Home Improvement: Weaknesses in HUD's Management and Oversight of the
Title I Program (Letter Report, 07/16/98, GAO/RCED-98-216).
Pursuant to a congressional request, GAO reviewed the Department of
Housing and Urban Development's (HUD) administration of the National
Housing Act Title I program, focusing on: (1) the extent to which the
information needed to manage the program was available to HUD; (2) the
extent to which HUD was overseeing the program's lenders; (3) whether
options and information presented by Price Waterhouse in its
HUD-commissioned study of the Title I program could provide lenders with
greater incentives to improve loan underwriting and servicing; and (4)
whether HUD has any efforts planned or under way to strengthen its
management and oversight.
GAO noted that: (1) HUD is not collecting the information needed for
managing the Title I property improvement loan program; (2)
specifically, GAO found that when loans are made, HUD collects little
information on the borrowers, the properties, or the loan terms, such as
the borrowers' income and the addresses of the properties being
improved; (3) moreover, HUD does not maintain information on why it
denies loan claims or why it subsequently approves some of those claims
for payment; (4) HUD provides limited oversight of lenders' compliance
with the program's regulations; (5) it conducted four on-site quality
assurance reviews of lenders in fiscal year 1997 of the approximately
3,700 lenders participating in the program; (6) regarding the need for
oversight of lenders' compliance, GAO found that loan claim files
submitted by lenders to HUD following loan defaults often do not contain
required loan documents; (7) in addition, some claims are paid by HUD
even though there are indications that the lenders did not comply with
the required underwriting standards when insuring the loans; (8) in
August 1997, Price Waterhouse in its HUD-commissioned review of the
Title I program reported, among other things, on options and provided
information on how to restructure the program; (9) these options could
provide greater incentives for lenders to improve the making and
servicing of the program's loans; (10) under HUD's 2020 Management
Reform Plan and related efforts, the agency is making significant
changes in all of its single-family housing programs, including the
Title I program; (11) these changes are motivated in part by HUD's goals
to downsize the agency and to address long-standing agencywide
management weaknesses; (12) the changes being made that affect the Title
I home improvement insurance program include: (a) streamlining and
automating the program's claims examination process; and (b)
consolidating the agency's efforts to monitor lenders into four
locations; and (13) however, it is uncertain whether these changes will
affect the weaknesses GAO identified in the oversight of the Title I
program.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: RCED-98-216
TITLE: Home Improvement: Weaknesses in HUD's Management and
Oversight of the Title I Program
DATE: 07/16/98
SUBJECT: Federal agency reorganization
Internal controls
Lending institutions
Property improvement loans
Data collection
Federal aid for housing
Housing programs
Loan defaults
Claims processing
IDENTIFIER: HUD 2020 Management Reform Plan
Mutual Mortgage Insurance Fund
HUD Title I Property Improvement Program
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Cover
================================================================ COVER
Report to Congressional Requesters
July 1998
HOME IMPROVEMENT - WEAKNESSES IN
HUD'S MANAGEMENT AND OVERSIGHT OF
THE TITLE I PROGRAM
GAO/RCED-98-216
Home Improvement
(385680)
Abbreviations
=============================================================== ABBREV
FHA - Federal Housing Administration
HUD - Department of Housing and Urban Development
OIG - Office of the Inspector General
OMB - Office of Management and Budget
Letter
=============================================================== LETTER
B-279489
July 16, 1998
The Honorable Rick A. Lazio
Chairman, Subcommittee on Housing
and Community Opportunity
Committee on Banking
and Financial Services
House of Representatives
The Honorable Kenneth E. Bentsen, Jr.
House of Representatives
Homeowners who have little equity in their homes at times obtain
property improvement loans under Title I of the National Housing Act
to make alterations or repairs. These loans are made by banks and
other private lenders from their own funds and are insured by the
Department of Housing and Urban Development's (HUD) Federal Housing
Administration (FHA). If borrowers default on their loans, banks
submit claims to HUD, which pays or denies them.
Concerned about how well this Title I program was being operated, you
asked us to determine (1) the extent to which the information needed
to manage the program was available to HUD; (2) the extent to which
HUD was overseeing the program's lenders; (3) whether options and
information presented by Price Waterhouse in its HUD-commissioned
study of the Title I program could provide lenders with greater
incentives to improve loan underwriting\1 and servicing; and (4)
whether HUD has any efforts planned or under way to strengthen its
management and oversight. In April 1998, we testified on the
preliminary results of our work before the Subcommittee on Housing
and Community Opportunity of the House Committee on Banking and
Financial Services.\2
--------------------
\1 Underwriting is the process of analyzing a borrower's willingness
and ability to repay a loan.
\2 Home Improvement: Weaknesses in HUD's Management and Oversight of
the Title I Program (GAO/T-RCED-98-177, Apr. 30, 1998).
RESULTS IN BRIEF
------------------------------------------------------------ Letter :1
HUD is not collecting the information needed for managing the Title I
property improvement loan program. Specifically, we found that when
loans are made, HUD collects little information on the borrowers, the
properties, or the loan terms, such as the borrowers' income and the
addresses of the properties being improved. Moreover, HUD does not
maintain information on why it denies loan claims or why it
subsequently approves some of those claims for payment.
HUD provides limited oversight of lenders' compliance with the
program's regulations. It conducted four on-site quality assurance
reviews of lenders in fiscal year 1997 of the approximately 3,700
lenders participating in the program.\3 Regarding the need for
oversight of lenders' compliance, we found that loan claim files
submitted by lenders to HUD following loan defaults often do not
contain required loan documents, including the original loan
applications and certifications signed by the borrowers stating that
the property improvement work has been completed. In addition, some
claims are paid by HUD even though there are indications that the
lenders did not comply with the required underwriting standards when
insuring the loans.
In August 1997, Price Waterhouse in its HUD-commissioned review of
the Title I program reported, among other things, on options and
provided information on how to restructure the program, such as
further restricting the use of Title I loan proceeds and capping loan
interest rates. These options could provide greater incentives for
lenders to improve the making and servicing of the program's loans.
