Rural Housing: Shift to Guaranteed Program Can Benefit Borrowers and
Reduce Government's Exposure (Letter Report, 12/21/94,
GAO/RCED/AIMD-95-63).

Refinancing accounted for more than half of the record trillion dollars
in new mortgages in 1993, the year that saw a 30-year low in mortgage
interest rates.  Although the Farmers Home Administration (FmHA) saw a
rise in the number of borrowers who paid off their FmHA housing loans
and graduated to private credit, FmHA still has thousands of borrowers
paying interest rates significantly higher than those available from
private lenders--in part because of regulatory and legal financing
restrictions.  This report (1) describes the current status of FmHA's
single-family housing loan portfolio and (2) examines the merits of
allowing borrowers with direct loans to refinance their loans within the
direct loan program or through FmHA's guaranteed loan program for
single-family housing.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  RCED/AIMD-95-63
     TITLE:  Rural Housing: Shift to Guaranteed Program Can Benefit 
             Borrowers and Reduce Government's Exposure
      DATE:  12/21/94
   SUBJECT:  Mortgage loans
             Government guaranteed loans
             Subsidies
             Loan repayments
             Homeowners loans
             Loan interest rates
             Rural housing programs
             Credit
             Cost control
IDENTIFIER:  FmHA Direct Farm Loan Program
             FmHA Guaranteed Farm Loan Program
             
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Cover
================================================================ COVER


Report to Congressional Requesters

December 1994

RURAL HOUSING - SHIFT TO
GUARANTEED PROGRAM CAN BENEFIT
BORROWERS AND REDUCE GOVERNMENT'S
EXPOSURE

GAO/RCED/AIMD-95-63

Refinancing Rural Housing Loans


Abbreviations
=============================================================== ABBREV

  FmHA - Farmers Home Administration
  x - x

Letter
=============================================================== LETTER



B-259539

December 21, 1994

The Honorable Gary A.  Condit
Chairman
The Honorable Craig Thomas
Ranking Minority Member
Information, Justice, Transportation,
 and Agriculture Subcommittee
Committee on Government Operations
House of Representatives

Refinancings accounted for over half of the record trillion dollars
in new mortgages in 1993, the year that saw a 30-year low in mortgage
interest rates.  The Farmers Home Administration (FmHA) saw a rise in
the number of borrowers who paid off their FmHA housing loans and
thus graduated to private credit during this same period.\1 However,
in part, because of regulatory and legal financing restrictions, FmHA
still has thousands of borrowers paying mortgage interest rates
significantly higher than rates available to new FmHA borrowers or
borrowers in the private sector. 

FmHA makes both direct and guaranteed housing and farm loans to rural
Americans who cannot otherwise obtain loans at reasonable rates. 
FmHA's direct loans for single-family housing are designed to promote
successful homeownership for low-income rural residents by providing
mortgage loans and, depending on borrowers' incomes, interest
subsidies to lower monthly mortgage payments.  The direct loans are
meant to provide temporary credit--borrowers are required to graduate
from the direct program when their incomes are sufficient to afford
private credit.  The loans are serviced by FmHA in about 1,700 county
offices and account for about 35 percent of the county offices'
workload. 

In 1991, FmHA initiated a new program in the form of guaranteed loans
for single-family housing that were designed to assist
moderate-income rural borrowers.  To qualify for the program, homes
may be new or existing residences located in rural areas.  In
guaranteeing a single-family housing loan, FmHA agrees, in the event
that a borrower defaults, to reimburse a commercial lender for up to
90 percent of lost principal plus accrued interest and liquidation
costs. 

This report responds to your request to (1) describe the current
status of FmHA's single-family housing loan portfolio and (2) examine
the merits of allowing borrowers with direct loans to refinance their
loans within the direct loan program or through FmHA's guaranteed
loan program for single-family housing. 


--------------------
\1 As part of the reorganized U.S.  Department of Agriculture, the
rural housing programs previously under FmHA will be administered by
the newly formed Rural Housing and Community Development Service. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

As of September 30, 1994, FmHA held a portfolio of about 765,000
direct loans for single-family housing with a total outstanding
principal balance of $18.6 billion.  In fiscal years 1991 through
1994, FmHA guaranteed an additional 25,000 housing loans for about
$1.5 billion. 

The majority of FmHA's direct loan borrowers would not benefit from
refinancing because the borrowers receive substantial subsidies, low
interest rates, or a combination of the two.  However, 92,000
nonsubsidized FmHA loans are held by borrowers who continue to pay
interest rates of 9.5 percent or higher on an outstanding principal
balance of $2.2 billion.  About 13,000 of those loans carry rates of
13 percent or above.  These nonsubsidized, high-interest- paying
direct loan borrowers, along with an additional 7,200 borrowers who
receive minimal subsidies but still pay above-market rates, would
benefit from refinancing.  However, current regulations prohibit
lowering interest rates within the direct program, and refinancing
using the guaranteed program would require a legislative change. 

While lowering borrowers' interest rates within the direct program or
refinancing other borrowers using the guaranteed loan program would
help FmHA reach its objective of promoting successful homeownership,
refinancing eligible borrowers through the guaranteed program would
also help FmHA meet its requirement to graduate direct loan borrowers
to private credit.  A legislative change to allow such refinancings
would provide an option for the thousands of moderate-income
borrowers caught in the middle--ineligible for subsidies but unable
to graduate to nonguaranteed private credit. 

