Rural Housing Programs: Opportunities Exist for Cost Savings and
Management Improvement (Letter Report, 11/16/95, GAO/RCED-96-11).
Pursuant to a congressional request, GAO provided information on the
Rural Housing and Community Development Service's (RHCDS) housing loan
programs, focusing on opportunities for cost savings and management
improvements in the loan programs.
GAO found that: (1) RHCDS is making progress in improving operations in
its loan programs, but further program delivery improvements could
result in savings to the federal government and benefits to borrowers
and tenants in the programs; (2) centralized servicing of RHCDS loans
could result in annual savings of over $100 million through staff
reductions and greater staff productivity and efficiency; (3) the number
of direct loan program borrowers graduating to private credit could be
increased by allowing borrowers to refinance their loans with commercial
lenders and considering all loans for potential graduation; (4) changes
need to be made to achieve RHCDS temporary credit goal, since RHCDS has
few mechanisms in place to force loan graduation; (5) RHCDS could reduce
multifamily housing program costs by eliminating certain equity loans
made to owners, and funding more projects not requiring rental
assistance; and (6) the process used to fund individual projects does
not ensure that the neediest areas receive program assistance.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: RCED-96-11
TITLE: Rural Housing Programs: Opportunities Exist for Cost
Savings and Management Improvement
DATE: 11/16/95
SUBJECT: Rural housing programs
Centralization
Reductions in force
Mortgage loans
Cost control
Subsidies
Homeowners loans
Loan interest rates
Rental housing
Disadvantaged persons
IDENTIFIER: RHCDS Rent Subsidy Program
RHCDS Direct Loan Program
FmHA Multifamily Housing Program
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Cover
================================================================ COVER
Report to Congressional Requesters
November 1995
RURAL HOUSING PROGRAMS -
OPPORTUNITIES EXIST FOR COST
SAVINGS AND MANAGEMENT IMPROVEMENT
GAO/RCED-96-11
Rural Housing Programs
(385456)
Abbreviations
=============================================================== ABBREV
GAO - General Accounting Office
IG - Inspector General
RHCDS - Rural Housing and Community Development Service
USDA - U.S. Department of Agriculture
Letter
=============================================================== LETTER
B-265711
November 16, 1995
The Honorable Rick A. Lazio
Chairman, Subcommittee on Housing
and Community Opportunity
Committee on Banking and
Financial Services
House of Representatives
The Honorable Doug Bereuter
House of Representatives
The U.S. Department of Agriculture's (USDA) Rural Housing and
Community Development Service (RHCDS) provides about $2.85 billion
per year for rural housing loans. As of June 30, 1995, RHCDS had an
outstanding single-family and multifamily housing loan portfolio of
about $30 billion, which represents a significant federal investment
in affordable housing for rural low-income Americans.
The largest portion of the loan portfolio is for single-family direct
and guaranteed mortgage loans that are made to families or
individuals who are without adequate housing and who are unable to
obtain loans from private lenders at reasonable costs. On the basis
of their incomes, direct loan borrowers are eligible for subsidy
payments to reduce the cost of the interest on the loans. If after a
loan is made the income of a subsidized borrower increases so that
private mortgage credit becomes affordable, the borrower is required
to "graduate" from RHCDS' direct loan program to private credit.
Rural multifamily rental housing loans, made to finance
apartment-style housing or to purchase and rehabilitate existing
rental housing, constitute the remainder of the portfolio. Rental
assistance payments are made to owners of RHCDS-financed rental
projects to reduce the rents paid by low-income tenants.
This report responds to your request for information on RHCDS'
single- and multifamily housing loan programs and for suggestions
that we and others, such as RHCDS officials, have previously made
that could result in cost savings and/or management improvements in
those programs.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :1
The Rural Housing and Community Development Service is making
progress in improving operations in both its single- and multifamily
programs. However, we and others, including Service officials, have
identified opportunities to strengthen the way these programs are
delivered to rural Americans. Improved program delivery can result
in savings to the federal government and benefits to the borrowers
and tenants in the programs.
In a September 1993 report\1 and subsequent testimonies, we found
that centralized servicing of the Service's loans, a common practice
of private businesses, could result in savings through greater staff
productivity and efficiency. The Service and the Congressional
Budget Office have stated that centralized servicing of the $18.7
billion direct loan portfolio could save over $100 million annually.
These savings are primarily based on significant reductions in field
staff. In December 1993, the Service began plans to establish a
centralized loan-servicing system, but not until September 1995 did
the agency begin to analyze the need for it to retain most of its
field structure. Unless the Service makes a firm commitment to
reduce the number of staff and field offices and develops plans for
the centralized office to perform the customer services previously
handled in local offices, most of the savings from centralized
servicing may not materialize.
The number of borrowers graduating from the direct loan program to
private credit sources could be increased by (1) changing the law to
allow direct loan borrowers to refinance their loans using the
Service's loan guaranty program with commercial lenders, as we
suggested in a December 1994 report,\2 and (2) eliminating the
Service's policies that prohibit considering certain loans for
graduation. Such changes could help the Service meet its goal of
providing temporary rather than long-term credit, reduce servicing
costs, and in some cases lower borrowers' interest costs. However,
because the Service has few mechanisms to force graduation, more
fundamental changes in the program's design--such as changing
mortgage payment terms, as suggested by Service staff--may be needed
if the temporary credit goal is to be fully achieved.