Under HUD's 2020 Management Reform Plan and related efforts, the
agency is making significant changes in all of its single-family
housing programs, including the Title I program. These changes are
motivated in part by HUD's goals to downsize the agency and to
address long-standing agencywide management weaknesses. The changes
being made that affect the Title I home improvement insurance program
include (1) streamlining and automating the program's claims
examination process and (2) consolidating the agency's efforts to
monitor lenders into four locations. However, it is uncertain
whether these changes will affect the weaknesses we identified in the
oversight of the Title I program.
--------------------
\3 In our April 1998 testimony on the preliminary results of our
Title I work, we reported, based on information provided by HUD, that
HUD had conducted two reviews of Title I lenders in fiscal year 1997.
Subsequently, additional information provided by HUD showed that it
had conducted two other reviews of Title I lenders in fiscal year
1997.
BACKGROUND
------------------------------------------------------------ Letter :2
The Title I property improvement program was established by the
National Housing Act (12 U.S.C. 1703) to encourage lending
institutions to finance property improvement projects that would
preserve the nation's existing housing stock. Under the program, FHA
insures 90 percent of a lender's claimable loss on an individual
defaulted loan. The total amount of claims that can be paid each
year to a lender is limited to 10 percent of the value of the total
program loans held by each lender. In fiscal year 1997, FHA paid
about $112 million on 8,179 Title I property improvement claims.
Since the inception of the program in 1934, FHA has provided credit
protection for Title I loans for over 35 million households to
finance a variety of alterations and repairs. These property
improvements are intended to improve or protect the basic livability
or utility of a home, including structural additions and alterations;
siding; roofing; insulation; and plumbing, heating, and cooling
systems. Although property improvement loans made under Title I can
be obtained for other types of structures, most loans are for
improvements to single-family homes.\4
Today, the value of the outstanding loans in the Title I program is
relatively small compared with FHA's other housing insurance
programs. As of September 30, 1997, the value of loans outstanding
on the property improvement program totaled about $4.4 billion on
364,423 loans. By contrast, the value of outstanding FHA
single-family home loans in its Mutual Mortgage Insurance Fund
totaled about $360 billion. Similarly, Title I's share of the
remodeling market for owner-occupied, single-family homes is
small--estimated at about 1 percent by the National Association of
Home Builders and estimated by HUD at about 3.1 to 3.6 percent of the
total financed home improvement work.
Approximately 3,700 lenders are approved by FHA to make Title I
loans. Lenders are responsible for managing many aspects of the
program, including establishing interest rates and loan terms, making
and servicing loans, monitoring the contractors, and dealing with
borrowers' complaints. In conducting these activities, lenders are
responsible for complying with FHA's underwriting standards and
regulations and for ensuring that home improvement work is inspected
and completed. FHA is responsible for approving lenders, monitoring
their operations, and reviewing the claims submitted for defaulted
loans. The Title I program's officials consider lenders to have the
sole responsibility for the program's operations and HUD's role to be
primarily overseeing lenders and ensuring that the claims paid on
defaulted loans are proper.
A homeowner obtains a property improvement loan by applying directly
to a Title I lender or by having a Title I lender-approved
dealer--that is, a contractor--prepare a credit application or
otherwise assist the homeowner in obtaining the loan from the lender.
For a direct loan, the proceeds are disbursed to the homeowner when
the Title I loan is approved. However, the proceeds from a loan
obtained through the assistance of a dealer are disbursed by the
lender to the dealer when the home improvement work is completed.
During fiscal years 1986 through 1996, about 520,000 direct and
383,000 dealer loans were made under the program. In calendar year
1997, about 60 percent of the loans (49,872) were made directly to
borrowers, while 40 percent (33,360) were made through dealers. By
statute, the maximum amount of property improvement loans is $25,000
on a single-family home, and the maximum loan term is about 20 years.
Loans in excess of $7,500 must be secured by a recorded lien on the
property being improved.
Title I regulations require borrowers to have enough income to meet
the periodic payments required by a property improvement loan. HUD's
guidelines generally require that borrowers' total fixed expenses not
exceed 45 percent of the their effective gross income. However, this
expense-to-income ratio can be exceeded if a lender determines and
documents compensating factors concerning a borrower's credit
worthiness that would support approval of the loan. Most Title I
borrowers have low to moderate incomes, little equity in their homes,
and/or poor credit histories. According to data collected by Price
Waterhouse in an August 1997 study of the Title I program, most Title
I borrowers nationally in 1995 had incomes that were at or near
median area incomes. The exception was borrowers in California,
where about 70 percent of the borrowers had incomes that were 115
percent above the area median income. Nationwide, the average size
of a loan was $12,163 as of September 1997.
HUD's expenses under the Title I program, such as the claim payments
made by FHA on defaulted loans, are financed from three sources of
revenue: (1) insurance charges to lenders of 0.5 percent of the
original loan amount for each year the loan is outstanding, (2) funds
recovered from borrowers who defaulted on loans, and (3)
appropriations. In the August 1997 report, Price Waterhouse
concluded that the program was underfunded during fiscal years 1990
through 1996. Price Waterhouse estimated that a net funding deficit
of about $150 million occurred during the period, with a net funding
deficit in 1996 of $11 million.\5 Data from the Price Waterhouse
report on estimated projected termination rates for the program's
loans made in fiscal year 1996 can be used to calculate an estimated
cumulative claim rate of about 10 percent over the life of the Title
I loans insured by FHA in that fiscal year. Since the inception of
the Title I program, about 27 percent of borrowers who have defaulted
on their loans did so within 12 months of the loans' origination,
while 58 percent defaulted within 24 months.
The number of consumer inquiries and complaints made nationally about
home improvement contractors is significant. According to data
compiled by the Washington, D.C., Metropolitan Area Better Business
Bureau, in 1997 about 241,000 inquiries were made nationally about
home improvement contractors, making it the second most often asked
about industry. In addition, the Bureau received 6,829 consumer
complaints nationwide about home remodeling contractors and another
4,452 about roofers in 1997, making those occupations fifth and
eleventh in terms of the number of complaints.
