Mortgage Financing: Additional Action Needed to Manage Risks of  
FHA-Insured Loans with Down Payment Assistance (09-NOV-05,	 
GAO-06-24).							 
                                                                 
The Federal Housing Administration (FHA) permits borrowers to	 
obtain down payment assistance from third parties; but, research 
has raised concerns about the performance of loans with such	 
assistance. Due to these concerns, GAO examined the (1) trends in
the use of down payment assistance with FHA-insured loans, (2)	 
the impact that the presence of such assistance has on purchase  
transactions and house prices, (3) how such assistance influences
the performance of these loans, and (4) FHA's standards and	 
controls for these loans.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-24						        
    ACCNO:   A41218						        
  TITLE:     Mortgage Financing: Additional Action Needed to Manage   
Risks of FHA-Insured Loans with Down Payment Assistance 	 
     DATE:   11/09/2005 
  SUBJECT:   Homeowners loans					 
	     Housing						 
	     Lending institutions				 
	     Mortgage loans					 
	     Nonprofit organizations				 
	     Prices and pricing 				 
	     Standards						 

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GAO-06-24

   

     * [1]Report to the Chairman, Subcommittee on Housing and Community
       Opportunity, Committee on Financial Services, House of Representatives

          * [2]November 2005

     * [3]MORTGAGE FINANCING

          * [4]Additional Action Needed to Manage Risks of FHA-Insured Loans
            with Down Payment Assistance

     * [5]Highlights
     * [6]Contents

          * [7]Results in Brief
          * [8]Background
          * [9]The Percentage of Purchase Loans in FHA's Portfolio with Down
            Payment Assistance Has Been Increasing Since 2001
          * [10]Seller-Funded Assistance Affects Home Purchase Transactions
            and Can Raise House Prices

               * [11]Seller-Funded Down Payment Assistance Changes the
                 Structure of the Purchase Transaction
               * [12]Seller-Funded Down Payment Assistance Often Results in
                 Higher Sales Prices

          * [13]FHA-Insured Loans with Down Payment Assistance, particularly
            from Seller-Funded Nonprofits, Do Not Perform as Well as Similar
            Loans without Assistance
          * [14]Stricter Standards and Additional Controls Could Help FHA
            Manage the Risks Posed by Loans with Down Payment Assistance

               * [15]FHA Standards Permit Borrowers to Obtain Down Payment
                 Assistance from Seller-Funded Sources
               * [16]FHA Does Not Conduct Routine Loan Performance Analyses
                 on Loans with Down Payment Assistance
               * [17]FHA's Monitoring of Down Payment Assistance Lending is
                 Limited

          * [18]Conclusions
          * [19]Recommendations for Executive Action
          * [20]Agency Comments and Our Evaluation

     * [21]Objectives, Scope, and Methodology
     * [22]Automated Valuation Model Analysis
     * [23]Loan Performance Analysis

          * [24]Data and Sample Selection
          * [25]Specification of Delinquency and Claim Models
          * [26]Estimation Results

               * [27]Delinquency Results
               * [28]Claim Results

          * [29]Prepayment Model
          * [30]Loss Given Default Model

     * [31]Comments from the Department of Housing and Urban Development
     * [32]GAO Contact and Staff Acknowledgments

Report to the Chairman, Subcommittee on Housing and Community Opportunity,
Committee on Financial Services, House of Representatives

November 2005

MORTGAGE FINANCING

Additional Action Needed to Manage Risks of FHA-Insured Loans with Down
Payment Assistance

Contents

Tables

Figures

Abbreviations

November 9, 2005

Letter

The Honorable Bob Ney
Chairman
Subcommittee on Housing and Community Opportunity
Committee on Financial Services
House of Representatives

Dear Mr. Chairman:

Mortgage insurance provided by the Federal Housing Administration (FHA) of
the U.S. Department of Housing and Urban Development (HUD) insures
billions of dollars in private home loans each year. One of FHA's primary
goals is to expand homeownership opportunities for first-time homebuyers
and other borrowers who would not otherwise qualify for conventional
mortgages on affordable terms. Homebuyers who receive FHA-insured
mortgages often have limited funds and, to meet the 3 percent borrower
investment FHA requires, may obtain down payment assistance from a third
party, including not only a relative but also a charitable organization
(nonprofit) that is funded by the property seller. A purpose of a down
payment is to create "instant equity" for the new homeowner, and our work
and others have shown that loans with greater owner investment generally
perform better.^1 HUD's Office of Inspector General (OIG) has raised
concerns about the performance of FHA-insured loans with down payment
assistance from seller-funded nonprofits.^2 In light of these concerns,
you asked us to evaluate how FHA-insured home loans with down payment
assistance perform compared with loans that are originated without such
assistance. The insurance program is supported in part through insurance
premiums that FHA charges its borrowers, and FHA estimates that the
mortgage insurance fund operates at a profit. In response to your request,
this report examines (1) trends in the use of down payment assistance in
FHA-insured loans (e.g., volume and source), (2) the impact that the
presence of down payment assistance has on the structure of the purchase
transaction and the house price of FHA-insured loans, (3) the effect of
down payment assistance on the performance of FHA-insured loans, and (4)
the extent to which FHA standards and controls for loans with down payment
assistance are consistent with government internal control guidelines and
mortgage industry practices.

To describe trends in the use of down payment assistance with FHA-insured
loans, we obtained loan-level data from HUD on single-family purchase
money mortgage loans.^3 We analyzed the data by source of assistance to
determine trends in loan volume and the proportion of loans with down
payment assistance (including geographic variations). To examine the
structure of the purchase transaction for loans with and without down
payment assistance, we reviewed HUD policy guidebooks and reports and
interviewed real estate agents, lenders, appraisers, and other key players
involved in transactions with down payment assistance. To examine how down
payment assistance impacted the house price of FHA-insured loans, we
examined the sales prices of homes by the use and source of down payment
assistance using property value estimates derived from an Automated
Valuation Model (AVM).^4 To examine how down payment assistance influences
the performance of FHA-insured loans, we obtained from HUD a sample of
single-family purchase money loans endorsed in fiscal years 2000, 2001,
and 2002 and performance data on those loans (current as of June 30,
2005).^5 To examine the extent to which FHA standards and controls for
loans with down payment assistance were consistent with government
internal control guidelines, we reviewed FHA regulations and guidelines
for loans with down payment assistance and
compared these with certain internal control standards.^6 We also
interviewed mortgage industry participants about the controls they used to
manage the risks associated with affordable loan products that permit down
payment assistance and, as appropriate, compared their practices with
FHA's. We did not verify that these institutions did in fact use these
controls. We selected these entities because they offered products
intended to expand affordable homeownership opportunities in part by
permitting down payment assistance. Appendix I provides a full description
of our scope and methodology. We performed our audit work in Boston,
Massachusetts, and Washington, D.C., from January 2005 to September 2005
in accordance with generally accepted government auditing standards.

Results in Brief

The proportion of FHA-insured loans that are financed in part by down
payment assistance from various sources has increased substantially in the
last few years, while the overall number of loans that FHA insures has
fallen dramatically. Assistance from nonprofit organizations funded by
sellers has accounted for a growing percentage of that assistance.^7 From
2000 to 2004, the total proportion of FHA-insured loans with down payment
assistance grew from 35 to nearly 50 percent. Approximately 6 percent of
FHA-insured loans in 2000 received down payment assistance from
seller-funded nonprofits, but by 2004 nonprofit assistance had grown to
about 30 percent. Our analysis showed that those states where the use of
nonprofit down payment assistance, primarily from seller-funded
nonprofits, was higher than average tended to have lower-than-average
house price appreciation rates.
 
Down payment assistance provided by a seller-funded nonprofit can alter
the structure of the purchase transaction in important ways. First, when a
homebuyer receives assistance from a seller-funded nonprofit, many
nonprofits require the property sellers to make a payment to the nonprofit
that equals the amount of assistance the homebuyer receives plus a service
fee, after the closing. This requirement creates an indirect funding
stream from property sellers to homebuyers that does not exist in other
transactions, even those involving some other type of down payment
assistance. Second, mortgage industry participants reported, and a HUD
contractor study found, that property sellers who provided down payment
assistance through nonprofits often raised the sales price of the homes
involved in order to recover the required payments that went to the
organizations.^8 Our AVM analyses found that homes bought with
seller-funded nonprofit assistance appraised at and sold for higher prices
than comparable homes bought without assistance, resulting in larger loans
for the same collateral and higher effective loan-to-value (LTV) ratios.^9
Specifically, we found that homes with seller-funded down payment
assistance were appraised and sold for about 2 to 3 percent more than
comparable homes without such assistance. That is, homebuyers would have
less equity in the transaction than would otherwise be the case. FHA
requires lenders to inform appraisers of the presence and source of down
payment assistance but does not require that lenders identify whether the
down payment assistance provider receives funding from property sellers.
Without this information, appraisers cannot consider the impact that such
assistance could have on the purchase price of a home and potentially on
the appraiser's estimate of the home's market value.

Loans with down payment assistance do not perform as well as loans without
down payment assistance; this may be explained, in part, by the homebuyer
having less equity in the transaction. Holding other variables constant,
our analysis indicated that FHA-insured loans with down payment assistance
had higher delinquency and claim rates than similar loans without such
assistance. These differences in performance may be explained, in part, by
the higher sales prices of comparable homes bought with seller-funded down
payment assistance.

FHA has implemented some standards and internal controls to manage the
risks associated with loans with down payment assistance, but stricter
standards and additional controls could help FHA better manage risks posed
by loans with down payment assistance while meeting its mission of
expanding homeownership opportunities. First, with regard to standards,
like other mortgage industry participants, FHA generally applies the same
underwriting standards to loans with down payment assistance that it
applies to loans without such assistance. One important exception is that
FHA, unlike others, does not limit the use of down payment assistance from
seller-funded nonprofits. Some mortgage industry participants view down
payment assistance from seller-funded nonprofits as a seller inducement to
the sale and, therefore, either restrict or prohibit its use. FHA has not
viewed such assistance as a seller inducement and, therefore, does not
subject this assistance to the limits it otherwise places on contributions
from sellers. Although FHA, like others, applies the same underwriting
standards to loans with down payment assistance as it applies to loans
without such assistance, because FHA's portfolio is heavily weighted
toward loans with down payment assistance, stricter standards may be
warranted for such loans. Second, with regard to controls, FHA has taken
steps to assess and manage the risks associated with loans with down
payment assistance, but additional controls may be warranted. For example,
FHA has conducted ad hoc loan performance analyses of loans with down
payment assistance and contracted for two studies to assess the use of
such assistance with FHA-insured loans, but FHA has not routinely assessed
the impact that the widespread use of down payment assistance has had on
loan performance. Also, FHA has targeted monitoring of appraisers that do
a high volume of loans with down payment assistance, but FHA has not
targeted its monitoring of lenders that do a high volume of loans with
down payment assistance, even though FHA holds lenders, as well as
appraisers, accountable for ensuring a fair valuation of the property it
insures.

We make recommendations designed to better manage the risks of loans with
down payment assistance generally and more specifically from seller-funded
nonprofits. Overall, we recommend that in considering the cost and benefit
of its policy permitting down payment assistance, FHA also consider risk
mitigation techniques such as including down payment assistance as a
factor when underwriting loans or monitoring more closely loans with such
assistance. With regard to down payment assistance providers that receive
funding from property sellers, we recommend that FHA take additional steps
to mitigate the risk associated with these loans. These controls include
treating such assistance as a seller contribution and, therefore, subject
to existing limits on seller contributions.

We provided a draft of this report to HUD, and the Assistant Secretary for
Housing--Federal Housing Commissioner provided written comments, which are
discussed later in this report and reprinted in appendix IV. HUD generally
agreed with the report's findings, stating that the report confirmed its
own analysis of loan performance and the findings of an independent
contractor hired by FHA to evaluate how seller-funded down payment
assistance programs operate. HUD also agreed to take steps to better
identify the source of down payment assistance, which would permit it to
better monitor the performance of these loans. HUD also agreed to consider
incorporating the presence and source of down payment assistance when
underwriting loans.

HUD also commented on certain aspects of selected recommendations. First,
although HUD agreed with the report's recommendation to perform routine
and targeted loan performance analyses of loans with down payment
assistance, it stated that FHA already monitors the performance of these
loans. We recognized in our report that FHA does perform ad hoc analyses
of loan performance, but because of the substantial number of FHA loans
that involve some form of down payment assistance, and the risk of these
loans, we continue to believe that FHA should more routinely monitor the
performance of these loans. Second, HUD disagreed with our recommendation
that it should revise its standards to treat assistance from a
seller-funded nonprofit organization as a seller inducement to purchase,
arguing, based on advice of HUD's Office of the General Counsel, that if
the gift of down payment assistance is made by the nonprofit entity to the
buyer before closing, while the seller's contribution to the nonprofit
entity occurs after the closing, then the buyer has not received funds
that can be traced to the seller's contribution. We realize that FHA
relies on this advice to authorize sellers to do indirectly what they
cannot do directly. Nevertheless, because gifts of down payment assistance
from seller-funded nonprofits are ultimately funded by the sellers, they
are like gifts of down payment assistance made directly by sellers. We,
therefore, continue to believe that assistance from a seller-funded entity
should be treated as a seller inducement to purchase. Finally, while the
draft report was with the agency for comment, HUD's contractor completed
the 2005 Annual Actuarial Review. Consistent with our recommendation, the
contractor included the presence and source of down payment assistance as
a factor in estimating loan performance--finding that it is a very
important factor. However, in reviewing the contractor's methodology, we
found certain limitations may understate the impact that down payment
assistance has on estimates of loan performance. We, therefore, modified
our recommendation to address one of these weaknesses and to emphasize the
continuing need to consider the presence and source of down payment
assistance in future loan performance models.

Background

Mortgage insurance, a commonly used credit enhancement, protects lenders
against losses in the event of default. Lenders usually require mortgage
insurance when a homebuyer has a down payment of less than 20 percent of
the value of the home. FHA, the U.S. Department of Veterans Affairs (VA),
the U.S. Department of Agriculture's Rural Housing Service (RHS), and
private mortgage insurers provide this insurance. In 2003, lenders
originated $3.8 trillion in single-family mortgage loans, of which more
than 60 percent were for refinancing. Of all the insured loans originated
in 2003, including refinancings, private companies insured about 64
percent, FHA about 26 percent, VA about 10 percent, and RHS a very small
number.

One of FHA's primary goals is to expand homeownership opportunities for
first-time homebuyers and other borrowers who would not otherwise qualify
for conventional mortgages on affordable terms. As a result, FHA plays a
particularly large role in certain market segments, including first-time
and low-income homebuyers. During 2001 to 2003, FHA insured about 3.7
million mortgages with a total value of about $425 billion. FHA insures
most of its single-family mortgages under its Mutual Mortgage Insurance
Fund (Fund), which is primarily funded with borrowers' insurance premiums
and proceeds from the sale of foreclosed properties. FHA's mortgage
insurance program is currently a negative subsidy program--that is, the
Fund is self-financed and FHA estimates that it operates at a profit;
however, the Fund is experiencing higher-than-estimated claims. The
economic value of the Fund that supports FHA's guarantees depends on the
relative size of cash outflows and inflows over time. Cash flows out of
the Fund from payments associated with claims on defaulted loans and
refunds of up-front premiums on prepaid mortgages. To cover these
outflows, FHA receives cash inflows from borrowers' up-front and annual
insurance premiums and net proceeds from recoveries on defaulted loans. If
the Fund were to be exhausted, the U.S. Treasury would have to cover
lenders' claims directly. We reported that FHA submitted a $7 billion
reestimate for the Fund's credit subsidy and interest as of the end of
2003, primarily due
to an increase in estimated and actual claims over what FHA previously
estimated.^10 Several recent events may help explain the increase in
claims, including changes to underwriting guidelines, competition from the
private sector, and an increase in down payment assistance. A program
assessment included with the 2006 President's Budget noted that FHA's loan
performance model is neither accurate nor reliable because it consistently
under predicts claims. Since 1990, the National Housing Act has required
an annual and independent actuarial analysis of the economic net worth and
soundness of the Fund.^11

FHA has been backing mortgages with low down payments for many years. For
example, almost 90 percent of FHA-insured mortgages originated in 2000 had
an LTV ratio greater than 95 percent. LTV ratios are important because of
the direct relationship that exists between the amount of equity borrowers
have in their homes and the likelihood of default. The higher the LTV
ratio, the less cash borrowers will have invested in their homes and the
more likely it is that they may default on mortgage obligations,
especially during times of economic hardship.

The number of loans that FHA insures each year has fallen dramatically
since 2000 (fig. 1). This decline is likely due, in part, to greater
availability of low and no down payment products from the conventional
market. Specifically, in 1992 Congress authorized HUD to establish housing
goals for Fannie Mae and Freddie Mac that direct them to contribute to the
affordability and availability of housing for low- and moderate-income
families, underserved areas, and special affordable housing for very
low-income families.^12 In the 1990s, private mortgage insurers began
insuring loans with low down payments; concurrently, Fannie Mae and
Freddie Mac began purchasing these loans. More recently, the conventional
market has introduced products such as zero-down payment loans that have
attracted homebuyers who might otherwise have applied for an FHA-insured
mortgage. Certain conventional mortgage products also permit down payment
assistance.