Service staff are considering options for reducing the costs of the
multifamily housing program by (1) eliminating equity loans made to
owners to discourage them from prepaying their loans and replacing
low-income tenants with those able to pay higher rents and (2)
funding more projects that do not require rental assistance. Also,
from a management perspective, we\3 and others, including the Surveys
and Investigations Staff of the House Committee on Appropriations,
have found that the process currently used to fund individual
projects does not ensure that the neediest areas receive assistance
from the program.
--------------------
\1 U.S. Department of Agriculture: Centralized Servicing for FmHA
Single-Family Housing Loans (GAO/RCED-93-231BR, Sept. 23, 1993).
\2 Rural Housing: Shift to Guaranteed Program Can Benefit Borrowers
and Reduce Government's Exposure (GAO/RCED/AIMD-95-63, Dec. 21,
1994).
\3 Rental Housing: Distribution and Use of FmHA's Rural Rental
Housing Program Funds (GAO/RCED-94-141, June 1, 1994).
BACKGROUND
------------------------------------------------------------ Letter :2
RHCDS was established by Public Law 103-354, the Federal Crop
Insurance Reform and Department of Agriculture Reorganization Act of
1994, dated October 13, 1994. Its programs include the housing
programs previously administered by the Farmers Home Administration
and the rural community loan programs previously administered by the
Rural Development Administration.\4 (See fig. 1.)
Figure 1: Rural Housing in a
Reorganized U.S. Department of
Agriculture
(See figure in printed
edition.)
RHCDS' housing mission is to improve the quality of life in rural
America by assisting rural residents in obtaining adequate and
affordable housing. "Rural areas" include open country and places
with populations of 10,000 or less, but some towns with populations
between 10,000 and 20,000 may qualify under certain circumstances.
Major program activities, authorized by title V of the Housing Act of
1949, as amended, include single-family direct and guaranteed
homeownership and repair loans, direct multifamily rental housing
loans, and rental assistance payments.
--------------------
\4 The part of the Farmers Home Administration that handled farm
loans has been consolidated into the new Consolidated Farm Service
Agency.
RURAL SINGLE-FAMILY HOUSING
---------------------------------------------------------- Letter :2.1
RHCDS' direct single-family loans are designed to promote successful
homeownership for low-income and very-low-income rural Americans who
cannot otherwise obtain loans at reasonable rates.\5 Houses must be
modest in design, cost, and price. Interest rates on these loans are
subsidized and, depending on the borrower's household income, the
subsidy can reduce the borrower's effective interest rate to as low
as 1 percent. RHCDS is required by law to recapture all or a portion
of the subsidy it provides when the property is sold or vacated.
Direct loans are meant to provide temporary credit--borrowers are
required to graduate from the direct loan program to private credit
when their incomes are sufficient to afford private credit. RHCDS
has loaned $49 billion in making over 2 million direct loans since
1950.\6 As of June 30, 1995, RHCDS held a portfolio of about 750,000
direct loans made to 643,000 borrowers with a total outstanding
principal balance of $18.7 billion.\7
In 1991, RHCDS initiated a new program to assist moderate-income
rural borrowers through guaranteed loans for single-family housing.
Guaranteed loan borrowers are not provided with interest subsidies.
To qualify for the program, homes may be new or existing residences
located in rural areas. In guaranteeing a single-family housing
loan, RHCDS agrees, in the event that a borrower defaults, to
reimburse a commercial lender for up to 90 percent of the lost
principal plus accrued interest and liquidation costs. In fiscal
years 1991 through 1994, RHCDS guaranteed 25,000 housing loans for
about $1.5 billion.
--------------------
\5 Very-low-income applicants are those whose incomes are 50 percent
or less of an area's median income; low-income applicants are those
whose incomes are 51 to 80 percent of an area's median income.
\6 Dollar figures used in this report are actual dollars unless
otherwise noted.
\7 Some borrowers have more than one loan. For example, a borrower
can assume an existing loan and then receive a second loan from RHCDS
to cover the costs of such items as the replacement of a furnace.
RURAL MULTIFAMILY HOUSING
---------------------------------------------------------- Letter :2.2
RHCDS' multifamily housing loans are designed to help low-income
rural renters obtain access to decent, safe, and affordable housing
by holding down mortgage costs. RHCDS and its predecessor agencies
have financed more than 18,000 projects with more than 450,000 rental
units since the loan program was first authorized in 1962. The
loans, which are usually for 50 years at interest rates as low as 1
percent, can be made to individuals, partnerships, public agencies,
limited equity cooperatives, Indian tribes, nonprofit organizations,
and for-profit corporations. Recipients of the loans also must be
unable to provide moderate-cost rental units without financing by
RHCDS.
As of January 1994, RHCDS' rental assistance was available to about
235,000 housing units through a direct outlay program that is
administered in tandem with RHCDS' multifamily loans. RHCDS makes
payments directly to RHCDS-financed projects to reduce the rents
(including utilities) paid by qualifying low-income households to no
more than 30 percent of their monthly incomes, as adjusted for
certain expenses. Residents in more than 90,000 other units,
however, were paying a greater percentage of their income for rent.\8
(App. I contains information on proposed loan levels and outlays for
RHCDS' major rural housing programs for fiscal year 1996.)
--------------------
\8 As of January 1994, about 77 percent of the households in RHCDS'
multifamily projects were classified as very-low-income. The average
annual household income of these tenants was $8,116 before the
application of certain downward adjustments used to classify income
for program purposes, and $7,037 after these adjustments were
applied.
OPPORTUNITIES FOR COST SAVINGS
IN THE SINGLE-FAMILY AREA
------------------------------------------------------------ Letter :3
There are opportunities to save millions of federal dollars in
operating rural single-family housing programs. These opportunities
include centralizing loan servicing, graduating borrowers from the
direct loan program, and reforming the requirements for recapturing
loan interest subsidies.