In the last year, borrowers' allegations about shoddy and incomplete
work by Title I dealers and possible fraud in the program have been
the subject of media reports. In response to the media reports of
abuses and excessive claims with the dealer-initiated loans, HUD
proposed on July 3, 1997, to take steps that would eliminate this
portion of the program. A decision on dealer loans had not been made
as of June 25, 1998. However, in commenting on a draft of this
report, HUD stated that it has sought public comment, through the
rulemaking process, on whether and under what circumstances the
dealer component of the program should be retained. In addition, in
October 1997, HUD's Office of the Inspector General (OIG) reported on
the results of its survey of the Title I property improvement
program. The OIG's report concluded that the dealer portion of the
program traditionally experienced higher claim rates and greater
program abuse than the direct loan portion of the program.
--------------------
\4 Title I property improvement loans also may be used for
multifamily housing and nonresidential structures. Under another
component of the program, loans insured by FHA can be used to
purchase manufactured homes. A manufactured home is built entirely
in a factory, transported to a homesite, and installed.
\5 Price Waterhouse defined the net funding position as the current
value of the premiums collected minus the current value of the
claims. Current value refers to past payments plus accumulated
interest, plus expected future payments discounted by the interest
rate on 5-year U.S. Treasury bonds. The estimated negative net
funding deficit implies that premiums will be insufficient to pay the
expected claims.
INFORMATION NEEDED TO MANAGE
THE PROGRAM IS NOT COLLECTED BY
HUD
------------------------------------------------------------ Letter :3
HUD is not collecting the information needed to manage the Title I
program. Specifically, we found that HUD (1) collects little
information when loans are made on the borrowers, properties, and
loan terms; (2) does not always have accurate data on the types of
loans for which claims are submitted; and (3) does not maintain
information on why it denies loan claims or why it subsequently
approves some of them for payment. As a result, HUD cannot identify
the characteristics of the borrowers and neighborhoods served by the
program, nor can it accurately identify certain abuses of the program
or default experience by loan types. Also, HUD has no basis for
reviewing the reasonableness of decisions made to deny and
subsequently approve claims.
HUD COLLECTS LITTLE
INFORMATION ON BORROWERS,
PROPERTIES, AND LOANS
---------------------------------------------------------- Letter :3.1
When FHA-approved Title I lenders make program loans, they collect
information on the borrowers, such as age, income, and sex; the
property, such as its address; and the loan terms, such as the
interest rate. While lenders are required to report much of this
information to their respective regulatory agencies--such as the
Federal Reserve System, the Office of the Comptroller of the
Currency, and the National Credit Union Administration--under the
Home Mortgage Disclosure Act,\6 HUD collects little of this
information when Title I loans are made. Instead, using information
that it requires lenders to provide, HUD records only the lender's
and borrower's names, the state and county, as well as the amount,
term, and purpose of the loan. Because it does not collect more
detailed information, HUD cannot identify the characteristics of the
borrowers and the neighborhoods served by the program, nor can it
identify certain potential abuses of the program. Additional
information that HUD collects on other single-family home loan
insurance programs, such as the borrowers' addresses, Social Security
numbers, income, and debt, is not collected by HUD when Title I loans
are made. HUD does collect all of the information available on
borrowers, property, and loans when Title I loans default and lenders
submit claims. Title I officials told us they collect little
information when loans were made because they consider the program to
be lender-operated. In an August 1997 report on the Title I program,
Price Waterhouse commented on the lack of data collected by HUD on
this program and indicated that the cost of obtaining information
would be marginal.
Because HUD does not collect borrowers' Social Security numbers and
property addresses when loans are made, it would have difficulty
determining whether some borrowers are obtaining multiple Title I
loans. It would also have difficulty determining whether some
borrowers are exceeding the maximum amount of Title I loans per
property at the time new loans are made. The Title I statute limits
the total amount of indebtedness on Title I loans to $25,000 for each
single-family property.
In this regard, our examination of HUD's Title I claims data found a
number of instances in which the same Social Security number was used
for multiple claims. As discussed previously, claims on about 10
percent of the program's loans can be expected over the life of the
loans. Our examination of 16,556 claims paid by HUD between January
1994 and August 1997 revealed 247 instances in which the same Social
Security number appeared on multiple claims.\7 These cases totaled
about $5.2 million in paid claims. In several instances, claims were
paid on as many as five loans having the same Social Security number
during the 3-1/2-year period. Our Office of Special Investigations,
together with HUD's Office of the Inspector General, is inquiring
further into the circumstances surrounding these loans. However,
because these loans might have been for multiple properties, or were
multiple loans on the same property that totaled less than $25,000,
they might not have violated the program's statute. Allowing
individual borrowers to accumulate large amounts of Title I HUD
insured debt, however, exposes HUD to large losses if such heavily
indebted borrowers default on their loans. In addition, while
information available to HUD allows potential abuses of the $25,000
indebtedness limit to be identified after loans have defaulted,
control over the indebtedness limitation is not possible for the 90
percent of the program's loans that do not default because HUD does
not collect borrowers' Social Security numbers and property addresses
when the loans are made.
A HUD official told us that in April 1998, HUD submitted a request to
the Office of Management and Budget (OMB) to be allowed to collect
additional information for the Title I program that would be similar
to the information HUD collects on other FHA insurance programs for
single-family home loans. The additional information HUD was seeking
to collect includes the borrower's address, Social Security number,
income, and debt. OMB's action on HUD's request was pending as of
June 1998.
Also, in commenting on a draft of this report, HUD stated it had
started the processes necessary to collect more data on each Title I
insured loan. The amount of data collected will be increased
significantly, and the method of collection converted from paper to
electronic reporting by lenders, according to HUD. These changes
will bring the data and reporting requirements for Title I loans more
in line with the requirements for FHA's single-family mortgage
insurance program, according to HUD. HUD has established a target
date of 1999 for the implementation of these changes. Exhibits I and
II of HUD's comments on a draft of this report, contained in appendix
II, outline HUD's current and additional requirements for the data
lenders are to submit.
--------------------
\6 The act was enacted in 1975 to require some lending institutions
to report various data about the loans, including applicant and
borrower characteristics.
\7 Appendix I describes our scope and methodology.