Figure 1: Number of FHA-Insured Single-Family Purchase Money Loans, Fiscal
Years 2000 through 2005

Note: Loans insured by FHA's 203(b) program, its main single-family
program, and its 234(c) condominium program. Small specialized programs,
such as 203(k) rehabilitation and 221(d) subsidized mortgages, were not
included.

Homebuyers with FHA-insured loans need to make a 3 percent contribution
toward the purchase of the property. FHA, like many conventional mortgage
lenders, permits homebuyers to obtain these funds from certain third-party
sources and use the money for the down payment and closing costs.
Generally, mortgage industry participants accept as third-party sources
relatives, a borrower's employer, government agencies, and charitable
organizations (nonprofits).^13

Among nonprofits that provide down payment assistance, some receive
contributions from property sellers. When a homebuyer receives down
payment assistance from one of these organizations, the organization
requires the property seller to make a financial payment to their
organization. These nonprofits are commonly called "seller-funded" down
payment assistance providers. Examples of seller-funded nonprofits that
provide the most down payment assistance to homebuyers with FHA-insured
mortgages, include: Nehemiah Corporation of America; AmeriDream,
Incorporated; and The Buyers Fund, Incorporated. A 1998 memorandum from
HUD's Office of the General Counsel found that funds from a seller-funded
nonprofit were not in conflict with FHA's guidelines that prohibit down
payment assistance from sellers.^14 In contrast, some nonprofits do not
require property sellers to make a financial payment to their organization
in return for providing down payment assistance to a homebuyer. Examples
of these nonprofits that provide the most down payment assistance to
homebuyers with FHA-insured mortgages, include the Clay Foundation,
Incorporated; and Family Housing Resources, Incorporated. For a nonprofit
to provide down payment assistance to a homebuyer, regardless of its
funding source, FHA requires that the organization have a Taxpayer
Identification Number.^15 FHA does not approve down payment assistance
programs administered by nonprofits; instead, lenders are responsible for
assuring that the gift to the homebuyer from a nonprofit meets FHA
requirements.

FHA relies on lenders to underwrite the loans and determine their
eligibility for FHA mortgage insurance. Lenders wanting to participate in
FHA's mortgage programs receive approval from HUD. As of August 2004, over
10,000 lending institutions had been approved. These lenders review loan
applications and assess applicants' creditworthiness and ability to make
payments. FHA relies on these lenders to ensure compliance with FHA
standards. Lenders often initiate the use of down payment assistance from
seller-funded down payment assistance providers. Additionally, FHA and its
lenders rely upon appraisers to provide an independent and accurate
valuation of properties. A primary role of appraisals in the loan
underwriting process is to provide evidence that the collateral value of a
property is sufficient to avoid losses on a loan if the borrower is unable
to repay the loan.

Legislation sets certain standards for FHA-insured loans. Currently,
depending on a property's appraised value and the average closing costs
within a state, the LTV limits range from 97.15 to 98.75 percent.^16
However, because FHA allows financing of the up-front insurance premium,
borrowers can receive a mortgage with an effective LTV ratio of close to
100 percent. FHA also has flexibility in how it implements changes to an
existing product. For example, the HUD Secretary can change underwriting
requirements for existing products and has done this many times. Specific
examples include a decrease in items considered as borrower's debts and an
expanded definition of what can be included as borrower's effective income
when lenders calculate qualifying ratios. Additionally, HUD is supporting
a legislative proposal that would enable HUD to insure mortgages with no
down payment. Borrowers would also be able to finance certain closing
costs. FHA would charge borrowers premiums that would be higher than those
for FHA's regular 203(b) mortgage product. The program is targeted to
first-time homebuyers, and borrowers would be required to participate in
homebuyer counseling. According to HUD, a zero down payment program would
provide FHA with a better way to serve families in need of down payment
assistance. We previously recommended that Congress and FHA consider a
number of means to mitigate the risks that a no down payment product and
any other new single-family insurance product may pose. Such means may
include limiting the initial availability of new products, requiring
higher premiums, and requiring stricter underwriting and enhanced
monitoring. Such risk mitigation techniques would help protect the Fund
while allowing FHA time to learn more about the performance of such
loans.^17

The mortgage industry is increasingly using credit scoring, automated
underwriting, and mortgage scoring. Credit scoring models, which estimate
the credit risk of individuals', use statistical analyses that identify
the characteristics of borrowers who are most likely to make loan payments
and then create a weight or score for each characteristic. Credit scores,
also  known  as  FICO scores because they are generally based on software
developed by Fair, Isaac and Company, range from 300 to 850, with higher
scores indicating a better credit history. Automated underwriting is the
process of collecting and processing the data used in the underwriting
process. During the 1990s, private mortgage insurers, the GSEs, and larger
financial institutions developed automated underwriting systems, and by
2002 more than 60 percent of all mortgages were underwritten using these
systems. This percentage continues to rise.^18  Mortgage scoring is a
technology-based tool that relies on the statistical analysis of millions
of previously originated mortgage loans to determine how key attributes
such as credit history, property characteristics, and mortgage terms
affect future loan performance. FHA has developed and recently implemented
a mortgage scoring tool, called the Technology Open to Approved Lenders
(TOTAL) Mortgage Scorecard, that can be used in conjunction with existing
automated underwriting systems.

We identified and reviewed three studies that evaluated the extent to
which the presence of down payment assistance impacts loan performance,
but these analyses have been limited in that they do not consider other
variables that may be important to delinquency and claim, such as
borrowers' credit scores and the period during which a loan is observed.
HUD's OIG conducted two studies looking at defaults on FHA-insured loans
with down payment assistance.^19 In the first study, the OIG found that
the default rate for a sample of FHA-insured loans with down payment
assistance provided by Nehemiah, a seller-funded nonprofit, was more than
double that of loans that did not get assistance from this nonprofit (4.64
percent and 2.11 percent, respectively). The second more recent study
found that the default rate for the same sample of Nehemiah-assisted loans
had quadrupled to 19.42 percent. Moreover, this default rate was double
the default rate for loans that did not get assistance from this nonprofit
(9.7 percent). The OIG's studies did not adjust for other variables that
could potentially explain these differences in loan performance, such as
differences in borrowers' credit scores or house price appreciation after
the loans were originated. In response to the OIG's findings, FHA
contracted for analysis of a sample of FHA-insured loans to identify the
presence and source of down payment assistance. A coalition of down
payment assistance nonprofits, Homeownership Alliance of Nonprofit
Downpayment Providers (HAND), released a study which found that
delinquency rates for loans with assistance from nonprofits were about 11
percent higher than for loans with gifts from relatives. HAND also noted
that the delinquency rates on loans with assistance from nonprofits were
about the same as the delinquency rates on loans receiving other forms of
assistance.^20 The HAND study adjusted for geographic distribution, but
not for other factors, such as borrowers' credit scores or the age of the
loans. Because loans with assistance from nonprofits were a small portion
of FHA's portfolio until 2000, most of the loans in this sample with
assistance from nonprofits would have had little time in which to
experience a delinquency, unlike other loans in the sample.

The Percentage of Purchase Loans in FHA's Portfolio with Down Payment
Assistance Has Been Increasing Since 2001

As the number of home mortgages FHA insures each year has fallen, the
number of FHA-insured single-family purchase money loans with nonprofit
down payment assistance has not. As a result, the proportion of loans with
down payment assistance that FHA insures each year has increased
significantly. From 2000 to 2004, the total proportion of FHA-insured
single-family purchase money loans that had an LTV ratio greater than 95
percent and that also involved down payment assistance, from any source,
grew from 35 to nearly 50 percent (fig. 2).^21 Assistance from nonprofit
organizations, about 93 percent of which were funded by sellers, accounted
for an increasing proportion of this assistance. Approximately 6 percent
of FHA-insured loans received down payment assistance from nonprofit
organizations in 2000, but, by 2004 this figure had grown to about 30
percent.^22 Our analysis of a sample of FHA-insured loans from 2000 to
2002 showed that the average amount of down payment assistance, regardless
of source, was about $3,400 and that the amount of down payment assistance
relative to sales price was about 3 percent.^23

Figure 2: Number of FHA-Insured Single-Family Purchase Money Loans and
Percentage of Loans with Down Payment Assistance, by Source (Loans with
LTV Ratio Greater Than 95 percent, Fiscal Years 2000-2005)

Note: Percentage of loans with down payment assistance by source for 2000,
2001, and 2002 are based on a representative sample of FHA-insured
purchase money loans with an LTV ratio greater than 95 percent. Of the
loans in the sample with nonprofit assistance, 93.5 percent had
seller-funded assistance, 1.8 percent had nonseller-funded assistance, 0.5
percent had assistance from a nonprofit with both seller-funded and
nonseller-funded programs, and 4.2 percent had assistance from nonprofits
with a status that we could not identify. For these years, our category
"nonprofit" includes only loans with assistance from nonprofit
organizations we could verify as requiring funds from sellers as a
condition of providing assistance. All other loans with nonprofit
assistance were included in the nonseller-funded (other sources) group.

Percentage of loans with down payment assistance by source for 2003
through April 2005 are based on the total universe of FHA-insured purchase
money loans with an LTV ratio greater than 95 percent. For these years,
our category "nonprofit" includes loans with assistance from all nonprofit
organizations. We reviewed the nonprofit assistance provider for 95.2
percent of the loans with nonprofit assistance. Of these loans, 93.5
percent had seller-funded assistance, 1.5 percent had nonseller-funded
assistance, 1.1 percent had assistance from a nonprofit with both
seller-funded and nonseller-funded programs, and 3.9 percent had
assistance from nonprofits with a status that we could not identify. We
did not review nonprofit organizations that provided a low volume of
assistance.

As figure 2 illustrates, the total number of FHA-insured loans originated
fell dramatically between 2001 and 2005. Realtors that we spoke to from
across the country told us that fewer homebuyers were using FHA-insured
mortgages, opting instead for conventional low and zero down payment
mortgage products and loans with secondary financing that do not require
private mortgage insurance. In addition, officials from government
agencies that provide down payment assistance noted either a decrease in
the use of FHA mortgage insurance, an increase in the demand for
conventional mortgages, or both.

Although the number of FHA-insured loans decreased markedly from 2001 to
2004, the number of FHA-insured loans with down payment assistance did
not. As a result, these loans constitute a growing share of FHA's total
portfolio. Growth in the number of seller-funded nonprofit providers and
the growing acceptance of this type of assistance have contributed to the
increase in the use of down payment assistance. According to industry
professionals, relatives have traditionally provided such assistance, but
in the last 10 years other sources have emerged, including not only
seller-funded nonprofit organizations, but also government agencies and
employers. The mortgage industry has responded by developing practices to
administer this type of assistance, such as FHA's policies requiring gift
letters and documentation of the transfer of funds. Lenders also reported
that seller-funded down payment assistance providers, in particular, have
developed practices accepted by FHA and lenders. For example,
seller-funded programs have standardized gift letter and contract addendum
forms for documenting both the transfer of down payment assistance funds
to the homebuyer and the financial contribution from the property seller
to the nonprofit organization. As a result, for FHA-insured loans, lenders
are increasingly aware of and willing to accept down payment assistance,
including from seller-funded nonprofits.

States that have higher-than-average percentages of FHA-insured loans with
nonprofit down payment assistance, primarily from seller-funded programs,
tend to be states with lower-than-average house price appreciation rates
(fig. 3).^24 From May 2004 to April 2005, 34.6 percent of all FHA-insured
purchase money loans nationwide involved down payment assistance from a
nonprofit organization, and 15 states had percentages that were higher
than this nationwide average. Fourteen of these 15 states also had house
price appreciation rates that were below the median rate for all states.
In addition, the eight states with the lowest house appreciation rates in
the nation all had higher-than-average percentages of nonprofit down
payment assistance. Generally, states with high proportions of FHA-insured
loans with nonprofit down payment assistance were concentrated in the
Southwest, Southeast, and Midwest.

Figure 3: Percentage of FHA-Insured Single-Family Purchase Money Loans
Using Nonprofit Down Payment Assistance and House Price Appreciation
Rates, by State

Some real estate agents we spoke with commented that in housing markets
with low house appreciation rates, sellers do not typically receive
multiple offers for their properties. As a result, they may turn to
seller-funded down payment assistance providers to attract and expand the
pool of potential homebuyers and facilitate purchase transactions that can
result in higher sales prices. In contrast, in real estate markets with
high house appreciation rates, such as San Francisco and New York City,
mortgage industry participants reported that they generally see more
assistance in the form of secondary financing involving first and second
mortgages. This assistance is often provided by government agencies and
nonprofit instrumentalities of government. In addition, lenders and
private mortgage insurers described housing markets located on the coasts,
and in urban areas in general as having higher proportions of homebuyers
utilizing down payment assistance in the form of secondary financing.

Purchase transactions in which the seller was a builder had higher usage
of nonprofit down payment assistance than did other purchase transactions.
In our sample of loans endorsed in 2000, 2001, and 2002, homes sold by
builders were more than twice as likely to involve down payment assistance
from seller-funded nonprofits as homes sold by nonbuilder property
sellers. Specifically, of the home purchase transactions involving
nonbuilder property sellers, 8.3 percent had seller-funded down payment
assistance, compared with 19.3 percent of transactions with homes sold by
builders. Ninety-seven percent of the loans originated by one lender that
was affiliated with a builder involved nonprofit down payment assistance.

Seller-Funded Assistance Affects Home Purchase Transactions and Can Raise
House Prices

The presence of down payment assistance from seller-funded nonprofits can
alter the structure of purchase transactions and often results in higher
house prices. As we have seen, homebuyers may receive down payment
assistance from a variety of sources besides seller-funded nonprofits,
including relatives and various government and nonprofit homebuyer
assistance programs. When buyers receive assistance from sources other
than seller-funded nonprofits, the home purchase takes place like any
other purchase transaction--buyers use the funds to pay part of the house
price, the closing costs, or both, reducing the mortgage by the amount
they pay and creating "instant equity." However, seller-funded down
payment assistance programs typically require property sellers to make a
financial contribution and pay a service fee after the closing, creating
an indirect funding stream from property sellers to homebuyers that does
not exist in a typical transaction. Further, our analysis indicated and
mortgage industry participants we spoke with reported that property
sellers often raised the sales price of their properties in order to
recover the contribution to the seller-funded nonprofit that provided the
down payment assistance. In these cases, homebuyers may have mortgages
that were higher than the true market value price of the house and would
have acquired no equity through the transaction.

Seller-Funded Down Payment Assistance Changes the Structure of the
Purchase Transaction

FHA guidelines state that providers of down payment assistance may not
have an interest in the sale of the property, noting that assistance from
sellers, real estate agents, builders, and associated entities are
considered an inducement to buy.^25  FHA guidelines do allow sellers to
contribute up to 6 percent of the sales price toward closing costs,
although none of this money can be used to meet the 3 percent borrower
contribution requirement.^26  Contributions from sellers exceeding 6
percent of the sales price or exceeding the actual closing costs result in
a dollar-for-dollar reduction to the sales price when calculating the
loan's LTV ratio. In spite of these FHA requirements, FHA lists among
acceptable providers not only relatives, a borrower's employer, and
homeownership programs but also charitable organizations
(nonprofits)--including those that are funded by contributions from
property sellers. Like down payment assistance from all other sources, FHA
does not limit the amount of assistance from seller-funded nonprofits, and
homebuyers can use this assistance for the down payment and closing costs.

As a result, individuals and entities that HUD has described as having an
interest in the sale of a property may provide gift assistance to
homebuyers indirectly through these nonprofits, effectively circumventing
the 6 percent rule. The presence of this type of assistance changes the
way a property is purchased by creating an indirect funding stream from
the seller to the buyer (fig. 4). That is, after the closing, these
organizations commonly require property sellers to provide both a
financial payment equal to the amount of assistance paid to the homeowner
and a service fee. Before the sale of the property, sellers that partner
with these nonprofits often complete an addendum to the sales contract
that outlines, as a condition of the sale, their commitment to providing a
financial payment and fee after closing (fig. 5).

Figure 4: Structure of FHA Individual Purchase Transaction, with
Nonseller-Funded Down Payment Assistance and with Seller-Funded Down
Payment Assistance

Figure 5: Generic Illustration of Addendum to the Sales Contract Completed
Prior to Closing that Facilitates Seller's Commitment to Providing
Financial Payment to the Nonprofit Organization after Closing

Seller-Funded Down Payment Assistance Often Results in Higher Sales Prices

When a homebuyer receives down payment assistance from a seller-funded
nonprofit, property sellers often raise the sales price of the property to
recover the required payment to the nonprofit providing the assistance.
GAO analysis of a national sample of FHA-insured loans endorsed in 2000,
2001, and 2002 suggests that homes with seller-funded assistance were
appraised and sold for about 3 percent more than comparable homes without
such assistance.^27 Additionally, our analysis of more recent loans, a
sample of FHA-insured loans settled in March 2005, indicates that homes
sold with nonprofit assistance were appraised and sold for about 2
percentage points more than comparable homes without nonprofit
assistance.^28 To examine the possibility that sales prices of homes with
seller-funded assistance were in fact higher than sales prices of
comparable homes without such assistance, we contracted with First
American Real Estate Solutions to provide estimates of the value of homes
in a sample of FHA-insured loans.  The values were calculated for the
month prior to the closing, using an AVM. AVMs, which use statistical
processes to estimate the property values, using property characteristics
and trends in sales prices in the surrounding areas, are widely used in
the mortgage industry for quality control and other purposes. We examined
the ratio of the estimated AVM values to the appraisal values and sales
prices and found that the ratios for loans with seller-funded nonprofit
down payment assistance ranged from about 2 to 3 percentage points lower
than the ratios for loans without such assistance. In other words, for
loans with seller-funded down payment assistance, the appraised value and
sales price were higher as compared with loans without such assistance.
See appendix II for the details of our analysis.