OPPORTUNITIES TO CENTRALIZE
LOAN SERVICING
---------------------------------------------------------- Letter :3.1
Servicing RHCDS' 724,000 direct loans using a state-of-the-art system
from a central location could eliminate the need for numerous manual
processes currently required in each of RHCDS' hundreds of county
offices. Thus, centralized servicing could reduce staff costs. In
December 1993, the Administrator of RHCDS gave approval to begin
planning for centralized servicing, and in May 1995, RHCDS awarded a
contract to purchase an off-the-shelf servicing system. In September
1995, RHCDS began to study whether it would change the size of and
functions to be performed by its field structure, given the new
capacity for automation.
In our September 1993 report and subsequent testimonies, we endorsed
the concept of centralized servicing of RHCDS' single-family housing
loans as an example of the type of private-sector management concept
needed to "reengineer" the Department of Agriculture. We reported
that allowing the public and private sectors to compete for
centralized servicing of the direct loan portfolio that was being
serviced by local RHCDS field offices would fundamentally change the
way RHCDS does business and could increase efficiencies, innovations,
and customer satisfaction.
The private sector has shown that centralized servicing--using highly
specialized personnel at one location to perform all loan-servicing
actions after a home loan is closed--results in far greater staff
productivity and efficiency.\9 The benefits of centralized servicing
typically include lower delinquency rates as a result of more
efficient servicing and reduced staff levels as a result of staff
specialization. Also, escrow capability helps borrowers budget their
payments and protects the government's security interest by ensuring
that taxes and insurance are paid.
In September 1993, we reported that RHCDS had developed three plans
of action since 1988 for developing centralized servicing and escrow
capability but that no final decision had been made to begin
implementation. In December 1993, RHCDS developed a new plan that
was approved by the Administrator. In December 1994, USDA officials
gave the final go-ahead to request proposals from companies
interested in selling RHCDS an off-the-shelf commercial loan
origination and servicing system that would be modified to enable
RHCDS to handle its particular loan-servicing requirements. RHCDS
awarded a $7.3 million contract to Data-Link System, a subsidiary of
FIserv, Inc., in May 1995. RHCDS projects total budget costs of $39
million for the system, expects to begin phasing in the system by
October 1996, and plans to have placed in escrow by September 1998
the tax and insurance payments for all but existing borrowers who are
current on their payments.
Centralized servicing should reduce the need for such labor-intensive
tasks as researching county tax records and calling in tax-delinquent
borrowers to work out repayment terms each year. RHCDS believes the
system will substantially lower servicing costs, saving over $100
million per year by fiscal 2000 and each year thereafter. A 1991
RHCDS study concluded that centralized servicing could yield a net
savings of 2,200 staff positions and the consolidation or closing of
742 county offices. On the basis of this study, the Congressional
Budget Office estimated about $171 million in budget outlay savings
from the associated reductions in full-time employees in fiscal years
1999 and 2000.
However, these cost savings will not be fully achieved if RHCDS adds
a new centralized staff and keeps most of its present field
structure. RHCDS plans to phase in a new staff of about 700
employees in its St. Louis Finance Center to service its housing
portfolio using a centralized servicing system.
The Secretary of Agriculture announced his Department-wide
reorganization in December 1994, including the planned closing of
about 1,200 field offices. The reorganization plan projects reducing
RHCDS' field staff during fiscal years 1995 through 1999. However,
centralized servicing technology was not specified in the criteria
for identifying which offices to close.
In September 1995, the Under Secretary for Rural Economic and
Community Development established a task force to recommend the size
of and appropriate functions to be performed by a rural housing and
community development field structure within a centralized servicing
environment. In addition to studying the impact of centralized
servicing on field offices, the task force expects to study whether
some of the resources freed up as a result of centralized servicing
should be used to meet other unmet rural development priorities.
Included in the task force's preliminary description of critical
unmet needs are job tasks such as providing technical assistance to
rural communities, promoting the community facilities loan guarantee
program, and providing outreach for the multifamily housing program.
The task force is also expected to consider the second phase of the
National Performance Review, which in August 1995 recommended a
centralized servicing system for RHCDS' rural housing portfolio. The
National Performance Review states that $250 million in savings over
5 years would accrue from closing additional county offices and
reducing staff by up to 1,200 full-time equivalents. The task force
is expected to report back to the Under Secretary in November 1995.
In addition, the potential exists to reduce servicing costs to the
levels obtained by private-sector companies by adopting
private-sector processes and practices. However, private-sector
efficiencies will not be achieved unless RHCDS focuses on changing
the underlying work processes in keeping with the new technology. A
1992 study contracted by RHCDS concluded that with the proper
procedures and communication methods in a centralized environment,
the "need for face to face communications with the borrowers and
visits to the properties can be reduced to a minimum."\10
--------------------
\9 Centralized servicing operations typically include holding funds
in escrow, reviewing interest credit, applying and collecting late
payment fees, counseling on credit issues, and handling delinquent
accounts.
\10 Analysis of Single Family Rural Housing Loan Servicing System,
International Business Consultants Corp. (Sept. 16, 1992), p. 34.
OPPORTUNITIES TO INCREASE
LOAN GRADUATIONS
---------------------------------------------------------- Letter :3.2
In our December 1994 report, we identified over $2.2 billion in
direct nonsubsidized loans, constituting 12 percent of the
outstanding direct loan portfolio, whose borrowers could benefit by
receiving a lower interest rate if they were allowed to graduate by
refinancing through the guaranteed program. Such an approach would
have the advantages of (1) assisting borrowers in obtaining private
credit when their financial conditions have improved but are still
not sufficient to qualify for nonguaranteed private credit and (2)
reducing servicing costs that account for about 35 percent of the
county offices' workloads. In addition, allowing borrowers to
refinance through guaranteed loans would be consistent with farm
credit programs that allow farmers to refinance their direct loans
through the guaranteed farm loan program.