INFORMATION ON TYPES OF
LOANS FOR WHICH CLAIMS ARE
SUBMITTED IS NOT ALWAYS
ACCURATE
---------------------------------------------------------- Letter :3.2
While HUD collects more extensive information on program loans when
they default, we found problems with the accuracy of some of the
information recorded in its claims database. Our random sample of 53
loans on which claims had been denied and then subsequently paid by
HUD found that 7 loans, or 13 percent, had been miscoded as dealer
loans when they were direct loans or vice versa.\8
Accurate classification is important because HUD recently cited the
high default rates on dealer loans, among other reasons, for
proposing that the dealer loan portion of the program be eliminated.
In a May 29, 1997, press release, the Secretary of HUD announced that
a 4-month review of the Title I property improvement program found
serious problems with the dealer portion of the program and that HUD
was proposing that steps be taken that would eliminate dealer loans.
Property improvement loans would still, however, be available
directly from lenders. HUD has received various opinions about
eliminating this portion of the program, but a final decision has not
yet been made. Considering how many loans might have been miscoded
as dealer or direct loans, we question HUD's ability to identify
default experience by loan type. A Title I official told us that the
miscoding was caused by lenders incorrectly reporting loan types and
by HUD's contractors incorrectly entering these data in the database.
--------------------
\8 Our sample consisted of 39 dealer loans and 14 direct loans, from
a universe of 3,161 dealer loans and 2,479 direct loans, as recorded
in HUD's Title I database. We found that three (7.7 percent) of the
loans classified as dealer loans were actually direct loans, and four
(28.65 percent) of the loans classified as direct loans were actually
dealer loans. Calculating a weighted average, so that dealer and
direct loans in the sample matched their frequency in the population,
produced an estimated error rate of 19.4 percent for the Title I
database. The 95-percent confidence interval for the error rate on
the dealer/direct classification extended from 4 to 35 percent.
INFORMATION ON WHY CLAIMS
ARE DENIED AND SUBSEQUENTLY
APPROVED IS NOT MAINTAINED
---------------------------------------------------------- Letter :3.3
HUD does not maintain information on why claims are denied or, for
claims that were originally denied but subsequently paid, on why the
claims were paid and which of the program's officials made the
decision to pay them. HUD can deny claims for property improvement
loans for a number of reasons, including missing documents, such as
the original note, security instrument, or inspection report; failure
to provide evidence of the borrower's legal interest in the property;
poor underwriting; and misstatements, inconsistent data, or fraud.
However, HUD does not have a system in place to provide information
on why claims are denied or approved for payment following a denial.
HUD could not provide us with information on how many claims it
denied because of poor underwriting or other program abuses or on
which lenders had a higher-than-average number of claims denied for
specific program violations. In addition, we were unable to
determine from HUD's data system why a denied claim was subsequently
paid following an appeal by the lender or a waiver by HUD. Such
information is important in determining how well lenders are
complying with the program's regulations, whether internal controls
need to be strengthened, and which lenders should be targeted for
review by HUD's Quality Assurance Division.
In addition, the files for claims that were initially denied by HUD
and subsequently paid frequently did not contain the names of the
program's officials who decided the denied claims should be paid and
the reasons for their decisions. Of the 53 randomly selected loan
claim files we examined, 50 contained no evidence of further review
by a HUD official following the initial denial or did not provide any
basis for eventually paying the claim.\9 Unless information about who
makes decisions to deny claims and the reasons for the denials and
the subsequent payments is documented, HUD has no basis for reviewing
the reasonableness of those decisions.
In December 1997, HUD made changes to its claims database system so
that it can identify the reasons for denying claims. The Title I
program's officials agreed that such information is important in
determining how well the program's regulations are being complied
with and in targeting lenders for quality assurance reviews. Claims
examiners are now required to identify their reasons for denying a
claim, including the section of the regulation that the lender
violated. However, HUD has not addressed the lack of documentation
in the claim files explaining the reasons for paying claims that were
previously denied.
--------------------
\9 Using a weighted average, we estimate that there was no evidence
of further review in about 91 percent of the loan files. Using a
95-percent confidence interval, we estimate that the percentage of
files that contained no evidence of further review at between 79 and
100 percent.
HUD'S OVERSIGHT OF THE
PROGRAM'S LENDERS IS LIMITED
------------------------------------------------------------ Letter :4
HUD's quality assurance reviews and its Title I claims examination
process are the primary controls HUD has in place to ensure that
lenders are complying with the program's regulations. However, the
on-site monitoring reviews HUD conducted of lenders' compliance with
the program's regulations have declined significantly over the last 3
years. According to HUD officials, fewer reviews were done because
of limited staff resources and HUD's assignment of monitoring
priorities. Moreover, some claim files do not contain complete
information or are missing documents, which makes it difficult to
determine why certain claims were approved for payment. As a result,
HUD has little assurance that lenders are complying with the
program's regulations.
HUD MONITORS FEW OF THE
PROGRAM'S LENDERS
---------------------------------------------------------- Letter :4.1
HUD's monitoring reviews of Title I lenders to identify compliance
problems have declined substantially in recent years. During fiscal
years 1995 through 1997, HUD performed 35 targeted, on-site quality
assurance reviews of Title I lenders. Most of these reviews (26)
were performed in fiscal year 1995. During fiscal year 1996, HUD
performed five on-site reviews; during fiscal year 1997, it performed
four.\10 According to HUD officials, HUD had a staff of 23
individuals to monitor the 3,700 lenders approved by FHA to make
Title I loans and about 8,000 other FHA-approved lenders making loans
under other FHA insurance programs. Because of its limited
monitoring resources, HUD decided to focus on major, high-volume FHA
programs, officials said. Monitoring priorities have also caused HUD
to do few follow-up reviews to ascertain whether lenders had
corrected deficiencies uncovered by the quality assurance reviews.
As a result, it is difficult to determine what impact the quality
assurance reviews that were performed might have had on improving
lenders' compliance.
In addition to the targeted, on-site lender reviews, HUD also visited
four lenders in Texas to examine and obtain information on the
lenders' dealer loan case files. HUD conducted these reviews
primarily in response to news stories by Texas reporters about
dealers performing shoddy property improvement work. According to
HUD officials, the reviews revealed instances of contractor fraud,
flagrant program abuses, and noncompliance with the program's
requirements. As a result, HUD headquarters issued limited denials
of participation to 51 contractors. A limited denial of
participation prohibits the recipient from participating in all FHA
single-family housing programs nationwide for a period not to exceed
1 year.
