------
Loan and any Adjustment Date therefor, the fixed percentage set forth in the
related Mortgage Note, which is the maximum amount by which the Mortgage Rate
for such Mortgage Loan may increase or decrease (without regard to the Maximum
Mortgage Rate or the Minimum Mortgage Rate) on

                                      104
<PAGE>

such Adjustment Date from the Mortgage Rate in effect immediately prior to such
Adjustment Date.

          "Permitted Transferee":  Any transferee of a Residual Certificate
           --------------------
other than a Disqualified Organization or a non-U.S. Person.

          "Person":  Any individual, corporation, limited liability company,
           ------
partnership, joint venture, association, joint stock company, trust,
unincorporated organization or government or any agency or political subdivision
thereof.

          "Plan":  Any employee benefit plan or certain other retirement plans
           ----
and arrangements, including individual retirement accounts and annuities, Keogh
plans and bank collective investment funds and insurance company general or
separate accounts in which such plans, accounts or arrangements are invested,
that are subject to ERISA or Section 4975 of the Code.

          "Pool Balance":  As of any date of determination, the aggregate unpaid
           ------------
principal balance of the Mortgage Loans as of such date.

          "Pre-Funded Amount":  With respect to any date of determination, the
           -----------------
amount on deposit in the Pre-Funding Account.

          "Pre-Funding Account":  The account established and maintained
           -------------------
pursuant to Section 4.05, as defined herein, and which must be an Eligible
Account.

          "Prepayment Assumption":  As defined in the Prospectus Supplement.
           ---------------------

          "Prepayment Charge":  With respect to any Mortgage Loan, the charges
           -----------------
or premiums, if any, due in connection with a full or partial prepayment of such
Mortgage Loan in accordance with the terms thereof.

          "Prepayment Interest Shortfall":  As to any Distribution Date and any
           -----------------------------
Mortgage Loan (other than a Mortgage Loan relating to an REO Property) that was
the subject of (a) a Principal Prepayment in full during the related Prepayment
Period, an amount equal to the excess of interest accrued during the related
Prepayment Period at the Mortgage Rate (net of the Servicing Fee) on the
Principal Balance of such Mortgage Loan over the amount of interest (adjusted to
the Mortgage Rate (net of the Servicing Fee)) paid by the Mortgagor for such
Prepayment Period to the date of such Principal Prepayment in full or (b) a
partial Principal Prepayment during the prior calendar month, an amount equal to
interest accrued during the related Prepayment Period at the Mortgage Rate (net
of the Servicing Fee) on the amount of such partial Prepayment.

          "Prepayment Period":  As to any Distribution Date, the calendar month
           -----------------
preceding the month of such Distribution Date.

          "Principal Balance":  With respect to any Mortgage Loan or related REO
           -----------------
Property, at any given time, (i) the Principal Balance of the Mortgage Loan as
of the Cut-off Date or Subsequent Cut-off Date, as applicable, minus (ii) the
sum of (a) the principal portion of

                                      105
<PAGE>

the Monthly Payments due with respect to such Mortgage Loan or REO Property
during each Due Period ending prior to the most recent Distribution Date which
were received or with respect to which an Advance was made, and (b) all
Principal Prepayments with respect to such Mortgage Loan or REO Property, and
all Insurance Proceeds, Liquidation Proceeds and REO Proceeds, to the extent
applied by the Servicer as recoveries of principal in accordance with Section
3.13 hereof with respect to such Mortgage Loan or REO Property, and (c) the
principal portion of any Realized Loss with respect thereto for any previous
Distribution Date.

          "Principal Prepayment":  Any payment of principal made by the
           --------------------
Mortgagor on a Mortgage Loan which is received in advance of its scheduled Due
Date and which is not accompanied by an amount of interest representing the full
amount of scheduled interest due on any Due Date in any month or months
subsequent to the month of prepayment.

          "Principal Remittance Amount":  With respect to any Distribution Date,
           ---------------------------
the sum of (i) each scheduled payment of principal collected or advanced on the
Mortgage Loans by the Servicer that were due during the related Due Period, (ii)
the principal portion of all partial and full principal prepayments of the
Mortgage Loans applied by the Servicer during the related Prepayment Period,
(iii) the principal portion of all related Net Liquidation Proceeds and
Insurance Proceeds received during such Prepayment Period, (iv) that portion of
the Repurchase Price, representing principal of any repurchased Mortgage Loan,
deposited to the Collection Account during such Prepayment Period, (v) the
principal portion of any related Substitution Adjustment Amounts deposited in
the Collection Account during such Prepayment Period, (vi) in the case of the
Distribution Date immediately following the end of the Funding Period, any
amount remaining in the Pre-Funding Account not used by the Trustee to purchase
Subsequent Mortgage Loans and (vii) on the Distribution Date on which the Trust
Fund is to be terminated pursuant to Section 11.01, that portion of the
Termination Price, in respect of principal.

          "Prospectus":  The Prospectus Supplement together with the Base
           ----------
Prospectus attached thereto with respect to the Offered Certificates.

          "Prospectus Supplement":  That certain Prospectus Supplement dated
           ---------------------
March 23, 2001 relating to the public offering of the Offered Certificates.

          "Purchase Agreement":  The agreement, dated as of March 1, 2001,
           ------------------
between the Seller, the Company, the Trustee and the Certificate Administrator,
regarding the transfer of the Mortgage Loans by the Seller to or at the
direction of the Company.

          "Qualified Liquidation":  The meaning set forth from time to time in
           ---------------------
the definition thereof at Section 860F(a)(3) of the Code and applicable to the
Trust.

          "Qualified Mortgage":  The meaning set forth from time to time in the
           ------------------
definition thereof at Section 860G(a)(3) of the Code and applicable to the
Trust.

          "Qualified Replacement Mortgage":  A Mortgage Loan substituted for
           ------------------------------
another pursuant to Section 3.01 of the Purchase Agreement and that satisfies
all of the criteria set forth from time to time in the definition thereof at
Section 860G(a)(4) of the Code and applicable to the Trust, all as evidenced by
an Officer's Certificate of the Seller delivered to the Certificate
Administrator on behalf of the Trustee prior to any such substitution.

                                      106
<PAGE>

          "Rate Stepup Date":  The first Distribution Date to occur after the
           ----------------
Optional Termination Date has occurred.

          "Rating Agency":  Any nationally recognized statistical rating
           -------------
organization, or its successor, that rated the Offered Certificates at the
request of the Company at the time of the initial issuance of the Offered
Certificates.  Initially such rating agencies shall consist of Moody's and
Standard & Poor's.  If such organization or a successor is no longer in
existence, "Rating Agency" shall be such nationally recognized statistical
rating organization, or other comparable Person, designated by the Company,
notice of which designation shall be given to the Certificate Administrator and
the Trustee.  References herein to the highest short-term unsecured rating
category of a Rating Agency shall mean A-1 or better in the case of Standard &
Poor's and P-1 or better in the case of Moody's and in the case of any other
Rating Agency shall mean such equivalent rating.  References herein to the
highest long-term rating category of a Rating Agency shall mean "AAA" in the
case of Standard & Poor's and "Aaa" in the case of Moody's and in the case of
any other Rating Agency, such equivalent rating.

          "Realized Loss":  With respect to each Mortgage Loan (or REO Property)
           -------------
as to which a Cash Liquidation or REO Disposition has occurred, an amount (not
less than zero)  equal to (i) the Principal Balance of the Mortgage Loan (or REO
Property) as of the date of Cash Liquidation or REO Disposition, plus (ii)
interest (and REO Imputed Interest, if any) at the Net Mortgage Rate from the
Due Date as to which interest was last paid or advanced to Certificateholders up
to the last day of the month in which the Cash Liquidation (or REO Disposition)
occurred on the Principal Balance of such Mortgage Loan (or REO Property)
outstanding during each Due Period that such interest was not paid or advanced,
minus (iii) Net Liquidation Proceeds (after giving effect to coverage provided
by any MI policy), if any, received with respect to such Cash Liquidation (or
REO Disposition), minus the portion thereof reimbursable to the Servicer or any
Subservicer with respect to related Advances or expenses as to which the
Servicer or Subservicer is entitled to reimbursement thereunder but which have
not been previously reimbursed.  With respect to each Mortgage Loan which has
become the subject of a Deficient Valuation, the difference between the
principal balance of the Mortgage Loan outstanding immediately prior to such
Deficient Valuation and the principal balance of the Mortgage Loan as reduced by
the Deficient Valuation.  With respect to each Mortgage Loan which has become
the object of a Debt Service Reduction, the amount of such Debt Service
Reduction.

          "Record Date":  With respect to each Distribution Date, the Close of
           -----------
Business on the Business Day immediately preceding the related Distribution
Date.

          "Reference Banks":  Deutsche Bank, Barclay's Bank PLC, The Bank of
           ---------------
Tokyo-Mitsubishi, LTD. and National Westminster Bank PLC and their successors in
interest; provided that if any of the foregoing banks are not suitable to serve
as a Reference Bank, then any leading banks selected by the Certificate
Administrator which are engaged in transactions in Eurodollar deposits in the
international Eurocurrency market (i) with an established place of business in
London, (ii) not controlling, under the control of or under common control with
the Seller or any Affiliate thereof, (iii) whose quotations appear on the
Reuters Screen LIBO Page on the relevant Interest Determination Date and (iv)
which have been designated as such by the Certificate Administrator.

                                      107
<PAGE>

          "Regular Certificate":  Any of the Class A-1 Certificates, Mezzanine
           -------------------
Certificates, Class AIO Certificates, Class O Certificates or Class P
Certificates.

          "Related Documents":  With respect to each Mortgage Loan, the
           -----------------
documents specified in Section 2.01 hereof and any documents required to be
added to such documents pursuant to this Agreement, the Purchase Agreement or
any Subsequent Transfer Instrument.

          "Relief Act":  The Soldiers' and Sailors' Civil Relief Act of 1940, as
           ----------
amended.

          "Relief Act Shortfall":  As to any Distribution Date and any Mortgage
           --------------------
Loan (other than a Mortgage Loan relating to an REO Property), any shortfalls
relating to the Relief Act or similar legislation or regulations.

          "REMIC":  A "real estate mortgage investment conduit" within the
           -----
meaning of Section 860D of the Code.

          "REMIC Available Funds":  As to each Distribution Date, an amount
           ---------------------
equal to the amount on deposit in the Payment Account, representing the sum of
(i) the aggregate amount of scheduled payments on the related Mortgage Loans due
on the related Due Date and received on or prior to the related Determination
Date, (ii) miscellaneous fees and collections, including prepayment penalties
with respect to the Mortgage Loans (but excluding late fees), (iii) any
unscheduled payments and receipts, including Mortgagor prepayments on the
related Mortgage Loans, received during the related Prepayment Period and
proceeds of repurchases, and adjustments in the case of substitutions and
terminations, Net Liquidation Proceeds, Insurance Proceeds, MI Insurance
Proceeds and proceeds from the sale of Converted Mortgage Loans, (iv) all
Advances made for such Distribution Date in respect of the related Mortgage
Loans, (v) on the Distribution Date relating to the Due Period in which the
termination of the Funding Period occurred, the amount on deposit in the Pre-
Funding Account at such time, and (vi) on each Payment Date on or prior to the
Distribution Date in June 2001, the amount, if any, withdrawn from the Interest
Coverage Account for such Class.

          "REMIC Available Funds Cap Rate":  With respect to any Distribution
           ------------------------------
Date, the percentage equivalent of a fraction, the numerator of which is equal
to the Interest Remittance Formula Amount for that Distribution Date less the
Administrative Fees for that Distribution Date, and the denominator of which is
the product of (1) the actual number of days in the related Accrual Period,
divided by 360 and (2) the aggregate Certificate Principal Balances of the
Underwritten Certificates immediately prior to such Distribution Date.

          "REMIC Available Funds Cap Shortfall Amount":  With respect to any
           ------------------------------------------
Distribution Date and Class of Underwritten Certificates, the excess, if any, of
(1) the interest due on such Class calculated using the Formula Rate applicable
to such Class (less any Prepayment Interest Shortfalls and Relief Act Shortfalls
allocable to that Class) minus (2) the interest due on such Class, calculated
using the REMIC Pass-Through Rate applicable to such Class (less any Prepayment
Interest Shortfalls and Relief Act Shortfalls allocable to that Class).

          "REMIC Current Interest":  For any Distribution Date and each Class of
           ----------------------
Underwritten Certificates, the amount of interest accrued during the related
Accrual Period at the related REMIC Pass-through Rate on the Certificate
Principal Balance of such Class

                                      108
<PAGE>

immediately prior to such Distribution Date, in each case, reduced by any
Prepayment Interest Shortfalls and any Relief Act Shortfalls allocated to that
class (allocated to each Certificate based on its respective entitlements to
interest irrespective of any Prepayment Interest Shortfalls or Relief Act
Shortfalls for that Distribution Date).

          "REMIC Interests Sale Agreement":  The REMIC Interests Sale Agreement,
           ------------------------------
dated as of March 1, 2001, between the Company and NRFC.

          "REMIC Monthly Interest Distributable Amount":  For any Distribution
           -------------------------------------------
Date and any Class of Underwritten Certificates, the sum of (1) the Unpaid
Interest Shortfall Amount for that Class and Distribution Date and (2) the REMIC
Current Interest for that Class and Distribution Date.  In the event of a
shortfall in the full amount necessary to pay both the Unpaid Interest Shortfall
Amount and the REMIC Current Interest for a Class, the money will first be
applied to the Unpaid Interest Shortfall Amount and then to the REMIC Current
Interest.

          "REMIC Pass-Through Rate":  With respect to the Underwritten
           -----------------------
Certificates (other than the Class AIO Certificates) and any Distribution Date,
the lesser of (x) the related Formula Rate for such Distribution Date and (y)
the REMIC Available Funds Cap Rate for such Distribution Date.

          "REMIC Provisions":  Provisions of the federal income tax law relating
           ----------------
to real estate mortgage investment conduits which appear at Section 860A through
860G of Subchapter M of Chapter 1 of the Code, and related provisions, and
regulations and rulings promulgated thereunder, as the foregoing may be in
effect from time to time.

          "REMIC Regular Interests":  The Lower-Tier REMIC Regular Interests and
           -----------------------
the Upper-Tier REMIC Regular Interests.

          "REMIC Trust":  The segregated pool of assets containing of the Trust
           -----------
Fund, but excluding the Non-REMIC Accounts.

          "REO Acquisition":  The acquisition by the Servicer on behalf of the
           ---------------
Trustee for the benefit of the Certificateholders of any REO Property pursuant
to Section 3.13 hereof.

          "REO Disposition":  As to any REO Property, a determination by the
           ---------------
Servicer that it has received substantially all Insurance Proceeds, Liquidation
Proceeds, REO Proceeds and other payments and recoveries (including proceeds of
a final sale) which the Servicer expects to be finally recoverable from the sale
or other disposition of the REO Property.

          "REO Imputed Interest":  As to any REO Property, for any period, an
           --------------------
amount equivalent to interest (at the Net Mortgage Rate that would have been
applicable to the related Mortgage Loan had it been outstanding net, with
respect to a negative amortization loan, of amounts that would have been
Deferred Interest, if any) on the unpaid principal balance of the Mortgage Loan
as of the date of acquisition thereof for such period as such balance is reduced
pursuant to Section 3.13 hereof by any income from the REO Property treated as a
recovery of principal and with respect to a negative amortization loan, as such
balance is increased by the addition of Deferred Interest.

                                      109
<PAGE>

          "REO Proceeds":  Proceeds, net of expenses, received in respect of any
           ------------
REO Property (including, without limitation, proceeds from the rental of the
related Mortgaged Property), which proceeds are required to be deposited into
the Collection Account within two days of receipt by the Servicer.

          "REO Property":  A Mortgaged Property that is acquired by the Trust by
           ------------
foreclosure or by deed in lieu of foreclosure.

          "Repurchase Event":  With respect to any Mortgage Loan, either (i) a
           ----------------
discovery that, as of the Closing Date the related Mortgage was not a valid lien
on the related Mortgaged Property subject only to (A) the lien of real property
taxes and assessments not yet due and payable, (B) covenants, conditions, and
restrictions, rights of way, easements and other matters of public record as of
the date of recording of such Mortgage and such other permissible title
exceptions as are permitted and (C) other matters to which like properties are
commonly subject which do not materially adversely affect the value, use,
enjoyment or marketability of the related Mortgaged Property or (ii) with
respect to any Mortgage Loan as to which the Seller delivers an affidavit
certifying that the original Mortgage Note has been lost or destroyed, a
subsequent default on such Mortgage Loan if the enforcement thereof or of the
related Mortgage is materially and adversely affected by the absence of such
original Mortgage Note.