In addition, some mortgage industry participants told us that homes
purchased with down payment assistance from seller-funded nonprofits may
be appraised for higher values than if the same homes were purchased
without assistance. Appraisers we spoke with said that lenders, realtors,
and sellers sometimes pressured them to "bring in the value" in order to
complete the sale. Additionally, a prior HUD contractor study corroborates
the existence of these pressures.^29 FHA requires lenders to provide
information to appraisers about the source and amount of assistance.
However, FHA reporting requirements do not require lenders to inform
appraisers whether the source of the assistance is a seller-funded
nonprofit.^30 HUD has issued several Mortgagee Letters that provide
clarifications regarding FHA standards and requirements for loans with
down payment assistance.^31 For example, in January 2005, HUD issued a
Mortgagee Letter to clarify FHA's standards requiring that appraisers be
informed of the presence and source of down payment assistance, regardless
of its source.^32 Also in January 2005, HUD issued a Mortgagee Letter to
reiterate that lenders are required to ensure that appraisals comply with
FHA requirements.^33 Lenders we spoke with reported that they document the
source of the assistance--a relative, nonprofit, and a borrower's
employer, for instance--but, typically do not inform appraisers about the
relationship between the seller and the down payment assistance provider.

Marketing materials from seller-funded nonprofits often emphasize that
property sellers using these down payment assistance programs earn a
higher net profit than property sellers who do not. These materials show
sellers receiving a higher sales price, that more than compensates for the
fee typically paid to the down payment assistance provider. For homebuyers
who receive assistance from seller-funded nonprofits, the higher sales
prices result in mortgages that are higher than mortgages made using other
types of down payment assistance, such as a gift from a relative, or with
no assistance at all.

Additionally, several mortgage industry participants we interviewed noted
that when homebuyers obtained down payment assistance from seller-funded
nonprofits, property sellers increased their sales prices to recover their
payments to the nonprofits providing the assistance. Again, a prior HUD
contractor study corroborates the existence of this practice.^34 A higher
sales price results in a larger loan for the same collateral and,
therefore, a higher effective LTV ratio (fig. 6).

Figure 6: Example of LTV Ratio Calculations for FHA-Insured Loans, by
Source of Down Payment Funds

The higher sales price that often results from a transaction involving
seller-funded down payment assistance can have the perverse effect of
denying buyers any equity in their properties and creating higher
effective LTV ratios. As we have seen, FHA guidance stipulates that any
financial assistance provided by a party with an interest in the sale of
the property is limited to 6 percent of the sales price and can be used
only for closing costs. Contributions from interested parties, such as
sellers, that exceed 6 percent of the sales price or the actual closing
costs result in a dollar-for-dollar reduction to the sales price when
calculating the loan's LTV ratio. Along with the maximum allowable LTV
ratio, the effect of this requirement is to ensure that FHA homebuyers
obtain a certain amount of "instant equity" at closing. That is, when the
sales price represents the fair market value of the house, and the
homebuyer contributes 3 percent of the sales price at the closing, the LTV
ratio is less than 100 percent. But when a seller raises the sales price
of a property to accommodate a contribution to a nonprofit that provides
down payment assistance to the buyer, the buyer's mortgage may represent
100 percent or more of the property's true market value.

FHA-Insured Loans with Down Payment Assistance, particularly from
Seller-Funded Nonprofits, Do Not Perform as Well as Similar Loans without
Assistance

Holding other variables constant, FHA-insured loans with down payment
assistance do not perform as well as similar loans without such
assistance. Furthermore, loans with down payment assistance from
seller-funded nonprofits do not perform as well as loans with assistance
from other sources. This difference in performance may be explained, in
part, by the higher sales prices of comparable homes bought with
seller-funded down payment assistance.

For our analyses, we used two samples (i.e., national and MSA) of
FHA-insured single-family purchase money loans endorsed in 2000, 2001, and
2002.^35 We grouped the loans into the following three categories:

oloans with assistance from seller-funded nonprofit organizations,

oloans with assistance from nonseller-funded sources, and

oloans without assistance.^36

We analyzed loan performance by source of down payment assistance,
controlling for the maximum age of the loan. As shown in figure 7, in both
samples and in each year, loans with down payment assistance from
seller-funded nonprofit organizations had the highest rates of delinquency
and claims, and loans without assistance the lowest. Specifically, between
22 and 28 percent of loans with seller-funded assistance had experienced a
90-day delinquency, compared to 11 to 16 percent of loans with assistance
from other sources and 8 to 12 percent of loans without assistance. The
claim rates for loans with seller-funded assistance ranged from 6 to 18
percent, for loans with other sources of assistance ranged from 5 to 10
percent, and for loans without assistance from 3 to 6 percent.

Figure 7: Delinquency and Claim Rates, by Maximum Age of Loan and Source
of Down Payment Funds

Note: Analysis based on data from two samples of loans drawn for a file
review study funded by HUD and conducted by the Concentrance Consulting
Group. The sampled loans were purchase money loans endorsed in 2000, 2001,
and 2002 with LTV ratios greater than 95 percent. The national sample
consisted of just over 5,000 loans, and the MSA sample consisted of 1,000
loans for each of the three MSAs: Atlanta, Indianapolis, and Salt Lake
City.

Even when other variables relevant to loan performance were held constant,
loans with down payment assistance and, in particular, seller-funded
assistance, had higher delinquency and claim rates. In order to test
whether other factors correlated with the receipt of seller-funded
assistance--for example, the concentration of these loans in slowly
appreciating areas--we used regression analyses that controlled for this
and other potentially relevant variables (see app. III for the details of
our analyses).^37 As figure 8 illustrates, seller-funded assistance was
found to have a substantial impact on claim and delinquency in both the
national and MSA samples.

Specifically, the results from the national sample indicated that
assistance from a seller-funded nonprofit raised the probability that the
loan had gone to claim by 76 percent relative to similar loans with no
assistance. Differences in the MSA sample were even larger; the
probability that loans with seller-funded nonprofit assistance would go to
claim was 166 percent higher than it was for comparable loans without
assistance. Similarly, results from the national sample showed that down
payment assistance from a seller-funded nonprofit raised the probability
of delinquency by 93 percent compared with the probability of delinquency
in comparable loans without assistance. For the MSA sample, this figure
was 110 percent.^38

Loans with down payment assistance from nonseller-funded sources did not
perform as well as loans without assistance when other variables relevant
to loan performance were held constant. We found that this type of down
payment assistance had a substantial impact on the probability of claim
and delinquency in both the national and MSA samples (see fig. 8). In the
national sample, it raised the probability of claim by 49 percent and the
probability of delinquency by 21 percent relative to similar loans with no
down payment assistance.^39 In the MSA sample, it raised the probability
of claim by 45 percent and the probability of delinquency by 36 percent
compared with loans without assistance.^40

Figure 8: Effect of Down Payment Assistance on the Probability of
Delinquency and Claim, Controlling for Selected Variables

Note: Loans without down payment assistance are set at 100 percent. The
results show the effect of a change in the variable on the odds
ratio--that is, the probability of a claim (or delinquency) divided by the
probability of not experiencing a claim (or delinquency). However, the
probability of experiencing a claim or delinquency in any given quarter is
fairly small; so, the change in the odds ratio is very close to the change
in the probability. The analysis is based on data from two samples of
loans drawn for a file review study funded by HUD and conducted by the
Concentrance Consulting Group. The loans in the samples were endorsed in
2000, 2001, and 2002 and had LTV ratios greater than 95 percent. The
national sample consisted of just over 5,000 loans and the MSA sample
consisted of 1,000 purchase money loans for each of the three MSAs:
Atlanta, Indianapolis, and Salt Lake City. The loan performance data
(current as of June 2005) are from HUD's Single-Family Data Warehouse. For
a detailed description of the regression model and other data sources, see
appendix III.

The higher probability of claims in the MSA sample, as compared to the
national sample, may be attributable to higher house price appreciation
rates at the national level as compared to the MSAs. Research suggests
that delinquent borrowers who have accumulated equity in their properties
are more likely than other borrowers to prepay in order to avoid
claims.^41 During the 5-year period from the first quarter of 2000 to the
last quarter of 2004, the median house price increase in the national
sample was about 39 percent. During the same period, the Salt Lake City,
Indianapolis, and Atlanta MSAs realized increases in the median price of
existing homes of 11 percent, 18 percent, and 32 percent, respectively. On
average, then, borrowers in the national sample could be expected to have
accumulated more equity than those in the MSAs and to be more likely to
sell their homes and prepay their mortgages if they faced delinquency. The
effect of the increased LTV ratio associated with loans with seller-funded
down payment assistance may be less important in the presence of
substantial accumulated equity.^42

The effect of seller-funded down payment assistance on loan performance is
substantial and to achieve an equivalent decline in loan performance
requires substantial changes in other factors. For example, the presence
of seller-funded down payment assistance increased claims by 76 percent.
Adjusting other factors to increase claims by 76 percent would require
lowering a borrower's credit score about 60 points, for example, or
raising the payment to income ratio about 25 percentage points. Both of
these adjustments to a loan are significant.

We also examined differences in loss severities between loans with
seller-funded assistance and unassisted loans. Although our analysis was
tentative because many claims had not yet completed the property
disposition process, it suggested that the ultimate losses from loans with
seller-funded assistance were greater than other loans. We could determine
the net profit or loss for only 184 loans from the national sample and for
only 205 loans from the MSA sample. We used a regression to predict the
loss rate, or the dollar amount of loss (or profit, in a few cases),
divided by the original mortgage balances.^43 The loss rate for loans with
seller-funded assistance was about 5 percentage points higher in both
samples. The differences were not statistically significant in the
national sample but were in the MSA sample. Our analysis of loss
severities indicated no significant differences in loss rates between
unassisted loans and loans with nonseller-funded assistance in the
national sample. In the MSA sample, loans with nonseller-funded assistance
did have statistically significantly higher loss rates.

The weaker performance of loans with seller-funded down payment assistance
may be explained, in part, by the higher sales prices of homes when buyers
receive such assistance, resulting in higher effective LTV ratios. Prior
GAO analysis has found that, controlling for other factors, high LTV
ratios lead to increased claims.^44 Our analysis of AVM data in the
national sample of loans endorsed in 2000, 2001, and 2002 indicated that
the sales prices of homes with seller-funded down payment assistance were
3 percent higher than the sales prices of comparable homes without it,
leading to higher effective LTV ratios for these loans. GAO analysis
suggests that this 3 percent difference in sales price translates into a
16 percent increase in claims. Claim rates for loans with seller-funded
assistance in the 2000-2002 national sample were about 19 percent to 39
percent higher than claim rates for loans with other forms of
assistance--a
difference that may largely explain the difference in claim rates between
seller-funded and other forms of assistance.^45

Stricter Standards and Additional Controls Could Help FHA Manage the Risks
Posed by Loans with Down Payment Assistance

FHA has implemented some standards and internal controls to manage the
risks associated with loans with down payment assistance, but stricter
standards and additional controls could help the agency better manage the
risks these loans pose. First, FHA applies the same standards to loans
with down payment assistance that it applies to all loans but is less
restrictive in the sources of down payment assistance it permits than
other mortgage industry participants. Government internal control
guidelines advise agencies to consider and recognize the value of industry
practices that may be applicable to agency operations.^46 Private mortgage
insurers, Fannie Mae, and Freddie Mac offer practices that could be
instructive in this instance. Mortgage industry participants told us that
they viewed down payment assistance from seller-funded nonprofits as an
inducement and, therefore, either restricted or prohibited its use. FHA
does not share this view and has not held this assistance to the same
limits it places on funds from sellers. Second, FHA has assessed, on an ad
hoc basis, the performance of loans with down payment assistance. In
contrast, government internal control guidelines recommend that agencies
routinely identify risks that could impede efficient and effective
management and develop approaches to analyze and manage risk. Finally,
although FHA has implemented targeted monitoring of appraisers that do a
high volume of loans with down payment assistance, the agency has not
implemented targeted monitoring of lenders that do a high volume of loans
with down payment assistance.

FHA Standards Permit Borrowers to Obtain Down Payment Assistance from
Seller-Funded Sources

Government internal control guidelines do not prescribe standards
specifically for loans with down payment assistance but do advise agencies
to consider and recognize the value of industry practices that may be
applicable to agency operations. FHA practices related to down payment
assistance are in many ways comparable to industry practices. The agency
applies the same standards to loans with down payment assistance as it
does to other FHA-insured loans--for example, placing a 6 percent cap on
the amount of funds sellers can contribute to loan transactions and
requiring borrowers to meet the same underwriting requirements as other
borrowers. FHA does not consider the presence, source, or amount of down
payment assistance as a factor in its underwriting guidelines; more
specifically, FHA does not include down payment assistance as a variable
in its TOTAL Mortgage Scorecard.^47 Similarly, mortgage industry
participants reported not imposing additional underwriting criteria for
loans with down payment assistance.

FHA's standards regarding sources of down payment assistance differ from
those of key mortgage industry participants in one important
respect--while FHA permits down payment assistance from seller-funded
sources, mortgage industry participants restrict or prohibit such
assistance. FHA, like other mortgage industry participants, does not
permit homebuyers to obtain down payment assistance directly from property
sellers but does permit them to get it from nonprofits that receive
contributions from property sellers. Further, FHA does not include down
payment assistance from seller-funded nonprofits in the 6 percent limit
that it has imposed on seller contributions. In contrast, some mortgage
industry participants we met with told us that they viewed down payment
assistance from seller-funded nonprofits as an inducement and, therefore,
either restricted or prohibited its use. Although some mortgage industry
participants do permit homebuyers to use seller-funded nonprofits, these
entities typically impose restrictions on the amount of assistance a
homebuyer may receive and how the funds can be used. For example, Fannie
Mae and Freddie Mac permit homebuyers to obtain funds provided by
seller-funded nonprofits but only up to 3 percent of the sales price and
only for closing costs. FHA standards for other sources of down payment
assistance are similar to those of mortgage industry participants we spoke
with. Specifically, neither limits the amount of assistance a homebuyer
may receive from sources such as relatives, and this money can be used for
the down payment, as well as the closing costs. Also, as mentioned
earlier, FHA applies the same underwriting standards to loans with down
payment assistance as it applies to loans without such assistance.

Mortgage industry participants we spoke with cited three reasons for
restricting down payment assistance from seller-funded nonprofits. First,
some mortgage industry participants noted that seller-funded nonprofits
are not disinterested third parties because of the contingency requiring
contributions from sellers after the loan closes. Second, some mortgage
industry participants noted that homebuyers receiving down payment
assistance from seller-funded nonprofits often finance larger loan amounts
than they would otherwise because sellers increase the sales price to
compensate for the contribution. Third, some mortgage industry
participants noted that, in effect, seller-funded nonprofits can be used
as intermediaries to enable sellers to contribute funds in excess of HUD's
6 percent limit on seller contributions.

Additionally, another HUD program has more restrictive standards on
permitted sources of down payment assistance. The American Dream
Downpayment Initiative, a program administered by HUD's Office of
Community Planning and Development that provides grants for down payment
assistance programs, does not permit seller-funded nonprofits to
administer its funds.^48 And, in 1999, HUD proposed a rule that would
prohibit borrowers from obtaining down payment assistance from
organizations that received funds from sellers. HUD stated that this rule
was "intended to prevent a seller from providing funds to an organization
as a quid pro quo for that organization's down payment assistance for
purchase of one or more homes from the seller."^49 HUD later withdrew this
rule after receiving 1,871 public comments on the proposed rule; all but
21 opposed it.

HUD officials noted that HUD permits seller-funded down payment assistance
because the assistance does not compromise FHA guidance prohibiting
homebuyers from using funds from property sellers and other interested
parties toward a down payment. FHA considers seller contributions to the
homebuyer in excess of 6 percent of the sales price and direct seller down
payment assistance as inducements to purchase that must be factored into
the purchase transaction.^50 These funds result in a dollar-for-dollar
reduction to the sales price before the LTV ratio is calculated. Further,
FHA requires any down payment assistance be essentially a gift that is not
subject to repayment. HUD officials stated that seller-funded nonprofits
are not sellers and do not require homebuyers to pay back the funds. In
addition, these officials noted that the seller and buyer--in a
transaction involving seller-funded down payment assistance--agree on the
sales price and pointed out that the contribution the nonprofit receives
from the seller after the closing supports future homebuyers. For these
reasons, we were told, HUD did not recognize a direct relationship between
the property seller and the homebuyer stemming from the activities of the
seller-funded nonprofit organization.