--------------------
\10 Although HUD conducted just four reviews in fiscal year 1997, it
commented that the lenders reviewed accounted for over 35 percent of
the 84,000 new Title I loans.
REQUIRED DOCUMENTS ARE
MISSING FROM LOAN FILES
---------------------------------------------------------- Letter :4.2
When making Title I loans, lenders are required to ensure that
borrowers represent acceptable credit risks, having a reasonable
ability to make payments on the loans, and to see that the property
improvement work is completed. However, our examination of 53 loan
claim files revealed that one or more of the required documents
needed to ensure program compliance were missing from more than half
(30) of the files.\11 Title I regulations do not require that a claim
be denied if key documents, such as an original loan application,
certificate of completion, or inspection report, are not in the claim
file. However, the program's regulations state that the Secretary of
HUD may deny a claim for insurance in whole or in part if the
program's regulations have been violated unless a waiver of
compliance with the regulations is granted. HUD's claims examination
manual states in the "Reasons for Denial" section that "a complete
file consists of all documents relative to the processing and
maintenance of the loan" and specifically lists missing inspection
reports and completion certificates as reasons for denying a claim.
According to a program official, for a claim to be paid on any
property improvement loan with a principal balance of $7,500 or more,
or on any direct loan without a completion certificate, the file must
contain either (1) an inspection report showing that the work has
been completed or (2) an inspection report, accompanied by a
noncompliance letter, showing that the work has not been completed.
In addition, a claim submitted after a default has occurred on a
dealer loan should not be paid unless a signed completion certificate
is in the file.\12 The 53 cases we examined were the official claim
files maintained by HUD after claims were paid and should have
contained all documents and other information related to the loans.
HUD officials could not explain why key documents needed to ensure
program compliance were missing from the files. Our review of the 53
cases revealed the following:
-- In 12 cases, the required original loan applications, signed by
the borrowers, were not in the loan files.\13 According to HUD's
regulations, as part of the credit application process, the
lender must obtain a separate, dated loan application on a
HUD-approved form. Title I regulations require that the loan
application and all other documents supporting the lender's
decision that the borrower is an acceptable credit risk be
retained in the loan file. The original loan application is
important because it is used by the claims examiner to review
the adequacy of the lender's underwriting and to ensure that the
borrower's signature and Social Security number match those on
other documents, including the credit report.
-- In 20 cases, the required completion certificates certifying
that the property improvement work had been completed were
missing or were signed but not dated by the borrowers. We found
that completion certificates were missing, or not dated, for 17
dealer loans and 3 direct loans. Title I regulations require
that the lender obtain a completion certificate signed by the
borrower certifying that the work has been completed. This
requirement differs for dealer and direct loans. A completion
certificate is always required for a dealer loan because under
Title I regulations, loan funds cannot be disbursed until the
lender has obtained a signed certificate certifying that the
work has been completed. For a direct loan, the program's
regulations require that the borrower submit a signed completion
certificate to the lender within 6 months after the loan
proceeds are disbursed, with one 6-month extension if necessary.
If a borrower fails to provide the completion certificate within
the required 12-month period, lenders are required to conduct an
on-site inspection of the completed work. Thus, it is
permissible under the program's regulations for a direct loan
file not to contain a certificate of completion if the file
instead contains an inspection report showing that the lender,
after not receiving the certificate, conducted an inspection.
-- For 33 loans for which the program's regulations required that
inspections be conducted by the lenders, 19 loan files did not
contain the inspection report. Once work has been completed and
loan funds have been disbursed, Title I regulations require that
the lender inspect the work paid for by any property improvement
loan with a principal amount of $7,500 or more or by any direct
loan for which the borrower failed to provide a completion
certificate. The purpose of the inspection is to verify that
the improvements are eligible for Title I loan insurance and to
confirm that the work has, in fact, been completed. If the
borrower refuses to cooperate with the lender in permitting the
inspection, the lender must promptly report this fact to HUD.
--------------------
\11 We randomly sampled from the 5,640 program claims that were
originally denied and then paid by HUD during the period from October
1994 through July 1997. Using a weighted average of direct and
dealer loans, we estimate 49 percent of the loan files had missing
program compliance documents. Using a 95-percent confidence
interval, we estimate that the percentage of files with missing
documents was between 30 and 68 percent.
\12 In commenting on a draft of this report, HUD reiterated that the
omission of a particular document from a claim file may not warrant
denial of the claim. We agree. As pointed out in this paragraph,
for example, while the program's regulations always require a
completion certificate for a dealer loan, it is not required for
direct loans if the lender conducts an on-site inspection of the
completed work.
\13 In commenting on a draft of this report, HUD pointed out that it
can pay claims when original documentation is missing and that
lenders can be in substantial compliance with the agency's
regulations if they submit facsimile or other documents. In our
review, we considered facsimiles of completion certificates and
inspection reports in the loan files as adequate documentation to
support the payment of the claims. However, we considered the
omission of the original loan applications from the files as
inadequate documentation because HUD's claims examination manual
requires the original loan applications to be in the files.
LENDERS DO NOT ALWAYS COMPLY
WITH THE PROGRAM'S
REGULATIONS
---------------------------------------------------------- Letter :4.3
We also reviewed the 53 claim files to determine how well lenders
were complying with underwriting standards. According to the
program's regulations, a Title I lender should exercise prudence and
diligence in determining whether the borrower (and any co-borrower)
is solvent and an acceptable credit risk, with a reasonable ability
to make payments on the loan obligation. All documentation
supporting the underwriting determination should be retained in the
loan file, according to HUD's regulations. HUD can deny a lender's
claim if the lender has not followed HUD's underwriting standards in
making the loan. However, HUD does not examine the quality of a
lender's loan underwriting during the claims process if the borrower
made 12 loan payments before defaulting on the loan. Since 27
percent of the Title I loans that default do so within the first
year, this practice, in effect, exempts the majority of defaulted
loans from an examination of the quality of the lenders'
underwriting. Of the 53 loans in our sample, 13 defaulted within 12
months of the loan's origination and were subject to an underwriting
review by HUD. We focused our underwriting examination on the claim
files for these 13 loans.
