Homeownership: Problems Persist With HUD's 203(k) Home
Rehabilitation Mortgage Insurance Program (10-SEP-01,
GAO-01-1124T).
The Department of Housing and Urban Development's (HUD) 203(K)
Home Rehabilitation Mortgage Insurance Program helps promote the
rehabilitation and repair of housing by combining, in one insured
mortgage, the funds needed to purchase and rehabilitate a
single-family home. The loans are made by banks and other private
lenders from their own funds and are insured by HUD's Federal
Housing Administration. The program's history of waste, fraud,
and abuse prompted a GAO review of HUD program oversight about
two years ago. The 203(K) program is inherently more risky than
HUD's principal single-family loan insurance program because its
rehabilitation component makes it more complex and susceptible to
misuse. HUD's Inspector General and others noted such risks in
1997 and 1998 reports on the department's management of the
program. HUD was not adequately targeting 203(K) loans and
lenders for review, properly training and overseeing
consultants/inspectors, and monitoring nonprofit organization's
participation in the program.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-01-1124T
ACCNO: A01764
TITLE: Homeownership: Problems Persist With HUD's 203(k) Home
Rehabilitation Mortgage Insurance Program
DATE: 09/10/2001
SUBJECT: Government guaranteed loans
Housing programs
Housing repairs
Mortgage loans
Mortgage programs
Mortgage protection insurance
HUD 203(k) Home Rehabilitation Mortgage
Insurance Program
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GAO-01-1124T
Testimony Before the Subcommittee on Oversight and Investigations, House
Financial Services Committee, House of Representatives
United States General Accounting Office
GAO For Release on Delivery Expected at 10: 00 a. m. EDT Monday September
10, 2001
HOMEOWNERSHIP Problems Persist With HUD?s 203( k) Home Rehabilitation
Mortgage Insurance Program
Statement of Stanley J. Czerwinski Director, Physical Infrastructure Issues
GAO- 01- 1124T
Page 1 GAO- 01- 1124T Homeownership
Madame Chairwoman and Members of the Subcommittee: We are here today to
testify on the Department of Housing and Urban Development?s (HUD) 203( k)
Home Rehabilitation Mortgage Insurance Program. The 203( k) program was
established to help promote the rehabilitation and repair of housing through
a program that combines, in one insured mortgage, the funds needed to
purchase and rehabilitate a single- family home. The loans are made by banks
and other private lenders from their own funds and are insured by HUD?s
Federal Housing Administration (FHA). The 203( k) program has a history of
waste, fraud, and abuse that resulted in our review of HUD?s oversight of
the program approximately 2 years ago. 1 My testimony today will summarize
the findings and recommendations of our report as well as HUD?s actions on
our recommendations since the report was issued.
In summary, our work showed: The 203( k) program is inherently more risky
than HUD?s principal singlefamily loan insurance program because its
rehabilitation component
makes it more complex and susceptible to misuse. HUD?s Inspector General and
others have noted such risks in 1997 and 1998 reports on the department?s
management of the program. HUD was not adequately targeting 203( k) loans
and lenders for review,
properly training and overseeing consultants/ inspectors, and monitoring
nonprofit organization?s participation in the program. HUD has implemented
three of the four recommendations we made to address these three areas.
The 203( k) Home Rehabilitation Mortgage Insurance Program is HUD?s primary
program for rehabilitating and repairing single- family homes. 2 Because
loans insured under this program have characteristics of both home purchase
and construction loans, lenders who want to get a loan insured under the
203( k) program must follow a more complex process to approve and disburse
the loans than they would under FHA?s other mortgage loan insurance
programs. The program provides borrowers the
1 Homeownership: Problems Persist with HUD?s 203( k) Home Rehabilitation
Loan Program (GAO/ RCED- 99- 124, June 14, 1999) 2 The Rehabilitation Home
Mortgage Insurance program was authorized by section 203( k) of the National
Housing Act, as amended, 12 U. S. C. 1709( k). Background
Page 2 GAO- 01- 1124T Homeownership
convenience of financing both the purchase or refinancing of a house and the
cost of its rehabilitation through a single mortgage. Eligible borrowers may
include the owner/ occupant, nonprofit organizations, and investors,
although there has been a moratorium on investors? eligibility since October
1996. 3 The program protects lenders against financial losses by insuring a
loan for the full value of the rehabilitated home before the rehabilitation
process begins. If the borrower defaults and the lender subsequently
forecloses on the loan, the lender can file an insurance claim with HUD for
the unpaid balance of the loan.