RHCDS has the legal authority to require borrowers to graduate to
private credit if it appears that credit can be obtained from another
source at reasonable rates and terms. However, RHCDS is statutorily
prohibited from refinancing direct housing loans using its guaranteed
program. We recommended that the Congress consider amending the
Housing Act of 1949 to allow RHCDS' direct loan borrowers to
refinance their mortgage loans using the guaranteed program. The
administration has endorsed our recommendation and believes its
implementation would increase the marketability of these loans to
secondary market purchasers, such as the Federal National Mortgage
Association. As of July 31, 1995, legislation had not been
introduced in the Congress to implement this recommendation.
Other opportunities may exist to increase graduations involving loans
with balances under $5,000 and subsidized loans. RHCDS' policy does
not allow loans with balances under $5,000 to be considered for
graduation. Over 80,000 loans, or almost 12 percent of the
outstanding portfolio, are over 10 years old and have outstanding
balances under $5,000. RHCDS pays more to service some of these
loans than it receives in interest each year. For example, in 1994
RHCDS received $152.70 in interest on a 26-year-old loan in Illinois.
Yet RHCDS estimated servicing costs of about $240 per loan for that
year. RHCDS officials believe that eliminating this policy or
offering incentives to borrowers with low loan balances could
increase graduations. Similarly, RHCDS' policy does not permit
considering borrowers with interest subsidies for graduation because
of the general view that no banks would accept such borrowers.
However, in our December 1994 report we pointed out that about 7,200
subsidized loans had effective interest rates which at that time
exceeded the RHCDS-guaranteed loan rate.
RHCDS officials agree that changing the law to allow direct loan
borrowers to refinance their direct loans using RHCDS guaranteed
loans, providing incentives, and eliminating policies that prohibit
considering loans with balances of less than $5,000 and small subsidy
payments for graduation should incrementally improve graduation
rates. But more fundamental changes in the program's design are
needed if temporary credit and the acceleration of graduation rates
are to become more prevalent.
An RHCDS staff member suggested basing mortgage payments for
nonsubsidized borrowers on income rather than having mortgage
payments remain fixed. Such a policy could have a significant impact
on graduation rates because it would help overcome the major
disincentive for borrowers to graduate--holding a lower
fixed-interest rate than the prevailing private-market mortgage
interest rate.
When borrowers first enter the direct loan program, they typically
receive interest subsidies when 20 percent of their adjusted annual
incomes are insufficient to cover their payments for principal,
interest, taxes, and insurance at the prevailing mortgage interest
rate. Under the current program, borrowers make mortgage payments of
20 percent of their adjusted annual incomes and stop receiving
subsidies when their incomes increase to the point where they can
afford the full mortgage payments. However, as a borrower's income
continues to increase, the percentage of income going toward the
mortgage payment drops. If the mortgage interest rate is below the
prevailing rates offered in private markets, the borrower has little
incentive to refinance.
RHCDS and its predecessor agencies have historically not vigorously
enforced the graduation requirement because the only option available
was foreclosure and because the agencies believed that U.S.
attorneys would not accept such cases. However, if the program is
changed to require borrowers to pay 20 percent of their incomes as
mortgage payments, the effective interest rates paid by higher-income
borrowers will begin to exceed those required by established mortgage
interest rates. When a borrower's effective interest rate exceeds
those available on the private market, a strong incentive for
graduation will exist. Payments made in excess of the amount
required by the mortgage interest rate could be credited to the
borrower and used to retire the borrower's deferred obligation to pay
back a portion of the interest subsidies provided over the life of
the loan, which is discussed in the next section of this report.
Because RHCDS stops collecting income information once borrowers stop
receiving interest subsidies, we cannot estimate the impact of such a
program change. However, in examining individual loan files of
borrowers who have graduated, we have seen consistent growth in
incomes from the time borrowers stopped receiving interest subsidies
to the time when they refinanced to private credit. Of course, such
a change would increase graduation rates only if the household
incomes of the borrowers who no longer qualify for interest subsidies
continue to grow.
OPPORTUNITIES TO REFORM THE
REQUIREMENT TO RECAPTURE
INTEREST SUBSIDIES
---------------------------------------------------------- Letter :3.3
The Housing Act of 1949, as amended, requires RHCDS to recapture a
portion of the subsidy provided over the life of the direct loan when
the borrower sells or vacates a property. The idea is that because
taxpayers paid a portion of the mortgage, they are entitled to a
portion of the property's appreciation. Unlike a shared appreciation
mortgage, in which the investor's return is fixed when the loan is
originated, the amount recaptured by RHCDS is based on a complex
formula that primarily factors in the subsidy provided, the reduction
in principal attributable to the subsidy, and the property's
appreciation. The total amount recaptured can equal the total of the
subsidy provided and the reduction in principal attributable to the
subsidy, but it can be no more than 78 percent of the property's
appreciation.
The recapture process is administratively burdensome and fraught with
reliability problems. RHCDS estimates that each year, 10 staff years
are spent by its St. Louis Finance Office monitoring the recapture
of interest subsidies. Field office staff perform the calculation
each time a borrower expresses interest in refinancing to private
credit. According to USDA's Inspector General (IG), the manual
accounting system used to figure the recapture amounts and poor
internal controls frequently result in incorrect or inconsistent
recapture computations. RHCDS believes that the planned in-house
centralized servicing system will overcome the problems cited by the
IG.