We found that for 4 of the 13 loans on which HUD eventually paid
claims, lenders made questionable underwriting decisions. The Title
I program's regulations require that the credit application and the
review by the lender must establish that the borrower is an
acceptable credit risk, has 2 years of stable employment, and has an
income that will be adequate to meet the periodic payments required
by the loan, along with the borrower's other housing expenses and
recurring charges. However, information in the claim files for these
four loans indicated that the borrowers might not have had sufficient
income to qualify for their loans or had poor credit. For example,
on one loan, the lender used a pay stub covering the first 2 weeks of
March to calculate the borrower's annual income. The pay stub showed
that the borrower's year-to-date earnings were $6,700 by the middle
of March, and this amount was used to calculate that his annual
income was $34,000, or about $2,800 per month. But the pay stub also
showed that for a 2-week period in March, the borrower worked a full
week with overtime; the borrower's usual earnings were about $1,600
per month. The file contained no other documentation, such as income
tax returns, W-2 forms, or verification from the employer to support
the higher monthly income. The program's officials told us that it
was acceptable to use one pay stub to calculate monthly income but
that the "yearly earnings to date" figure should not be used because
it can at times overstate the actual income earned during a normal
pay period. The borrower, with about $1,600 per month in corrected
income, still met HUD's income requirements for the amount of the
loan. However, HUD denied the lender's original claim because its
underwriting standards had not been followed in that the borrower had
poor credit at the time the loan was made. In a letter responding to
HUD's denial of its claim, the lender acknowledged that the borrower
had limited credit at the time the loan was made, but pointed to the
(miscalculated) higher income of $2,800 per month to justify making
the loan. This reasoning was apparently accepted by HUD as there was
no evidence in the claim file that HUD questioned the error in
calculating the borrower's monthly income. The borrower defaulted on
the loan after making two payments, and HUD paid a claim of $14,000.
THE CLAIMS EXAMINATION
PROCESS IS HUD'S PRIMARY
CONTROL OVER THE QUALITY OF
THE LENDERS' UNDERWRITING
---------------------------------------------------------- Letter :4.4
The number of quality assurance reviews being conducted by HUD of
Title I lenders has declined significantly in the last few years. In
addition, the quality assurance staff does not collect data on
lenders whose loans go into default within 2 years after the loans'
origination date. As a result, HUD's claims examination process has
become the primary tool available to ensure that lenders are
underwriting loans properly. As noted earlier, however, HUD does not
examine the lenders' underwriting on the majority of defaulted Title
I loans (73 percent) because the defaults occurred 12 months after
the date of the loans' origination. In addition, Title I program
officials stated that lenders will, at times, make additional
payments for the defaulted borrowers to move the default date beyond
the 12-month cutoff date to avoid underwriting reviews.\14 In
contrast, for its single-family mortgage insurance program, FHA
considers any loan for which foreclosure occurs within 18 months of
the loan's endorsement date to be an indicator of potentially unsound
underwriting practices (e.g., lending to unqualified borrowers).\15
Since 31 percent of Title I loans default between the 13th and 24th
month after the loans' origination, increasing the review period from
12 to 24 months after origination would result in over half of all
defaulted Title I loans being subjected to underwriting reviews by
HUD. Increasing the number of defaulted Title I loans subjected to
underwriting reviews before insurance claims are paid would provide
added incentive for lenders to properly underwrite Title I loans and
could reduce HUD's exposure to financial losses.
--------------------
\14 The officials were not certain about how often this occurs. Our
examination of default dates showed no grouping of defaults at the
13- to 14-month period, which would seem to indicate that this may
not be a common practice. However, 31 percent of Title I loans
default between the 13th and 24th month after the loans' origination,
and making even an additional 8 to 10 payments on a large loan may be
worth it to a lender when the alternative is to have a $15,000 or
$25,000 claim denied for poor underwriting.
\15 After making a mortgage loan on a single-family home, a lender
seeks FHA's approval to insure the loan. The date when FHA formally
approves mortgage insurance for the loan is termed the "loan
endorsement date" and occurs sometime after the date of the loan's
origination.
HUD HAS FOUND SIMILAR
PROBLEMS WITH LENDERS'
NONCOMPLIANCE
---------------------------------------------------------- Letter :4.5
HUD itself has identified similar problems with lenders'
noncompliance with the Title I program's regulations. As noted
previously, during fiscal years 1995 through 1997, HUD performed 35
on-site quality assurance reviews of Title I lenders. Among other
things, HUD cited lenders for engaging in poor credit underwriting
practices and for having loan files that were missing inspection
reports or that included inspection reports that were not signed or
dated. HUD sent the lenders letters detailing its findings and
requesting written responses addressing the findings. HUD, however,
did not perform follow-up, on-site reviews on 34 of the lenders to
ensure that they had taken corrective actions. As a result of the 35
on-site reviews, nine lenders were referred to HUD's Mortgagee Review
Board for further action.\16 The Board assessed four of these lenders
a total of $23,500 in civil penalties.\17
--------------------
\16 The HUD Reform Act of 1989 (12 U.S.C. 1708) and implementing
regulations established the Mortgagee Review Board within FHA to take
actions against HUD-approved mortgagees, including Title I lenders
who do not comply with HUD requirements.
\17 During this period, the Board also took administrative actions
against 28 other Title I property improvement lenders and assessed
some of them a total of $249,500 in civil money penalties for
violating the program's regulations.
MARKET INCENTIVES COULD
INCREASE LENDERS' COMPLIANCE
WITH THE PROGRAM'S REGULATIONS
------------------------------------------------------------ Letter :5
HUD contracted with Price Waterhouse to obtain information on the
Title I program and on options for improving the program's
management. Information reported by Price Waterhouse in its August
1997 study of the Title I program suggests ways to restructure the
program by giving lenders greater incentives to comply with the
program's regulations. One option discussed in the report would be
to reduce the portion of losses FHA insures on an individual
defaulted Title I loan to less than the current 90 percent. Another
option would be to set a cap on allowable interest rates to some
level above the prevailing rate on U.S. Treasury bonds. Each of
these options would increase the amount of risk lenders are exposed
to and provide greater incentives for them to do a better job in the
underwriting and servicing of Title I loans. At the same time,
however, it is likely that some potential Title I borrowers would be
adversely affected since they would be judged by lenders as being too
risky to participate in the program under the new guidelines. Given
the lack of historical information on Title I borrowers and loans, we
were unable to estimate the likely impact of these options on the
program's participants or on the participation of lenders.