Although FHA applies many of the same standards to loans with down payment
assistance as it applies to other loans, it does impose additional
documentation requirements on loans with down payment assistance. Lenders
must obtain a "gift letter" that includes the donor's name and contact
information; an explanation of the donor's relationship to the borrower;
the dollar amount of the assistance; and a statement that specifies that
no repayment is required. They must ensure that the down payment
assistance meets FHA's requirements, document the Taxpayer Identification
Numbers for all nonprofits, and provide evidence of the transfer of funds
from the donor to the borrower.^51 As noted earlier, lenders must also
tell appraisers when a transaction involves down payment assistance and
its source, and appraisers must include this information in their reports.
However, FHA guidance does not require lenders to inform appraisers if the
source of the assistance is a seller-funded nonprofit.

FHA Does Not Conduct Routine Loan Performance Analyses on Loans with Down
Payment Assistance

Government risk assessment guidelines recommend that agencies routinely
identify risks that could impede efficient and effective management and
develop approaches, either qualitative or quantitative, to analyze and
manage these risks. Additionally, some mortgage industry participants
reported that they did some quantitative loan performance analyses on
loans with down payment assistance in order to understand the risks
associated with these loans.

FHA has conducted some risk analysis on its loans with down payment
assistance. For example, FHA officials recently told us that they had been
analyzing the performance of loans with down payment assistance on an ad
hoc basis. FHA's Office of Evaluation has been conducting analyses since
February 2000, comparing the performance of loans with down payment
assistance with those made without assistance. For example, from January
through July 2005, FHA carried out four ad hoc loan performance analyses
of all FHA-insured loans. FHA's analyses indicate that loans with down
payment assistance do not perform as well as loans without down payment
assistance. However, according to FHA officials FHA has not undertaken
ongoing periodic loan performance analyses that consider the presence and
source of down payment assistance.

HUD has also initiated two research efforts to evaluate down payment
assistance as it relates to FHA-insured loans and down payment assistance.
The first study evaluated the accuracy of loan-level data maintained in
HUD's information systems and collected information on sources and amounts
of gift assistance.^52 The study included a comparison of data found in
key documents FHA maintained with the information lenders had transmitted
via the Computerized Homes Underwriting Management System (CHUMS).^53 This
research found that, for loans with down payment assistance, the gift
amounts and sources in HUD's information system were frequently missing or
different from the information in the documents. The study also found that
needed Taxpayer Identification Numbers were missing for 74 percent of
loans reviewed that involved assistance from nonprofit organizations. As a
result of the study, HUD clarified the data requirements for loans with
down payment assistance. For example, in January 2005 HUD reiterated its
requirement for lenders to provide information on the presence, amount,
and source of down payment assistance.

The second study evaluated the influence of assistance from seller-funded
nonprofits on the origination of FHA-insured loans through interviews with
various mortgage industry participants.^54 This study found that
seller-funded down payment assistance providers serve primarily as
conduits for the transfer of down payment funds between buyers and sellers
in order to meet HUD's gift eligibility requirement. Additionally, the
study found that many appraisers, mortgage lenders, underwriters,
seller-funded down payment assistance providers, and real estate agents
reported that homes sold with seller-funded down payment assistance had
inflated appraised values and property sales prices. The second study
resulted in a report issued in March 2005 and included several
recommendations to FHA. FHA is currently assessing whether HUD should
approach loans with down payment assistance differently (e.g., apply an
enhanced risk-based premium structure on loans with down payment
assistance from certain sources); but as of September 2005 FHA had not
taken any action.

FHA annually contracts for an actuarial review. A key component of this
review is an assessment of loan performance. These analyses of loan
performance--which also help in estimating program subsidy costs--consider
a number of factors including the loan's LTV ratio and mortgage age.
However, the presence and source of down payment assistance were not
included in these loan performance analyses prior to the actuarial review
for 2005.^55 This actuarial review indicates that down payment assistance
has a significant impact on the performance of these loans. Specifically,
when the actuarial review incorporated down payment assistance into the
econometric model, the estimated value of FHA's insurance fund for 2005
decreased by $1.8 billion. The actuarial review also stated that down
payment assistance "has had a major economic impact on the fund" and that
these loans should be closely monitored. However, the analysis in the
actuarial review may understate the magnitude of the effect of down
payment assistance on claim rates because the gift letter source variable
used in the actuarial review understates the number of loans with gift
assistance for loans endorsed between 2000 and 2002, according to HUD's
contractors. Additionally, the impact of down payment assistance may be
greater than found in the actuarial review. Specifically, the actuarial
review's estimates of loan performance are based on the historical
experience of loans made with down payment assistance, most of which were
originated between 2000 and 2005--a period marked by rapid house price
appreciation. However, because down payment assistance has a greater
impact in areas of low price appreciation, should the rate of house price
appreciation decline in the future, the effects of down payment assistance
may be greater. Further, the actuarial review does not examine the impact
that the presence and source of down payment assistance may have on claim
severity. As noted earlier, FHA recently took action to clarify data
reporting requirements regarding the source and amount of down payment
assistance, but these FHA reporting requirements do not differentiate
seller-funded nonprofits from nonseller-funded types of nonprofits.^56

FHA's Monitoring of Down Payment Assistance Lending is Limited

Government internal control guidelines advise agencies to monitor external
entities that perform critical functions, in part to ensure that these
entities are accountable for their operations. FHA relies on numerous
outside entities--including lenders and appraisers--to perform critical
functions, including functions specific to loans with down payment
assistance. As we have seen, lenders must ensure that assistance provided
by nonprofits organizations meets FHA requirements and that the nonprofits
have current Taxpayer Identification Numbers. Furthermore, FHA and its
lenders rely upon appraisers to provide an independent and accurate
valuation of properties, including confirmation of sales and financing
concessions such as down payment assistance and seller contributions.

Two recent GAO reviews found that FHA performs some oversight of both
lenders and appraisers, but that opportunities exist for improved
monitoring.^57 As we have seen, additional opportunities still exist for
improving FHA's monitoring of loans with down payment assistance. FHA
carries out risk-based monitoring of lenders and appraisers that are
involved in the process of endorsing FHA-insured loans, using loan
performance data (e.g., higher early defaults and claims), complaints of
irregularities or fraudulent practices, the results of technical reviews
of individual loans, and other factors to target lenders for review.
However, FHA has not implemented targeted monitoring of lenders that do a
high volume of loans with down payment assistance. HUD monitors appraisers
that it has determined pose risks to FHA's insurance fund, targeting
individual appraisers on several risk factors, such as involvement with
loans that have early default rates and those that are insured under HUD
programs known to be at a higher risk of fraud and abuse. FHA has also
implemented targeted monitoring of appraisers that do a high volume of
loans with down payment assistance. When an appraiser is targeted, FHA
first does a desk review and then, if necessary, conducts a field review.

Conclusions

Homebuyers receiving down payment assistance from seller-funded nonprofits
pay higher purchase prices, reducing their initial equity in the home. In
effect, these homebuyers are financing the down payment assistance and
paying for it over time. Moreover, loans with down payment
assistance--particularly from seller-funded sources--perform significantly
worse than loans without such assistance. These loans have higher claims
and delinquencies--meaning that some households receiving assistance
ultimately lose their homes. However, down payment assistance has helped
some households become homeowners, or become homeowners sooner than they
might have without such assistance.

Down payment assistance can impose additional risks to the loans FHA
insures, and it has taken steps toward managing these risks by conducting
ad hoc loan performance analyses and studies. More recently, HUD has
supported legislation for a no down payment product that would help
homebuyers who lack down payment funds, obviating the need for down
payment assistance. This legislation includes tools for mitigating the
risks of such loans with higher premiums and homebuyer counseling. We
previously recommended that Congress and FHA consider a number of means,
such as enhanced monitoring, to mitigate the risks that a no down payment
product and any other new single-family insurance product may pose. Such
techniques would help protect the Fund while allowing FHA time to learn
more about the performance of such loans.^58 Likewise, such tools may be
useful in mitigating the risks associated with loans with down payment
assistance.

Although FHA has taken some steps to understand the risks associated with
loans with down payment assistance, it could take additional steps to
understand and manage the risks that loans with down payment assistance
represent, while still meeting its mission of expanding homeownership
opportunities. Furthermore, because the proportion of loans FHA insures
that involve some form of down payment assistance has increased
dramatically in the last 5 years, and because the risks associated with
down payment assistance are substantial, the need for FHA to better manage
these risks has become increasingly important. For example, FHA requires
lenders to collect and report information on the presence and source of
down payment assistance, but it does not require them to collect and
report whether the entity providing the assistance is funded by property
sellers. Without this information, FHA cannot, on a regular basis, monitor
and evaluate the prevalence of this form of assistance or its impact on
loan performance.

More routine and systematic analysis of the impact that all forms of down
payment assistance have on loan performance would also provide FHA with an
ongoing assessment of the effect that the increasing use of down payment
assistance is having on loan performance. Though we found that the
presence and source of down payment assistance is an important predictor
of loan performance, FHA does not now include it as a factor in its TOTAL
Mortgage Scorecard automated underwriting tool. We recommended in our
September 2005 report that FHA assess and report the impact that including
the presence of down payment assistance would have on the forecasting
ability of the loan performance models used in FHA's actuarial reviews of
the Fund.^59 Consistent with our recommendation, in October 2005, FHA, for
the first time, included down payment assistance as a factor in its annual
actuarial review estimates of loan performance. However, because data on
the use and source of down payment assistance is still limited, the review
may underestimate the impact that down payment assistance has on claims.
Further the review does not consider the impact that down payment
assistance may have on the severity of claims.

Finally, although FHA holds lenders and appraisers accountable for the
quality of appraisals, appraisers may not have complete information
affecting the sales price of the home. Specifically, FHA requires lenders
to inform appraisers of all contract terms, including seller concessions,
which may include down payment assistance. However, FHA does not require
lenders to inform appraisers when down payment assistance is provided by a
seller-funded nonprofit. Further, as we have seen, such assistance creates
an indirect funding stream from the seller to the buyer and, thus,
becomes, in effect, a seller inducement. However, because FHA does not
consider down payment assistance from a seller-funded nonprofit an
inducement to purchase, it does not require that lenders reduce the sales
price before applying the appropriate LTV ratio.

Recommendations for Executive Action

While balancing the goals of providing homeownership opportunities and
managing risk, FHA should consider implementing additional controls to
manage the risks associated with loans that involve "gifts" of down
payment assistance, especially from seller-funded nonprofit organizations,
as these loans pose additional risks to the FHA mortgage insurance fund.
Specifically, given the increased risks posed by loans with down payment
assistance, from any source, we recommend that the Secretary of HUD direct
the Assistant Secretary for Housing (Federal Housing Commissioner) to
consider the following four actions to better understand and manage these
risks:

oTo provide FHA with data that would permit the agency to identify whether
down payment assistance is from a seller-funded down payment assistance
provider, modify FHA's "gift letter source" categories to include
"nonprofit seller-funded" and "nonprofit nonseller-funded" and require
lenders to accurately identify and report this information when submitting
loan information to FHA;

oTo more fully consider the risks posed by down payment assistance when
underwriting loans, include the presence and source of down payment
assistance as a loan variable in FHA's TOTAL Mortgage Scorecard during the
underwriting process;

oTo ensure that FHA has an ongoing understanding of the impact that down
payment assistance has on loan performance, implement routine and targeted
performance monitoring of loans with down payment assistance, including
analyses that consider the source of assistance; and

oTo more accurately reflect the impact that down payment assistance has on
loan performance, continue to include the presence and source of down
payment assistance in future loan performance models. To enhance the
actuarial reviews' estimates of claims, consider including in the annual
review of actuarial soundness, the impact that the presence and source of
down payment assistance has on claim severity.

We further recommend that the Secretary of HUD direct the Assistant
Secretary for Housing (Federal Housing Commissioner) to take the following
two actions to balance the goals of expanding homeownership and sustaining
the actuarial soundness of the Fund by managing the risks associated with
loans that involve "gifts" of down payment assistance from nonprofit
organizations that receive funding from sellers:

oTo ensure that appraisers have the information necessary to establish the
market value of the properties, require lenders to inform appraisers about
the presence of down payment assistance from a seller-funded source; and

oBecause down payment assistance provided by seller-funded entities is, in
effect, a seller inducement, revise FHA standards to treat assistance from
seller-funded nonprofits as a gift from the seller and, therefore, subject
to the prohibition against using seller contributions to meet the 3
percent borrower contribution requirement.

Agency Comments and Our Evaluation

We provided a draft of this report to HUD for its review and comment. We
received written comments from HUD's Assistant Secretary for Housing
(Federal Housing Commissioner), which are reprinted in appendix IV. HUD
generally agreed with the report's findings, noting that the analysis of
loan performance is consistent with its own findings regarding the
performance of loans with down payment assistance and how seller-funded
down payment assistance programs operate. HUD also agreed to take steps
that will improve its oversight of down payment assistance lending.
Specifically, HUD will modify its information systems to document
assistance from seller-funded nonprofits, and HUD will consider
incorporating down payment assistance into FHA's TOTAL Mortgage Scorecard
and requiring lenders to inform appraisers when assistance is provided by
seller-funded nonprofits.

The department commented on certain aspects of selected recommendations.
First, although HUD agreed with the report's recommendation to perform
routine and targeted loan performance analyses of loans with down payment
assistance, it maintained that FHA already performs monitoring of these
loans. We recognized that FHA has conducted ad hoc risk analyses of its
loans with down payment assistance. Additionally, the actuarial review of
FHA's insurance Fund for 2005 includes, for the first time, down payment
assistance as a variable in its model of loan performance. Consistent with
our findings, the 2005 actuarial review found the presence of down payment
assistance to be a significant factor in explaining loan performance.
Further, the 2005 actuarial review states that loans with down payment
assistance  should be closely monitored. We agree. Because the proportion
of loans FHA insures that involve some form of down payment assistance is
growing dramatically, and because the risks associated with down payment
assistance are substantial, we continue to recommend that FHA more
routinely monitor the performance of loans with down payment assistance.

Second, HUD disagreed with our recommendation that it should revise its
standards to prohibit the use of down payment assistance from
seller-funded nonprofit organizations to meet the three percent borrower
contribution requirement. Our recommendation was based on our conclusion
that the down payment assistance provided by seller-funded nonprofits was,
in effect, a seller inducement to purchase. As the basis of its
disagreement with our recommendation, FHA cites a 1998 internal HUD Office
of the General Counsel memorandum, acknowledged in our report. The 1998
HUD memorandum reasoned that as long as seller-funded down payment
assistance is provided to the buyer before closing, and the seller's
contribution to the nonprofit entity occurs after closing, the buyer has
not received funds that can be directly traced to the seller's
contribution.

We realize that FHA relies on HUD's 1998 memorandum to authorize sellers
to do indirectly what they cannot do directly, namely provide gifts of
down payment assistance to buyers. We continue to believe that HUD should
recognize that because gifts of down payment assistance from seller-funded
nonprofits are ultimately funded by the sellers, they are like gifts of
down payment assistance made directly by sellers. We, therefore, continue
to believe that FHA should revise its standards to treat assistance from a
seller-funded entity as a seller inducement to purchase.

In addition, as noted in our report, HUD agreed with our conclusion and
recommendation after it issued its 1998 memorandum. In 1999, HUD proposed
a rule that would have prohibited use of gifts from nonprofit
organizations for buyers' down payment assistance, if the organizations
received funds for the gifts--directly or indirectly--from sellers.
Although HUD later withdrew the rule without substantive explanation, we
continue to believe HUD's rationale in proposing the rule was correct.

Third, in its comment letter, HUD stated that FHA has  incorporated the
source of down payment assistance in the 2005 actuarial review of the
Mutual Mortgage Insurance Fund, which was published during the course of
obtaining HUD's comments on a draft of this report. In response, we have
added information describing the analyses contained in the 2005 actuarial
review, and modified our recommendation to address a weakness in the
actuarial review's analysis of down payment assistance, and to emphasize
the need to continue considering the presence and source of down payment
assistance in future loan performance models.

As agreed with your office, unless you publicly announce the contents of
this report earlier, we plan no further distribution until 30 days from
the report date. At that time, we will send copies of this report to the
appropriate Congressional Committees and the Secretary of Housing and
Urban Development. We also will make copies available to others upon
request. In addition, the report will be available at no charge on the GAO
Web site at http://www.gao.gov.

If you or your staff have any questions concerning this report, please
contact me at (202) 512-8678 or [email protected]. Contact points for
our Offices of Congressional Relations and Public Affairs may be found on
the last page of this report. GAO staff who made major contributions to
this report are listed in appendix V.

Sincerely yours,

William B. Shear

Director, Financial Markets and Community Investment

Appendix I

Objectives, Scope, and Methodology

To examine trends in the use of down payment assistance with loans insured
by the Federal Housing Administration (FHA), we obtained loan data from
the U.S. Department of Housing and Urban Development (HUD) on
single-family purchase money mortgage loans--that is, loans used for the
purchase of a home rather than to refinance an existing mortgage.