          "Repurchase Price":  With respect to any Mortgage Loan (i) required to
           ----------------
be repurchased on any date by the Seller pursuant to the Purchase Agreement,
(ii) permitted to be purchased by the Servicer pursuant to Article III hereof or
(iii) required to be purchased by the Converted Loan Purchaser pursuant to the
Converted Loan Purchase Agreement, an amount equal to the sum, without
duplication, of (i) 100% of the Principal Balance thereof (without reduction for
any amounts charged off) and (ii) unpaid accrued interest at the Mortgage Rate
on the outstanding principal balance thereof from the Due Date to which interest
was last paid by the Mortgagor (or with respect to which an Advance was last
made by the Servicer) to the first day of the month following the month of
purchase plus (iii) the amount of any unreimbursed Servicing Advances or
unreimbursed Advances made with respect to such Mortgage Loan plus (iv) any
other amounts owed to the Servicer or the Subservicer pursuant to Section 3.07
hereof and not included in clause (iii) of this definition.

          "Request for Release":  A request for release in substantially the
           -------------------
form of Exhibit E hereto.

          "Residual Certificate":  The Class RL Certificates and the Class RU
           --------------------
Certificates.

          "Residual Interest":  The sole class of "residual interests" in a
           -----------------
REMIC within the meaning of Section 860G(a)(2) of the Code.

          "Responsible Officer":  With respect to the Trustee or the Certificate
           -------------------
Administrator, any officer thereof with direct responsibility for the
administration of this Agreement and also, with respect to a particular matter,
any other officer to whom such matter is referred because of such officer's
knowledge of and familiarity with the particular subject.

          "Retained Certificates":  The Class O Certificates, the Class P
           ---------------------
Certificates, the Class R Certificates and the Class AIO Certificates.

                                      110
<PAGE>

          "Rolling 60-Day Delinquency Percentage":  For any Distribution Date,
           -------------------------------------
the average of the 60-Day Delinquency Percentages for the Mortgage Loans as of
the last day of each of the three (or 1 and 2 in the case of the first two
Distribution Dates, as applicable) most recently ended Due Periods.

          "Rolling 90-Day Delinquency Percentage":  For any Distribution Date,
           -------------------------------------
the average of the 90-Day Delinquency Percentages for the Mortgage Loans as of
the last day of each of the three (or 1 and 2 in the case of the first two
Distribution Dates, as applicable) most recently ended Due Periods.

          "Seller":  NovaStar Mortgage, Inc., a Virginia corporation, and its
           ------
successors and assigns.

          "Servicer":  NovaStar Mortgage, Inc., a Virginia corporation, and its
           --------
successors and assigns.

          "Servicer Remittance Date":  Not later than 12:00 p.m. New York time
           ------------------------
on the first Business Day prior to each Distribution Date.

          "Servicing Account":  The separate trust account created and
           -----------------
maintained by the Servicer or each Subservicer with respect to the Mortgage
Loans or REO Property, which shall be an Eligible Account, for collection of
taxes, assessments, insurance premiums and comparable items as described in
Section 3.08 hereof.

          "Servicing Advances":  All customary, reasonable and necessary "out of
           ------------------
pocket" costs and expenses incurred in connection with (a) a default,
delinquency or other unanticipated event in the performance by the Servicer of
its servicing obligations, including, without duplication, but not limited to,
the cost of (i) the preservation, restoration and protection of a Mortgaged
Property, (ii) any enforcement or judicial proceedings, including foreclosures,
(iii) the management and liquidation of any REO Property, (iv) compliance with
the obligations under Section 3.13 hereof, and (v) expenses incurred in
connection with any Mortgage Loan being registered on the MERS System, or (b) a
transfer of servicing due to a Servicing Default, which costs and expenses,
shall not exceed, in any one month, the Servicing Transfer Costs Cap.

          "Servicing Default":  The meaning assigned in Section 7.01 hereof.
           -----------------

          "Servicing Fee":  With respect to the Mortgage Loans and any
           -------------
Distribution Date, the product of (i) the Servicing Fee Rate divided by 12 and
(ii) the Principal Balance of such Mortgage Loans as of such Distribution Date.

          "Servicing Fee Rate":  With respect to any Mortgage Loan, 0.50% per
           ------------------
annum.

          "Servicing Officer":  Any officer of the Servicer involved in, or
           -----------------
responsible for, the administration and servicing of the Mortgage Loans whose
name and specimen signature appear on a list of servicing officers furnished to
the Certificate Administrator by the Servicer or a Subservicer, as such list may
be amended from time to time.

                                      111
<PAGE>

          "Servicing Transfer Costs Cap":  With respect to the reimbursement
           ----------------------------
pursuant to Section 3.7(a)(v) of a successor servicer for Servicing Advances
made for expenses incurred in transferring the servicing of the Mortgage Loans
following a Servicing Default, for any Payment Date, an amount equal to 1/12th
of the product of (a) $60.00 and (b) (i) on any Payment Date in the first year
following such servicing transfer, the number of Mortgage Loans in the Trust on
the date of such servicing transfer, and (ii) on any Payment Date in each
subsequent year following such servicing transfer, the number of Mortgage Loans
in the Trust on the anniversary date of such servicing transfer; provided,
however, that the aggregate cumulative reimbursements for such Servicing Advance
shall not exceed the actual expenses incurred in connection with such servicing
transfer; provided, further, that for the purposes of Section 3.07(a)(v), the
funds for such reimbursements shall be deemed to have come from recoveries on
each of the Mortgage Loans remaining in the Trust.

          "Servicing Transfer Costs":  Reasonable and necessary costs and
           ------------------------
expenses incurred, by or on behalf of the Trustee, Certificate Administrator or
successor Servicer in connection with the transfer of servicing in the event of
termination of the Servicer as servicer hereunder and the resulting transfer to
the successor Servicer.

          "Standard & Poor's":  Standard & Poor's Ratings Services, a division
           -----------------
of The McGraw Hill Companies, Inc., or its successor in interest.

          "Startup Day":  As defined in Section 10.01(b) hereof.
           -----------

          "Subsequent Cut-off Date":  With respect to those Subsequent Mortgage
           -----------------------
Loans which are sold to the Trust pursuant to a Subsequent Transfer Instrument,
the first day of the month in which the Subsequent Transfer Date occurs.

          "Subsequent Mortgage Loan":  A Mortgage Loan sold by the Company to
           ------------------------
the Trust Fund pursuant to Section 2.08, such Mortgage Loan being identified on
the Mortgage Loan Schedule attached to a Subsequent Transfer Instrument.

          "Subsequent Transfer Date":  With respect to each Subsequent Transfer
           ------------------------
Instrument, the date on which the related Subsequent Mortgage Loans are sold to
the Trust Fund.

          "Subsequent Transfer Instrument":  Each Subsequent Transfer
           ------------------------------
Instrument, dated as of a Subsequent Transfer Date, executed by the Trustee and
the Company substantially in the form attached hereto as Exhibit D, by which
Subsequent Mortgage Loans are transferred to the Trust Fund.

          "Sub-Servicer":  Any Person with which either Servicer has entered
           ------------
into a Subservicing Agreement and which meets the qualifications of a Sub-
Servicer pursuant to Section 3.02 hereof.

          "Subservicing Account":  An account established by a Sub-Servicer
           --------------------
which meets the requirements set forth in Section 3.06(e) and is otherwise
acceptable to the applicable Servicer.

                                      112
<PAGE>

          "Subservicing Agreement":  The written contract between either
           ----------------------
Servicer and a Sub-Servicer relating to servicing and administration of certain
Mortgage Loans as provided in Section 3.02 hereof.

          "Subservicing Fee":  With respect to each Mortgage Loan and any
           ----------------
Distribution Date, the portion of the Servicing Fee paid to a Subservicer.

          "Substitution Adjustment Amount":  As defined in Section 2.03 hereof.
           ------------------------------

          "Supplemental Interest Account":  The reserve fund established and
           -----------------------------
maintained pursuant to Section 4.04.

          "Supplemental Interest Amount Due":  With respect to any Class of
           --------------------------------
Underwritten Certificates and any Distribution Date, the sum of (x) the REMIC
Available Funds Cap Shortfall Amount for such Class of Certificates and such
Payment Date and (y) the Available Funds Cap Carryforward Amount for such Class
and Distribution Date.

          "Supplemental Interest Payment":  With respect to any Distribution
           -----------------------------
Date:

          (i) for the Class A-1 Certificates, the lesser of (x) the Supplemental
Interest Amount Due for the Class A-1 Certificates and (y) the Class AIO Current
Interest for that Distribution Date;

          (ii) for the Class M-1 Certificates, the lesser of (x) the
Supplemental Interest Amount Due for the Class M-1 Certificates and (y) any
portion of the Class AIO Current Interest for that Distribution Date not applied
to the payment of the Supplemental Interest Payment Amount for the Class A-1
Certificates on that Distribution Date;

          (iii)  for the Class M-2 Certificates, the lesser of (x) the
Supplemental Interest Amount Due for the class M-2 Certificates and (y) any
portion of the Class AIO Current Interest for that Distribution Date not applied
to the payment of the Supplemental Interest Amount Due for the Class A-1 and the
Class M-1 Certificates on that Distribution Date; and

          (iv) for the Class M-3 Certificates, the lesser of (x) the
Supplemental Interest Payment Amount Due for the Class M-3 Certificates and (y)
any portion of the Class AIO Current Interest for that Distribution Date not
applied to the payment of the Supplemental Interest Amounts Due for the Class A-
1, Class M-1 and Class M-2 Certificates on that Distribution Date.

          "Tax Matters Person":  The tax matters person appointed pursuant to
           ------------------
Section 10.01(e) hereof.

          "Tax Returns":  The federal income tax return on Internal Revenue
           -----------
Service Form 1066, U.S. Real Estate Mortgage Investment Conduit Income Tax
Return, including Schedule Q thereto, Quarterly Notice to Residual Interest
Holders of the REMIC Taxable Income or Net Loss Allocation, or any successor
forms, to be filed by the Certificate Administrator, as agent of the Trustee, on
behalf of each REMIC, together with any and all other information reports or
returns that may be required to be furnished to the Certificateholders or filed
with the Internal

                                      113
<PAGE>

Revenue Service or any other governmental taxing authority under any applicable
provisions of federal, state or local tax laws.

          "Termination Price":  As defined in Section 11.01(a) hereof.
           -----------------

          "Telerate Page 3750":  The display page currently so designated on the
           ------------------
Dow Jones Telerate Service (or such other page as may replace that page on that
service for the purpose of displaying comparable rates or prices) and "Reference
Banks" means leading banks selected by the Certificate Administrator and engaged
in transactions in European deposits in the international Eurocurrency market.

          "Treasury Regulations":  Regulations, including proposed or temporary
           --------------------
Regulations, promulgated under the Code.  References herein to specific
provisions of proposed or temporary regulations shall include analogous
provisions of final Treasury Regulations or other successor Treasury
Regulations.

          "Trigger Event":  A Trigger Event is in effect with respect to any
           -------------
Distribution Date if the Rolling 60-Day Delinquency Percentage calculated with
respect to that Distribution Date exceeds 14% of the current Principal Balance
of the Mortgage Loans.

          "Trust":  NovaStar Mortgage Funding Trust 2001-1, the trust created
           -----
hereunder.

          "Trust Fund":  All of the assets of the Trust, which is the trust
           ----------
created hereunder consisting of the Lower-Tier REMIC, the Upper-Tier REMIC, the
Interest Coverage Account, the Pre-Funding Account and the Supplemental Interest
Account.

          "Trustee":  Wells Fargo Bank Minnesota, N.A., a national banking
           -------
association, and its successors and assigns or any successor Agreement trustee
appointed pursuant to the terms of the Agreement.

          "Underwriter":  First Union Securities, Inc. and Morgan Stanley Dean
           -----------
Witter & Co., their successors and assigns.

          "Underwriting Agreement":  The Underwriting Agreement, dated as of
           ----------------------
March 23, 2001, among the Underwriters, the Company, the Seller and NFI with
respect to the offer and sale of the Class A-1 Certificates and the Mezzanine
Certificates, as the same may be amended from time to time.

          "Underwriting Guidelines":  The underwriting guidelines set forth in
           -----------------------
the Prospectus Supplement under the heading "Description of the Mortgage Pool--
Underwriting Standards for Mortgage Loans".

          "Underwritten Certificates" means, collectively, the Class A-1 and
           -------------------------
Mezzanine Certificates.

          "United States Person" or "U.S. Person":  A citizen or resident of the
           --------------------      -----------
United States, a corporation, partnership or other entity treated as a
corporation or partnership for federal income tax purposes (other than a
partnership that is not treated as a U.S. Person pursuant to any

                                      114
<PAGE>

applicable Treasury regulations) created or organized in, or under the laws of,
the United States, any state thereof or the District of Columbia, or an estate
the income of which from sources without the United States is includible in
gross income for United States federal income tax purposes regardless of its
connection with the conduct of a trade or business within the United States, or
a trust if a court within the United States is able to exercise primary
supervision over the administration of the trust and one or more United States
persons have authority to control all substantial decisions of the trust. The
term "United States" shall have the meaning set forth in Section 7701 of the
Code.

          "Unpaid Interest Shortfall Amount":  With respect to each Class of
           --------------------------------
Underwritten Certificates and (i) the first Distribution Date, zero, and (ii)
any Distribution Date after the first Distribution Date, the sum of (a) the
Unpaid Interest Shortfall Amount for that Class as of the prior Distribution
Date, (b) the excess of the amount of the REMIC Current Interest due with
respect to that Class on the prior Distribution Date over the amount actually
distributed to the Holders of that Class on account of the REMIC Current
Interest on the prior Distribution Date and (c) interest on the sum of (a) and
(b) to the extent permitted by law, at the Formula Rate for such Class for the
related Accrual Period.

          "Upper-Tier REMIC":  The REMIC established pursuant to Section 2.09
           ----------------
hereof.  The assets of the Upper-Tier REMIC shall be the Lower-Tier REMIC
Regular Interests.

          "Upper-Tier REMIC Regular Interests":  As defined in Section 2.09(c)
           ----------------------------------
hereof.

          "Voting Rights":  The portion of the voting rights of all of the
           -------------
Certificates which is allocated to any Certificate.  At all times the Class A-1
Certificates and the Mezzanine Certificates shall have 96% of the Voting Rights
(allocated among the Holders of the Class A-1 Certificates and the Mezzanine
Certificates in proportion to the then outstanding Certificate Principal
Balances of their respective Certificates), the Class AIO Certificates shall
have 1% of the Voting Rights, the Class O Certificates shall have 1% of the
Voting Rights, the Class P Certificates shall have 1% of the Voting Rights and
the Class RU Certificates shall have 1% of the Voting Rights.  The Voting Rights
allocated to any Class of Certificates (other than the Class AIO Certificates,
Class O Certificates, Class P Certificates and the Class RU Certificates) shall
be allocated among all Holders of each such Class in proportion to the
outstanding Certificate Principal Balance of such Certificates and the Voting
Rights allocated to the Class AIO Certificates, Class O Certificates, Class P
Certificates and the Class RU Certificates shall be allocated among all Holders
of each such Class in proportion to such Holders' respective Percentage
Interest; provided, however that when none of the Regular Certificates are
outstanding, 100% of the Voting Rights shall be allocated among Holders of the
Class RU Certificates in accordance with such Holders' respective Percentage
Interests in the Certificates of such Class.

          "Weighted Average Mortgage Rate":  With respect to any Distribution
           ------------------------------
Date, the weighted average of the Mortgage Rates of the Mortgage Loans (weighted
by the Principal Balances of the Mortgage Loans).