REDUCING TITLE I INSURANCE
COULD INCREASE INCENTIVES
FOR LENDERS TO COMPLY WITH
THE PROGRAM'S REGULATIONS
---------------------------------------------------------- Letter :5.1
The Title I program is a coinsurance program, with HUD insuring 90
percent of the unpaid principal balance and uncollected interest,
plus uncollected legal fees on individual loans. According to Price
Waterhouse, the level of risk lenders bear has not been great enough
in recent years to force lenders to lend and service loans in a
prudent fashion. As a result, the program's current risk-sharing
structure has failed to protect FHA from losses in excess of premium
revenue, according to the Price Waterhouse report.
One way to increase incentives for lenders to improve the originating
and servicing of loans is to reduce the insurance coverage on
individual claims. While reducing coverage would increase incentives
for lenders to be prudent, it may also reduce lending to the riskiest
borrowers served by the program. It is also possible that some
lenders may stop making Title I loans. Given the limited data
available on Title I borrower demographics and loan characteristics,
we could not estimate the impact that this change would have on the
program's participants or on the participation of lenders in the
program.
CAPPING INTEREST RATES COULD
REDUCE LENDERS' INCENTIVE TO
MAKE RISKY LOANS
---------------------------------------------------------- Letter :5.2
Title I loans are often made with interest rates above those for
mortgages on single-family homes. Price Waterhouse surveyed lenders
in June and July 1997 and found that Title I lenders charged interest
rates ranging from 9 to 18 percent. These rates were substantially
above the 8-percent mortgage interest rate that prevailed at that
time, but in line with the 8- to 18-percent rates charged on
conventional home improvement loans. Our examination of interest
rates on 12,477 loans on which claims were submitted by lenders to
HUD during the period from January 1995 through August 1997 found
interest rates as high as 21 percent. The typical loan's interest
rate was in the range of 12 to 16 percent (see fig. 1).
Figure 1: Distribution of
Interest Rates on Defaulted
Title I Loans
(See figure in printed
edition.)
Capping interest rates on Title I loans could reduce the
profitability of lending to risky borrowers and help FHA reduce its
losses. Currently, lenders may find it profitable to originate risky
loans if, on the loans that succeed, they generate revenues high
enough to more than offset the losses they sustain on loans that
terminate in claims. Price Waterhouse's report on the Title I
program suggests capping interest rates as one way of discouraging
risky lending. The report also notes that it would be necessary to
cap points and origination fees as well as interest rates because
points and fees are a part of the lenders' total yield on the loans.
Such a policy change would reduce both lenders' interest in the
program and their willingness to lend to the riskiest borrowers.
HUD IS CHANGING THE TITLE I
PROGRAM
------------------------------------------------------------ Letter :6
Under HUD's 2020 Management Reform Plan and related efforts, the
agency has been making changes to the Title I program's operations.
HUD has relocated its claims examination unit to the Albany (New
York) Financial Operations Center and has contracted with Price
Waterhouse to develop claims examination guidelines. According to
the program's officials in Albany, the new claims process will be
more streamlined and automated and will allow lenders to file claims
electronically. In addition, HUD is consolidating all single-family
housing operations from 81 locations across the nation into four
Single-Family Homeownership Centers. Each center has established a
quality assurance division to (1) monitor lenders; (2) recommend
sanctions against lenders and the program's other participants, such
as contractors and loan officers; (3) issue limited denials of
participation against program participants; and (4) refer lenders for
audits or investigations. However, since HUD's quality assurance
staff will monitor lenders involved in all FHA single-family housing
programs, the impact of this change on improving HUD's oversight of
Title I lenders is unclear. Overall, by the end of fiscal year 1998,
the quality assurance staff will have increased to 76, up from 43 in
February 1998. The quality assurance staff has conducted four
on-site reviews of Title I lenders since October 1, 1997. HUD
expects that the addition of more quality assurance staff will
increase the number of lenders being reviewed, including Title I
lenders, and allow more comprehensive reviews of lenders' operations.
CONCLUSIONS
------------------------------------------------------------ Letter :7
Weaknesses exist in HUD's management of its Title I property
improvement loan insurance program and in its oversight of the
program's lenders. These weaknesses center on the absence of
information needed to manage the program and HUD's oversight of
lenders' compliance with the program's regulations. As a result, HUD
does not know who the program is serving, whether lenders are
complying with the program's regulations, or whether certain
potential program abuses are occurring, such as violations of the
$25,000 limit on the amount of Title I loan indebtedness allowed for
each property. The challenge faced by HUD in managing and overseeing
this program centers on how to obtain the information needed to
manage the program and to strengthen the oversight of lenders for
what is a relatively small program compared with other FHA housing
insurance programs.
We concur with HUD's decision to seek approval to collect additional
information on the Title I program's borrowers, properties, and loans
at the time that loans are made. Given the small cost of obtaining
this information, we are optimistic that HUD's downsizing will not
impede this effort. Similarly, restructuring the Title I program by
providing lenders with greater incentives to comply with the
regulations could improve HUD's oversight of the lenders without
significantly diverting HUD's monitoring resources from high-volume
FHA loan insurance program lenders. Unless HUD improves its
management information and oversight of the Title I property
improvement program and provides lenders with greater incentives to
comply with the program's regulations, it will continue to have
little assurance that the program is operating efficiently and free
of abuse.
RECOMMENDATIONS TO THE
SECRETARY OF HUD
------------------------------------------------------------ Letter :8
To promote effective management and accountability in the Title I
program, we recommend that the Secretary of HUD direct the Assistant
Secretary for Housing-Federal Housing Commissioner to do the
following:
-- Improve the information available to manage the program by
ensuring that information on the types of loans made is accurate
and recorded correctly in HUD's data systems.