First, to measure the use of down payment assistance from fiscal year 2000
to 2002, we used two samples of loans originally drawn for a file review
study funded by HUD and conducted by the Concentrance Consulting Group
(Concentrance).^1 That study found that FHA's Single-Family Data Warehouse
was not a reliable source for identifying loans with down payment
assistance. A review of paper files indicated that down payment assistance
was frequently not recorded in the database and that the source of the
assistance (government, nonprofit, relative, etc.) was often miscoded.
Therefore, we limited our review to the 8,294 files reviewed by
Concentrance for which the presence, source, and amount of assistance had
been ascertained from a review of the paper files. The national sample
consisted of just over 5,000 loans from a simple random sample of FHA
purchase money loans endorsed in fiscal years 2000, 2001, and 2002, while
the Metropolitan Statistical Area (MSA) sample consisted of just over
1,000 purchase money loans from each of the three MSAs (Atlanta,
Indianapolis, and Salt Lake City) endorsed over the same time period.^2
Only loans with loan-to-value (LTV) ratios greater than 95 percent were
sampled. The sample included loans insured by FHA's 203(b) program, its
main single-family program, and its 234(c) condominium program. Small
specialized programs, such as 203(k) rehabilitation and 221(d) subsidized
mortgages were not included in the sample.

Second, to measure the use of down payment assistance for fiscal years
2003, 2004, and 2005, we obtained from HUD loan-level data for
single-family purchase money loans with an LTV ratio greater than 95
percent. We utilized HUD's loan-level data for these years, because in
January 2003 FHA implemented changes to its data collection requirements
for loans with down payment assistance. We believed that these changes
should lead to improved data quality.

We analyzed the data, by source of assistance, for trends in loan volume
and in the proportion of loans with down payment assistance. For fiscal
years 2000, 2001, and 2002, we generalized the percentage breakouts from
the representative sample to the universe of FHA-insured single-family
purchase money loans endorsed in these years. We also analyzed
state-by-state variations in the proportion of loans with nonprofit down
payment assistance; loans endorsed from May 2004 through April 2005 were
included in this analysis. We met with appropriate FHA officials to
discuss the quality of the data. Based on these discussions, we determined
that the FHA data we used were sufficiently reliable for our analysis.

To examine the structure of the purchase transaction for loans with and
without down payment assistance, we reviewed HUD policy guidebooks and
reports on down payment assistance. We also interviewed HUD officials;
staff from Fannie Mae and Freddie Mac; staff from selected conventional
mortgage providers, private mortgage insurers, mortgage industry groups
representing realtors and appraisers, state and local government agencies,
and nonprofit down payment assistance providers; and individual real
estate agents and appraisers. During the interviews, we asked a structured
set of questions designed for the particular type of industry participant.
We also reviewed the Web sites of selected mortgage industry participants.

To examine how down payment assistance impacts the prices of houses
purchased with FHA-insured loans, we examined the sales prices of homes by
the use and source of down payment assistance using property value
estimates derived from an Automated Valuation Model (AVM).^3 We contracted
with First American Real Estate Solutions to obtain property value
estimates derived from their AVMs on two samples of FHA-insured
single-family purchase money loans. One sample included the data set of
8,294 loans endorsed in fiscal years 2000, 2001, and 2002--the sample
developed by Concentrance. The second sample included a stratified random
sample of 2,000 FHA purchase money loans with first amortization dates in
April 2005, extracted from FHA's Single-Family Data Warehouse.^4 We used
the AVM data as benchmarks to determine if a relationship existed between
property valuation and the presence and source of down payment assistance
by examining the ratio of the estimated AVM value to the appraised value
and the sales price of the home. We met with staff of First American Real
Estate Solutions to discuss the data and models in their AVM, including
the steps the firm takes to verify the accuracy and maintain the integrity
of the data. Based on these discussions, we determined that the AVM data
we used were sufficiently reliable for our analysis. For a detailed
description of our data sources and analysis, see appendix II.

To evaluate the influence of down payment assistance on the performance of
FHA-insured home mortgage loans, we conducted multiple loan performance
analyses on HUD data for the sample of loans endorsed in fiscal years
2000, 2001, and 2002. We used information on the source of down payment
funds--data developed by Concentrance; delinquency, claim, and loss data;
and other factors that research had indicated can affect loan performance.
The loan performance data we used were current through June 30, 2005.
First, we analyzed loan performance by source of down payment assistance,
controlling for the maximum age of the loan. Second, we compared the
performance of the loans by the presence and source of down payment
assistance while holding other variables constant. Third, we examined the
size of the effect of down payment assistance on loan performance relative
to the size of the effect of other variables that influence loan
performance, including LTV ratio and credit score. Fourth, using AVM data
obtained from First American Real Estate Solutions for these loans, we
also assessed the extent to which higher sales prices explained any
difference in the performance of FHA-insured loans with down payment
assistance. For a detailed description of our data sources, performance
measures, and risk models, see appendix III.

To examine the extent to which FHA standards and controls for loans with
down payment assistance are consistent with government internal control
guidelines and, as appropriate, mortgage industry practices, we first
assessed whether key FHA controls were consistent with the guidelines in
GAO's August 2001 Internal Control Management and Evaluation Tool.^5 These
guidelines include (1) ensuring that an agency's operations are consistent
with any applicable industry or business norms; (2) using qualitative and
quantitative methods to identify risk and determine relative risk rankings
on a scheduled and periodic basis; (3) ensuring that adequate mechanisms
exist to identify risks to the agency arising from its reliance on
external parties to perform critical agency operations; and (4) ensuring
that statutory requirements--as well as agency requirements, policies, and
regulations--are applied properly.  Second, we compared FHA's standards
and controls to mortgage industry practices, as appropriate. We
interviewed officials from HUD, Fannie Mae, Freddie Mac, conventional
mortgage providers, private mortgage insurers, state and local government
agencies, and nonprofit down payment assistance providers. These entities
provided us with information about the controls they reported using to
manage the risks associated with affordable loan products that permit down
payment assistance. We did not verify that these entities, in fact, used
these controls. We also reviewed descriptions of mortgage products
permitting down payment assistance that are supported by mortgage industry
participants and compared the standards used by these entities.

Appendix II

Automated Valuation Model Analysis

This appendix describes our analysis of differences in the sales prices
and appraised values of homes purchased with and without down payment
assistance and insured by the Federal Housing Administration (FHA). The
U.S. Department of Housing and Urban Development's (HUD) Office of
Inspector General (OIG) and others have indicated that appraisals and
sales prices may be higher for homes with seller-funded assistance,
relative to comparable homes without such assistance. Higher prices for
comparable collateral can lead to higher loan amounts when supported by
higher appraisals, which may cause higher delinquency, claim, and loss
rates for loans with seller-funded assistance. To examine this
possibility, we contracted with First American Real Estate Solutions
(First American) to provide estimated house values from their Automated
Valuation Models (AVM). AVMs from First American and other vendors are
widely used by lenders, mortgage insurers, HUD, and government-sponsored
enterprises for quality control and other purposes.

First American obtains data from local governments, large lenders, and
other sources on house price sales and property characteristics across
most of the United States. These data are used in statistical analyses
that model the sales prices of properties, as a function of their
characteristics, and appreciation trends for the surrounding
neighborhoods. The models estimate a property's value on a given date,
along with a likely range for that value and a confidence score,
indicating the probability that the property's true value is within 10
percent of the estimated value. First American used four models to value
the transactions we submitted, with about 95 percent of the cases relying
on one of two models. Both of these are hybrid models, in that they use
both hedonic regression to estimate property value and repeat sales
methods to estimate a more precise estimated value for a property.^1
Hedonic regression places values on the characteristics of a property,
such as square footage, number of bathrooms, and presence of a garage, to
use when examining comparable properties. The repeat sales method uses
multiple sales of the same properties over time to estimate the growth
rates, and then uses these growth rates to estimate a sales price based on
the previous sales prices of the property and the estimated growth rate in
prices. In about 5 percent of the cases, when these two models could not
provide a value estimate, two other
models that rely on neural net methods to produce value estimates were
used.^2

GAO provided First American with addresses for the 8,294 loans in the
Concentrance Consulting Group (Concentrance) sample of loans endorsed in
fiscal years 2000, 2001, and 2002.^3 First American was asked to provide
an estimate of each home's value with an "as-of" date 2 weeks before the
loan's actual settlement date. GAO also provided addresses from a
stratified random sample of 2,000 FHA purchase money loans extracted from
FHA's Single-Family Data Warehouse with first amortization dates in April
2005. The stratification was based on the gift letter source code in FHA's
system, so that 1,000 loans had gift assistance from a nonprofit, and
1,000 did not.^4 As GAO did not have the settlement dates for this sample,
we asked the contractor to value the homes as of March 1, 2005.^5 We did
not provide First American with any information pertaining to the source
of the purchaser's down payment funds.

First American might not be able to estimate the value of a particular
property for a variety of reasons. For example, a data entry error or
unusual address might prevent a match between FHA's database and the
contractor's, or a local jurisdiction might not allow public access to
property transaction records, reducing the number of properties in the
contractor's database. In addition, there might be too few transactions in
an area to allow a precise estimate of a property's value. "Hit rate"
refers to the percentage of loans for which First American was able to
make an estimate of property value. The hit rates were over 70 percent for
the 2000, 2001, and 2002 national and Metropolitan Statistical Area (MSA)
samples and 65 percent for the 2005 stratified national sample (tables
1-8). Hit rates were low for the Indianapolis component of the MSA sample,
and confidence scores for Indianapolis were much lower than for the other
two MSAs and for both national samples. Further, in Indianapolis,
estimated values were much higher than sales prices for the loans that
were valued. First American told us that Indiana is a nondisclosure
state--that is, state law prohibits access to property transaction records
by the general public.^6 For this reason, the contractor used secondary
sources to value properties in this state. Utah is also a nondisclosure
state. Although hit rates and confidence scores were higher for Salt Lake
City than for Indianapolis, sales price ratios were also high for this
MSA. Therefore, we dropped the Indianapolis and Salt Lake City components
from one set of MSA results, and we present one table with just the
Atlanta results. While some nondisclosure states, such as Indiana and
Kansas, had low confidence scores, others did not. For example, Texas is a
nondisclosure state but had a high hit rate and high confidence scores.
First American has an arrangement that allows them to access Multiple
Listing Service data for several urban counties in Texas, providing a
substitute for government records. For two cases that clearly represented
outliers in the Concentrance data files, we replaced a value from the
Concentrance review with a value from the Single-Family Data Warehouse.^7

To examine the possibility that the presence of seller-funded nonprofit
down payment assistance might increase appraisals and sales prices, we
calculated the ratio of the AVM estimate of property value to the sales
price and the appraised value from FHA's records. Both the numerator and
denominator(s) were random variables. The AVM estimate was a model
estimate with an associated error, and sales prices and appraisals
reflected the buyer's or appraiser's estimate of a home's true value,
which may have errors of varying magnitudes. The ratio of two normally
distributed random variables has a Cauchy distribution (a distribution
with fat tails and an undefined mean). Hence, tests of the difference in
medians are generally more informative than tests of differences in
means.^8 We tested the difference in medians with a Kruskal-Wallis test
and the difference in means with a T-test. We also tested the difference
in medians or in means using only records with confidence scores of more
than 50, rejecting transactions with low confidence; we report these
results in tables 1-8 as the high confidence median and the high
confidence mean. We also tested for differences in the trimmed means,
rejecting the top and bottom 1 percent of the transactions; we report
these results in tables 1-8 as the trimmed mean.^9 Because of the
statistical problems inherent in testing the mean of a ratio of random
variables, we relied on the difference in medians as our primary indicator
of a significant difference in valuations.

The results of the analysis are presented in tables 1-4, which show the
difference in the ratio of the AVM estimate to the appraised value and
sales price for loans with and without nonprofit down payment assistance.
The median ratio of the AVM estimate to the appraised value was slightly
over 1, except for the MSA sample with Indianapolis included, for which
the ratio was about 1.1.^10 The median ratio of the AVM value to the sales
price was generally 1 or 2 percentage points higher than the ratio of the
AVM value to the appraised value, as appraised values were the same as
sales prices for about half the transactions but were up to 4 percentage
points higher than sales prices for most of the other half. In the
national sample for 2000, 2001, and 2002, prices and appraisal ratios were
both about 3 percentage points lower for loans with seller-funded
assistance, indicating that sales prices and appraisals were typically
about 3 percentage points higher for transactions with seller-funded
assistance than they were for comparable homes without such assistance.
The appraisal ratio was also 3 percentage points lower when the sample was
restricted to estimated values with confidence scores above 50; in these
cases, the sales price ratio was 4 percentage points lower, indicating
that homes with seller-funded assistance sold for about 4 percentage
points more than comparable homes without assistance. Differences in the
MSA sample for these years were not as large, with a 1 percentage point
difference in the median appraisal ratio and differences of about 2
percentage points for the price ratio and for the appraisal ratio when the
sample was restricted to estimated values with high confidence scores.
Kruskal-Wallis tests for a difference in medians were always significant
at 1 percent in one-tailed tests.^11 T-tests for differences in means were
generally significant at 5 percent or more in one-tailed tests, except for
the national sample appraisal ratio. T-tests were also conducted on
differences in means with the top and bottom 1 percent of the ratio
distribution excluded. These trimmed mean results were similar to the mean
results but with higher significance levels and sometimes larger
differences.

For the March 2005 national sample, median differences in both sales price
and appraisal ratios were about 2.3 percentage points and were
statistically significant with p-values of less than 1 percent in
one-tailed tests. These findings indicate that sales prices and appraisals
were about 2.3 percentage points higher for transactions with nonprofit
assistance than they were for comparable homes without nonprofit
assistance. Mean differences were slightly smaller, ranging between 1 and
2 percentage points. The mean price difference was statistically
significant at 5 percent in a one-tailed test, while appraisal ratio
differences in means were not significant. Again, because of the
statistical difficulties inherent in testing the ratio of two random
variables, we relied primarily on tests of the difference in medians.

Table 1: The Ratio of AVM Value to Appraisal Value and Sales
Price--Nonprofit Down Payment Assistance, National Sample, Fiscal Years
2000, 2001, and 2002

      78 % hit rate.    
Confidence score: 78 
          median        
Type                 Nonprofit   Mean Median       High       High Trimmed 
                        assistance              confidence confidence    mean 
                                                      mean     median         
Appraisal value      No         1.071  1.030      1.068      1.027   1.063 
ratio                Yes        1.055  1.002      1.041      1.000   1.043 
                        Difference 0.016  0.028      0.027      0.027   0.020 
                        p-value    0.084  0.001      0.008      0.001   0.006 
Sales price ratio    No         1.095  1.046      1.090      1.043   1.084 
                        Yes        1.067  1.012      1.053      1.007   1.053 
                        Difference 0.028  0.034      0.037      0.036   0.031 
                        p-value    0.011  0.001      0.001      0.001   0.001 

Source: GAO.

Notes: p-value is for one-tailed test; p-value of .001 means .001 or less;
p-value of .5 means .5 or greater; p-values statistically significant at
5% or better are bold.

Table 2: The Ratio of AVM Value to Appraisal Value and Sales
Price--Nonprofit Down Payment Assistance, MSA Sample, Fiscal Years 2000,
2001, and 2002

      85 % hit rate.    
Confidence score: 78 
          median        
Type                 Nonprofit   Mean Median       High       High Trimmed 
                        assistance              confidence confidence    mean 
                                                      mean     median         
Appraisal value      No         1.106  1.080      1.086      1.061   1.102 
ratio                Yes        1.096  1.067      1.068      1.039   1.093 
                        Difference 0.010  0.013      0.018      0.022   0.009 
                        p-value    0.093  0.024      0.008      0.001   0.058 
Sales price ratio    No         1.126  1.095      1.105      1.076   1.123 
                        Yes        1.110  1.078      1.081      1.052   1.107 
                        Difference 0.016  0.017      0.024      0.024   0.016 
                        p-value    0.015  0.003      0.001      0.001   0.006 

Source: GAO.

Notes: p-value is for one-tailed test; p-value of .001 means .001 or less;
p-value of .5 means .5 or greater; p-values statistically significant at
5% or better are bold.

Table 3: The Ratio of AVM Value to Appraisal Value and Sales
Price--Nonprofit Down Payment Assistance, Atlanta MSA Sample, Fiscal Years
2000, 2001, and 2002

      95 % hit rate.    
Confidence score: 85 
          median        
Type                 Nonprofit   Mean Median       High       High Trimmed 
                        assistance              confidence confidence    mean 
                                                      mean     median         
Appraisal value      No         1.037  1.013      1.035      1.012   1.035 
ratio                Yes        1.025  0.989      1.022      0.988   1.012 
                        Difference 0.012  0.024      0.013      0.024   0.023 
                        p-value    0.165  0.001      0.130      0.001   0.002 
Sales price ratio    No         1.057  1.028      1.056      1.027   1.057 
                        Yes        1.039  1.001      1.036      1.001   1.026 
                        Difference 0.018  0.027      0.020      0.026   0.031 
                        p-value    0.079  0.001      0.056      0.001   0.001 

Source: GAO.