                                      115<PAGE>

                                                                    Exhibit 10.1

                            NOVASTAR MORTGAGE, INC.
                                   as Seller,

                      NOVASTAR MORTGAGE FUNDING CORPORATION
                                   as Company,

                        WELLS FARGO BANK MINNESOTA, N.A.
                   as Trustee and Certificate Administrator,

                                       and

                            FIRST UNION NATIONAL BANK
                                  as Custodian

                        MORTGAGE LOAN PURCHASE AGREEMENT

                            Dated as of March 1, 2001

                    Fixed and Adjustable Rate Mortgage Loans

                 NovaStar Mortgage Funding Trust, Series 2001-1
      NovaStar Home Equity Loan Asset-Backed Certificate, Series 2001-1
<PAGE>

                                TABLE OF CONTENTS
                               -----------------
<TABLE>
<CAPTION>
                                                                              Page
                                                                              ----
<S>        <C>                                                              <C>
ARTICLE I  DEFINITIONS.........................................................  1
   Section 1.01  Definitions...................................................  1
ARTICLE II  SALE OF MORTGAGE LOANS AND RELATED PROVISIONS......................  2
   Section 2.01  Sale of Initial Mortgage Loans and MI Policies................  2
   Section 2.02  Conveyance of the Subsequent Mortgage Loans...................  5
   Section 2.03  Pre-Funding Account...........................................  9
   Section 2.04  Interest Coverage Account.....................................  9
ARTICLE III  REPRESENTATIONS AND WARRANTIES; REMEDIES FOR BREACH...............  9
   Section 3.01  Seller Representations and Warranties.........................  9
   Section 3.02  Company Representations and Warranties........................ 22
   Section 3.03  [reserved].................................................... 23
ARTICLE IV  SELLER'S COVENANTS................................................. 23
   Section 4.01  Covenants of the Seller....................................... 23
   Section 4.02  Payment of Expenses........................................... 24
ARTICLE V  CONDITIONS TO INITIAL MORTGAGE LOAN PURCHASE........................ 24
   Section 5.01  Conditions of Company's Obligations........................... 24
ARTICLE VI  INDEMNIFICATION BY THE SELLER  WITH RESPECT TO THE MORTGAGE LOANS.. 25
   Section 6.01  Indemnification With Respect to the Mortgage Loans............ 25
   Section 6.02  Limitation on Liability of the Seller......................... 25
ARTICLE VII  TERMINATION....................................................... 25
   Section 7.01  Termination................................................... 25
ARTICLE VIII  MISCELLANEOUS PROVISIONS......................................... 27
   Section 8.01  Amendment..................................................... 27
   Section 8.02  Governing Law................................................. 27
   Section 8.03  Notices....................................................... 27
   Section 8.04  Severability of Provisions.................................... 28
   Section 8.05  Relationship of Parties....................................... 28
   Section 8.06  Counterparts.................................................. 28
   Section 8.07  Further Agreements............................................ 28
   Section 8.08  Intention of the Parties...................................... 29
   Section 8.09  Successors and Assigns; Assignment of Purchase Agreement...... 29
   Section 8.10  Survival.                                                      29
   Section 8.11  Liability of the Trustee...................................... 29
</TABLE>
                                    Exhibits
                                    --------
Exhibit 1  Mortgage Loan Schedule for Initial Mortgage Loans
Exhibit 2  Subsequent Transfer Instrument

                                        i
<PAGE>

          THIS MORTGAGE LOAN PURCHASE AGREEMENT (this "Purchase Agreement"),
dated as of March 1, 2001, is made among NovaStar Mortgage, Inc. (the "Seller"),
NovaStar Mortgage Funding Corporation (the "Company"), Wells Fargo Bank
Minnesota, N.A. (the "Trustee" and the "Certificate Administrator"), and First
Union National Bank (the "Custodian").

                         W I T N E S S E T H  T H A T:
                         - - - - - - - - - -  - - - -

          WHEREAS, pursuant to the terms of this Purchase Agreement, the Seller
will sell the Initial Mortgage Loans and the related MI Policies to the Company
on the Closing Date;

          WHEREAS, pursuant to the terms of the Pooling and Servicing Agreement,
the Company will transfer the Initial Mortgage Loans and the related MI
Policies, and assign all of its rights under the Purchase Agreement, to the
Trustee, without recourse, on the Closing Date;

          WHEREAS, pursuant to the terms of the Pooling and Servicing Agreement,
the Trustee will issue the Certificates;

          WHEREAS, pursuant to the terms of the Pooling and Servicing Agreement,
the Trustee will transfer to the Company the Certificates;

          WHEREAS, pursuant to the terms of the Underwriting Agreement, the
Company will sell the Underwritten Certificates to the Underwriter;

          WHEREAS, pursuant to the terms of the REMIC Interests Sale Agreement,
the Company will sell the Retained Certificates to NRFC;

          WHEREAS, pursuant to the terms of the Pooling and Servicing Agreement,
the Servicer will service the Mortgage Loans; and

          WHEREAS, pursuant to the terms of the Converted Loan Purchase
Agreement, the Converted Loan Purchaser will purchase the Converted Mortgage
Loans from the Trustee.

                                   ARTICLE I

                                   DEFINITIONS

          Section 1.01 Definitions. For all purposes of this Purchase Agreement,
                       -----------
except as otherwise expressly provided herein or unless the context otherwise
requires, capitalized terms not otherwise defined herein shall have the meanings
assigned to such terms in the Definitions contained in Section 1.01 of the
Pooling and Servicing Agreement, dated as of March 1, 2001, among the Trustee,
the Certificate Administrator, the Custodian, the Company and NovaStar Mortgage,
Inc., as seller and servicer (the "Servicer"), which is incorporated by
reference herein. All other capitalized terms used herein shall have the
meanings specified herein.
<PAGE>

                                   ARTICLE II

                 SALE OF MORTGAGE LOANS AND RELATED PROVISIONS

          Section 2.01  Sale of Initial Mortgage Loans and MI Policies.
                        ----------------------------------------------

          (a) The Seller hereby sells, and the Company hereby purchases on the
Closing Date the Initial Mortgage Loans identified (and the related MI Policies)
on the Mortgage Loan Schedule annexed hereto as Exhibit 1, the proceeds thereof
and all rights under the Related Documents (including the related Mortgage
Files). The Initial Mortgage Loans consist of conventional, residential first
lien mortgage loans with fixed and adjustable interest rates. The Initial
Mortgage Loans will have a Principal Balance as of the close of business on the
Cut-off Date, after giving effect to any payments due on or before such date
whether or not received, of approximately $211,419,715.44. The sale of the
Initial Mortgage Loans will take place on the Closing Date, subject to and
simultaneously with the deposit of the Initial Mortgage Loans and the Original
Pre-Funded Amount and the Interest Coverage Amount into the Trust Fund, the
issuance of the Securities by the Trustee and the sale of the Underwritten
Certificates pursuant to the Underwriting Agreement. The purchase price (the
"Purchase Price") for the Initial Mortgage Loans to be paid by the Company to
the Seller on the Closing Date shall consist of the following:

              (i) a payment in an amount equal to $407,753,070.80 representing
the net proceeds of the sale of the Underwritten Certificates, which payment
shall be paid to the Seller by wire transfer in immediately available funds on
the Closing Date by or on behalf of the Company, or as otherwise agreed by the
Company; and

              (ii) a payment in an amount equal to $20,000 representing the
proceeds of the sale of the Retained Certificates by the Company to NRFC
pursuant to the REMIC Interests Sale Agreement, which payment shall be paid to
the Seller by wire transfer in immediately available funds on the Closing Date
by or on behalf of the Company, or as otherwise agreed by the Company.

          (b) [reserved]

          (c) In connection with such conveyances by the Seller, the Seller
shall on behalf of and at the direction of the Company deliver to, and deposit
with the Custodian on behalf of the Trustee, on or before the Closing Date in
the case of an Initial Mortgage Loan, and two Business Days prior to the related
Subsequent Transfer Date in the case of a Subsequent Mortgage Loan, the
following documents or instruments with respect to each Mortgage Loan (the
"Mortgage File"):

              (i) the original Mortgage Note endorsed to "Wells Fargo Bank
Minnesota, N.A., as Trustee of the NovaStar Mortgage Funding Trust, Series
2001-1, relating to the NovaStar Home Equity Loan Asset-Backed Certificates,
Series 2001-1";

              (ii) the original Mortgage with evidence of recording thereon, or,
if the original Mortgage has not yet been returned from the public recording
office, a copy of the

                                       2
<PAGE>

original Mortgage certified by the Seller or the public recording office in
which such original Mortgage has been recorded, and if the Mortgage Loan is
registered on the MERS System, such Mortgage shall include thereon a statement
that it is a MOM Loan and shall include the MIN for such Mortgage Loan;

              (iii) unless the Mortgage Loan is registered on the MERS System,
an original assignment (which may be included in one or more blanket assignments
if permitted by applicable law) of the Mortgage endorsed to "Wells Fargo Bank
Minnesota, N.A, as Trustee of the NovaStar Mortgage Funding Trust, Series 2001-
1, relating to the NovaStar Home Equity Loan Asset-Backed Certificates, Series
2001-1", and otherwise in recordable form;

              (iv) originals of any intervening assignments of the Mortgage
showing an unbroken chain of title from the originator thereof to the Person
assigning it to the Trustee (or to MERS, if the Mortgage Loan is registered on
the MERS System, and noting the presence of a MIN, if the Mortgage Loan is
registered on the MERS System), with evidence of recording thereon, or, if the
original of any such intervening assignment has not yet been returned from the
public recording office, a copy of such original intervening assignment
certified by the Seller or the public recording office in which such original
intervening assignment has been recorded;

              (v) the original policy of title insurance (or a commitment for
title insurance, if the policy is being held by the title insurance company
pending recordation of the Mortgage);

              (vi) a true and correct copy of each assumption, modification,
consolidation or substitution agreement, if any, relating to the Mortgage Loan;
and

              (vii) an executed copy of the notice of assignment and
acknowledgement of assignment with respect to the Mortgage Loans covered by the
MI Policies, and the MI Policy number for each Mortgage Loan insured by a MI
Policy.

          If a material defect in any Mortgage File is discovered which may
materially and adversely affect the value of the related Mortgage Loan, or the
interests of the Trustee (as pledgee of the Mortgage Loans), or the
Certificateholders in such Mortgage Loan, including if any document required to
be delivered to the Custodian has not been delivered (provided that a Mortgage
File will not be deemed to contain a defect for an unrecorded assignment under
clause (i) above for 180 days following submission of the assignment if the
Seller has submitted such assignment for recording pursuant to the terms of the
following paragraph), the Seller shall cure such defect, repurchase the related
Mortgage Loan at the Repurchase Price or substitute an Eligible Substitute
Mortgage Loan for the related Mortgage Loan upon the same terms and conditions
set forth in Section 3.01 hereof as to the Initial Mortgage Loans and the
Subsequent Mortgage Loans and Section 2.02(c) hereof as to the Subsequent
Mortgage Loans for breaches of representations and warranties.

          Promptly after the Closing Date in the case of an Initial Mortgage
Loan or, in the case of a Subsequent Mortgage Loan, promptly after the
Subsequent Transfer Date (or after the date of transfer of any Eligible
Substitute Mortgage Loan), the Seller at its own expense shall

                                       3
<PAGE>

complete and submit for recording in the appropriate public office for real
property records each of the assignments referred to in clause (i) above, with
such assignment completed in favor of the Trustee, excluding any Mortgage Loan
that is registered on the MERS System if MERS is identified on the Mortgage or
on a properly recorded assignment of Mortgage as the mortgagee of record. While
such assignment to be recorded is being recorded, the Custodian shall retain a
photocopy of such assignment. If any assignment is lost or returned unrecorded
to the Custodian because of any defect therein, the Seller is required to
prepare a substitute assignment or cure such defect, as the case may be, and the
Seller shall cause such substitute assignment to be recorded in accordance with
this paragraph.

          In instances where an original Mortgage or any original intervening
assignment of Mortgage is not, in accordance with clause (ii) or (iv) above,
delivered by the Seller to the Custodian, on behalf of the Trustee, prior to or
on the Closing Date in the case of an Initial Mortgage Loan or, in the case of a
Subsequent Mortgage Loan, prior to or on the Subsequent Transfer Date, the
Seller will deliver or cause to be delivered the originals of such documents to
the Custodian, on behalf of the Trustee, promptly upon receipt thereof.

          In connection with the assignment of any Initial Mortgage Loan
registered on the MERS System, promptly after the Closing Date, the Seller
further agrees that it will cause, at the Seller's own expense, the MERS System
to indicate that such Initial Mortgage Loan has been assigned by the Seller to
the Trustee in accordance with this Agreement for the benefit of the
Certificateholders by including in such computer files (a) the applicable
Trustee code in the field "[IDENTIFY THE FIELD NAME FOR TRUSTEE]" which
identifies the Trustee and (b) the code "NovaStar 2001-1" (or its equivalent) in
the field "Pool Field" which identifies the series of the Certificates issued in
connection with such Mortgage Loans.

          Effective on the Closing Date, the Company hereby acknowledges its
acceptance of all right, title and interest to the Initial Mortgage Loans and
other property, existing on the Closing Date and thereafter created and conveyed
to it pursuant to this Section 2.01.

          The Trustee, as assignee or transferee of the Company, shall be
entitled to all scheduled principal payments due after the Cut-off Date, all
other payments of principal due and collected after the Cut-off Date, and all
payments of interest on the Initial Mortgage Loans. No scheduled payments of
principal due on or before the Cut-off Date and collected after the Cut-off Date
shall belong to the Company pursuant to the terms of this Purchase Agreement.
The Pooling and Servicing Agreement shall provide that any late payment charges
collected in connection with a Mortgage Loan shall be paid to the Servicer as
provided therein.

          (d)   [RESERVED]

          (e)  The parties hereto intend that the transactions set forth herein
constitute a sale by the Seller to the Company on the Closing Date of all the
Seller's right, title and interest in and to the Initial Mortgage Loans and
other property as and to the extent described above. In the event the
transactions set forth herein shall be deemed not to be a sale, the Seller
hereby grants to the Company as of the Closing Date a security interest in all
of the Seller's right, title and interest in, to and under the Initial Mortgage
Loans and such other property, to secure all of the Seller's

                                       4
<PAGE>

obligations hereunder and this Purchase Agreement shall constitute a security
agreement under applicable law and in such event, the parties hereto acknowledge
that the Custodian, in addition to holding the Initial Mortgage Loans on behalf
of the Trustee for the benefit of the Certificateholders, holds the Initial
Mortgage Loans as designee of the Company. The Seller agrees to take or cause to
be taken such actions and to execute such documents, including without
limitation the filing of all necessary UCC-1 financing statements filed in the
State of Virginia and the State of Kansas (which shall have been submitted for
filing as of the Closing Date and each Subsequent Transfer Date, as applicable),
any continuation statements with respect thereto and any amendments thereto
required to reflect a change in the name or corporate structure of the Seller or
the filing of any additional UCC-1 financing statements due to the change in the
principal office of the Seller, as are necessary to perfect and protect the
interests of the Company and its respective assignees in each Initial Mortgage
Loan and the proceeds thereof and the interests of the Trustee and its assignees
in each Subsequent Mortgage Loan and the proceeds thereof. The Company agrees to
take or cause to be taken such actions and to execute such documents, including
without limitation the filing of all necessary UCC-1 financing statements, and
continuation statements with respect thereto and any amendments thereto as are
necessary to perfect and protect the interests of the Trustee and its assignees
in each Initial Mortgage Loan.

          Section 2.02  Conveyance of the Subsequent Mortgage Loans.
                        -------------------------------------------
          (a)  Subject to the conditions set forth in paragraph (b) below in
consideration of the Trustee's delivery on the related Subsequent Transfer Dates
of all or a portion of the balance of funds in the Pre-Funding Account, the
Seller shall on any Subsequent Transfer Date sell, transfer, assign, set over
and convey, without recourse, to the Company, who shall then sell, transfer,
assign, set over and convey, without recourse, to the Trustee, but subject to
the other terms and provisions of this Purchase Agreement, all of the right,
title and interest of the Seller in and to (i) the Subsequent Mortgage Loans
(and the related MI Policies) identified on the related Mortgage Loan Schedule
attached to the related Subsequent Transfer Instrument delivered by the Seller
on such Subsequent Transfer Date, (ii) principal due and interest accruing on
the Subsequent Mortgage Loans after the related Subsequent Cut-off Date and
(iii) with respect to such Subsequent Mortgage Loans all items to be delivered
pursuant to Section 2.01(c) above and the other items in the related Mortgage
Files; provided, however, that the Seller reserves and retains all right, title
and interest in and to principal received and interest accruing on the
Subsequent Mortgage Loans prior to the related Subsequent Cut-off Date. The
transfer by the Seller to the Company, and by the Company to the Trustee, of the
Subsequent Mortgage Loans identified on each Mortgage Loan Schedule attached to
the related Subsequent Transfer Instrument shall be absolute and is intended by
the Trustee, the Company and the Seller to constitute and to be treated as a
sale of the Subsequent Mortgage Loans by the Seller to the Company, and a sale
of the Subsequent Mortgage Loans by the Company to the Trustee.

          In the event such transactions shall be deemed not to be a sale, the
Seller hereby grants to the Company as of each Subsequent Transfer Date a
security interest in all of the Seller's right, title and interest in, to and
under the related Subsequent Mortgage Loans and such other property, to secure
all of the Seller's obligations hereunder, and this Purchase Agreement shall
constitute a security agreement under applicable law, and in such event, the
parties hereto

                                       5
<PAGE>

acknowledge that the Custodian, in addition to holding the Subsequent Mortgage
Loans and the related MI Policies on behalf of the Trustee for the benefit of
the Certificateholders, holds the Subsequent Mortgage Loans and the related MI
Policies as designee of the Company. The Seller agrees to take or cause to be
taken such actions and to execute such documents, including without limitation
the filing of all necessary UCC-1 financing statements filed in the State of
Virginia and the State of Kansas (which shall be submitted for filing as of the
related Subsequent Transfer Date), any continuation statements with respect
thereto and any amendments thereto required to reflect a change in the name or
corporate structure of the Seller or the filing of any additional UCC-1
financing statements due to the change in the principal office of the Seller as
are necessary to perfect and protect the interests of the Company and its
assignees in the Subsequent Mortgage Loans.