Although the 203( k) program was established in its present form in 1978, it
was not widely used until 1994, when HUD began promoting and streamlining
the program to make it more user- friendly for borrowers and lenders. As a
result of these efforts, the number of 203( k) loans that HUD insured grew
from about 4, 000 in fiscal year 1994 to over 18,000 in fiscal year 1997.
From this peak, the number of insured 203( k) loans fell to about 10,000 in
fiscal year 2000. As of July 31, 2001, the total value of HUD?s 203( k)
portfolio was approximately $4.5 billion.
The 203( k) program poses inherent risks because it is much more complex
than HUD?s largest single- family loan program, the 203( b) program. The
203( k) program?s complexity stems from the rehabilitation component of the
program, which (1) relies heavily on estimates, reports, and opinions; (2)
has many underwriting and funding steps; and (3) involves participants other
than the borrower and the lender. For example, to close a 203( k) loan, a
lender must set- aside in an escrow account the estimated funds to pay for
the rehabilitation. A HUD- approved consultant is often needed to determine
the extent of work that must be done to rehabilitate a property and the
estimated cost of that work. In addition, a HUD- approved inspector is
needed to monitor the progress of the rehabilitation and cosign with the
borrower any request of escrow funds.
The program?s high degree of risk is also reflected in the poorer
performance of 203( k) loans compared with loans made under the 203( b)
program- HUD?s largest single- family loan program. For example, for loans
made from fiscal years 1994 through 1996, we found that as of September 30,
1998, the cumulative claim rates for 203( k) loans were
3 Because of abuses by investors in the program, a moratorium on investor
participation was implemented in October 1996. The 203( k) Program
Design Is Inherently Risky
Page 3 GAO- 01- 1124T Homeownership
almost double the rates for 203( b) loans. A claim results when a loan goes
into default and results in a claim being filed against the insurance fund.
In addition, we found that the 203( k) program was expected to incur net
losses of over $25 million for loans insured in fiscal years 1994 through
1998, while the 203( b) program was expected to incur net gains for the same
period. Consistent with these findings, a 1998 study by HUD contractors
asserted that the 203( k) program posed a high risk of loss to the
department and that this risk had been reflected in high default and claim
rates.
Both internal and outside reviews of the 203( k) program have concluded that
under its current design, the program is susceptible to a variety of
problems. For example, HUD?s Inspector General reported in 1997 that the
program?s design encouraged risky property deals, overstated property
appraisals, and phony or excessive fees. In addition, an internal HUD study
of the 203( k) program identified several inherent program risks, including
the failure of participants to accurately estimate the cost of
rehabilitation or to complete rehabilitation work in an acceptable manner.
We also found that outside reviews of the 203( k) program concluded that
under its current design, the program is susceptible to a variety of
problems. For example, in October 1998, contractors hired by HUD to study
the 203( k) program reported that the department had done little to reduce
the risks of the program. The contractor?s draft report identified several
major risks associated with the 203( k) program, including program
complexity, insufficient lender monitoring, inadequate guidance concerning
consultants, hesitant management direction, and increased loss potential
from nonprofit organizations.
During our 1999 review, we found that HUD had not implemented the oversight
procedures necessary to mitigate the 203( k) program?s unique risks and
potential for abuse. Specifically, we found that HUD was not (1) adequately
targeting 203( k) loans and lenders for review, (2) properly training and
overseeing consultants and home inspectors, and (3) adequately monitoring
nonprofit organizations? participation in the program.