Notes: p-value is for one-tailed test; p-value of .001 means .001 or less;
p-value of .5 means .5 or greater; p-values statistically significant at
5% or better are bold.

Table 4: The Ratio of AVM Value to Appraisal Value and Sales
Price--Nonprofit Down Payment Assistance, National Sample, March 2005

      65 % hit rate.    
Confidence score: 77 
          median        
Type                 Nonprofit   Mean Median       High       High Trimmed 
                        assistance              confidence confidence    mean 
                                                      mean     median         
Appraisal value      No         1.051  1.024      1.049      1.024   1.047 
ratio                Yes        1.037  1.001      1.036      1.000   1.025 
                        Difference 0.014  0.023      0.013      0.024   0.022 
                        p-value    0.116  0.007      0.156      0.006   0.006 
Sales price ratio    No         1.079  1.044      1.075      1.039   1.070 
                        Yes        1.058  1.021      1.057      1.013   1.048 
                        Difference 0.021  0.023      0.018      0.026   0.022 
                        p-value    0.049  0.008      0.084      0.006   0.013 

Source: GAO.

Notes: p-value is for one-tailed test; p-value of .001 means .001 or less;
p-value of .5 means .5 or greater; p-values statistically significant at
5% or better are bold.

We also tested for the differences in ratios between transactions with no
gift assistance versus transactions with gift assistance from sources
other than nonprofits (tables 5-8). We found no significant differences in
any of the samples that we examined and no consistent pattern in the signs
of the differences. Transactions with assistance had differences in
medians that were sometimes slightly positive and sometimes slightly
negative.

Table 5: The Ratio of AVM Value to Appraisal Value and Sales Price--Down
Payment Assistance from Other Sources, National Sample, Fiscal Years 2000,
2001, and 2002

     78 % hit rate.    
    Confidence score:  
        78 median      
Type                Other        Mean Median       High       High Trimmed 
                       assistance               confidence confidence    mean 
                                                      mean     median         
Appraisal value     No          1.072  1.032      1.069      1.028   1.064 
ratio               Yes         1.070  1.027      1.065      1.024   1.060 
                       Difference  0.002  0.005      0.004      0.004   0.004 
                       p-value     0.430  0.420      0.280      0.360   0.255 
Sales price ratio   No          1.094  1.046      1.091      1.042   1.083 
                       Yes         1.096  1.046      1.089      1.043   1.086 
                       Difference -0.002  0.000      0.002     -0.001  -0.003 
                       p-value     0.500  0.397      0.420      0.500   0.500 

Source: GAO.

Notes: p-value is for one-tailed test; p-value of .001 means .001 or less;
p-value of .5 means .5 or greater; no differences were statistically
significant at 5% or better.

Table 6: The Ratio of AVM Value to Appraisal Value and Sales Price--Down
Payment Assistance from Other Sources, MSA Sample, Fiscal Years 2000,
2001, and 2002

      85 % hit rate.    
Confidence score: 78 
          median        
Type                 Other       Mean Median       High       High Trimmed 
                        assistance              confidence confidence    mean 
                                                      mean     median         
Appraisal value      No         1.108  1.079      1.085      1.052   1.103 
ratio                Yes        1.101  1.080      1.087      1.072   1.101 
                        Difference 0.007 -0.001     -0.002     -0.020   0.002 
                        p-value    0.194  0.381      0.500      0.500   0.392 
Sales price ratio    No         1.128  1.097      1.105      1.068   1.124 
                        Yes        1.122  1.093      1.106      1.083   1.121 
                        Difference 0.006  0.004     -0.001     -0.015   0.003 
                        p-value    0.224  0.375      0.500      0.500   0.340 

Source: GAO.

Notes: p-value is for one-tailed test; p-value of .001 means .001 or less;
p-value of .5 means .5 or greater; no differences were statistically
significant at 5% or better.

Table 7: The Ratio of AVM Value to Appraisal Value and Sales Price--Down
Payment Assistance from Other Sources, Atlanta MSA Sample, Fiscal Years
2000, 2001, and 2002

     95 % hit rate.    
    Confidence score:  
        85 median      
Type                Other        Mean Median       High       High Trimmed 
                       assistance               confidence confidence    mean 
                                                      mean     median         
Appraisal value     No          1.037  1.012      1.036      1.012   1.035 
ratio               Yes         1.036  1.017      1.033      1.017   1.036 
                       Difference  0.001 -0.005      0.003     -0.005  -0.001 
                       p-value     0.450  0.500      0.400      0.500   0.500 
Sales price ratio   No          1.056  1.026      1.056      1.025   1.057 
                       Yes         1.058  1.030      1.056      1.029   1.058 
                       Difference -0.002 -0.004      0.000     -0.004  -0.001 
                       p-value     0.500  0.500      0.500      0.500   0.500 

Source: GAO.

Notes: p-value is for one-tailed test; p-value of .001 means .001 or less;
p-value of .5 means .5 or greater; no differences were statistically
significant at 5% or better.

Table 8: The Ratio of AVM Value to Appraisal Value and Sales Price--Down
Payment Assistance from Other Sources, National Sample, March 2005

     65 % hit rate.    
    Confidence score:  
        77 median      
Type                Other        Mean Median       High       High Trimmed 
                       assistance               confidence confidence    mean 
                                                      mean     median         
Appraisal value     No          1.051  1.026      1.031      1.022   1.049 
ratio               Yes         1.053  1.024      1.021      1.028   1.044 
                       Difference -0.002  0.002      0.010     -0.006   0.005 
                       p-value     0.500  0.354      0.373      0.433   0.379 
Sales price ratio   No          1.073  1.040      1.069      1.033   1.069 
                       Yes         1.095  1.045      1.091      1.054   1.072 
                       Difference -0.022 -0.005     -0.022     -0.021  -0.003 
                       p-value     0.500  0.500      0.500      0.500   0.500 

Source: GAO.

Notes: p-value is for one-tailed test; p-value of .001 means .001 or less;
p-value of .5 means .5 or greater; no differences were statistically
significant at 5% or better.

Appendix III

Loan Performance Analysis

This appendix describes the econometric models that we built and the
analysis that we conducted to examine the performance of mortgage loans
that received down payment assistance and were insured by the U.S.
Department of Housing and Urban Development's (HUD) Federal Housing
Administration (FHA). We developed multiple regression models to forecast
delinquency, claim, prepayment, and loss on two samples of FHA
single-family purchase money loans endorsed in 2000, 2001, and 2002.^1 The
national sample included all 50 states and the District of Columbia but
excluded U.S. territories. The Metropolitan Statistical Area (MSA) sample
consisted of loans in three MSAs where the use of down payment assistance
was relatively high: Atlanta, Indianapolis, and Salt Lake City. The data
were current as of June 30, 2005.

Our forecasting models used observations on loan quarters--that is,
information on the characteristics and status of an insured loan during
each quarter of its life - to predict conditional foreclosure and
prepayment probabilities.^2 Our model used a pair of binary logistic
regressions to predict the probability of claim, or prepayment, as a
function of several key predictor variables. Some of these variables, such
as initial loan-to value (LTV) ratio, credit score, and the presence of
down payment assistance, do not vary over the life of a loan, while
others, such as accumulated equity from amortization and price
appreciation, may change and are updated quarterly.

Data and Sample Selection

For our analysis, we used the 8,294 loans in the Concentrance Consulting
Group's (Concentrance) sample of FHA single-family purchase money mortgage
loans endorsed in fiscal years 2000, 2001, and 2002, for which the
presence, source, and amount of assistance had been ascertained through a
loan file review.^3 Only loans with LTV ratios greater than 95 percent
were sampled. The national sample consisted of just over 5,000 loans from
a simple random sample of purchase money loans, while the MSA sample
consisted of just over 1,000 purchase money loans from each of three MSAs:
Atlanta, Indianapolis, and Salt Lake City. Concentrance's loan file review
also recorded the borrowers' credit scores, an important predictor of loan
performance that, at the time, was not captured in FHA's Single-Family
Data Warehouse.

We supplemented these files with information from FHA's Single-Family Data
Warehouse. We then merged variables reflecting delinquency, claim, and
prepayment information with the Concentrance files, along with information
on borrowers' assets and data on national and local economic conditions.
We obtained state-level unemployment rates from the Bureau of Labor
Statistics, 30-year fixed rate mortgage rates from Freddie Mac, 1- and
10-year Treasury interest rates from the Federal Reserve, the Personal
Consumption Expenditure Deflator from the Bureau of Economic Analysis, and
median existing house prices at the state level from Global Insights,
Inc., in order to measure house price appreciation over time. Table 9
lists the names and definitions of the variables used in the models.

Table 9: Names and Definitions of the Variables Used in Our Regression
Models

                                        

Constructed risk              Combines the variables used in a prior GAO   
                                 report to predict claim probability,         
                                 including initial LTV ratio, price           
                                 appreciation after origination, loan size,   
                                 location, interest rate, unemployment rate,  
                                 loan type, and other variables^a             
FICO score                    FICO score of borrower in case binder (if    
                                 two scores, it is the lower score; if three  
                                 scores it is the median score)               
No FICO score                 Equals 1 if no FICO score was available for  
                                 the borrower                                 
Borrower reserves             Equals 1 if the borrower had less than 2     
                                 months of mortgage payment in liquid assets  
                                 after closing                                
Front-end ratio               Housing payments divided by income           
Seller-funded down payment    Equals 1 if the borrower received down       
assistance                    payment assistance from a seller-funded      
                                 program^b                                    
Nonseller-funded down payment Equals 1 if the borrower received down       
assistance                    payment assistance from a source other than  
                                 a seller-funded program                      
Underserved area              Equals 1 if the home is in a census tract    
                                 designated by HUD as underserved             
Condominium                   Equals 1 if the loan is a 234(c) condominium 
                                 loan                                         
First-time homebuyer          Equals 1 if the borrower was flagged in      
                                 HUD's database as a first-time homebuyer     
LTV ratio                     The ratio of the original mortgage amount to 
                                 the sales price of the house                 
15-year mortgage              Equals 1 if the mortgage term is 25 years or 
                                 less (mostly 15 year terms)                  
Endorsed in fiscal year 2000  Equals 1 if endorsed in fiscal year 2000     
Endorsed in fiscal year 2001  Equals 1 if endorsed in fiscal year 2001     
House price appreciation rate Growth rate in the median price of existing  
                                 housing, reduced by 0.5 percent per quarter  
                                 to adjust for increasing quality of the      
                                 housing stock^c                              
First 6 quarters              Number of quarters since origination, up to  
                                 6                                            
Next 6 quarters               Number of quarters since the sixth quarter   
                                 after origination, up to 12                  
Following quarters            Number of quarters since the twelfth quarter 
                                 after origination                            
Adjustable Rate Mortgage      Equals 1 if adjustable rate mortgage         
(ARM)                                                                      
Atlanta MSA                   Equals 1 if in the Atlanta MSA sample        
Salt Lake City MSA            Equals 1 if in the Salt Lake MSA sample      
Relatively high equity        The ratio of the market value of the         
                                 mortgage to the book value of the mortgage,  
                                 when greater than 1.2: measures the          
                                 incentive of the borrower to refinance the   
                                 loan                                         
Relatively low equity         The ratio of the market value of the         
                                 mortgage to the book value of the mortgage,  
                                 when less than 1.2                           
Initial interest rate         The initial interest rate on the mortgage    
Original mortgage amount      The balance of the mortgage at time of       
                                 origination                                  

Source: GAO.

^aGAO-01-460.

^bIn a small number of cases borrowers received both types of assistance.
In these cases, the record was assigned to the category with the larger
amount of assistance.

^cGlobal Insights, Inc.

Specification of Delinquency and Claim Models

The models we estimated used logistic regression to predict the
probability of a loan becoming seriously delinquent or resulting in a
claim on FHA's insurance coverage, as a function of credit score, equity,
and other variables. Equity and credit scores have consistently been found
to be important predictors of mortgage credit risk and some studies have
found that other variables, such as qualifying ratios, are important.^4
The dependent variable is the conditional probability of a loan becoming
90 
days delinquent, or resulting in a claim, in a given quarter, conditional
on the loan having survived until that quarter.^5

We estimated the delinquency and claim regressions using both national and
MSA samples of loans. For each of these samples, we developed four
different delinquency regressions and four different claim regressions.
The first model used for delinquency and claim regressions we based on the
variables used in the FHA Technology Open to Approved Lenders (TOTAL)
Mortgage Scorecard (used by FHA's TOTAL Mortgage Scorecard automated
underwriting algorithm as predictors of credit risk). These variables were
initial LTV ratio, credit score, housing payment-to-income ratio (the
front-end ratio), borrower reserves, and mortgage term (15-year or 30-year
term). To these, we added variables for house price appreciation,
variables reflecting the passage of time, and variables indicating the
presence and source of down payment assistance. For the second model, we
augmented the model based on the FHA TOTAL Mortgage Scorecard variables
with indicators of whether the mortgage was an adjustable rate mortgage,
the property was located in an underserved area, the property was a
condominium, and the purchaser was a first-time homebuyer. We based the
third regression model on GAO's model of FHA actuarial soundness that we
estimated in 2001.^6 That model used, among others, the initial LTV ratio,
loan type (30-year fixed, 15-year fixed, investor, or adjustable rate
mortgage), property type (one or multiple unit), Census division,
accumulated equity stemming from house price appreciation and
amortization, and a set of variables reflecting the passage of time, to
predict the annual probability of a loan terminating in a claim. We
created a variable called constructed risk, using the results of the 2001
actuarial study. Because that study used millions of loans in the model
estimation, its estimates of the effects of certain variables, such as
accumulated equity, may be more precise than those produced using the
thousands of loans in the Concentrance sample. However, the actuarial
study did not use credit score as a predictor variable or consider down
payment assistance. Therefore, we included the constructed risk variable
along with credit score information, borrower reserves, front-end ratio,
and presence and source of down payment assistance. The fourth model
augments GAO's actuarial model by adding three variables: underserved
area, condominium, and first-time homebuyer. GAO estimated prepayments and
losses twice, once in a national sample, and once in a MSA sample.

The LTV ratio calculated from FHA's database will tend to understate the
true LTV ratio of the mortgage if homes with seller-funded down payment
assistance are sold for higher prices than are comparable homes without
such assistance.^7 Comparable homes would have the same value, yet the
home purchased with assistance may have a larger loan. For example, FHA
regulations allow the borrower to take out a mortgage for about $99,000 on
a $100,000 home. With seller-funded down payment assistance, the same home
might sell for $103,000 and qualify for a $102,000 loan.^8 The calculated
LTV ratio would be about 99 percent in each case ($99,000/$100,000 or
$102,000/$103,000), but the transaction with seller-funded assistance
would have a larger mortgage, backed by the same collateral. In such
cases, the initial LTV ratio would be understated, the borrower's equity
subsequent to origination would be overstated, and the risk of delinquency
or claim for such loans should be higher than for loans with comparable
LTV ratios and subsequent price appreciation. To test for this
possibility, we included a variable, seller-funded down payment
assistance, which was set equal to 1 for loans that received seller-funded
down payment assistance. To test for the possibility that down payment
assistance in general, and not just seller-funded assistance, raised
delinquency and claim probabilities, we included a variable,
nonseller-funded down payment assistance, which was set equal to 1 for
loans that received down payment assistance from relatives, a borrower's
employer, government programs, nonprofits that were not seller-funded, or
nonprofits with a source of funding that was not ascertained.

Estimation Results

Tables 10 through 17 present the estimation results for our 90-day
delinquency regressions, and tables 18 through 25 present the results for
our claim regressions for the national samples and MSA samples. Our
results are consistent with other research that finds credit scores and
accumulated equity to be important variables predicting delinquency and
claims.^9 In specifications that use the constructed risk variable (tables
12, 13, 16, 17, 20, 21, 24, and 25), we find it a statistically
significant predictor of delinquency or claim. Additionally, credit score
is highly significant. The front-end ratio, which FHA uses in its
underwriting, is also very important. Borrower reserves, however,
generally have the wrong sign, and are statistically insignificant. In
some specifications indicators for condominium loans, for loans to
first-time homebuyers, and for loans in underserved areas are added, and
they are also found to be insignificant. In specifications that use TOTAL
Mortgage Scorecard variables (tables 10, 11, 14, 15, 18, 19, 22, and 23),
credit score has statistically significant effect of the expected sign.
The front-end ratio is also an important predictor with the expected sign.
Again reserves are not an important predictor; neither are the 15-year
loan indicator, the initial LTV ratio, and indicators for condominiums or
underserved areas.

The failure to find a significant effect for short-term loans is not
surprising, as such loans constitute only about 1 percent of the loans in
each sample. The lack of a significant effect for LTV ratio is also not
surprising. The Concentrance samples are restricted to high-LTV loans, and
about 85 percent of loans in the sample had LTV ratios in a very narrow
range (98 to 100 percent). Over 99 percent of loans had LTV ratios between
96 and 102 percent. The lack of variation in this variable meant that the
regression had little ability to identify its effect.