          In the event such transactions shall be deemed not to be a sale, the
Company hereby grants to the Trustee as of each Subsequent Transfer Date a
security interest in all of the Company's right, title and interest in, to and
under the related Subsequent Mortgage Loans and such other property, to secure
all of the Company's obligations hereunder, and this Purchase Agreement shall
constitute a security agreement under applicable law, and in such event, the
parties hereto acknowledge that the Custodian, in addition to holding the
Subsequent Mortgage Loans and the related MI Policies on behalf of the Trustee
for the benefit of the Certificateholders, holds the Subsequent Mortgage Loans
and the related MI Policies as designee of the Trustee. The Company agrees to
take or cause to be taken such actions and to execute such documents, including
without limitation, the filing of all necessary UCC-1 financing statements filed
in the State of Delaware and the State of Kansas (which shall be submitted for
filing as of the related Subsequent Transfer Date), any continuation statements
with respect thereto and any amendments thereto required to reflect a change in
the name or corporate structure of the Company or the filing of any additional
UCC-1 financing statements due to the change in the principal office of the
Company, as are necessary to perfect and protect the interests of the Trustee
and its assignees the Subsequent Mortgage Loans.

          The related Mortgage File for each Subsequent Mortgage Loan shall be
delivered to the Custodian, on behalf of the Trustee, two Business Days prior to
the related Subsequent Transfer Date.

          The Trustee on each Subsequent Transfer Date shall acknowledge its
acceptance of all right, title and interest to the related Subsequent Mortgage
Loans and other property, existing on the Subsequent Transfer Date and
thereafter created, conveyed to it pursuant to this Section 2.02.

          The Trustee, as trustee of the Trust Fund, shall be entitled to all
scheduled principal payments due after each Subsequent Cut-off Date, all other
payments of principal due and collected after each related Subsequent Cut-off
Date, and all payments of interest on the Subsequent Mortgage Loans, minus that
portion of any such payment which is allocable to the period prior to the
related Subsequent Cut-off Date. No scheduled payments of principal due on or
before the related Subsequent Cut-off Date and collected after the related
Subsequent Cut-off Date shall belong to the Trust Fund pursuant to the terms of
this Purchase Agreement.

                                       6
<PAGE>

          The purchase price paid by the Certificate Administrator, at the
direction of the Trustee, from amounts released from the Pre-Funding Account
shall be one-hundred percent (100%) of the aggregate Principal Balances of the
Subsequent Mortgage Loans so transferred (as identified on the Mortgage Loan
Schedule attached to the related Subsequent Transfer Instrument provided by the
Seller).

          (b)  The Seller shall transfer to the Company, who shall transfer to
the Trustee, the Subsequent Mortgage Loans and the other property and rights
related thereto described in Section 2.02(a) above, and the Certificate
Administrator shall cause to be released funds from the related Pre-Funding
Account, only upon the satisfaction of each of the following conditions on or
prior to the related Subsequent Transfer Date:

               (i)  the Seller shall have provided the Company, who shall have
provided the Trustee, with a timely Addition Notice, which notice shall be given
no fewer than four (4) Business Days prior to the related Subsequent Transfer
Date and shall designate the Subsequent Mortgage Loans to be sold to the Company
and then to the Trustee and the aggregate Principal Balances of such Subsequent
Mortgage Loans as of the related Subsequent Cut-off Date and any other
information reasonably requested by the Trustee with respect to the Subsequent
Mortgage Loans;

               (ii) the Seller shall have delivered to the Company, who shall
have delivered to the Trustee, a duly executed Subsequent Transfer Instrument
substantially in the form of Exhibit 2(A) or 2(B), as applicable, (A) confirming
the satisfaction of each condition precedent and representations specified in
this Section 2.02(b), Section 2.02(c) and in the related Subsequent Transfer
Instrument and (B) including a Mortgage Loan Schedule attached thereto listing
the Subsequent Mortgage Loans;

              (iii) as of each Subsequent Transfer Date, as evidenced by
delivery of the Seller's Subsequent Transfer Instrument in the form of Exhibit
2(A) and the Company's Subsequent Transfer Instrument is the form of Exhibit
2(B), neither the Seller nor the Company shall be insolvent or have been made
insolvent by such transfers, nor shall they be aware of any pending insolvency;
(iv) such sale and transfer shall not result in a material adverse tax
consequence to the Certificateholders;

              (v)  the Funding Period shall not have terminated; and

              (vi) the Seller shall have delivered to the Certificate
Administrator, the Trustee, and the Rating Agencies Opinions of Counsel
addressed to the Rating Agencies, the Trustee and the Certificate Administrator
with respect to the transfers of the Subsequent Mortgage Loans substantially in
the form of the Opinion of Counsel delivered to the Certificate Administrator,
the Trustee and the Rating Agencies on the Closing Date (1) regarding certain
corporate matters and (2) confirming the existence of a true sale.

                                       7
<PAGE>

          (c) The obligation of the Trustee to purchase a Subsequent Mortgage
Loan on any Subsequent Transfer Date is subject to the following conditions: (1)
each such Subsequent Mortgage Loan shall satisfy the representations and
warranties specified in the related Subsequent Transfer Instrument and this
Purchase Agreement; (2) the Seller shall not select such Subsequent Mortgage
Loans in a manner that it reasonably believes is adverse to the interests of the
Majority Certificateholders; (3) the Seller shall have delivered certain
Opinions of Counsel required pursuant to Section 2.02(b)(vi) hereof; (4) as of
the related Subsequent Cut-off Date, the Subsequent Mortgage Loans shall satisfy
the following criteria: (i) each Subsequent Mortgage Loan shall not be 30 or
more days contractually delinquent as of the related Subsequent Cut-off Date;
(ii) the remaining stated term to maturity of each Subsequent Mortgage Loan
shall not exceed 360 months; (iii) the lien securing each Subsequent Mortgage
Loan shall be first priority; (iv) each Subsequent Mortgage Loan shall have an
outstanding Principal Balance of at least $10,000; (v) each Subsequent Mortgage
Loan shall be underwritten in accordance with the Underwriting Guidelines; (vi)
each Subsequent Mortgage Loan shall have a Loan-to-Value Ratio of no more than
100%; (vii) each Subsequent Mortgage Loan shall have a stated maturity of no
later than July 25, 2031; (viii) no Subsequent Mortgage Loan shall permit
negative amortization; (ix) each Subsequent Mortgage Loan shall either have a
fixed Mortgage Rate of at least 7% or, if an adjustable loan, a Gross Margin of
at least 3%; (x) a minimum of 70% of the Subsequent Mortgage Loans (by
Subsequent Cut-off Date Principal Balance) shall have an adjustable Mortgage
Rate; (xi) the weighted average Loan-to-Value Ratio of the Subsequent Mortgage
Loans (by Subsequent Cut-off Date Principal Balance) shall be no more than 87%;
(xii) approximately 98% of the Subsequent Mortgage Loans shall either (A) have a
Loan-to-Value Ratio of no more than 55% or (B) have a Loan-to-Value Ratio of
greater than 55% and be covered by an MI Policy; (xiii) the Subsequent Mortgage
Loans (by Subsequent Cut-off Date Principal Balance) shall have a weighted
average coupon of at least 9.80%; (xiv) pursuant to the Underwriting Guidelines,
no fewer than 35% of the Subsequent Mortgage Loans (by Subsequent Cut-off Date
Principal Balance) shall be AAA and AA credit risks, no fewer than 20% of the
Subsequent Mortgage Loans (by Subsequent Cut-off Date Principal Balance) shall
be A and A- credit risks, and no more than 15% of the Subsequent Mortgage Loans
(by Subsequent Cut-off Date Principal Balance) shall be B, C, and C- credit
risks; (xv) no greater than 20% of such Subsequent Mortgage Loans (by Subsequent
Cut-off Date Principal Balance) shall be FICO Enhanced loans pursuant to the
Underwriting Guidelines; (xvi) the Subsequent Mortgage Loans (by Subsequent
Cut-off Date Principal Balance) shall have a weighted average FICO score issued
by a consumer credit rating agency of at least 600; (xvii) at least 85% of such
Subsequent Mortgage Loans (by Subsequent Cut-off Date Principal Balance) shall
be loans for primary residences; (xviii) no more than 35% of the Subsequent
Mortgage Loans (by Subsequent Cut-off Date Principal Balance) shall have stated
loan documentation; (xix) at least 70% of the Subsequent Mortgage Loans (by
Subsequent Cut-off Date Principal Balance) shall be loans for single family
residences; (xx) no more than 55% of the Subsequent Mortgage Loans (by
Subsequent Cut-off Date Principal Balance) shall be loans that are the subject
of cash-out refinances.

          The acceptance of the Subsequent Mortgage Loans by the Trustee is
subject to the Seller receiving a written consent from each of the Rating
Agencies that states that the addition

                                       8
<PAGE>

of such Subsequent Mortgage Loans will not cause the Rating Agencies to
downgrade any of their ratings on the Underwritten Certificates.

          Notwithstanding the foregoing, Subsequent Mortgage Loans with
characteristics varying from those set forth above may be purchased by the
Trustee and included in the Trust Fund, if (i) the aggregate credit risk of such
Subsequent Mortgage Loans is similar to that of the Initial Mortgage Loans and
(ii) the Seller receives a written consent from each of the Rating Agencies that
states that the addition of such Subsequent Mortgage Loans will not cause the
Rating Agencies to downgrade any of their ratings of the Underwritten
Certificates.

         (d)  Within five Business Days after the end of the Funding Period, the
Seller shall deliver to the Rating Agencies, the Trustee, the Certificate
Administrator and the Custodian a copy of the updated Mortgage Loan Schedule
including the Subsequent Mortgage Loans in electronic format.

         Section 2.03  Pre-Funding Account.  No later than the Closing Date, the
                       -------------------
Certificate Administrator will establish and maintain, on behalf of the Trustee,
pursuant to the Pooling and Servicing Agreement, the Pre-Funding Account. On the
Closing Date, the Trustee will deposit in the Pre-Funding Account the Original
Pre-Funded Amount from the net proceeds of the sale of the Underwritten
Certificates.

         Section 2.04  Interest Coverage Account.  No later than the Closing
              -------------------------
Date, the Certificate Administrator will establish and maintain, on behalf of
the Trustee, pursuant to the Pooling and Servicing Agreement the Interest
Coverage Account. On the Closing Date, the Trustee will deposit in the Interest
Coverage Account the Interest Coverage Amount from the net proceeds of the sale
of the Underwritten Certificates.

                                  ARTICLE III

                        REPRESENTATIONS AND WARRANTIES;
                               REMEDIES FOR BREACH

         Section 3.01  Seller Representations and Warranties.  The Seller hereby
                       -------------------------------------
represents and warrants to the Company and the Trustee as of the date hereof, as
of the Closing Date (or if otherwise specified below, as of the date so
specified) and as of each Subsequent Transfer Date:

         (a)  As to the Seller:

              (i)  The Seller (i) is a corporation duly organized, validly

existing and in good standing under the laws of the State of Virginia and (ii)
is qualified and in good standing as a foreign corporation to do business in
each jurisdiction where such qualification is necessary, except where the
failure so to qualify would not have a material adverse effect on the Seller's
ability to enter into this Purchase Agreement and each Seller's Subsequent
Transfer Instrument and to consummate the transactions contemplated hereby and
thereby;

                                       9
<PAGE>

              (ii) The Seller has the power and authority to make, execute,
deliver and perform its obligations under this Purchase Agreement and each
Seller's Subsequent Transfer Instrument and all of the transactions contemplated
under this Purchase Agreement and each Seller's Subsequent Transfer Instrument,
and has taken all necessary corporate action to authorize the execution,
delivery and performance of this Purchase Agreement and each Seller's Subsequent
Transfer Instrument;

              (iii) The Seller is not required to obtain the consent of any
other Person or any consent, approval or authorization from, or registration or
declaration with, any governmental authority, bureau or agency in connection
with the execution, delivery, performance, validity or enforceability of this
Purchase Agreement or any Seller's Subsequent Transfer Instrument, except for
such consents, approvals or authorization, or registration or declaration, as
shall have been obtained or filed, as the case may be;

              (iv) The execution and delivery of this Purchase Agreement and
each Seller's Subsequent Transfer Instrument and the performance of the
transactions contemplated hereby by the Seller will not violate any provision of
any existing law or regulation or any order or decree of any court applicable to
the Seller or any provision of the certificate of incorporation or bylaws of the
Seller, or constitute a material breach of any mortgage, indenture, contract or
other agreement to which the Seller is a party or by which the Seller may be
bound;

              (v)  No litigation or administrative proceeding of or before any
court, tribunal or governmental body is currently pending, or to the knowledge
of the Seller threatened, against the Seller or any of its properties or with
respect to this Purchase Agreement or any Seller's Subsequent Transfer
Instrument, the Certificates which in the opinion of the Seller has a reasonable
likelihood of resulting in a material adverse effect on the transactions
contemplated by this Purchase Agreement or any Seller's Subsequent Transfer
Instrument;

              (vi) This Purchase Agreement and each Seller's Subsequent Transfer
Instrument constitute the legal, valid and binding obligations of the Seller,
enforceable against the Seller in accordance with its terms, except as
enforceability may be limited by applicable bankruptcy, insolvency,
reorganization, moratorium or other similar laws now or hereafter in effect
affecting the enforcement of creditors' rights in general and except as such
enforceability may be limited by general principles of equity (whether
considered in a proceeding at law or in equity);

              (vii) This Purchase Agreement constitutes a valid transfer and
assignment to the Company of all right, title and interest of the Seller in and
to the Cut-off Date Principal Balance of the Initial Mortgage Loans, all monies
due or to become due with respect thereto, and all proceeds of such Cut-off Date
Principal Balance of the Initial Mortgage Loans, and this Purchase Agreement and
the related Seller's Subsequent Transfer Instrument constitutes a valid transfer
and assignment to the Trustee of all right, title and interest of the Seller in
and to the Subsequent Cut-off Date Principal Balance of the Subsequent Mortgage
Loans, all monies due or to become due with respect thereto, and all proceeds of
such Subsequent Cut-off Date Principal Balance of the Subsequent Mortgage Loans;

                                       10
<PAGE>

              (viii) The Seller is not in default with respect to any order or
decree of any court or any order or regulation of any federal, state or
governmental agency, which default might have consequences that would materially
and adversely affect the condition (financial or other) or operations of the
Seller or its properties or might have consequences that would materially
adversely affect its performance hereunder; and

              (ix) The Servicer or any Subservicer who will be servicing any
Mortgage Loan pursuant to the Pooling and Servicing Agreement or a Subservicing
Agreement is qualified to do business in all jurisdictions in which its
activities as Servicer or Subservicer of the Mortgage Loans serviced by it
require such qualifications except where failure to be so qualified will not
have a material adverse effect on such servicing activities.