As shown in figure 2, as of September 30, 1994, RHCDS had recaptured
$562 million, or less than 10 percent of the $5.8 billion in
subsidies provided on loans that have left the portfolio. About $7.1
billion in subsidy payments was outstanding on active loans. Whether
the government should (1) attempt to increase revenues by recapturing
a greater share of the subsidy in the future or (2) abandon the
recapture program because of the high administrative costs and low
expected appreciation rates are two extreme positions taken on the
issue. Additional study is needed before any definitive conclusions
can be reached.
Figure 2: Interest Subsidy
(See figure in printed
edition.)
Note: Total subsidy granted--$12.9 billion.
In addition, because recapture is not mandated when homes are
refinanced, RHCDS' policy allows borrowers who pay off direct RHCDS
loans but continue to occupy the properties to defer the payments for
recapturing the subsidies. As of June 30, 1995, RHCDS' records show
that about $119 million is owned by borrowers who have refinanced
their mortgages but continue to occupy the properties. RHCDS does
not charge interest on the amounts owed by these borrowers.
RHCDS officials pointed out that a legislative change to require
recapture when properties are refinanced, in addition to when they
are sold or vacated, would save the administrative costs of
calculating and setting up the borrowers' deferred obligations and
increase federal revenues. As an alternative, legislative changes
could be made to allow RHCDS to charge market rate interest on
recapture amounts owed by borrowers to help recoup the government's
administrative and borrowing costs. However, these changes would
also likely reduce the number of borrowers of direct RHCDS loans who
graduate to private credit.
OPPORTUNITIES FOR COST SAVINGS
AND MANAGEMENT IMPROVEMENTS IN
THE MULTIFAMILY AREA
------------------------------------------------------------ Letter :4
RHCDS and others have proposed program changes aimed at reducing the
cost of the multifamily program. Some changes would shorten benefit
periods or serve higher-income populations. We and others have also
found that the process for funding individual projects for
multifamily rental housing does not ensure that the neediest areas
receive assistance from the program.
While the multifamily housing loan program has a long history of
serious problems, a number of managerial improvements have been
undertaken by RHCDS during the past several years. (A discussion of
instances of multifamily program fraud, waste, and abuse found by the
IG, along with RHCDS' plans for addressing such problems, can be
found in app. II.)
OPPORTUNITIES TO REDUCE
MULTIFAMILY PROGRAMS' COSTS
---------------------------------------------------------- Letter :4.1
The basic goal of RHCDS' two principal multifamily housing programs
is to make rental housing affordable to lower-income people in rural
America. The two programs make rents more affordable by holding down
project developers' mortgage costs and, to the extent possible,
subsidizing tenants who cannot afford to pay the full amount of the
projects' rents.
To hold down mortgage costs, RHCDS typically provides 50-year loans
at an interest rate of 1 percent. Annual authorized loan levels for
this program were about $500 million to $575 million in fiscal years
1987 through 1994. However, because of a number of concerns about
the program, the Congress reduced loan levels to $220 million in
fiscal year 1995. This change has sparked interest in making more
efficient and effective use of the available funds. The following
are some of the ideas being considered by RHCDS officials:
Shorten the term of the loan. This action would reduce the cost of
the interest subsidy for each loan, but it would also reduce the
time that the housing was restricted to lower-income tenants.
Net savings could be achieved by shortening the term of the loan
from 50 to 40 years. Another option would be to shorten the
term even more (say, to 25 years) but continue to amortize the
loan as if it were for a 50-year term. This action would keep
monthly payments low but would leave a large unpaid loan balance
at the end of the term that would either have to be paid off in
a lump sum or refinanced. Neither of these options would likely
require a change to RHCDS' current legislative authority,
according to RHCDS officials. However, RHCDS believes
shortening the loan term could increase a project's monthly loan
payments, which could lead to higher rents and the need for
increased federal rental assistance or a greater rent burden on
the tenants.
Eliminate certain equity loans. These loans were authorized by the
Congress to discourage the owners of qualifying older projects
from prepaying their loans and replacing lower-income tenants
with those able to pay higher rents. In general, a project
funded before December 21, 1979, is eligible for an additional
loan in an amount up to 90 percent of the owner's equity if the
owner demonstrates to RHCDS the intent and financial ability to
prepay. Approved applications are placed on a waiting list, and
the loans are made as funds become available. Each year, RHCDS
allocates a portion of its loan program appropriation to fund
some of these equity loans. As a result, equity loans compete
for available appropriations with loans for constructing new
projects and with loans for rehabilitating older projects that
are in poor condition. To date, RHCDS has made about 300 equity
loans totaling over $109 million; 74 more, totaling about $26
million, are awaiting funding. These loans typically have been
for the maximum allowable amount, which is 90 percent of the
owner's equity in the project.
RHCDS officials told us they believe that relatively few property
owners would prepay their loans and leave the program even without
the equity loans. They noted that in a few local markets, projects
might be more valuable to owners as commercial-rate rental property
but that this situation is generally not the case. Eliminating the
loans would require a change to the legislation that authorizes the
multifamily loan program (the Housing Act of 1949, as amended).
Increase the amount of equity that owners contribute to projects.
The authorizing legislation also limits the amount of equity
that RHCDS can require borrowers to contribute on original
loans. The required equity contribution is limited to 5 percent
of a project's cost for projects that receive federal
low-income-housing tax credits and to 3 percent for other
projects. Raising this limit could reduce the size of
individual loans and thus the government's cost of subsidizing
the interest rates.