HUD?s four homeownership centers are responsible for the general management
of the 203( k) program in their respective regions. The centers perform
technical reviews- desktop audits of loans already insured by FHA- to
determine the quality of underwriting for specific loans. They Program Risk
Noted in
Studies HUD?s Oversight of the 203( k) Program Was Inadequate
Page 4 GAO- 01- 1124T Homeownership
also conduct quality assurance reviews- in- depth reviews of a lender?s
troubled loans and internal control systems for originating loans- to assess
the lenders? performance and operations. Although HUD was aware of the high-
risk nature of the 203( k) program, we found that the homeownership centers
did not target 203( k) loans for technical reviews. Furthermore, concerning
the 203( k) loans they did review, they did not send the detailed results of
their evaluations to the lenders. Consequently, the lenders did not have the
information necessary to act on the problems that were uncovered by HUD?s
review. We recommended that HUD improve its identification of lenders?
underwriting violations, as well as its notification and penalization of
lenders who commit underwriting violations. HUD has not completed action on
this recommendation. HUD, however, is in the process of hiring a contractor
to review the results of its desk reviews of 203( k) lenders and develop
criteria for assessing the risks associated with 203( k) lenders.
We also found that while the homeownership centers had conducted quality
assurance reviews of lenders participating in the 203( k) program, they did
not specifically target 203( k) loans for review. Officials at two of the
centers said they felt that they did not have staff who were qualified to
evaluate a lender?s underwriting of 203( k) loans. Furthermore, HUD was
unable to tell us how many 203( k) loans had been examined as part of its
quality assurance reviews. We recommended that HUD target high- risk 203( k)
lenders for quality assurance reviews. In response, HUD issued specific
procedures in May 2000 for identifying high- risk 203( k) lenders and
targeting them for annual monitoring.
Although consultants and inspectors are key participants in the 203( k)
program, we found that HUD had no uniform criteria for their training,
approval, or evaluation. Consultants and inspectors are used to perform home
inspections, identify health and safety problems, and provide descriptions
of the work to be performed and cost estimates for homebuyers. In addition
to having at least 3 years of specialized experience, consultants and
inspectors must receive training in the 203( k) program. However, at two of
the four homeownership centers we visited, HUD had not trained any 203( k)
consultants and inspectors. In addition, three of the four centers had not
evaluated the performance of their consultants or inspectors. Finally, we
also found cases in which HUD failed to address consultants? abuses or
incompetence. For example, according to customer complaints we reviewed, a
203( k) inspector in Chicago allowed a contractor to receive thousands of
dollars for work that the contractor either did not do or did inadequately.
We recommended that HUD establish strict criteria to ensure that
consultants/ inspectors are
Page 5 GAO- 01- 1124T Homeownership
well versed in residential construction/ rehabilitation and cost estimating.
In response, HUD issued guidance on July 26, 2000, that sets new standards
and procedures for 203( k) consultants participation in the program.
Although approved nonprofit organizations can obtain 203( k) loans, we found
that HUD was not adequately ensuring their compliance with HUD?s guidelines
for participating in the program. HUD?s guidelines require the homeownership
centers to recertify nonprofit organizations every 2 years. However, at
three of the four centers we visited, we found no evidence that the centers
had recertified any of their approved nonprofit organizations. Loans to
nonprofit organizations represent a small portion of the 203( k) program,
but the performance of these loans has been significantly worse than for any
other borrower type in the 203( k) program. We recommended that HUD
establish strict criteria for qualifying and recertifying nonprofit
organizations for their continued participation in the program. In response,
HUD issued guidance on March 3, 2000, that sets uniform standards for
nonprofit agencies participation and recertification in all FHA activities.
In beginning to implement our recommendations, HUD has taken some positive
steps toward tightening its control over the 203( k) program. However, the
inherent risk of this program means that the program requires continued
management attention and further improvements in oversight.
Madame Chairwoman, this concludes our prepared statement. We are happy to
answer any questions that you or Members of the Subcommittee may have.
For future contacts regarding this testimony, please contact Stanley
Czerwinski or Paul Schmidt at (202) 512- 2834. Individuals making key
contributions to this testimony included Paige Smith, Richard Smith, Steve
Westley, and Alwynne Wilbur. Contact and
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