          (b) As to each Initial Mortgage Loan as of the Closing Date, and with
respect to each Subsequent Mortgage Loan as of the Subsequent Transfer Date,
except as otherwise expressly stated:

              (i)  The information set forth on the Mortgage Loan Schedule with
respect to each Initial Mortgage Loan is true and correct in all material
respects as of the Closing Date, and with respect to each Subsequent Mortgage
Loan is true and correct in all material respects as of the related Subsequent
Transfer Date, and the information regarding the Initial Mortgage Loans and the
Subsequent Mortgage Loans on the computer diskette or tape delivered to the
Trustee prior to the Closing Date or Subsequent Transfer Date, as applicable, is
true and accurate in all material respects and describes the same Mortgage Loans
as the Mortgage Loans on the Mortgage Loan Schedule;

              (ii) The Mortgage Loans are not being transferred with any intent
to hinder, delay or defraud any creditors;

              (iii) No more than 4.47% of the Initial Mortgage Loans (by Cut-off
Date Principal Balance) were secured by condominium units; and no more than
12.55% of the Initial Mortgage Loans (by Cut-off Date Principal Balance) were
secured by properties in planned unit developments;

              (iv)  As of the Cut-off Date, (a) the remaining term of each
Mortgage Loan is not more than 360 months and not less than 119;

              (v)  No more than 44.74% of the Initial Mortgage Loans (by Cut-off
Date Principal Balance) have been the subject of cash-out refinances;

              (vi) No more than 15.15% of the Initial Mortgage Loans (by Cut-off
Date Principal Balance) have been the subject of rate and term (no cash-out)
refinances;

              (vii)  No fewer than 40.04% of the Initial Mortgage Loans (by
Cut-off Date Principal Balance) are purchase money loans;

              (viii) No more than 11.09% of the Initial Mortgage Loans (by
Cut-off Date Principal Balance) are secured by Mortgaged Properties located in
the State of Florida, no

                                       11
<PAGE>

more than 16.07% of the Initial Mortgage Loans (by Cut-off Date Principal
Balance) are secured by Mortgaged Properties located in the State of California
and no more than 10% of the Initial Mortgage Loans (by Cut-off Date Principal
Balance) are located in any other state;

              (ix) The original Principal Balances of the Initial Mortgage Loans
ranged from $28,700 to 576,000; the average outstanding Principal Balance of the
Initial Mortgage Loans is approximately $122,570.13;

              (x)  At least 77.64% of the Initial Mortgage Loans (by Cut-off
Date Principal Balance) were secured by a first lien on a parcel of real
property improved by a detached single family residence; no more than 4.01% of
the Initial Mortgage Loans (by Cut-off Date Principal Balance) were secured by a
first lien on a parcel of real estate improved by a two-to four-unit single
family residence; and no more than 1.33% of the Initial Mortgage Loans (by
Cut-off Date Principal Balance) were secured by a first lien on a parcel of real
estate improved by manufactured housing;

              (xi) [RESERVED];

              (xii) The Mortgage Rates of the Initial Mortgage Loans as of the
Cut-off Date range from 6.99% per annum to 13.99% per annum, and the weighted
average Mortgage Rate (by Cut-off Date Principal Balance) of the Initial
Mortgage Loans was 10.55%, per annum;

              (xiii) Approximately 57.09% of the Initial Mortgage Loans (by
Cut-off Date Principal Balance) have a Loan-to-Value Ratio in excess of 80%. No
Initial Mortgage Loan in the Mortgage Pool had a Loan-to-Value Ratio at
origination in excess of 100%, and the weighted average Loan-to-Value Ratio, (by
Cut-off Date Principal Balance) of the Initial Mortgage Loans was equal to or
less than 82.436%;

              (xiv) All of the Initial Mortgage Loans are secured by first liens
on the related Mortgaged Property;

              (xv)  [RESERVED];

              (xvi) There is no valid offset, right of rescission, defense,
claim or counterclaim of any obligor under any Mortgage Note or Mortgage,
including the obligation of the Mortgagor to pay the unpaid principal of or
interest on such Mortgage Note, and any applicable right of rescission has
expired, nor will the operation of any of the terms of such Mortgage Note or
Mortgage, or the exercise of any right thereunder, render either the Mortgage
Note or the Mortgage unenforceable, in whole or in part, or subject to any right
of rescission, set- off, recoupment, counterclaim or defense, including, without
limitation, the defense of usury, and no such right of rescission, set-off,
recoupment, counterclaim or defense has been asserted with respect thereto, and,
to the best of Seller's knowledge, no Mortgagor of the applicable Mortgage was a
debtor in any state or federal bankruptcy or insolvency proceeding;

              (xvii) There are no mechanics' liens or claims for work, labor or
material affecting any Mortgaged Property which are or may be a lien prior to,
or equal with, the

                                       12
<PAGE>

lien of such Mortgage, except those which are insured against by the title
insurance policy referred to in clause (xix) below;

              (xviii) As of the Cut-off Date in the case of an Initial Mortgage
Loan or as of the related Subsequent Cut-off Date in the case of a Subsequent
Mortgage Loan, each Mortgaged Property is free of material damage and is in good
repair and there is no proceeding pending or threatened for the total or partial
condemnation of any Mortgage Property;

              (xix) Each Mortgage is a valid and enforceable first lien on the
Mortgaged Property securing the related Mortgage Note and each Mortgaged
Property is owned by the Mortgagor in fee simple (except with respect to common
areas in the case of condominiums, PUDs and de minimis PUDs) subject only to (1)
                                            -- -------
the lien of nondelinquent current real property taxes and assessments, (2)
covenants, conditions and restrictions, rights of way, easements and other
matters of public record as of the date of recording of such Mortgage, such
exceptions appearing of record being acceptable to mortgage lending institutions
generally or specifically reflected in the appraisal made in connection with the
origination of the related Mortgage Loan or referred to in the lender's title
insurance policy delivered to the originator of the related Mortgage Loan and
(3) other matters to which like properties are commonly subject that do not
materially interfere with the benefits of the security intended to be provided
by such Mortgage. Immediately prior to the sale of such Mortgage Loan to the
Company in the case of an Initial Mortgage Loan and to the Trustee in the case
of a Subsequent Mortgage Loan pursuant to this Purchase Agreement, the Seller
had full right to sell and assign the same to the Company or the Trustee, as the
case may be. Immediately following the sale of such Mortgage Loan to the Company
and the Company's assignment and sale thereof of such Mortgage Loan to the
Trustee in the case of an Initial Mortgage Loan, the Trustee will have good
title thereto subject to no claims or liens. Immediately following the sale of
such Mortgage Loan to the Company and the Company's assignment and sale thereof
to the Trustee in the case of a Subsequent Mortgage Loan, the Trustee will have
good title thereto subject to no claims or liens;

              (xx) Each Mortgage Loan at origination complied in all material
respects with applicable state and federal laws, including, without limitation,
usury, equal credit opportunity, real estate settlement procedures, the Truth In
Lending Act of 1968, as amended, and disclosure laws and consummation of the
transactions contemplated hereby, including without limitation, the receipt of
interest by the owner of such Mortgage Loan or the Holders of Certificates
secured thereby, will not violate any such laws. Each Mortgage Loan is being
serviced in all material respects in accordance with applicable state and
federal laws, including, without limitation, the Truth In Lending Act of 1968,
as amended, and other consumer protection laws, real estate settlement
procedures, usury, equal credit opportunity and disclosure laws;

              (xxi) Neither the Seller nor any prior holder of any Mortgage has
impaired, waived, altered or modified the Mortgage or Mortgage Notes in any
material respect (except that a Mortgage Loan may have been modified by a
written instrument which has been recorded, if necessary to protect the
interests of the owner of such Mortgage Loan or the Certificates, and which has
been delivered to the Trustee); satisfied, canceled or subordinated such
Mortgage in whole or in part; released the applicable Mortgaged Property in
whole or in

                                       13
<PAGE>

part from the lien of such Mortgage; or executed any instrument of release,
cancellation or satisfaction with respect thereto;

              (xxii) A lender's policy of title insurance (on an ALTA or CLTA
form) or binder, or other assurance of title customary in the relevant
jurisdiction insuring the first lien priority of the Mortgage Loan in an amount
at least equal to the original Principal Balance of each such Mortgage Loan or a
commitment binder or commitment to issue the same was effective on the date of
the origination of each Mortgage Loan, each such policy is valid and remains in
full force and effect, and each such policy was issued by a title insurer
qualified to do business in the jurisdiction where the Mortgaged Property is
located, which policy insures the Seller and successor owners of indebtedness
secured by the insured Mortgage as to the first or second priority lien of the
Mortgage as applicable. The Seller is, and such successor owners will be, the
sole insured under such lender's title insurance policy; no claims have been
made under such mortgage title insurance policy; no prior holder of the
applicable Mortgage, including the Seller, has done, by act or omission,
anything which would impair the coverage of such mortgage title insurance
policy; and each such policy, binder or assurance contains all applicable
endorsements;

              (xxiii) All of the improvements which were included for the
purpose of determining the Appraised Value of the Mortgaged Property lie wholly
within the boundaries and building restriction lines of such property and no
improvements on adjoining properties encroach upon the Mortgaged Property;

              (xxiv) No improvement located on or being part of the Mortgaged
Property is in violation of any applicable zoning law or regulation, subdivision
law or ordinance, except where the failure to comply would not have a material
adverse effect on the market value of the Mortgaged Property. All inspections,
licenses and certificates required to be made or issued with respect to all
occupied portions of the Mortgaged Property and, with respect to the use and
occupancy and fire underwriting certificates, have been made or obtained from
the appropriate authorities and the Mortgaged Property is lawfully occupied
under applicable law except where the failure to comply would not have a
material adverse effect on the market value of the Mortgaged Property;

              (xxv) Each Mortgage Note and the applicable Mortgage are genuine,
and each is the legal, valid and binding obligation of the maker thereof,
enforceable in accordance with its terms, except as limited by bankruptcy,
insolvency, reorganization, moratorium, receivership and other similar laws
relating to creditors' rights generally or by equitable principles (regardless
of whether such enforcement is considered in a proceeding in equity or at law).
All parties to the Mortgage Note and the Mortgage had legal capacity to execute
the Mortgage Note and the Mortgage and each Mortgage Note and Mortgage has been
duly and properly executed by such parties;

              (xxvi) The proceeds of the Mortgage Loans have been fully
disbursed, there is no requirement for future advances thereunder and any and
all requirements as to completion of any on-site or off-site improvements and as
to disbursement of any escrow funds therefor have been complied with. All costs,
fees and expenses incurred in making, closing or

                                       14
<PAGE>

recording the Mortgage Loans were paid and the Mortgagor is not entitled to any
refund of amounts paid or due under the Mortgage Note;

              (xxvii) Each Mortgage contains customary and enforceable
provisions that render the rights and remedies of the holder thereof adequate
for the realization against the Mortgaged Property of the benefits of the
security, including (i) in the case of a Mortgage designated as a deed of trust,
by trustee's sale, and (ii) otherwise by judicial foreclosure or if applicable,
non-judicial foreclosure. Upon default by a Mortgagor on a Mortgage Loan and
foreclosure on, or trustee's sale of, the Mortgaged Property pursuant to the
proper procedures, the holder of the Mortgage Loan will be able to deliver good
and merchantable title to the property, subject to any applicable rights of
redemption;

              (xxviii) With respect to each Mortgage constituting a deed of
trust, either a trustee, duly qualified under applicable law to serve as such,
has been properly designated and currently so serves and is named in such
Mortgage or if no duly qualified trustee has been properly designated and so
serves, the Mortgage contains satisfactory provisions for the appointment of
such trustee by the holder of the Mortgage at no cost or expense to such holder,
and no fees or expenses are or will become payable by the Certificateholders to
the trustee under the deed of trust, except in connection with a trustee's sale
after default by the Mortgagor;

              (xxix) There exist no deficiencies with respect to escrow deposits
and payments, if such are required, for which customary arrangements for
repayment thereof cannot be made, and no escrow deficits or payments of other
charges or payments due the Seller have been capitalized under the Mortgage or
the applicable Mortgage Note;

              (xxx) The Mortgage Note is not and has not been secured by any
collateral, pledged account or other security other than real estate securing
the Mortgagor's obligations and no Mortgage Loan is secured by more than one
Mortgaged Property;

              (xxxi) As of the Closing Date in the case of an Initial Mortgage
Loan and as of the related Subsequent Transfer Date in the case of a Subsequent
Mortgage Loan, the improvements upon each Mortgaged Property are covered by a
valid and existing hazard insurance policy substantially acceptable to FNMA and
acceptable to the Seller which policy provides for fire extended coverage and
such other hazards as are customary in the area where the Mortgaged Property is
located representing coverage in an amount not less than the lesser of (A) the
maximum insurable value of the improvements securing such Mortgage Loan and (B)
the outstanding Principal Balance of the related Mortgage Loan; if the
improvement on the Mortgaged Property is a condominium unit, it is included
under the coverage afforded by a blanket policy for the condominium project. All
individual insurance policies contain a standard mortgagee clause naming the
Seller or the original holder of the Mortgage, and its successors in interest,
as mortgagee, and the Seller has received no notice that any premiums due and
payable thereon have not been paid; the Mortgage obligates the Mortgagor
thereunder to maintain all such insurance at the Mortgagor's cost and expense,
and upon the Mortgagor's failure to do so, authorizes the holder of the Mortgage
to obtain and maintain such insurance at the Mortgagor's cost and expense and to
seek reimbursement therefor from the Mortgagor. There has been no act

                                       15
<PAGE>

or omission which would impair the coverage of any such policy, the benefits of
the endorsement provided for herein, or the validity and binding effect of
either;

              (xxxii) If the Mortgaged Property is in an area identified in the
Federal Register by the Federal Emergency Management Agency as having special
flood hazards, a flood insurance policy in a form meeting the requirements of
the current guidelines of the Flood Insurance Administration is in effect with
respect to such Mortgaged Property with a generally acceptable carrier in an
amount representing coverage not less than the least of (A) the outstanding
Principal Balance of the Mortgage Loan, (B) the minimum amount required to
compensate for damage or loss on a replacement cost basis and (C) the maximum
amount of flood coverage that is available under federal law;

              (xxxiii) Except for the Mortgage Loans referred to in clause (xii)
as being delinquent, there is no material monetary default, breach, violation or
event of acceleration existing under the Mortgage or the applicable Mortgage
Note; and no material event which, with the passage of time or with notice and
the expiration of any grace or cure period, would constitute a material default,
breach, violation or event of acceleration, and neither the Seller, any of its
affiliates nor any servicer or subservicer of any related Mortgage Loan has
waived any default, breach, violation or event of acceleration; no foreclosure
action is threatened or has been commenced with respect to the Mortgage Loan;

              (xxxiv)  Each Mortgage Loan is being serviced by the Servicer;

              (xxxv) There is no obligation on the part of the Seller or any
other party to make any payments with respect to the related Mortgage Loan in
addition to the Monthly Payments required to be made by the applicable
Mortgagor;

              (xxxvi) Any future advances made prior to the Cut-off Date in the
case of an Initial Mortgage Loan and as of the related Subsequent Transfer Date
in the case of a Subsequent Mortgage Loan, with respect to any Mortgage Loan
have been consolidated with the outstanding principal amount secured by such
Mortgage, and the secured principal amount, as consolidated, bears a single
interest rate and single repayment term reflected on the Mortgage Loan Schedule.
Except with respect to the Negative Amortization Loans, the consolidated
principal amount does not exceed the original principal amount of the Mortgage
Loan. The Mortgage Note with respect to any Mortgage Loan does not permit or
obligate the Servicer to make future advances to the Mortgagor at the option of
the Mortgagor;

              (xxxvii) The Seller has caused or will cause to be performed any
and all acts required to preserve the rights and remedies of the Company and the
Trustee evidencing an interest in the Mortgage Loans in any insurance policies
applicable to the Mortgage Loans including, without limitation, any necessary
notifications of insurers, assignments of policies or interests therein, and
establishments of coinsured, joint loss payee and mortgagee rights in favor of
Trustee;

              (xxxviii) Except as set forth in clause (xlii), there are no
defaults by the Mortgagor in complying with the terms of any Mortgage, and all
taxes, governmental

                                       16
<PAGE>

assessments, insurance premiums, water, sewer and municipal charges which
previously became due and owing have been paid, or, if required by the terms of
the Mortgage Loan, an escrow of funds has been established in an amount
sufficient to pay for every such item which remains unpaid and which has been
assessed, but is not yet due and payable. Except for (A) payments in the nature
of escrow payments and (B) interest accruing from the date of the Mortgage Note
or date of disbursement of the Mortgage proceeds to the day which precedes by
one month the Due Date of the first installment of principal and interest,
including, without limitation, taxes and insurance payments, the Servicer has
not advanced funds, or induced, solicited or knowingly received any advance of
funds by a party other than the Mortgagor, directly or indirectly, for the
payment of any amount required by the Mortgage;

              (xxxix) At the time of origination, each Mortgaged Property was
the subject of an appraisal which conforms to the underwriting requirements of
the related originator; and the Mortgage File contains an appraisal of the
applicable Mortgaged Property;

              (xl)    None of the Mortgage Loans are graduated payment Mortgage
Loans or growth equity Mortgage Loans;

              (xli)   69.57% of the Initial ARM Mortgage Loans are Convertible
Mortgage Loans;

              (xlii)  Except with respect to no more than 0.5% of the Initial
Mortgage Loans (by Cut-off Date Principal Balance), none of the payments of
principal of or interest on or in respect of any Initial Mortgage Loans shall be
30 days or more but less than 60 days past due as of the Cut-off Date; except
with respect to no more than 0.25% of the Initial Mortgage Loans (by Cut-off
Date Principal Balance), none of the payments of principal or interest on or in
respect of any Initial Mortgage Loans shall be 60 days or more but less than 90
days past due as of the Cut-off Date; and no Initial Mortgage Loan was 90 days
or more past due as of the Cut-off Date (except that one Initial Mortgage Loan
was past 90 days due as of the Cut-off Date, such loan having been repurchased
by the Seller); (b) except as set forth in clause (a) above, no Initial Mortgage
Loan has been contractually delinquent for more than one monthly installment
period during the twelve months preceding the Cut-off Date; (c) except as set
forth in clause (a) above, all payments required to be made by the Mortgagor
under the terms of the Mortgage Note have been made and credited; and (d) to the
Seller's knowledge, there was no delinquent recording, tax or assessment lien
against the property subject to any Mortgage, except where such lien was being
contested in good faith and a stay had been granted against levying on the
property;