We were told by RHCDS multifamily program officials that the agency
is drafting a legislative proposal that would allow it to vary
borrowers' required equity contributions on the basis of local
community resources and housing needs. USDA's IG subsequently
recommended in August 1995 that RHCDS immediately seek a change to
the authorizing legislation to eliminate the restriction on equity
contributions that can be required of developers if tax credits are
received. The IG also recommended that as soon as this limitation is
removed, RHCDS implement procedures that consider tax credits as
government assistance when defining the necessary level of individual
loans.\11 In most cases, this change would result in lower loan
amounts and larger equity contributions by borrowers than RHCDS' past
procedures.
Reducing the costs of RHCDS' rent subsidy program without also
increasing the tenants' rent burden is more difficult. RHCDS has
considered the idea of setting aside 40 percent of the loan program's
annual funding for projects that do not require rental assistance.
In most cases, these would be projects with a mix of moderate- and
lower-income households, in which residents could afford to pay the
necessary rents. While existing projects predominately serve
households in the very-low-income category, those in the low- and
moderate-income categories are also eligible tenants.\12 While
implementing this idea would mean that the program would be serving a
somewhat higher-income population than at present, the program would
still be serving households that are eligible to receive assistance
under the authorizing legislation.
--------------------
\11 Rural Housing and Community Development Service, Rural Rental
Housing Project Funding and Eligibility, Washington, D.C., Audit
Report No. 04601-1-SF, Aug. 3, 1995.
\12 For a household of four, the moderate-income category includes
adjusted incomes up to $5,500 above 80 percent of the local area
median (with adjustments for areas with unusually high or low incomes
or housing costs).
OPPORTUNITIES TO BETTER
TARGET GREATEST NEED
---------------------------------------------------------- Letter :4.2
The funding of projects under RHCDS' multifamily rental housing loan
program is now based on priorities set forth in the authorizing
legislation. The legislation requires priority for projects that
will serve those in the most rural areas who have the greatest
housing needs because of their low incomes and inadequate housing.
RHCDS allocates funds to each state and selects projects within each
state using criteria designed to reflect these priorities. (See fig.
3.)
Figure 3: Selection Criteria
for Multifamily Projects
(See figure in printed
edition.)
However, this process does not ensure that the neediest areas receive
assistance from the program. Our June 1994 report and reports by
USDA's IG, the National Council of State Housing Agencies, and the
Surveys and Investigations Staff of the House Committee on
Appropriations have each identified problems in this area, including
that (1) housing needs estimated by RHCDS may differ from actual
needs; (2) developers determine the locations for proposed projects;
(3) the projects selected for funding may be inconsistent with the
priorities established by state and local governments; and (4) the
project selection procedures give too much weight to proposals for
projects located specified distances from urban areas. (See app.
III for additional information on problems reported by us and others
on the selection process for multifamily projects.)
RHCDS recognizes the limitations of the current funding process and
is taking steps to better target RHCDS' projects to rural areas with
the greatest need. Specifically, RHCDS officials said they would not
object to statutory authority to discontinue the current project
selection system and limit the selection of new projects to rural
areas that, on the basis of objective criteria, have the greatest
need. RHCDS envisions a system similar to that proposed last year in
an amendment offered during deliberations on the housing
reauthorization bill (H.R. 3838). The reauthorization bill was not
passed, but that amendment would have allowed RHCDS to identify
counties and communities with the greatest need for rural rental
housing funds and select projects only in those locations. The
sources of information used by RHCDS to determine need would have
included the U.S. Census and State Comprehensive Housing
Affordability Strategy plans. RHCDS officials believe that a system
of this nature, if enacted, would allow project selection to be more
consistent with local priorities.
Pending enactment of a legislative change, RHCDS is proceeding with
changes to the current project selection system to better direct
funding to rural areas with the greatest need for affordable housing,
while still meeting the current statutory priorities. Agency
officials expect proposed regulations reflecting these changes to be
published for public comment in the near future. The changes include
reducing the weight given to projects at least 20 miles from urban
areas; increasing the use of county data, rather than state data, in
estimating needs under the project selection process; and giving
additional weight to proposed projects that also use funding from
other sources, projects in underserved areas, and projects in areas
with the highest shares of households paying over 30 percent of their
incomes for rent. While these measures would not address all of the
concerns raised about the funding process, if effectively
implemented, they could better direct rural rental housing assistance
to the neediest areas.
AGENCY COMMENTS
------------------------------------------------------------ Letter :5
We provided a draft of this report to RHCDS for its review and
comment. We met with RHCDS officials, including the Acting
Administrator and the Assistant Administrator for Housing, to obtain
their comments. RHCDS officials generally agreed with the factual
material presented in the report. The Acting Administrator pointed
out that while she agrees that new centralized servicing technology
was not specified in the criteria considered by the Secretary's
reorganization task force, she believes the office-closing plans
were, to a degree, driven by the planned technology. She also
pointed out that the Under Secretary of Agriculture for Small
Community and Rural Development has recently formed a task force with
a 60-day mandate to decide on the appropriate field structure that
will be needed to operate in a centralized servicing environment.
The report was changed to reflect this view and new development.
RHCDS officials also provided other clarifying information, which we
incorporated where appropriate.
SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :6
To identify opportunities for cost savings and management
improvements in RHCDS' rural single-family and multifamily housing
programs, we interviewed personnel from RHCDS' Washington, D.C.,
office; Finance Office in St. Louis, Missouri; and field offices in
Maryland, Illinois, and Missouri. We also obtained program
regulations, guidance, and progress reports from RHCDS showing
corrective actions based on GAO's and the USDA IG's previous
recommendations and analyzed files and records as of March 31, 1995.