The lack of a significant effect for reserves in the claim and delinquency
regressions is surprising. It may indicate that down payment assistance
alters the relationship between reserves and credit risk. Without
assistance, borrowers with substantial liquid assets may have few reserves
after a down payment is made. With assistance, borrowers with substantial
liquid assets may retain those assets by not making a down payment with
their own funds. If liquid assets are a better measure of risk than are
reserves, then reserves may be a less useful risk indicator when
substantial numbers of loans have down payment assistance.

Delinquency Results

In both the national and MSA samples, down payment assistance
substantially increased the likelihood of 90-day delinquency. Using the
augmented GAO actuarial model, results in the national sample indicated
that down payment assistance from a seller-funded nonprofit raised the
delinquency rate by 100 percent, compared with similar loans with no
assistance (table 12).^10 Assistance from other sources raised the
delinquency rate by 20 percent, relative to similar loans with no
assistance. With the model based on the augmented TOTAL Mortgage Scorecard
variables, the results indicated that assistance from a seller-funded
nonprofit raised the delinquency rate by 93 percent, while assistance from
other sources raised the delinquency rate by 21 percent (table 10). The
differences between loans with seller-funded assistance and loans without
it are significant with a one-tailed test at a level of 1 percent in all
variations of the model. The differences between seller-funded assistance
and assistance from other sources were large and also significant at 1
percent in a one-tailed test in all variations. Differences in delinquency
rates in the MSA sample were also substantial. Considering the augmented
GAO actuarial model, loans with seller-funded down payment assistance had
delinquency rates that were 105 percent higher than the delinquency rates
on comparable loans without assistance, while loans with assistance from
other sources had delinquency rates that were 34 percent higher than the
delinquency rates of loans without assistance (table 16). The differences
between seller-funded assistance and no assistance, and between
seller-funded assistance and other assistance, were both significant at 1
percent in one-tailed tests in all variations.^11

Claim Results

Down payment assistance also had a substantial impact on claims in both
the national and MSA samples. Results from the national sample using the
augmented GAO actuarial model indicated that assistance from a
seller-funded nonprofit raised the claim rate by 81 percent, relative to
similar loans with no assistance, as shown in the odds ratio point
estimate column of table 20.^12 Assistance from other sources raised the
claim rate by 44 percent, relative to similar loans with no down payment
assistance. With the model based on the augmented TOTAL Mortgage Scorecard
variables, we found that assistance from a seller-funded nonprofit raised
the claim rate by 76 percent, while assistance from other sources raised
the claim rate by 49 percent (table 18). The differences between loans
with down payment assistance and those without it were statistically
significant with a one-tailed test at a level of 1 percent. Seller-funded
assistance had a larger impact on claims than did assistance from other
sources. Those differences, while large, were not quite significant at
conventional levels.^13 Differences in the MSA sample were even larger for
seller-funded nonprofit assistance. Using the GAO actuarial model, loans
with seller-funded down payment assistance had claim rates that were 134
percent higher than the claim rates on comparable loans without
assistance, while loans with down payment assistance from other sources
had claim rates that were 24 percent higher than the claim rates on loans
without assistance (table 25). The difference between seller-funded
assistance and no assistance, and the difference between seller-funded
assistance and other assistance, were both significant at 1 percent in
one-tailed tests in all variations of the model.

Several explanations are possible for the increase in delinquency and
claim rates associated with down payment assistance from nonseller-funded
sources. It is possible that the gifts from relatives were actually loans,
despite the inclusion of a gift letter indicating that repayment is not
expected. In these cases, the LTV ratio would be misstated, not because
the collateral value was overstated, but because the total amount of debt
incurred in the transaction was understated. It is also possible that
borrowers who could save for a down payment differed in key respects from
borrowers who could not. For example, some researchers have suggested that
households may increase their savings rates prior to purchasing a home.^14
Others have found evidence that young households increased their earnings
and savings by working more hours prior to purchasing their first home.^15
It may be the case that households that can more easily increase earnings
or reduce consumption in order to accumulate savings enter homeownership
when a down payment is required but that both flexible and inflexible
households purchase homes when no down payment is required. The inclusion
of households with less flexibility would tend to increase delinquencies
and claims.

While delinquency differences are about the same for the MSA sample and
the national sample, claim rate differences for seller-funded nonprofit
assistance are much larger in the MSA sample than they are in the national
sample. Research suggests that delinquencies are more likely to cure, or
to prepay, than to claim if the borrower is projected to have accumulated
equity.^16 The rate of house price appreciation in the national sample is
much higher than in the MSA samples, so that borrowers in the national
sample would have accumulated more equity. Over the 5-year period from the
first quarter of fiscal year 2000 to the last quarter of fiscal year 2004,
the median house price of existing houses increased 11 percent the Salt
Lake City MSA, 18 percent in the Indianapolis MSA, and 32 percent in the
Atlanta MSA. The median increase in the national sample was about 39
percent and the mean increase was 51 percent. It is possible that
substantial house price appreciation in the national sample weakened the
effect of seller-funded down payment assistance on claims, as the assisted
loans that became delinquent were more likely to be resolved without a
claim in rapidly appreciating markets.

Table 10: Delinquency Regression Results--National Sample, Model Based on
Augmented TOTAL Mortgage Scorecard Variables

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                             2.9662   3.8624     0.4425           
LTV ratio                           -0.00214    0.038     0.9551     0.998 
15-year mortgage                       0.096   0.2587     0.7105     1.101 
FICO score                           -0.0119 0.000716     <.0001     0.988 
No FICO score                         0.5569   0.1259     <.0001     1.745 
Borrower reserves                     0.0634   0.0895     0.4789     1.065 
Front-end ratio                        1.477   0.5467     0.0069      4.38 
Endorsed in fiscal year 2000         -0.1064   0.1047     0.3096     0.899 
Endorsed in fiscal year 2001         -0.0332   0.0979     0.7346     0.967 
ARM                                  -0.3078   0.1678     0.0667     0.735 
Underserved area                      0.0703   0.0785     0.3706     1.073 
Condominium                          -0.2547   0.1843     0.1669     0.775 
First-time homebuyer                 -0.0448   0.1064     0.6736     0.956 
Seller-funded down payment            0.6583   0.1111     <.0001     1.932 
assistance                                                                 
Nonseller-funded down payment         0.1911   0.0935      0.041     1.211 
assistance                                                                 
House price appreciation rate        -0.9398   0.7716     0.2232     0.391 
First 6 quarters                      0.1997   0.0259     <.0001     1.221 
Next 6 quarters                      0.00186   0.0492     0.9698     1.002 
Following quarters                    0.0558   0.0496     0.2603     1.057 

Source: GAO.

Table 11: Delinquency Regression Results--National Sample, Model Based on
TOTAL Mortgage Scorecard Variables

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                             0.3717   3.7917     0.9219           
LTV ratio                             0.0249    0.037     0.4997     1.025 
15-year mortgage                      0.1153   0.2585     0.6555     1.122 
FICO score                            -0.012 0.000714     <.0001     0.988 
No FICO score                         0.5782   0.1251     <.0001     1.783 
Borrower reserves                     0.0545   0.0892     0.5414     1.056 
Front-end ratio                       1.4461   0.5442     0.0079     4.246 
Endorsed in fiscal year 2000         -0.1498   0.1039     0.1493     0.861 
Endorsed in fiscal year 2001         -0.0351   0.0979     0.7197     0.965 
Seller-funded down payment            0.6384   0.1101     <.0001     1.894 
assistance                                                                 
Nonseller-funded down payment         0.1911   0.0933     0.0405     1.211 
assistance                                                                 
House price appreciation rate        -1.0039   0.7676      0.191     0.366 
First 6 quarters                      0.1994   0.0259     <.0001     1.221 
Next 6 quarters                     0.000889   0.0493     0.9856     1.001 
Following quarters                    0.0563   0.0497      0.257     1.058 

Source: GAO.

Table 12: Delinquency Regression Results--National Sample, Augmented GAO
Actuarial Model

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                             1.8293    0.498     0.0002           
Constructed risk                      0.1162   0.0175     <.0001     1.123 
FICO score                           -0.0116 0.000711     <.0001     0.988 
No FICO score                         0.5583   0.1255     <.0001     1.748 
Borrower reserves                     0.0476   0.0893     0.5943     1.049 
Front-end ratio                       1.2325   0.5399     0.0224      3.43 
Underserved area                      0.0415   0.0783     0.5961     1.042 
Condominium                          -0.2416   0.1713     0.1584     0.785 
First-time homebuyer                  -0.047   0.1062     0.6583     0.954 
Seller-funded down payment            0.6961   0.1086     <.0001     2.006 
assistance                                                                 
Nonseller-funded down payment         0.1839   0.0932     0.0484     1.202 
assistance                                                                 

Source: GAO.

Table 13: Delinquency Regression Results--National Sample, GAO Actuarial
Model

                             Analysis of                 Odds ratio 
                               maximum                   estimates  
                                                                    
                             likelihood                             
                              estimates                             
Parameter                    Estimate Standard   Pr >                Point 
                                            error  ChiSq             estimate 
Intercept                      1.8124   0.4868 0.0002            
Constructed risk                0.118   0.0174 <.0001      1.125 
FICO score                    -0.0117 0.000708 <.0001      0.988 
No FICO score                  0.5652   0.1247 <.0001       1.76 
Borrower reserves              0.0448   0.0891  0.615      1.046 
Front-end ratio                 1.191   0.5363 0.0264       3.29 
Seller-funded down             0.6979   0.1083 <.0001       2.01 
payment assistance                                               
Nonseller-funded down          0.1835   0.0929 0.0483      1.201 
payment assistance                                               

Source: GAO.

Table 14: Delinquency Regression Results--MSA Sample, Model Based on
Augmented TOTAL Mortgage Scorecard Variables

                             Analysis of          Odds ratio 
                               maximum            estimates  
                                                             
                             likelihood                      
                              estimates                      
Parameter                    Estimate Standard Pr > ChiSq            Point 
                                            error                    estimate 
Intercept                     -8.4601   8.0246     0.2918         
LTV ratio                      0.0457    0.079     0.5634   1.047 
15-year mortgage               0.2383   0.5188     0.6461   1.269 
FICO score                     -0.011 0.000826     <.0001   0.989 
No FICO score                  0.4604   0.1437     0.0014   1.585 
Borrower reserves             -0.0184   0.1163     0.8742   0.982 
Front-end ratio                2.2265    0.672     0.0009   9.268 
Endorsed in fiscal year       -0.2113   0.1344      0.116    0.81 
2000                                                              
Endorsed in fiscal year       -0.0661    0.113     0.5586   0.936 
2001                                                              
ARM                           -0.0869   0.1367     0.5249   0.917 
Underserved area               0.1458   0.0918     0.1124   1.157 
Condominium                    0.3403   0.2298     0.1387   1.405 
First-time homebuyer          -0.1141   0.1258     0.3643   0.892 
Seller-funded down              0.741   0.1146     <.0001   2.098 
payment assistance                                                
Nonseller-funded down          0.3074   0.1346     0.0224    1.36 
payment assistance                                                
Atlanta MSA                   -0.1697   0.1149     0.1399   0.844 
Salt Lake City MSA             0.2951   0.1265     0.0197   1.343 
House price appreciation       4.9561   2.2367     0.0267 142.033 
rate                                                              
First 6 quarters               0.2025   0.0294     <.0001   1.224 
Next 6 quarters                0.0374   0.0589     0.5256   1.038 
Following quarters            -0.0242   0.0626     0.6988   0.976 

Source: GAO.

Table 15: Delinquency Regression Results--MSA Sample, Model Based on TOTAL
Mortgage Scorecard Variables

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                            -4.3569   5.0712     0.3903           
LTV ratio                            0.00335   0.0465     0.9425     1.003 
15-year mortgage                      0.2403   0.5184      0.643     1.272 
FICO score                           -0.0109 0.000822     <.0001     0.989 
No FICO score                          0.463   0.1423     0.0011     1.589 
Borrower reserves                    -0.0185   0.1164     0.8735     0.982 
Front-end ratio                       2.1509   0.6709     0.0013     8.593 
Endorsed in fiscal year 2000         -0.1969   0.1292     0.1273     0.821 
Endorsed in fiscal year 2001         -0.0439   0.1114     0.6936     0.957 
Seller-funded down payment            0.7357   0.1138     <.0001     2.087 
assistance                                                                 
Nonseller-funded down payment         0.3091   0.1343     0.0214     1.362 
assistance                                                                 
Atlanta MSA                          -0.1443    0.114     0.2054     0.866 
Salt Lake City MSA                    0.3253   0.1244     0.0089     1.384 
House price appreciation rate         4.9592   2.2289     0.0261   142.478 
First 6 quarters                      0.2026   0.0294     <.0001     1.225 
Next 6 quarters                        0.038    0.059     0.5197     1.039 
Following quarters                   -0.0256   0.0628     0.6838     0.975 

Source: GAO.

Table 16: Delinquency Regression Results--MSA Sample, Augmented GAO
Actuarial Model

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                             1.0815   0.5621     0.0543           
Constructed risk                      0.1411   0.0239     <.0001     1.152 
FICO score                           -0.0108 0.000819     <.0001     0.989 
No FICO score                           0.45    0.143     0.0016     1.568 
Borrower reserves                    -0.0195   0.1159     0.8666     0.981 
Front-end ratio                       2.1455   0.6696     0.0014     8.546 
Underserved area                      0.1265   0.0914     0.1665     1.135 
Condominium                           0.3149   0.1905     0.0983      1.37 
First-time homebuyer                 -0.1261   0.1256     0.3152     0.882 
Seller-funded down payment             0.719   0.1125     <.0001     2.052 
assistance                                                                 
Nonseller-funded down payment         0.2932   0.1342     0.0289     1.341 
assistance                                                                 
Atlanta MSA                          -0.1538   0.1071     0.1508     0.857 
Salt Lake City MSA                    0.1268   0.1222     0.2991     1.135 

Source: GAO.

Table 17: Delinquency Regression Results--MSA Sample, GAO Actuarial Model

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                              0.987   0.5534     0.0745           
Constructed risk                      0.1419   0.0238     <.0001     1.152 
FICO score                           -0.0107 0.000814     <.0001     0.989 
No FICO score                         0.4409   0.1415     0.0009     1.554 
Borrower reserves                     -0.017   0.1158     0.8831     0.983 
Front-end ratio                       2.0408   0.6682     0.0023     7.697 
Seller-funded down payment            0.7131   0.1118     <.0001      2.04 
assistance                                                                 
Nonseller-funded down payment         0.2924   0.1338     0.0289      1.34 
assistance                                                                 
Atlanta MSA                           -0.131   0.1065     0.2185     0.877 
Salt Lake City MSA                    0.1711   0.1203     0.1549     1.187 

Source: GAO.

Table 18: Claim regression results - National Sample, Model Based on
Augmented TOTAL Mortgage Scorecard Variables

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                             4.6847   4.4388     0.2912           
LTV ratio                            -0.0575   0.0431     0.1816     0.944 
15-year mortgage                      0.4688   0.3668     0.2012     1.598 
FICO score                          -0.00926  0.00116     <.0001     0.991 
No FICO score                         0.7271   0.1946     0.0002     2.069 
Borrower reserves                    -0.0933   0.1558     0.5492     0.911 
Front-end ratio                       2.1398   0.8949     0.0168     8.498 
Endorsed in fiscal year 2000          0.0121   0.1814     0.9468     1.012 
Endorsed in fiscal year 2001          0.1217   0.1696      0.473     1.129 
ARM                                  -0.7761    0.345     0.0245      0.46 
Underserved area                      0.0268   0.1304      0.837     1.027 
Condominium                          -0.3245   0.3088     0.2933     0.723 
First-time homebuyer                 -0.3168   0.1663     0.0567     0.728 
Seller-funded down payment            0.5664   0.1924     0.0032     1.762 
assistance                                                                 
Nonseller-funded down payment         0.3995    0.148      0.007     1.491 
assistance                                                                 
House price appreciation rate        -1.6943   1.0614     0.1104     0.184 
First 6 quarters                       0.448   0.0545     <.0001     1.565 
Next 6 quarters                       0.1178   0.0554     0.0333     1.125 
Following quarters                    0.0879   0.0543     0.1052     1.092 

Source: GAO.

Table 19: Claim Regression Results--National Sample, Model Based on TOTAL
Mortgage Scorecard Variables

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                             3.0763   5.0183     0.5399           
LTV ratio                            -0.0413   0.0488      0.398      0.96 
15-year mortgage                      0.5144   0.3667     0.1607     1.673 
FICO score                          -0.00929  0.00116     <.0001     0.991 
No FICO score                         0.7393   0.1927     <.0001     2.094 
Borrower reserves                    -0.1276   0.1552     0.4108      0.88 
Front-end ratio                       1.9601   0.8969     0.0288       7.1 
Endorsed in fiscal year 2000         -0.0442    0.181      0.807     0.957 
Endorsed in fiscal year 2001          0.1316   0.1698     0.4384     1.141 
Seller-funded down payment            0.5012   0.1904     0.0085     1.651 
assistance                                                                 
Nonseller-funded down payment         0.3786   0.1475     0.0102      1.46 
assistance                                                                 
House price appreciation rate        -1.8949   1.0561     0.0728      0.15 
First 6 quarters                      0.4486   0.0545     <.0001     1.566 
Next 6 quarters                       0.1189   0.0554      0.032     1.126 
Following quarters                    0.0863   0.0543     0.1118      1.09 

Source: GAO.