              (xliii) Upon payment of the Purchase Price for the Mortgage Loans
by the Company or the Trustee, as applicable, pursuant to this Purchase
Agreement, the Seller has transferred to the Company in the case of an Initial
Mortgage Loan and to the Trustee in the case of a Subsequent Mortgage Loan, good
and marketable title to each Mortgage Note and Mortgage free and clear of any
and all liens, claims, encumbrances, participation interests, equities, pledges,
charges or security interests of any nature and has or had full right and
authority, subject to no participation of or agreement with any other person, to
sell and assign the same, and following the sale of each Initial Mortgage Loan,
the Company or the Trustee, as applicable, will

                                       17
<PAGE>

own such Mortgage Loan free and clear of any encumbrance, equity interest,
participation interest, lien, pledge, charge, claim or security interest;

              (xliv) The Seller acquired any right, title and interest in and to
the Mortgage Loans in good faith and without notice of any adverse claim;

              (xlv)  The Mortgage Note, the Mortgage, the related Assignment of
Mortgage and any other documents required to be delivered by the Seller have
been delivered to the Certificate Administrator. The Custodian is in possession
of a complete, true and accurate Mortgage File in accordance with Section 2.01
hereof. Substantially all Mortgage Loans have monthly payments due on the first
day of each month and each Mortgage Loan had an original term to maturity of no
greater than 30 years;

              (xlvi) Each Mortgage Loan contains a due-on-sale provision,
although each Mortgage Loan may be assumable if permitted by the Servicer under
certain circumstances;

              (xlvii) Each of the Mortgage and the Assignment of Mortgage is in
recordable form and is acceptable for recording under the laws of the
jurisdiction in which the Mortgaged Property is located;

              (xlviii) The Mortgagor has not notified the Seller, and the Seller
has no knowledge of any relief requested or allowed to the Mortgagor under the
Soldiers' and Sailors' Civil Relief Act of 1940, as amended;

              (xlix) To the best of the Seller's knowledge, there exists no
violation of any local, state, or federal environmental law, rule or regulation
in respect of the Mortgaged Property which violation has or could have a
material adverse effect on the market value of such Mortgaged Property. The
Seller has no knowledge of any pending action or proceeding directly involving
the related Mortgaged Property in which compliance with any environmental law,
rule or regulation is in issue; and, to the best of the Seller's knowledge,
nothing further remains to be done to satisfy in full all requirements of each
such law, rule or regulation constituting a prerequisite to the use and
employment of such Mortgaged Property;

              (l) Each Mortgage Loan conforms, and all such Mortgage Loans in
the aggregate conform, to the description thereof set forth in the Prospectus
and Prospectus Supplement in all material respects;

              (li) Immediately prior to the transfer to the Company or the
Trustee, as applicable, the Seller had good and marketable title thereto, and
the Seller is the sole owner of beneficial title to and holder of the Mortgage
Loan. The Seller is conveying the same to the Company or the Trustee, as
applicable, free and clear of any and all liens, claims, encumbrances,
participation interests, equities, pledges, charges or security interests of any
nature and has full right and authority to sell and assign the same pursuant to
this Purchase Agreement, except for liens which will be released simultaneously
with such conveyance;

                                       18
<PAGE>

              (lii) For each Mortgage Loan, the related Mortgage File contains a
true, accurate and correct copy of each of the documents and instruments
required to be included therein;

              (liii) The Servicer meets all applicable requirements under the
Pooling and Servicing Agreement, is properly qualified to service each Mortgage
Loan and has been servicing each Mortgage Loan prior to the Cut-off Date or the
related Subsequent Cut-Off Date, as the case may be;

              (liv) No instrument of release or waiver has been executed in
connection with the Mortgage Loans, and no Mortgagor has been released, in whole
or in part from its obligations in connection with a Mortgage Loan except in
connection with an assumption agreement which has been delivered to the Trustee;

              (lv) On the basis of a representation by the Mortgagor at the time
of origination of the Mortgage Loans, at least 90% of the Initial Mortgage
Loans, respectively, (by Cut-off Date Principal Balance) will be secured by
Mortgages on owner-occupied primary residence properties;

              (lvi) 13.26%, of the Initial Mortgage Loans, (by Cut-off Date
Principal Balance) provide for a balloon payment and each Mortgage Note with
respect to each such Mortgage Loan requires monthly payments of principal based
on 30 year amortization schedules and have scheduled maturity dates of 15 years
from the due date of the first monthly payment;

              (lvii) No Mortgage Loan was originated based on an appraisal of
the related Mortgaged Property made prior to completion of construction of the
improvements thereon;

              (lviii) None of the Mortgage Loans is a "buy down" mortgage loan;

              (lix)   [reserved];

              (lx) No selection procedure reasonably believed by the Seller to
be adverse to the interests of the Certificateholders was utilized in selecting
the Mortgage Loans;

              (lxi) The terms of the Mortgage Note related to each Adjustable
Rate Mortgage Loan provide that, following an initial period of two years or
three years following the month in which such Mortgage Loan was originated and
semiannually thereafter (each such date, an "Adjustment Date"), the Mortgage
Rate on such Mortgage Loan will be adjusted to equal the sum of (a) the related
Index and (b) a fixed percentage amount specified in the related Mortgage Note
(each, a "Gross Margin"); provided, however, that the Mortgage Rate generally
                          --------  -------
will not increase or decrease by the related Periodic Rate Cap, and will not
increase above a specified maximum Mortgage Rate over the life of the Adjustable
Rate Mortgage Loan (the "Maximum Mortgage Rate") or decrease below a specified
minimum Mortgage Rate over the life of the Adjustable Rate Mortgage Loan (the
"Minimum Mortgage Rate");

                                       19
<PAGE>

              (lxii) None of the Initial Mortgage Loans (by Cut-off Date
Principal Balance) are negative amortization loans, and none of the Subsequent
Mortgage Loans shall be negative amortization loans;

              (lxiii) No material misrepresentation, fraud or similar occurrence
with respect to a Mortgage Loan has taken place on the part of the Seller, its
affiliates or employees or any other person involved in the origination of the
Mortgage Loan or in the application for any insurance, including, but not
limited to the MI Policy, in relation to such Mortgage Loan;

              (lxiv) Each Mortgage Loan was originated by a mortgagee approved
by the Secretary of Housing and Urban Development pursuant to Sections 203 and
211 of the Act, a savings and loan association, a savings bank, a commercial
bank, credit union, insurance company or similar institution which is supervised
and examined by a federal or state authority;

              (lxv) With respect to each Mortgage Loan secured by manufactured
housing, such manufactured housing is permanently affixed to a foundation and
constitutes real estate under applicable state law;

              (lxvi) No Mortgage Loans are date of payment or simple interest
loans;

              (lxvii) The sale, transfer, assignment and conveyance of Mortgage
Loans by the Seller pursuant to this Purchase Agreement is not subject to and
will not result in any tax, fee or governmental charge payable by the Company,
the Trustee or the Certificate Administrator to any federal, state or local
government ("Transfer Taxes") other than Transfer Taxes which have or will be
paid by the Seller as due;

              (lxviii) [Reserved];

              (lxix) Approximately 99.96% of the Initial Mortgage Loans (by
Cut-Off Date Principal Balance) with a Loan-to-Value Ratio greater than 55% are
covered by a MI Policy issued by an MI Insurers;

              (lxx) Each of the Initial Mortgage Loans that is identified on
Schedule 1 hereto is covered by a MI Policy issued by the MI Insurers; (lxxi)
All requirements for the valid transfer of each MI Policy, including any
assignments or notices required in each MI Policy, have been satisfied; and

              (lxxii) As of the Closing Date with respect to each Initial
Mortgage Loan that is subject to a MI Policy and as of each Subsequent Transfer
Date with respect to each Subsequent Mortgage Loan that is subject to a MI
Policy, the Seller is unaware of any existing circumstances which would cause
the MI Insurers to deny a claim with respect to such Mortgage Loan.

     Upon discovery by the Seller or upon notice from the Company, the Trustee,
or the Certificate Administrator, as applicable, of a breach of any
representation or warranty in subsection (a) of this Section which materially
and adversely affects the interests of the

                                       20
<PAGE>

Certificateholders the Seller shall, within 45 days of its discovery or its
receipt of notice of such breach, either (i) cure such breach in all material
respects or (ii) to the extent that such breach is with respect to a Mortgage
Loan or a Related Document, either (A) repurchase such Mortgage Loan from the
Trustee at the Repurchase Price, or (B) substitute one or more Eligible
Substitute Mortgage Loans for such Mortgage Loan, in each case in the manner and
subject to the conditions and limitations set forth below.

     Upon discovery by the Seller or upon notice from the Company, the Trustee,
the Certificate Administrator or the Custodian, as applicable, of a breach of
any representation or warranty in this subsection (b) with respect to any
Mortgage Loan or upon the occurrence of a Repurchase Event, which materially and
adversely affects the value of the related Mortgage Loan or the interests of any
Certificateholders or of the Company or the Trustee in such Mortgage Loan
(notice of which shall be given to the Company and the Trustee by the Seller, if
it discovers the same) the Seller shall, within 90 days after the earlier of its
discovery or receipt of notice thereof, either cure such breach or Repurchase
Event in all material respects or either (i) repurchase such Mortgage Loan from
the Trustee at the Repurchase Price, or (ii) substitute one or more Eligible
Substitute Mortgage Loans for such Mortgage Loan, in each case in the manner and
subject to the conditions set forth below. The Repurchase Price for any such
Mortgage Loan repurchased by the Seller shall be deposited or caused to be
deposited by the Servicer in the Collection Account maintained by it pursuant to
Section 3.06 of the Pooling and Servicing Agreement.

     In the event that the Seller elects to substitute an Eligible Substitute
Mortgage Loan or Loans for a Deleted Mortgage Loan pursuant to this Section
3.01, the Seller shall deliver to the Custodian on behalf of the Trustee, with
respect to such Eligible Substitute Mortgage Loan or Loans, the original
Mortgage Note and all other documents and agreements as are required by Section
2.01 hereof, with the Mortgage Note endorsed as required by such Section 2.01
hereof. No substitution will be made in any calendar month after the
Determination Date for such month. Monthly Payments due with respect to Eligible
Substitute Mortgage Loans in the month of substitution shall not be part of the
Trust Fund and will be retained by the Servicer and remitted by the Servicer to
the Seller on the next succeeding Payment Date. For the month of substitution,
distributions to the Payment Account pursuant to the Pooling and Servicing
Agreement will include the Monthly Payment due on a Deleted Mortgage Loan for
such month and thereafter the Seller shall be entitled to retain all amounts
received in respect of such Deleted Mortgage Loan. The Servicer shall amend or
cause to be amended the Mortgage Loan Schedule to reflect the removal of such
Deleted Mortgage Loan and the substitution of the Eligible Substitute Mortgage
Loan or Loans and the Servicer shall deliver the amended Mortgage Loan Schedule
to the Certificate Administrator and the Trustee. Upon such substitution, the
Eligible Substitute Mortgage Loan or Loans shall be subject to the terms of this
Purchase Agreement and the Pooling and Servicing Agreement in all respects, the
Seller shall be deemed to have made the representations and warranties with
respect to the Eligible Substitute Mortgage Loan contained herein set forth in
this Section 3.01(b), to the extent set forth in the definition of "Eligible
Substitute Mortgage Loan", as of the date of substitution, and the Seller shall
be obligated to repurchase or substitute for any Eligible Substitute Mortgage
Loan as to which a Repurchase Event has occurred as provided herein. In
connection with the substitution of one or more Eligible Substitute Mortgage
Loans for one or more Deleted Mortgage Loans, the Servicer will

                                       21
<PAGE>

determine the amount (such amount, a "Substitution Adjustment Amount"), if any,
by which the aggregate principal balance of all such Eligible Substitute
Mortgage Loans as of the date of substitution is less than the aggregate
principal balance of all such Deleted Mortgage Loans (after application of the
principal portion of the Monthly Payments due in the month of substitution that
are to be distributed to the Payment Account in the month of substitution). The
Seller shall pay the amount of such shortfall to the Servicer for deposit into
the Collection Account on the day of substitution, without any reimbursement
therefor.

     Upon receipt by the Trustee of written notification, signed by a Servicing
Officer, of the deposit of such Repurchase Price or of such substitution of an
Eligible Substitute Mortgage Loan and deposit of any applicable Substitution
Adjustment Amount as provided above, the Custodian shall, on behalf of the
Trustee, cause to be released to the Seller the related Mortgage File for the
Mortgage Loan being repurchased or substituted for and the Trustee shall execute
and deliver such instruments of transfer or assignment prepared by the Servicer,
in each case without recourse, as shall be necessary to vest in the Seller or
its designee such Mortgage Loan released pursuant hereto and thereafter such
Mortgage Loan shall not be an asset of the Trustee.

     It is understood and agreed that the obligation of the Seller to cure any
breach with respect to or to repurchase or substitute for, any Mortgage Loan as
to which such a breach has occurred and is continuing shall, except to the
extent provided in Section 5.01 of this Purchase Agreement, constitute the sole
remedy respecting such breach available to the Company, the Trustee, the
Certificateholders (or the Certificate Administrator on behalf of the Trustee
for the benefit of Certificateholders) against the Seller.

     It is understood and agreed that the representations and warranties set
forth in this Section 3.01 shall survive delivery of the respective Mortgage
Files to the Certificate Administrator.

     (c) [reserved]

     Section 3.02  Company Representations and Warranties. The Company hereby
                   --------------------------------------
represents and warrants to the Seller as of the date hereof and as of the
Closing Date that:

     (a) The Company is duly organized and validly existing as a corporation in
good standing under the laws of the State of Delaware, with power and authority
to own its properties and to conduct its business as such properties are
currently owned and such business is presently conducted.

     (b) The Company is duly qualified to do business as a foreign corporation
in good standing and has obtained all necessary licenses and approvals in all
jurisdictions in which the ownership or lease of its property or the conduct of
its business shall require such qualifications and in which the failure to so
qualify would have a material adverse effect on the business, properties, assets
or condition (financial or other) of the Company and the ability of the Company
to perform under this Purchase Agreement.

                                       22
<PAGE>

     (c) The Company has the power and authority to execute and deliver this
Purchase Agreement and to carry out its terms; the Company has full power and
authority to purchase the property to be purchased from the Seller and the
Company has duly authorized such purchase by all necessary corporate action; and
the execution, delivery and performance of this Purchase Agreement have been
duly authorized by the Company by all necessary corporate action.

     (d) The consummation of the transactions contemplated by this Purchase
Agreement and the fulfillment of the terms hereof do not conflict with, result
in any breach of any of the terms and provisions of, or constitute (with or
without notice or lapse of time) a default under, the articles of incorporation
or bylaws of the Company, or any indenture, agreement or other instrument to
which the Company is a party or by which it is bound; nor result in the creation
or imposition of any Lien upon any of its properties pursuant to the terms of
any such indenture, agreement or other instrument (other than pursuant to the
Basic Documents); nor violate any law or, to the best of the Company's
knowledge, any order, rule or regulation applicable to the Company of any court
or of any federal or state regulatory body, administrative agency or other
governmental instrumentality having jurisdiction over the Company or its
properties.

     (e) The Company (A) is a solvent entity and is paying its debts as they
become due and (B) after giving effect to the transfer of the Mortgage Loans,
will be a solvent entity and will have sufficient resources to pay its debts as
they become due.

     Section 3.03 [reserved]

                                   ARTICLE IV

                               SELLER'S COVENANTS

     Section 4.01  Covenants of the Seller. The Seller hereby covenants as of
                   -----------------------
the date hereof and as of the Closing Date that, except for the transfer
hereunder, on and after the Closing Date, the Seller will not sell, pledge,
assign or transfer to any other Person, or grant, create, incur or assume any
Lien on, any Mortgage Loan, whether now existing or hereafter created, or any
interest therein; the Seller will notify the Certificate Administrator and the
Trustee of the existence of any such Lien on any Mortgage Loan immediately upon
discovery thereof; and the Seller will defend the right, title and interest of
the Trustee, on its own behalf and as assignee of the Company, in, to and under
the Mortgage Loans, whether now existing or hereafter created, against all
claims of third parties claiming through or under the Seller.

     In the event that the Custodian, the Certificate Administrator or the
Trustee receives actual notice of any Transfer Taxes arising out of the
transfer, assignment and conveyance of the Mortgage Loans, on written demand by
the Certificate Administrator, or upon the Seller's otherwise being given notice
thereof by the Certificate Administrator, the Seller shall pay any and all such
Transfer Taxes (it being understood that the Holders of the Certificates, the
Company, the Certificate Administrator and the Trustee shall have no obligation
to pay such Transfer Taxes).