We also met with IG officials and individuals representing banking,
building, and rural housing groups to obtain their views on cost
savings and other program reform opportunities. We conducted our
work between January and October 1995 in accordance with generally
accepted government auditing standards.
---------------------------------------------------------- Letter :6.1
We are sending copies of this report to interested congressional
committees and Members of Congress; the Secretary of Agriculture; and
the Director, Office of Management and Budget. We will also make
copies available to others upon request.
Please call me on (202) 512-7631 if you or your staff have any
questions. Major contributors to this report are listed in appendix
IV.
Judy A. England-Joseph
Director, Housing and Community
Development Issues
MAJOR RURAL HOUSING PROGRAMS'
PROPOSED LOAN LEVELS AND OUTLAYS,
FISCAL YEAR 1996
=========================================================== Appendix I
As shown in figure I.1, proposed new single-family guaranteed loans
totaling $1.3 billion, new direct loans totaling $1.2 billion, and
multifamily rental housing loans totaling $220 million constitute the
vast majority of the proposed $2.85 billion program loan level for
fiscal year l996.
Figure I.1: Fiscal 1996
Proposed Loan Levels--$2.85
Billion
(See figure in printed
edition.)
Figure I.2 shows proposed outlays of $1.32 billion for rural housing
in fiscal 1996.
Figure I.2: Fiscal Year 1996
Proposed Outlays--$1.32 Billion
(See figure in printed
edition.)
Note: Program subsidy amounts are estimated on a present value
bases; the administrative expenses are estimated on a cash basis.
Outlays for the housing loan programs are lower than the loan amounts
because they are based on subsidy costs and projected losses that are
less than loan levels. For example, while proposed single-family
guaranteed loans were the single largest portion of proposed loan
levels in figure I.1 ($1.3 billion), the proposed outlays associated
with this loan level were $6 million (these outlays are included in
the "Other" category in figure I.2). This occurs because the
guaranteed program's borrowers do not receive interest subsidies and
because expected default rates are lower than for the direct program.
The rural rental assistance program is the costliest program because
it is a direct outlay program. The Rural Housing and Community
Development Service (RHCDS) estimates that it will need more than
$2.4 billion just to renew existing rental assistance contracts that
will be expiring over the next 5 years (fiscal years 1996-2000).
This amount assumes renewals of expiring contracts over a 5-year
period. Given that the trend in tenants' average household incomes
appears to be heading down, the cost may go even higher, according to
RHCDS officials.
OPPORTUNITIES TO REDUCE FRAUD,
WASTE, AND ABUSE IN THE
MULTIFAMILY PROGRAM
========================================================== Appendix II
The U.S. Department of Agriculture's (USDA) Inspector General (IG)
has found instances of fraud, waste, and abuse by a number of
participants in the Rural Housing and Community Development Service's
multifamily housing loan program. Some of the more serious and
persistent findings have been (1) inflated, improper, and
undocumented charges for project construction costs; (2) unauthorized
use of project operating funds and reserve accounts; (3) failure to
perform essential maintenance; and (4) inadequate verification of
tenants' incomes. The instances of abuse often have involved
ownership or management ties between project developers' construction
contractors, material suppliers, and property management firms. The
IG's recently issued report on the multifamily housing loan
program\13 addresses another potential area of abuse on which we
testified in 1992\14 --that of developers realizing excessive profits
on projects through the combined benefits derived from RHCDS'
programs and federal low-income-housing tax credits.
RHCDS has taken a number of specific actions designed to address the
problems identified by the IG's work, and more are under way. These
actions relate to health and safety violations at RHCDS' projects,
RHCDS' enforcement tools, and the agency's efforts to improve
verification of tenants' incomes.
Because of confirmed reports of serious uncorrected health and safety
problems at selected projects, RHCDS during 1994 conducted a
nationwide review and inspection of all RHCDS-financed rural rental
housing projects that were over 5 years old. About 7 percent of the
14,142 projects reviewed were found to have health and safety
violations. According to RHCDS officials, these violations encompass
a wide range of severity--from inoperable smoke alarms to severe
structural deficiencies. About 9 percent of the projects had
seriously deferred maintenance that did not pose an immediate health
and safety danger. RHCDS officials concluded that conditions in the
states of Texas, Oklahoma, Mississippi, Louisiana, and Illinois were
serious enough to warrant special reviews of RHCDS' oversight
efforts. Reports on these reviews should be completed soon.
In response to the waste, fraud, and abuse problems, RHCDS has
bolstered its enforcement system to more effectively identify and
deal with program abusers. In March 1994, it issued instructions
establishing a system of civil penalties (fines) for noncriminal
violations of program rules. RHCDS officials also told us that they
have improved their system for notifying field offices of individuals
who have been barred or suspended from participating in RHCDS'
programs because of misconduct and that they will soon have on-line a
new automated system for tracking the performance of and identifying
problem borrowers.
RHCDS officials are examining ways to address another problem
area--verifying the incomes of tenants receiving rental assistance to
ensure that they are eligible. Property managers are responsible for
at least annually verifying tenants' incomes and reporting accurate
income data to RHCDS. These data are used, among other things, to
determine how much rent the tenant pays and how much, if any, rental
assistance subsidy RHCDS pays. However, income verification tends to
be an unpopular task with property managers, and understatement of
tenants' incomes has been a recurring problem.
RHCDS now checks the reliability of reported income data primarily by
matching it to wage data that employers report to state labor
agencies. According to RHCDS officials, this process can be
cumbersome, especially in states that do not have computerized
records, and the process cannot be used universally. Some states
have laws that prohibit the practice, and other states just are not
interested in helping out for one reason or another.