Table 20: Claim Regression Results--National Sample, Augmented GAO
Actuarial Model

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                            -2.2855   0.8291     0.0058           
Constructed risk                      0.2665   0.0244     <.0001     1.305 
FICO score                           -0.0088  0.00116     <.0001     0.991 
No FICO score                         0.7538   0.1937     <.0001     2.125 
Borrower reserves                    -0.1405   0.1559     0.3674     0.869 
Front-end ratio                       1.8786   0.8691     0.0307     6.544 
Underserved area                     -0.0771   0.1308     0.5559     0.926 
Condominium                          -0.2178   0.2986     0.4659     0.804 
First-time homebuyer                 -0.2937   0.1662     0.0771     0.745 
Seller-funded down payment            0.5947   0.1887     0.0016     1.812 
assistance                                                                 
Nonseller-funded down payment         0.3641   0.1483     0.0141     1.439 
assistance                                                                 

Source: GAO.

Table 21: Claim Regression Results--National Sample, GAO Actuarial Model

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                            -2.6245   0.8108     0.0012           
Constructed risk                      0.2656   0.0242     <.0001     1.304 
FICO score                          -0.00861  0.00115     <.0001     0.991 
No FICO score                         0.7174   0.1917     0.0002     2.049 
Borrower reserves                    -0.1575   0.1555     0.3111     0.854 
Front-end ratio                       1.7053   0.8705     0.0501     5.503 
Seller-funded down payment            0.5894   0.1878     0.0017     1.803 
assistance                                                                 
Nonseller-funded down payment         0.3443   0.1477     0.0197     1.411 
assistance                                                                 

Source: GAO.

Table 22: Claim Regression Results--MSA Sample, Model Based on Augmented
TOTAL Mortgage Scorecard Variables

                                       Analysis of Odds ratio 
                                           maximum  estimates 
                                                              
                                        likelihood            
                                         estimates            
Parameter                              Estimate   Standard   Pr >    Point 
                                                        error  ChiSq estimate 
Intercept                              -20.5482     9.2777 0.0268          
LTV ratio                                0.0309     0.0906 0.7334    1.031 
15-year mortgage                         0.5153     0.6032  0.393    1.674 
FICO score                             -0.00643    0.00108 <.0001    0.994 
No FICO score                            0.6042     0.1723 0.0005     1.83 
Borrower reserves                         0.179     0.1498 0.2322    1.196 
Front-end ratio                          1.3785     0.9056  0.128    3.969 
Endorsed in fiscal year 2000            -0.6808     0.1897 0.0003    0.506 
Endorsed in fiscal year 2001            -0.1985     0.1533 0.1954     0.82 
ARM                                     -0.3282     0.1857 0.0771     0.72 
Underserved area                         0.1533     0.1218 0.2083    1.166 
Condominium                              0.0761     0.2989  0.799    1.079 
First-time homebuyer                    -0.0626     0.1733 0.7179    0.939 
Seller-funded down payment               0.9768     0.1576 <.0001    2.656 
assistance                                                                 
Nonseller-funded down payment            0.3724     0.1864 0.0457    1.451 
assistance                                                                 
Atlanta MSA                             -0.5987     0.1764 0.0007     0.55 
Salt Lake City MSA                       0.7624     0.1591 <.0001    2.143 
House price appreciation rate           13.3648     2.8741 <.0001 >999.999 
First 6 quarters                         0.4356     0.0503 <.0001    1.546 
Next 6 quarters                          0.1633     0.0513 0.0015    1.177 
Following quarters                     -0.00873     0.0535 0.8704    0.991 

Source: GAO.

Table 23: Claim Regression Results--MSA Sample, Model Based on TOTAL
Mortgage Scorecard Variables

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                           -18.9754    7.322     0.0096           
LTV ratio                              0.018   0.0691     0.7941     1.018 
15-year mortgage                      0.5857   0.6014     0.3301     1.796 
FICO score                          -0.00645  0.00108     <.0001     0.994 
No FICO score                         0.6401   0.1701     0.0002     1.897 
Borrower reserves                      0.191   0.1499     0.2027      1.21 
Front-end ratio                       1.3525   0.9035     0.1344     3.867 
Endorsed in fiscal year 2000         -0.6919   0.1865     0.0002     0.501 
Endorsed in fiscal year 2001         -0.1672   0.1517     0.2703     0.846 
Seller-funded down payment            0.9732   0.1569     <.0001     2.647 
assistance                                                                 
Nonseller-funded down payment         0.3778   0.1863     0.0426     1.459 
assistance                                                                 
Atlanta MSA                          -0.5566   0.1748     0.0014     0.573 
Salt Lake City MSA                     0.765   0.1571     <.0001     2.149 
House price appreciation rate        13.0362   2.8596     <.0001  >999.999 
First 6 quarters                      0.4345   0.0503     <.0001     1.544 
Next 6 quarters                       0.1621   0.0513     0.0016     1.176 
Following quarters                  -0.00953   0.0536     0.8589     0.991 

Source: GAO.

Table 24: Claim Regression Results--MSA Sample, Augmented GAO Actuarial
Model

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                            -4.3382   0.7653     <.0001           
Constructed risk                      0.3949   0.0292     <.0001     1.484 
FICO score                          -0.00628  0.00108     <.0001     0.994 
No FICO score                         0.5396   0.1727     0.0018     1.715 
Borrower reserves                     0.1587   0.1491     0.2872     1.172 
Front-end ratio                       1.1872   0.9057     0.1899     3.278 
Underserved area                      0.0986   0.1218     0.4181     1.104 
Condominium                           0.1499   0.2587     0.5625     1.162 
First-time homebuyer                 -0.0842   0.1732     0.6267     0.919 
Seller-funded down payment            0.8555    0.154     <.0001     2.352 
assistance                                                                 
Nonseller-funded down payment         0.2174   0.1885     0.2488     1.243 
assistance                                                                 
Atlanta MSA                          -0.4073   0.1515     0.0072     0.665 
Salt Lake City MSA                    0.3428   0.1506     0.0229     1.409 

Source: GAO.

Table 25: Claim Regression Results--MSA Sample, GAO Actuarial Model

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                            -4.3714   0.7543     <.0001           
Constructed risk                      0.3956   0.0291     <.0001     1.485 
FICO score                          -0.00625  0.00108     <.0001     0.994 
No FICO score                         0.5421   0.1696     0.0014      1.72 
Borrower reserves                     0.1634   0.1486     0.2716     1.177 
Front-end ratio                         1.12   0.9029     0.2148     3.065 
Seller-funded down payment            0.8486    0.153     <.0001     2.336 
assistance                                                                 
Nonseller-funded down payment         0.2154   0.1879     0.2518      1.24 
assistance                                                                 
Atlanta MSA                          -0.3964   0.1512     0.0087     0.673 
Salt Lake City MSA                    0.3626   0.1488     0.0148     1.437 

Source: GAO.

Prepayment Model

Modeling conditional claim rates has a substantial advantage: It allows
time-varying covariates such as post-origination increases in house prices
to be incorporated into the regression model. But the use of conditional
claim rates also poses one possible disadvantage. If certain borrowers,
such as recipients of seller-funded assistance, had high rates of
prepayment, their conditional claim rates could be high not because they
had higher credit risk but because a small number of loans survived and
eventually went to claim. That is, the hazard rate would be large because
the denominator was small, not because the numerator was large. To examine
this possibility, we used a logistic regression that predicted the
quarterly conditional probability of prepayment to estimate the competing
risk of loans terminating in prepayment. The results are presented in
tables 26 and 27.

The regressions used as explanatory variables two variables that represent
the incentive to refinance--the ratio of the book value of the mortgage to
the value of the mortgage payments evaluated at currently prevailing
interest rates, split into two segments. One segment represented book
value exceeding market value, the other represented book value that was
less than market value. Additionally, the regression used variables that
measured the passage of time, the constructed risk variable, credit
scores, and indicators for down payment assistance. Results were as
expected. Loans with an incentive to refinance that was driven by the
interest rate had significantly higher rates of prepayment. High-risk
loans and those with low credit scores prepaid more slowly. We also found
that loans with seller-funded assistance prepaid more slowly than
comparable loans without assistance, demonstrating that our estimate of
the effect of assistance on loan performance was not inflated by rapid
prepayment in this group of loans.

Table 26: Prepayment Regression Results--Quarterly Conditional Probability
of Prepayment, National Sample

                                    Analysis of          Odds ratio 
                                      maximum            estimates  
                                                                    
                                    likelihood                      
                                     estimates                      
Parameter                           Estimate Standard Pr > ChiSq     Point 
                                                   error             estimate 
Intercept                           -15.0802   0.7199     <.0001           
Relatively high equity                3.2059   0.1639     <.0001    24.679 
Relatively low equity                 5.5491   0.6957     <.0001   256.998 
Constructed risk                     -0.0232   0.0137     0.0911     0.977 
FICO score                           0.00374 0.000293     <.0001     1.004 
No FICO score                        -0.2327   0.0691     0.0008     0.792 
ARM                                   0.6987   0.0853     <.0001     2.011 
Condominium                           0.2131   0.0611     0.0005     1.238 
Underserved area                     -0.1744   0.0365     <.0001      0.84 
First-time homebuyer                 -0.1203   0.0445     0.0068     0.887 
Seller-funded down payment           -0.2284   0.0641     0.0004     0.796 
assistance                                                                 
Nonseller-funded down payment        -0.0562   0.0412      0.173     0.945 
assistance                                                                 
First 6 quarters                      0.2094   0.0146     <.0001     1.233 
Next 6 quarters                      -0.0471   0.0236     0.0461     0.954 
Following quarters                    -0.049   0.0243      0.044     0.952 

Source: GAO.

Table 27: Prepayment Regression Results--Quarterly Conditional Probability
of Prepayment, MSA Sample

                             Analysis of          Odds ratio 
                               maximum            estimates  
                                                             
                             likelihood                      
                              estimates                      
Parameter                    Estimate Standard Pr > ChiSq            Point 
                                            error                    estimate 
Intercept                    -16.4562   0.8684     <.0001                  
Relatively high equity         2.7283   0.2334     <.0001  15.307          
Relatively low equity          6.6288   0.8161     <.0001 756.558          
Constructed risk               0.0174   0.0228     0.4469   1.018          
FICO score                    0.00527 0.000391     <.0001   1.005          
No FICO score                 -0.3271   0.0882     0.0002   0.721          
ARM                            0.3858   0.1059     0.0003   1.471          
Condominium                   -0.1332   0.0929     0.1514   0.875          
Underserved area              -0.2159   0.0486     <.0001   0.806          
First-time homebuyer           0.1096   0.0615     0.0745   1.116          
Seller-funded down            -0.2208   0.0556     <.0001   0.802          
payment assistance                                                         
Nonseller-funded down           0.064   0.0579     0.2689   1.066          
payment assistance                                                         
First 6 quarters               0.1487   0.0193     <.0001    1.16          
Next 6 quarters               -0.0359   0.0366     0.3256   0.965          
Following quarters            -0.1246   0.0404     0.0021   0.883          

Source: GAO.

Loss Given Default Model

We also examined the severity of the loss for loans that resulted in a
claim. The results of this analysis are limited because FHA's
Single-Family Data Warehouse had profit or loss amounts for only 389
loans.^17 We ran a regression to predict the loss rate, defined as the
profit or loss amount divided by the original mortgage amount. Explanatory
variables included the initial LTV ratio, credit score, initial interest
rate, original mortgage amount, house price appreciation since time of
origination, and indicators for whether the loan had seller-funded
nonprofit down payment assistance, assistance from another source, or no
assistance. The results of this analysis are in tables 28 and 29.

In the national sample, loans with seller-funded nonprofit assistance had
loss rates that were about 5 percentage points worse than those for loans
with no assistance. Loans with assistance from other sources had loss
rates about 2 percentage points better. Neither result was significant. In
the MSA sample, loans with seller-funded nonprofit assistance also had
loss rates about 5 percentage points worse, while loans with assistance
from other sources had loss rates about 7 percentage points worse. Both
were significant in a one-tailed test.

Table 28: Loss Regression Results--Loss Rate Given Default, National
Sample

Variable                               Parameter estimate t Value Pr > |t| 
Intercept                                         0.41124    0.22   0.8259 
LTV ratio                                        -0.01548   -0.79   0.4308 
Seller-funded down payment assistance            -0.04978   -1.08   0.2828 
Nonseller-funded down payment                     0.02139    0.61   0.5417 
assistance                                                                 
FICO score                                     0.00023796    0.82   0.4147 
No FICO score                                    -0.01532   -0.32   0.7456 
House price appreciation rate                     0.66013    2.17   0.0312 
Initial interest rate                            -0.03729   -1.91   0.0583 
Original mortgage amount                       0.00000218    5.11   <.0001 
R-squared = 0.1897                     

Source: GAO.

Note: N=184.

Table 29: Loss Regression Results--Loss Rate Given Default, MSA Sample

Variable                               Parameter estimate t Value Pr > |t| 
Intercept                                        0.020059    0.01   0.9911 
LTV ratio                                         -0.0251   -1.32   0.1895 
Seller-funded down payment assistance            -0.05107   -1.78   0.0769 
Nonseller-funded down payment                     -0.0698   -2.05   0.0416 
assistance                                                                 
FICO score                                     0.00027289    1.11   0.2703 
No FICO score                                     0.02254    0.72   0.4743 
House price appreciation rate                     1.54727    3.41   0.0008 
Initial interest rate                              0.0048    0.35   0.7261 
Original mortgage amount                       0.00000261    5.44   <.0001 
R-squared = 0.182                      

Source: GAO.

Note: N=205.

Appendix IV

Comments from the Department of Housing and Urban Development

Appendix V

GAO Contact and Staff Acknowledgments

William B. Shear (202) 512-8678

In addition to the individual named above, Mathew Scire, Assistant
Director; Anne Cangi; Emily Chalmers; Susan Etzel; Austin Kelly; John
McGrail; Marc Molino; Heddi Nieuwsma; and Mitchell Rachlis made key
contributions to this report.

(250236)

www.gao.gov/cgi-bin/getrpt?GAO-06-24 .

To view the full product, including the scope
and methodology, click on the link above.

For more information, contact William B. Shear at (202) 512-8678 or
[email protected].

Highlights of [36]GAO-06-24 , a report to the Chairman, Subcommittee on
Housing and Community Opportunity, Committee on Financial Services, House
of Representatives

November 2005

MORTGAGE FINANCING

Additional Action Needed to Manage Risks of FHA-Insured Loans with Down
Payment Assistance

The Federal Housing Administration (FHA) permits borrowers to obtain down
payment assistance from third parties; but, research has raised concerns
about the performance of loans with such assistance. Due to these
concerns, GAO examined the (1) trends in the use of down payment
assistance with FHA-insured loans, (2) the impact that the presence of
such assistance has on purchase transactions and house prices, (3) how
such assistance influences the performance of these loans, and (4) FHA's
standards and controls for these loans.

[37]What GAO Recommends

The Secretary of Housing and Urban Development should direct the FHA
Commissioner to implement additional controls to manage the risks
associated with loans that involve down payment assistance. Such controls
could involve considering the presence and source of down payment
assistance when underwriting loans. Further, the FHA Commissioner should
consider additional controls for loans with down payment assistance from
seller-funded nonprofits. In written comments, HUD generally agreed with
the report's findings. HUD also commented on certain aspects of selected
recommendations.

Almost half of all single-family home purchase mortgages that FHA insured
in fiscal year 2004 had down payment assistance. Nonprofit organizations
that received at least part of their funding from sellers provided
assistance for about 30 percent of these loans and represent a growing
source of down payment assistance. However, assistance from seller-funded
nonprofits alters the structure of the purchase transaction. First,
because many seller-funded nonprofits require property sellers to make a
payment to their organization; assistance from these nonprofits creates an
indirect funding stream from property sellers to homebuyers. Second, GAO
analysis indicated that FHA-insured homes bought with seller-funded
nonprofit assistance were appraised at and sold for about 2 to 3 percent
more than comparable homes bought without such assistance.

Regardless of the source of assistance and holding other variables
constant, GAO analysis indicated that FHA-insured loans with down payment
assistance have higher delinquency and claim rates than do similar loans
without such assistance. Furthermore, loans with assistance from
seller-funded nonprofits do not perform as well as loans with assistance
from other sources. This difference may be explained, in part, by the
higher sales prices of comparable homes bought with seller-funded
assistance.

Although FHA has implemented some standards and controls on loans with
down payment assistance, stricter standards and additional controls could
help in managing the risks these loans pose. FHA standards permit
assistance from seller-funded nonprofits; in contrast, mortgage industry
participants restrict such assistance. Further, government guidelines call
for routine identification of risks that could impede meeting program
objectives; however, FHA has not conducted routine analysis of the
performance of loans with down payment assistance.

Effect of Down Payment Assistance on the Probability of Delinquency and
Claim

References

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  36. http://www.gao.gov/cgi-bin/getrpt?GAO-06-24
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