                                       23
<PAGE>

     Section 4.02  Payment of Expenses.
                   -------------------

     (a) The Seller will pay on the Closing Date all expenses incident to the
performance of its obligations under this Purchase Agreement and the
Underwriting Agreement, including (i) the preparation, printing and any filing
of the preliminary prospectus, Prospectus Supplement and Prospectus (including
any schedules or exhibits and any document incorporated therein by reference)
originally filed and of each amendment or supplement thereto, (ii) the
preparation, printing and delivery to the Underwriter of this Purchase Agreement
and the Underwriting Agreement, the Pooling and Servicing Agreement and such
other documents as may be required in connection with the offering, purchase,
sale and delivery of the Certificates, (iii) the preparation, issuance and
delivery of the certificates for the Class A-1 Certificates to the Underwriter,
including any charges of DTC, CEDEL, S.A. and the Euroclear System in connection
therewith; (iv) the qualification of the Class A-1 Certificates, Mezzanine
Certificates and Class AIO Certificates under securities laws in accordance with
the provisions of Section 3(f) of the Underwriting Agreement, including filing
fees and the reasonable fees and disbursements of counsel for the Underwriter in
connection therewith and in connection with the preparation of the Blue Sky
Survey and any supplement thereto for delivery to potential investors, (v) in
addition to the initial printing and filing costs under (i) above, the printing
and delivery to the Underwriter of copies of each preliminary prospectus and of
the Prospectus and any amendments or supplements thereto for delivery to
potential investors, (vi) the fees and expenses of the Trustee, the Certificate
Administrator and the Custodian, including the fees and disbursements of counsel
for the Trustee, the Certificate Administrator and the Custodian in connection
with the Pooling and Servicing Agreement and the Certificates and (vii) any fees
payable in connection with the rating of the Certificates.

     (b) If the Underwriting Agreement is terminated by the Underwriter in
accordance with the provisions of Section 5 or Section 9(a)(i) thereof, the
Seller shall reimburse the Underwriter for all of their out-of-pocket expenses,
including the reasonable fees and disbursements of counsel for the Underwriter.

                                   ARTICLE V

                  CONDITIONS TO INITIAL MORTGAGE LOAN PURCHASE

     Section 5.01 Conditions of Company's Obligations. The Company's obligations
                  -----------------------------------
to purchase the Initial Mortgage Loans which it accepts for purchase hereunder
shall be subject to each of the following conditions:

     (a) the Mortgage File for each Initial Mortgage Loan shall have been
delivered in accordance with this Purchase Agreement;

     (b) the representations and warranties set forth in Section 3.01(b) hereof
with respect to each Initial Mortgage Loan shall be true as of the Closing Date;

     (c) the Underwriter or its affiliates shall have had an opportunity to
perform a due diligence review of each Mortgage Loan; and

                                       24
<PAGE>

     (d) the Seller shall have provided to the Underwriter or its affiliates
such other documents which are then required to have been delivered under this
Purchase Agreement or which are reasonably requested by the Underwriter or its
affiliates, which other documents may include UCC financing statements, a
favorable opinion or opinions of counsel with respect to matters which are
reasonably requested by the Underwriter, and/or an Officers' Certificate.

                                   ARTICLE VI

                          INDEMNIFICATION BY THE SELLER

                       WITH RESPECT TO THE MORTGAGE LOANS

     Section 6.01  Indemnification With Respect to the Mortgage Loans. The
                   --------------------------------------------------
Seller shall indemnify and hold harmless the Company from and against any loss,
liability or expense arising from the breach by the Seller of its
representations and warranties in Section 3.01 of this Purchase Agreement which
materially and adversely affects the value of any Mortgage Loan or the Company's
assignees' interest in any Mortgage Loan or from the failure by the Seller to
perform its obligations under this Purchase Agreement in any material respect.

     Section 6.02  Limitation on Liability of the Seller. None of the directors,
                   -------------------------------------
officers, employees or agents of the Seller shall be under any liability to the
Company, it being expressly understood that all such liability is expressly
waived and released as a condition of, and as consideration for, the execution
of this Purchase Agreement. Except as and to the extent expressly provided in
the Basic Documents, the Seller shall not be under any liability to the Trustee,
the Certificate Administrator, the Custodian or the Certificateholders. The
Seller and any director, officer, employee or agent of the Seller may rely in
good faith on any document of any kind prima facie properly executed and
submitted by any Person respecting any matters arising hereunder.

                                  ARTICLE VII

                                   TERMINATION

     Section 7.01  Termination.
                   -----------

     (a) Except as provided in Section 7.01(b) hereof, the respective
obligations and responsibilities of the Seller, the Company, the Trustee, the
Certificate Administrator and the Custodian created hereby shall terminate,
except for the Seller's indemnity obligations as provided herein, upon the
termination of the Trust Fund pursuant to the terms of the Pooling and Servicing
Agreement.

     (b) The Company may terminate this Purchase Agreement, by notice to the
Seller, at any time at or prior to the Closing Date:

              (i) if the Underwriting Agreement is terminated by the Underwriter
pursuant to the terms of the Underwriting Agreement or if there has been, since
the time of

                                       25
<PAGE>

execution of this Purchase Agreement or since the respective dates as of which
information is given in the Prospectus, any material adverse change in the
financial condition, earnings, business affairs or business prospects of the
Seller, whether or not arising in the ordinary course of business, or

              (ii) if there has occurred any material adverse change in the
financial markets in the United States, any outbreak of hostilities or
escalation thereof or other calamity or crisis or any change or development
involving a prospective change in national or international political, financial
or economic conditions, in each case the effect of which is such as to make it,
in the judgment of the Underwriter, impracticable to market the Class A-1
Certificates and the Mezzanine Certificates, or to enforce contracts for the
sale of the Class A-1 Certificates and the Mezzanine Certificates, or

              (iii) if trading in any securities of the Seller has been
suspended or limited by the Commission or the New York Stock Exchange, or if
trading generally on the American Stock Exchange or the New York Stock Exchange
or in the NASDAQ National Market System has been suspended or limited, or
minimum or maximum prices for trading have been fixed, or maximum ranges for
prices have been required, by any of said exchanges or by such system or by
order of the Commission, the National Association of Securities Dealers, Inc. or
any other governmental authority,

              (iv) if a banking moratorium has been declared by either Federal
or New York authorities,

              (v) either (A) a change in control of the Seller shall have
occurred other than in connection with and as a result of the issuance and sale
by the Seller or registered, publicly offered common stock; or (B) the
Underwriter determines in its sole discretion that any material adverse change
has occurred in the management of the Seller,

              (vi) there is (A) a material breach by the Seller of any
representation and warranty contained in this Purchase Agreement or the
Underwriting Agreement other than a representation or warranty relating to
particular Mortgage Loans, and the Underwriter has reason to believe in good
faith either that such breach is not curable within two (2) days or that such
breach may not have been cured in all material respects at the expiration of two
(2) days following discovery thereof by the Seller or (B) a failure by the
Seller to make any payment payable by it under this Purchase Agreement or (C)
any other failure by the Seller to observe and perform in any material respect
its material covenants, agreements and obligations with the Company, including
without limitation those contained in this Purchase Agreement, and the Company
has reason to believe in good faith that such failure may not have been cured in
all material respects at the expiration of two (2) days following discovery
thereof by the Seller, or

              (vii) the Seller fails to provide written notification to the
Underwriter of any change in its loan origination, acquisition or appraisal
guidelines or practices, or the Seller, without the prior consent of the
Underwriter (which shall not be unreasonably withheld), amends in any material
respect its loan origination, acquisition or appraisal guidelines or practices.

                                       26
<PAGE>

     If this Purchase Agreement is terminated pursuant to this Section 7.01(b),
such termination shall be without liability of any party to any other party
except as provided in Section 4.02 hereof.

                                  ARTICLE VIII

                            MISCELLANEOUS PROVISIONS

     Section 8.01  Amendment. This Purchase Agreement may be amended from time
                   ---------
to time by the Seller and the Company by written agreement signed by the Seller
and the Company, and if such amendment relates to the rights or obligations of
the Custodian, by the Custodian.

     Section 8.02  Governing Law. This Purchase Agreement shall be governed by
                   -------------
and construed in accordance with the laws of the State of New York and the
obligations, rights and remedies of the parties hereunder shall be determined in
accordance with such laws.

     Section 8.03  Notices. All demands, notices and communications hereunder
                   -------
shall be in writing and shall be deemed to have been duly given if personally
delivered at or mailed by registered mail, postage prepaid, addressed as
follows:

          (a)  if to the Seller:

               NovaStar Mortgage, Inc.
               1901 West 47th Place
               Suite 105
               Westwood, Kansas 66205
               Attention: Scott F. Hartman

or, such other address as may hereafter be furnished to the Company in writing
by the Seller.

          (b)  if to the Company:

               NovaStar Mortgage Funding Corporation
               1901 W. 47th Place
               Suite 105
               Westwood, Kansas 66205
               Attention: Kelly Meinders

or such other address as may hereafter be furnished to the Seller in writing by
the Company.

                                       27
<PAGE>

          (c)  if to the Certificate Administrator or the Trustee:

               Wells Fargo Bank Minnesota, N.A.
               1100 Broken Land Parkway
               Columbia, Maryland  21044
               Attention: NovaStar 2001-1

or such other address as may hereafter be furnished to the Seller in writing by
the Certificate Administrator.

          (d)  if to the Custodian:

               First Union National Bank
               4527 Metropolitan Court, Suite C
               Frederick, MD  21704
               Attention:  Robin Belanger, NovaStar 2001-1

or such other address as may hereafter be furnished to the Seller in writing by
the Custodian.

     Section 8.04  Severability of Provisions. If any one or more of the
                   --------------------------
covenants, agreements, provisions or terms of this Purchase Agreement shall be
held invalid for any reason whatsoever, then such covenants, agreements,
provisions or terms shall be deemed severable from the remaining covenants,
agreements, provisions or terms of this Purchase Agreement and shall in no way
affect the validity or enforceability of the other provisions of this Purchase
Agreement.

     Section 8.05  Relationship of Parties. Nothing herein contained shall be
                   -----------------------
deemed or construed to create a partnership or joint venture between the parties
hereto, and the services of the Seller shall be rendered as an independent
contractor and not as agent for the Company.

     Section 8.06  Counterparts. This Purchase Agreement may be executed in two
                   ------------
or more counterparts and by the different parties hereto on separate
counterparts, each of which, when so executed, shall be deemed to be an original
and such counterparts together shall constitute one and the same agreement.

     Section 8.07  Further Agreements. The Seller and the Company each agree to
                   ------------------
execute and deliver to the other such additional documents, instruments or
agreements as may be necessary or appropriate to effectuate the purposes of this
Purchase Agreement. Each of the Seller and the Company agrees to use its best
reasonable efforts to take all actions necessary to be taken by it to cause the
Class A-1 Certificates to be rated "Aaa" by Moody's and "AAA" by S&P, the Class
AIO Certificates to be rated "Aaa" by Moody's and "AAAr" by S&P, the Class M-1
Certificates to be rated "Aa2" by Moody's and "AA" by S&P, the Class M-2
Certificates to be rated "A2" by Moody's and "A" by S&P, the Class M-3
Certificates to be rated "Baa2" by Moody's and "BBB" by S&P, the Class P
Certificates to be rated "AAA" by Moody's, and each party will cooperate with
the other in connection therewith.

                                       28
<PAGE>

     Section 8.08  Intention of the Parties. It is the intention of the parties
                   ------------------------
that (i) the Company is purchasing on the Closing Date, and the Seller is
selling on the Closing Date, the Initial Mortgage Loans, rather than the Company
providing to the Seller a loan secured by the Initial Mortgage Loans on the
Closing Date, (ii) the Trustee is purchasing on the Closing Date, and the
Company is selling on the Closing Date, the Initial Mortgage Loans, rather than
the Trustee providing to the Company a loan secured by the Initial Mortgage
Loans, (iii) the Company will be purchasing on each Subsequent Transfer Date,
and the Seller will be selling on each Subsequent Transfer Date, the related
Subsequent Mortgage Loans, rather than the Company providing to the Seller a
loan secured by the related Subsequent Mortgage Loans on each Subsequent
Transfer Date, and (iv) the Trustee will be purchasing on each Subsequent
Transfer Date, and the Company will be selling on each Subsequent Transfer Date,
the related Subsequent Mortgage Loans, rather than the Trustee providing to the
Company a loan secured by the related Subsequent Mortgage Loans on each
Subsequent Transfer Date. Accordingly, the parties hereto each intend to treat
these transactions as (i) a sale by the Seller, and a purchase by the Company,
of the Initial Mortgage Loans on the Closing Date, (ii) a sale by the Company,
and a purchase by the Trustee, of the Initial Mortgage Loans on the Closing
Date, (iii) a sale by the Seller, and a purchase by the Company, of the related
Subsequent Mortgage Loans on each Subsequent Transfer Date, and (iv) a sale by
the Company, and a purchase by the Trustee, of the related Subsequent Mortgage
Loans on each Subsequent Transfer Date.

     Section 8.09  Successors and Assigns; Assignment of Purchase Agreement.
                   --------------------------------------------------------
This Purchase Agreement shall bind and inure to the benefit of and be
enforceable by the Seller, the Company, the Trustee, the Certificate
Administrator, the Custodian and their respective successors and assigns. The
obligations of the Seller under this Purchase Agreement cannot be assigned or
delegated to a third party without the consent of the Company, which consent
shall be at the Company's discretion. The parties hereto acknowledge that (i)
the Company is acquiring the Initial Mortgage Loans for the purpose of selling
them to the Trustee, who will hold the Initial Mortgage Loans for the benefit of
the Certificateholders and (ii) the Company is acquiring the Subsequent Mortgage
Loans for the purpose of selling them to the Trustee, who will hold the
Subsequent Mortgage Loans for the benefit of the Certificateholders. As an
inducement to the Company and the Trustee to purchase the Mortgage Loans, the
Seller acknowledges and consents to the assignment by the Company to the Trustee
of all of Company's rights or remedies against the Seller pursuant to this
Purchase Agreement and to the enforcement or exercise of any rights against the
Seller pursuant to this Purchase Agreement by the Company and the Trustee. Such
enforcement of a right or remedy by the Company, or the Trustee, as applicable,
shall have the same force and effect as if the right or remedy had been enforced
or exercised by the Company directly.

     Section 8.10  Survival. The representations and warranties made herein by
                   --------
the Seller and the provisions of Article V hereof shall survive the purchase of
the Mortgage Loans hereunder.

     Section 8.11  Liability of the Trustee and the Custodian. Each of the
                   ------------------------------------------
Trustee and the Custodian is entering into the Basic Documents to which it is a
party solely as Trustee or the Custodian, hereunder and thereunder, and not in
its individual capacity, and all persons having any claim against the Trustee
and Custodian, respectively, by reason of the transactions

                                       29
<PAGE>

contemplated by this Agreement or any other Basic Document shall look only to
the Trust Fund for payment or satisfaction thereof.

                                       30
<PAGE>

          IN WITNESS WHEREOF, the Seller, the Company, the Certificate
Administrator, the Trustee and the Custodian have caused their names to be
signed to this Mortgage Loan Purchase Agreement by their respective officers
thereunto duly authorized as of the day and year first above written.

                             NOVASTAR MORTGAGE, INC.
                                 as Seller

                             By: /s/ Kelly Meinders
                                 ------------------------------
                                 Name: Kelly Meinders
                                 Title:   Vice President

                             NOVASTAR MORTGAGE FUNDING   CORPORATION
                                 as Company

                             By: /s/ Kelly Meinders
                                 ------------------------------
                                 Name: Kelly Meinders
                                 Title:   Vice President

                             WELLS FARGO BANK MINNESOTA, N.A.
                                 as Trustee and Certificate Administrator

                             By: /s/ Amy Doyle
                                 ------------------------------
                                 Name: Amy Doyle
                                 Title:   Assistant Vice President

                             FIRST UNION NATIONAL BANK,
                                 as Custodian

                             By: /s/ Ronald L Fisher
                                 ------------------------------
                                 Name: Ronald L. Fisher
                                 Title: Vice President

               [Mortgage Loan Purchase Agreement Signature Page]
<PAGE>

                                    EXHIBIT 1

                         INITIAL MORTGAGE LOAN SCHEDULE
<PAGE>

                                  EXHIBIT 2(A)

                     SELLER'S SUBSEQUENT TRANSFER INSTRUMENT

          Pursuant to this Seller's Subsequent Transfer Instrument (the
"Seller's Instrument"), dated as of March 1, 2001, between NovaStar Mortgage,
Inc. as seller (the "Seller"), and NovaStar Mortgage Funding Corporation, as
company (the "Company"), and pursuant to the Mortgage Loan Purchase Agreement,
dated as of March 1, 2001 (the "Purchase Agreement"), among the Seller, the
Company, Wells Fargo Bank Minnesota, N.A., as Certificate Administrator (the
"Certificate Administrator") and as Trustee (the "Trustee"), and First Union
National Bank, as custodian (the "Custodian"), the Seller and the Company agree
to the sale by the Seller and the purchase by the Company of the Subsequent
Mortgage Loans listed on the attached Mortgage Loan Schedule (the "Subsequent
Mortgage Loans") and the related MI Policies.