We understand from RHCDS officials, however, that the Department of
Housing and Urban Development is pilot-testing a new system that
would allow automated, centralized verification of earned income with
data reported by employers to the Social Security Administration and
verification of investment income with data reported by financial
institutions to the Internal Revenue Service via Form 1099. RHCDS
hopes to also use this system, if it proves successful, as well as
strengthen its current wage-matching system with the states.
--------------------
\13 Rural Housing and Community Development Service, Rural Rental
Housing Project Funding and Eligibility, Washington, D.C., Audit
Report No. 04601-1-SF, Aug. 3, 1995.
\14 Rural Rental Housing: Excessive Profits and Program Fraud in
Multifamily Housing (GAO/T-RCED-92-63, May 13, 1992).
SUMMARY OF PRIOR STUDIES ON
MULTIFAMILY PROJECT SELECTION
PROCESS
========================================================= Appendix III
Our 1994 report\15 identified three reasons why rural rental housing
needs estimated under the Rural Housing and Community Development
Service's funding process may differ from actual needs:
First, the process estimates needs at one point in time and
therefore may not reflect current needs. The data used to
estimate needs generally come from the U.S. Census and are not
updated between Census years. As a result, the needs estimates
do not capture fluctuations in state and local economic and
demographic conditions during the 10 years between Censuses.
Second, in selecting projects for funding, RHCDS has generally used
data aggregated at the state and county levels to estimate
needs. RHCDS has recognized, however, that even when county
data are used, there may be more localized pockets of need that
go unfunded in counties that have a relatively low estimated
need overall. Accordingly, in fiscal 1994 RHCDS began to allow
its state directors to use local data for specific communities
if reliable data are available and vary from county data by a
threshold amount.
Third, the funding process may not account for all of the factors
that can contribute to an area's need for rental housing funds.
For example, project development costs, which can vary among
states, are not considered in the allocation process. A state
with relatively high costs may be able to fund fewer housing
units with a given amount of money than other states with lower
costs.
Our 1994 report also pointed out that project developers, rather than
RHCDS, determine where proposed projects will be located. If
developers consider that developing a project in a particular area is
infeasible or unattractive, they will not propose projects for that
location, even if projects are greatly needed. Under a targeting
program established by legislation in 1990, RHCDS does set aside a
portion of all rural housing program funds specifically for loans in
counties that have very high levels of poverty and substandard
housing and have been underserved by RHCDS' rural housing programs.
However, providing program assistance to these targeted areas still
depends on developers' willingness to propose projects in them.
A 1994 report by a task force of the National Council of State
Housing Agencies identified other problems with the current project
selection process.\16 Among other things, the task force found that
there was little or no coordination on project selection between
RHCDS' field offices and the state agencies that allocate federal
low-income-housing tax credits to certain projects. Many of the
projects applying to RHCDS for loans are eligible for, and receive,
these tax credits.
By law, the state agencies must develop project selection criteria
that are consistent with the needs and priorities set forth in the
state's Comprehensive Housing Affordability Strategy, a planning
document required by the Department of Housing and Urban Development
as a prerequisite for the state's receipt of federal housing
assistance. Although legislation in 1992 directed RHCDS to require
its state offices to establish a process for coordinating project
selection with the housing needs and priorities established in the
states' plans, the task force found that little coordination
occurred. As a result, the projects selected under RHCDS' funding
process may not be located in the areas identified by the states'
plans as the neediest.
Before the task force's report, RHCDS issued regulations in March
1994 instructing its state directors to cooperate with the state
agencies in the development of the states' housing affordability
plans to ensure that, to the extent possible, RHCDS' resources are
coordinated with the states' priorities. Under the regulations, such
cooperation may include, but is not limited to, sharing data on
RHCDS' estimates of need for areas within the state. However, the
task force found that RHCDS had not provided its state directors with
further guidance on how to coordinate their project selection with
the states' plans. RHCDS officials point out, however, that they are
bound by their own legislatively directed criteria, which are not
necessarily consistent with the state agencies' criteria. As a
result, RHCDS officials believe they can do little more to ensure
consistency without a change in the legislation.
Finally, a 1994 report by the Surveys and Investigations Staff of the
House Committee on Appropriations raised concerns about the weight
that RHCDS' selection process gives to projects located away from
urban areas.\17 According to the report, the preference given to
proposed projects in rural communities located at least 20 miles from
an urban area has resulted in some projects being built in small
rural communities that have only a limited need for rental housing,
while exempting projects in other communities that have a greater
need but are too close to a defined urban area.
--------------------
\15 Rental Housing: Distribution and Use of FmHA's Rural Rental
Housing Program Funds (GAO/RCED-94-141, June 1, 1994).
\16 Report of the Tax Credit/FmHA Task Force to the Board of
Directors of the National Council of State Housing Agencies, May 21,
1994.
\17 Practices and Procedures Regarding Certain Housing and Loan
Assistance Programs Under the Farmers Home Administration, A Report
to the Committee on Appropriations, U.S. House of Representatives,
by the Surveys and Investigations Staff, April 1994.
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix IV
HOUSING AND COMMUNITY DEVELOPMENT
ISSUE AREA
Eugene J. Chuday, Jr.
Patrick B. Doerning
Andrew E. Finkel
Woodliff L. Jenkins, Jr.
Leigh K. Ward
FINANCIAL MANAGEMENT POLICY ISSUE
AREA
Christie M. Arends
Arthur W. Brouk
*** End of document. ***