-- Improve the Title I claims examination process by ensuring that
(1) the documents included in the claim files clearly explain
why a claim that was originally denied was subsequently paid and
which program official authorized payment; (2) all documents
required by the program's guidelines and regulations, including
the original loan application, inspection report, and completion
certificate, are contained in the claim application package
before a claim is paid; (3) the number of claims subject to an
underwriting review is increased by extending the length of time
after origination during which loan defaults are subjected to
review, with notification of this change sent to lenders in
writing; and (4) procedures are developed to routinely provide
the Quality Assurance Division with the information collected
during the claims examination process that is needed to monitor
and target lenders for review.
AGENCY COMMENTS AND OUR
EVALUATION
------------------------------------------------------------ Letter :9
We provided HUD with a draft of this report for their review and
comment. (See app. II.) HUD agreed with our recommendations aimed
at ensuring that information on the types of loans made is accurate,
increasing the number of claims that are subject to an underwriting
review, and using information collected during the claims examination
process to monitor and target lenders for review. It also pointed
out actions it has under way or planned to implement these
recommendations. On our remaining recommendations, HUD commented
that its Albany staff already documents claim files to justify
payment decisions and who made them and requested a list of the 53
claims we reviewed to better understand and respond to our
recommendation that all required documentation be obtained before a
claim is paid.
While we did not review claim files processed by HUD's Albany office
because this office had assumed responsibility for claims only
shortly before our review began, we remain concerned about the extent
of the documentation of payment decisions in HUD's Albany office
claim files. Albany Title I officials told us in February 1998,
shortly after they began processing claims, that they were unsure
what documentation they would consider necessary for lenders to
submit beyond that needed to ensure a loan's enforceability (that is,
HUD's authority to recover the amount of the loans and related costs
from a borrower who defaults on the loan). These officials stated
that the Albany staff's primary focus is to pay claims. In response
to HUD's request, on June 11, 1998, we provided a list of the 53
claim cases we had reviewed to HUD's Albany office.
---------------------------------------------------------- Letter :9.1
We conducted our review from November 1997 through June 1998 in
accordance with generally accepted government auditing standards.
The details of our scope and methodology are presented in appendix I.
We are sending copies of this report to the appropriate Senate and
House committees; the Secretary of HUD; and the Director, Office
Management and Budget. We will make copies available to others upon
request.
Please call me at (202) 512-7631 if you or your staff have any
questions. Major contributors to this report are listed in appendix
III.
Judy A. England-Joseph
Director, Housing and Community
Development Issues
SCOPE AND METHODOLOGY
=========================================================== Appendix I
To determine whether HUD has the information it needs to manage the
Title I program, we reviewed Title I legislation in the National
Housing Act and the program's guidelines and procedures. We also
interviewed HUD officials who are responsible for the Title I
program's operations, lender monitoring, and claims examinations and
program guidance. We examined two computerized files, one of loan
originations endorsed and the other of claim payments made from
fiscal year 1986 through fiscal year 1996. We also examined 16,556
computerized files of loan claim payments paid by HUD from January
1994 through August 1997 to determine if any multiple claims were
submitted on the same borrower for the same property.
To determine the extent to which HUD was overseeing the program's
lenders, we interviewed Title I officials at headquarters and the
Denver Homeownership Center responsible for monitoring lenders, staff
of HUD's Mortgagee Review Board, and claims examination officials at
HUD headquarters and at the Albany (New York) Financial Operations
Center. We also interviewed officials of the association that
represents many of the Title I lenders for their views on the
adequacy of HUD's lender monitoring. We examined HUD's quality
assurance case files for the lenders it monitored during fiscal year
1995 through fiscal year 1997 and the files for those Title I lenders
who had action taken against them by the Mortgagee Review Board for
violating the program's requirements. We also interviewed the staff
from Price Waterhouse who are assisting the Title I program's claims
examination unit in preparing new procedures.
From 5,640 program claims that were originally denied and then paid
by HUD during the period from October 1994 through July 1997, we
obtained a random sample of 53 loan claims to review the required
documents and underwriting decisions. Because we used a probability
sample to develop our estimates, each estimate has a measurable
precision, or sampling error, which may be expressed as a plus/minus
figure. A sampling error indicates how closely we can reproduce from
a sample the results that we would obtain if we were to take a
complete count of the universe using the same measurement methods.
By adding the sampling error to and subtracting it from the estimate,
we can develop upper and lower bounds for each estimate. This range
is called a confidence interval. Sampling errors and confidence
intervals are stated at a certain confidence level--in this case, 95
percent. For example, a confidence interval, at the 95-percent
confidence level, means that in 95 out of 100 instances, the sampling
procedure we used would produce a confidence interval containing the
universe value we are estimating.
With the exception of verifying the sample on the types of loans
made, we did not independently verify the accuracy or test the
reliability of HUD's data. We did perform tests to check the
interval consistency of the data and worked with agency officials to
ensure that we interpreted the data properly.
To determine whether options and information presented by Price
Waterhouse in its HUD-commissioned study of the Title I program could
provide lenders with greater incentives to improve loan underwriting
and servicing, we reviewed Price Waterhouse's report of August 1997
and the program's regulations that influence loan risk. We also
examined 12,477 computerized files of claims submitted by lenders for
payment to HUD during the period January 1995 through August 1997 to
determine what interest rates lenders charged borrowers. Given the
limited data available on Title I borrower demographics and loan
characteristics, we were unable to estimate the likely impact of
these options on the program's participants or on the participation
of lenders in the program.
Our information on the efforts HUD plans or has under way to
strengthen the program's management and oversight was obtained
through interviews with HUD officials in charge of the Title I
program, reviewing HUD's 2020 Management Reform Plan, and reviewing
Price Waterhouse's August 1997 report on the program.
(See figure in printed edition.)Appendix II
COMMENTS FROM THE DEPARTMENT OF
HOUSING AND URBAN DEVELOPMENT
=========================================================== Appendix I
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III
Stanley Czerwinski
Sherrill Dunbar
Austin Kelly
Robert Procaccini
Phillis Riley
Patrick Valentine
*** End of document. ***