          Capitalized terms used and not defined herein have their respective
meanings as set forth in the definitions contained in the Pooling and Servicing
Agreement, dated as of March 1, 2001 (the "Pooling and Servicing Agreement"),
between the Trustee, the Certificate Administrator, the Custodian, the Company,
and the Seller/Servicer which definitions are incorporated by reference herein.
All other capitalized terms used herein shall have the meanings specified
herein.

          Section 1.  Conveyance of Subsequent Mortgage Loans.
                      ---------------------------------------

          (a) The Seller does hereby sell, transfer, assign, set over and convey
to the Company, without recourse, all of its right, title and interest in and to
the Subsequent Mortgage Loans and the related MI Policies, all scheduled
payments of principal and interest on the Subsequent Mortgage Loans due after
the Subsequent Cut-off Date, and all other payments of principal and interest on
the Subsequent Mortgage Loans collected after the Subsequent Cut-off Date (minus
that portion of any such payment which is allocable to the period prior to the
Subsequent Cut-off Date); provided, however, that no scheduled payments of
principal and interest due on or before the Subsequent Cut-off Date and
collected after the Subsequent Cut-off Date shall belong to the Company pursuant
to the terms of this Seller's Instrument. The Seller, contemporaneously with the
delivery of this Seller's Instrument, has delivered or caused to be delivered to
the Custodian, at the direction of the Company, each item set forth in Section
2.02(b) of the Purchase Agreement with respect to such Subsequent Mortgage Loans
and the related MI Policies. The transfer to the Company by the Seller of the
Subsequent Mortgage Loans identified on the attached Mortgage Loan Schedule
shall be absolute and is intended by the Seller, the Company, the Certificate
Administrator, the Trustee and the Certificateholders to constitute and to be
treated as a sale by the Seller.

          The parties hereto intend that the transactions set forth herein
constitute a sale by the Seller to the Company on the Subsequent Transfer Date
of all the Seller's right, title and interest in and to the Subsequent Mortgage
Loans and the related MI Policies, and other property as and to the extent
described above. In the event the transactions set forth herein shall be deemed
not to be a sale, the Seller hereby grants to the Company as of the Subsequent
Transfer
<PAGE>

Date a security interest in all of the Seller's right, title and interest in, to
and under the Subsequent Mortgage Loans, and such other property, to secure all
of the Seller's obligations hereunder, and this Purchase Agreement shall
constitute a security agreement under applicable law, and in such event, the
parties hereto acknowledge that the Custodian, in addition to holding the
Subsequent Mortgage Loans and the related MI Policies on behalf of the Trustee
for the benefit of the Certificateholders, holds the Subsequent Mortgage Loans
and the related MI Policies as designee and agent of the Company. The Seller
agrees to take or cause to be taken such actions and to execute such documents,
including without limitation the filing of all necessary UCC-1 financing
statements filed in the State of Maryland and the State of Kansas (which shall
be submitted for filing as of the Subsequent Transfer Date), any continuation
statements with respect thereto and any amendments thereto required to reflect a
change in the name or corporate structure of the Seller or the filing of any
additional UCC-1 financing statements due to the change in the principal office
of the Seller, as are necessary to perfect and protect the interests of the
Company and its assignees in each Subsequent Mortgage Loan, the related MI
Policies and the proceeds thereof.

          (b) The expenses and costs relating to the delivery of the Subsequent
Mortgage Loans, this Seller's Instrument and such other items required under the
Purchase Agreement shall be borne by the Seller.

          (c) Additional terms of the sale are set forth on Attachment A hereto.

          Section 2.  Representations and Warranties; Conditions Precedent.
                      ----------------------------------------------------

          (a) The Seller hereby affirms the representations and warranties set
forth in Section 3.01 of the Purchase Agreement that relate to the Seller and
the Subsequent Mortgage Loans as of the date hereof. The Seller hereby confirms
that each of the conditions set forth in Section 2.02(b) of the Purchase
Agreement are satisfied as of the date hereof and further represents and
warrants that each Subsequent Mortgage Loan complies with the requirements of
this Seller's Instrument and Section 2.02(c) of the Purchase Agreement.

          (b) The Seller is solvent, is able to pay its debts as they become due
and has capital sufficient to carry on its business and its obligations
hereunder; it will not be rendered insolvent by the execution and delivery of
this Seller's Instrument or by the performance of its obligations hereunder nor
is it aware of any pending insolvency; no petition of bankruptcy (or similar
insolvency proceeding) has been filed by or against the Seller prior to the date
hereof;

          (c) All terms and conditions of the Purchase Agreement are hereby
ratified and confirmed; provided, however, that in the event of any conflict the
provisions of this Seller's Instrument shall control over the conflicting
provisions of the Purchase Agreement.

          Section 3.  Recordation of the Seller's Instrument.  To the extent
                      --------------------------------------
permitted by applicable law, this Seller's Instrument, or a memorandum thereof
if permitted under applicable law, is subject to recordation in all appropriate
public offices for real property records in all of the counties or other
comparable jurisdictions in which any or all of the properties subject to the
Mortgages are situated, and in any other appropriate public recording office or
elsewhere, such

                                       2
<PAGE>

recordation to be effected by the Servicer, but only when accompanied by an
Opinion of Counsel to the effect that such recordation materially and
beneficially affects the interests of the Certificateholders or is necessary for
the administration or servicing of the Mortgage Loans.

          Section 4.  Governing Law.  This Seller's Instrument shall be
                      -------------
construed in accordance with the laws of the State of New York and the
obligations, rights and remedies of the parties hereunder shall be determined in
accordance with such laws, without giving effect to principles of conflicts of
law.

          Section 5.  Counterparts.  This Seller's Instrument may be executed in
                      ------------
one or more counterparts and by the different parties hereto on separate
counterparts, each of which, when so executed, shall be deemed to be an
original; such counterparts, together, shall constitute one and the same
instrument.

          Section 6.  Successors and Assigns.  This Seller's Instrument shall
                      ----------------------
inure to the benefit of and be binding upon the Seller and the Company and their
respective successors and assigns. The Certificate Administrator and the Trustee
shall be express third party beneficiaries hereto.

                                       3
<PAGE>

          IN WITNESS WHEREOF, the parties hereto have executed and delivered
this Seller's Instrument as of the day and year first written above.

                         NOVASTAR MORTGAGE, INC.,
                              as Seller

                              By: _____________________________
                              Name: Kelly Meinders
                              Title: Vice President

                         NOVASTAR MORTGAGE FUNDING CORPORATION,
                              as Company

                              By: _____________________________
                              Name: Kelly Meinders
                              Title: Vice President

              (Signature Page to Mortgage Loan Purchase Agreement)

                                       4
<PAGE>

       NOVASTAR HOME EQUITY LOAN ASSET-BACKED CERTIFICATES, SERIES 2001-1

             ATTACHMENT A TO SELLER'S SUBSEQUENT TRANSFER INSTRUMENT

                               _________ __, 2001

A.  Profile of Subsequent Mortgage Loans:

         1.  Subsequent Cut-off Date:              ____ __, 2001

         2.  Subsequent Transfer Date:             ____ __, 2001

         3.  Aggregate Principal Balance of the Subsequent Mortgage
Loans as of the Subsequent Cut-off Date:  $____

         4.  Purchase Price:                       100.00%

B.  As to all the Subsequent Mortgage Loans the subject of this Instrument:

    I.    Longest stated term to maturity:                      360 months
    II.   Minimum Mortgage Rate:                                     ____%
    III.  Maximum Mortgage Rate:                                     ____%
    IV.   WAC of all Mortgage Loans:                                 ____%
    V.    WAM of all Mortgage Loans:                                 ____%
    VI.   Largest Principal Balance:                              $  ____
    VII.  Non-owner occupied Mortgaged Properties:                   ____%
    VIII. California zip code concentration:                         ____%
    IX.   Condominiums:                                              ____%
    X.    Single-family:                                             ____%
    XI.   Weighted average term since origination:                   ____ months
    XII.  Mortgage Loans Covered by MI Policies                      ____%
<PAGE>

                                  EXHIBIT 2(B)

                    COMPANY'S SUBSEQUENT TRANSFER INSTRUMENT

          Pursuant to this Company's Subsequent Transfer Instrument (the "
Company's Instrument"), dated as of _______ __, 2001, between NovaStar Mortgage
Funding Corporation, as company (the "Company"), and Wells Fargo Bank Minnesota,
N.A., as trustee (the "Trustee"), and pursuant to the Mortgage Loan Purchase
Agreement, dated as of March 1, 2001 (the "Purchase Agreement"), among NovaStar
Mortgage, Inc., as seller (the "Seller"), the Company, Wells Fargo Bank
Minnesota, N.A., as Trustee and as Certificate Administrator (the "Certificate
Administrator"), and First Union National Bank, as custodian (the "Custodian"),
the Company and the Trustee agree to the sale by the Company and the purchase by
the Trustee of the subsequent Mortgage Loans listed on the attached Mortgage
Loan Schedule (the "Subsequent Mortgage Loans") and the related MI Policies, and
the pledge of the Subsequent Mortgage Loans by the Trustee.

          Capitalized terms used and not defined herein have their respective
meanings as set forth in the definitions contained in the Pooling and Servicing
Agreement, dated as of March 1, 2001 (the "Pooling and Servicing Agreement"),
between the Certificate Administrator, the Trustee, the Custodian, the Company
and the Servicer which definitions are incorporated by reference herein. All
other capitalized terms used herein shall have the meanings specified herein.

          Section 1.  Conveyance of Subsequent Mortgage Loans.
                      ---------------------------------------

          (a) The Company does hereby sell, transfer, assign, set over and
convey to the Trustee, without recourse, (i) all of its right, title and
interest in and to the Subsequent Mortgage Loans and the related MI Policies,
all scheduled payments of principal and interest on the Subsequent Mortgage
Loans due after the Subsequent Cut-off Date, and all other payments of principal
and interest on the Subsequent Mortgage Loans collected after the Subsequent
Cut-off Date (minus that portion of any such payment which is allocable to the
period prior to the Subsequent Cut-off Date); provided, however, that no
scheduled payments of principal and interest due on or before the Subsequent
Cut-off Date and collected after the Subsequent Cut-off Date shall belong to the
Trustee pursuant to the terms of this Company's Instrument and (ii) all of its
right, title and interest in and to the Seller's Subsequent Transfer Instrument,
dated as of ______ __, 2001 (the "Seller's Instrument"), between the Seller and
the Company. The Company, contemporaneously with the delivery of this Company's
Instrument, has delivered or caused to be delivered to the Custodian each item
set forth in Section 2.02(b) of the Purchase Agreement with respect to such
Subsequent Mortgage Loans. The transfer to the Trustee by the Company of the
Subsequent Mortgage Loans identified on the attached Mortgage Loan Schedule and
the related MI Policies shall be absolute and is intended by the Company, the
Trustee, the Certificate Administrator and the Certificateholders to constitute
and to be treated as a sale by the Company.

          The parties hereto intend that the transactions set forth herein
constitute a sale by the Company to the Trustee on the Subsequent Transfer Date
of all the Company's right, title and
<PAGE>

interest in and to the Subsequent Mortgage Loans and the related MI Policies,
and other property as and to the extent described above. In the event the
transactions set forth herein shall be deemed not to be a sale, the Company
hereby grants to the Trustee as of the Subsequent Transfer Date a security
interest in all of the Company's right, title and interest in, to and under the
Subsequent Mortgage Loans, and such other property, to secure all of the
Company's obligations hereunder, and this Company's Instrument shall constitute
a security agreement under applicable law, and in such event, the parties hereto
acknowledge that the Custodian on behalf of the Trustee, in addition to holding
the Subsequent Mortgage Loans and the related MI Policies for the benefit of the
Certificateholders, holds the Subsequent Mortgage Loans and the related MI
Policies as designee and agent of the Trustee. The Company agrees to take or
cause to be taken such actions and to execute such documents, including without
limitation the filing of all necessary UCC-1 financing statements filed in the
State of Delaware and the State of Kansas (which shall be submitted for filing
as of the Subsequent Transfer Date), any continuation statements with respect
thereto and any amendments thereto required to reflect a change in the name or
corporate structure of the Company or the filing of any additional UCC-1
financing statements due to the change in the principal office of the Company,
as are necessary to perfect and protect the interests of the Trustee and its
assignees in each Subsequent Mortgage Loan, the related MI Policies and the
proceeds thereof.

          (b) The expenses and costs relating to the delivery of the Subsequent
Mortgage Loans, this Company's Instrument and such other items required under
the Purchase Agreement shall be borne by the Company.

          Section 2.  Representations and Warranties; Conditions Precedent.
                      ----------------------------------------------------

          (a) The Company hereby affirms the representations and warranties set
forth in Section 3.02 of the Purchase Agreement that relate to the Company as of
the date hereof.

          (b) The Company is solvent, is able to pay its debts as they become
due and has capital sufficient to carry on its business and its obligations
hereunder; it will not be rendered insolvent by the execution and delivery of
this Company's Instrument or by the performance of its obligations hereunder nor
is it aware of any pending insolvency; no petition of bankruptcy (or similar
insolvency proceeding) has been filed by or against the Company prior to the
date hereof;

          (c) All terms and conditions of the Purchase Agreement are hereby
ratified and confirmed; provided, however, that in the event of any conflict the
provisions of this Company's Instrument shall control over the conflicting
provisions of the Mortgage Loan Purchase Agreement.

          Section 3.  Grant from Trustee to Certificate Administrator.  The
                      -----------------------------------------------
Trustee, as trustee for the benefit of the Certificateholders, hereby grants as
of the Subsequent Transfer Date to the Certificate Administrator, to secure all
of the Trustee's obligations under the Pooling and Servicing Agreement, all of
the Trustee's right, title and interest in and to, whether now existing or
hereafter created, (a) the Subsequent

                                       2
<PAGE>

Mortgage Loans, the related MI Policies and the proceeds thereof and all rights
under the Related Documents (including the related Mortgage Files); (b) all
funds on deposit from time to time in the Collection Account allocable to the
Subsequent Mortgage Loans, excluding any investment income from such funds; (c)
all its rights under the Seller's Instrument and this Company's Instrument; and
(d) all present and future claims, demands, causes and choses in action in
respect of any or all of the foregoing and all payments on or under, and all
proceeds of every kind and nature whatsoever in respect of, any or all of the
foregoing and all payments on or under, and all proceeds of every kind and
nature whatsoever in the conversion thereof, voluntary or involuntary, into cash
or other liquid property, all cash proceeds, accounts, accounts receivable,
notes, drafts acceptances, checks, deposit accounts, rights to payment of any
and every kind, and other forms of obligations and receivables, instruments and
other property which at any time constitute all or part of or are included in
the proceeds of any of the foregoing.

          Section 4.  Recordation of Instrument.  To the extent permitted by
                      -------------------------
applicable law, this Company's Instrument, or a memorandum thereof if permitted
under applicable law, is subject to recordation in all appropriate public
offices for real property records in all of the counties or other comparable
jurisdictions in which any or all of the properties subject to the Mortgages are
situated, and in any other appropriate public recording office or elsewhere,
such recordation to be effected by the Servicer, but only when accompanied by an
Opinion of Counsel to the effect that such recordation materially and
beneficially affects the interests of the Certificateholders or is necessary for
the administration or servicing of the Mortgage Loans.

          Section 5.  Governing Law.  This Company's Instrument shall be
                      -------------
construed in accordance with the laws of the State of New York and the
obligations, rights and remedies of the parties hereunder shall be determined in
accordance with such laws, without giving effect to principles of conflicts of
law.

          Section 6.  Counterparts.  This Company's Instrument may be executed
                      ------------
in one or more counterparts and by the different parties hereto on separate
counterparts, each of which, when so executed, shall be deemed to be an
original; such counterparts, together, shall constitute one and the same
instrument.

          Section 7.  Successors and Assigns.  This Company's Instrument shall
                      ----------------------
inure to the benefit of and be binding upon the Company and the Trustee and
their respective successors and assigns. The Certificate Administrator shall be
an express third party beneficiary hereto.

                                       3
<PAGE>

          IN WITNESS WHEREOF, the parties hereto have executed and delivered
this Company's Instrument as of the day and year first written above.

                        NOVASTAR MORTGAGE FUNDING CORPORATION,
                              as Company

                              By: _______________________________
                              Name: Kelly Meinders
                              Title: Vice President

                         WELLS FARGO BANK MINNESOTA, N.A.
                              as Trustee and Certificate Administrator

                              By: _______________________________
                              Name: _____________________________
                              Title: ____________________________

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