We identified up to $2.2 billion in loans held by direct loan
borrowers who could benefit by receiving a lower interest rate if
they were allowed to refinance through the guaranteed program.  If
these individuals refinance, the U.S.  Treasury will receive
immediate revenues from the loan payoffs, but it will also forgo
future revenues from mortgage payments.  Additional budget authority
may be required to issue these loan guarantees.  However, FmHA may
realize savings because banks would be originating and servicing
loans previously administered by FmHA's local county offices. 


   BACKGROUND
------------------------------------------------------------ Letter :2

In fiscal years 1988 through 1993, funding obligated for FmHA's new
single-family direct loans remained fairly constant at approximately
$1.3 billion annually.  In fiscal year 1994, funding increased to
$1.7 billion.  FmHA currently originates new loans only for borrowers
with incomes that are low enough to qualify for subsidy.  FmHA's
current regulations prohibit refinancing within the direct loan
program. 

FmHA may make a guaranteed single-family housing loan for up to 100
percent of the property's market value; the maximum loan amount is
$67,500, except in designated high-cost areas, where the loan amount
may be higher.  For a borrower to obtain an FmHA-guaranteed loan, a
lender must certify that it is unwilling to make the loan without a
government-backed guarantee.  Borrowers with direct loans cannot
graduate to private credit using the guaranteed program because the
1991 legislation authorizing the guaranteed program does not include
refinancing existing FmHA loans as an authorized purpose.  The 1991
legislation limits the program to loans used to acquire or construct
single-family residences.\2


--------------------
\2 Section 502(h) of the Housing Act of 1949 (42 U.S.C.  1472(h)). 


   STATUS OF FMHA'S HOUSING
   PORTFOLIO
------------------------------------------------------------ Letter :3

As of September 30, 1994, the outstanding principal balance on direct
loans for single-family housing was $18.6 billion.  About two-thirds
of those loans were held by borrowers who receive subsidies that
reduce the effective interest rates on their mortgages to as low as 1
percent.  (See app.  I.)

FmHA's guaranteed loan housing program has grown from about 1,000
loans issued in fiscal year 1991 to about 11,000 loans issued in
fiscal year 1994.  A total of over 25,000 loans were issued in the
program's first 4 years.  Those loans initially had an outstanding
principal balance of about $1.5 billion; about $1.2 billion is still
outstanding. 


   LOWERING INTEREST RATES WITHIN
   THE DIRECT PROGRAM
------------------------------------------------------------ Letter :4

Since we reported the effects of FmHA's prohibition against lowering
interest rates within the direct loan program at a March 1994 hearing
of a House banking subcommittee, FmHA has reexamined its policy and
now believes that it has the authority to lower borrowers' interest
rates under existing legislation without affecting current-year
budget funds.\3 Lowering interest rates on existing loans within the
direct loan program should better achieve the program's objectives of
promoting successful homeownership by lowering borrowers' payments,
reducing the need for subsidies, helping borrowers build equity, and
decreasing delinquencies and foreclosures.  However, lower payments
could act as a disincentive to voluntary graduation to private credit
and will result in reduced government revenues because of lower
interest rates paid by borrowers. 

FmHA plans to change its regulations to allow some existing borrowers
to reduce their mortgage interest rates to the rates offered to new
borrowers.  However, because FmHA plans to include this change as
part of an overall regulatory package of reforms, FmHA officials told
us it will not occur before October 1996. 


--------------------
\3 Housing Issues:  The Housing and Community Development Act of 1994
(GAO/T-RCED-94-148, Mar.  10, 1994). 


   REFINANCING USING THE
   GUARANTEED PROGRAM
------------------------------------------------------------ Letter :5

A logical step in graduating borrowers from direct loans to private
credit would be to replace direct loans with guaranteed loans when
the borrowers qualify.  FmHA has the legal authority to require
borrowers to graduate if it appears that other credit can be obtained
from another source at reasonable rates and terms.\4 Refinancing
borrowers using guaranteed loans would have several advantages. 


--------------------
\4 Title V of the Housing Act of 1949. 


      ASSIST BORROWERS TO OBTAIN
      PRIVATE CREDIT
---------------------------------------------------------- Letter :5.1

FmHA's policy requires that borrowers move from direct loans to
private credit at the earliest possible time.  Because qualifying for
private credit without a government guarantee is more stringent than
qualifying with a guarantee, movement from a direct loan to a
guaranteed loan is a logical progression for borrowers whose
financial condition has improved but is still not sufficient to
qualify for nonguaranteed private credit. 

Allowing borrowers of direct housing loans to refinance using FmHA's
guaranteed program would be a way to help borrowers as well as to
increase the number of graduations from the direct loan program. 
Borrowers who qualify to graduate to the guaranteed program would
benefit from lower interest rates in many cases and from minimal
downpayment requirements.  Through graduation, FmHA borrowers may
reduce their mortgage payments and improve their overall economic
condition.  In particular, the higher the rate of interest being paid
by nonsubsidized FmHA borrowers, in comparison with lower market
rates, the greater their incentive to graduate to the guaranteed
program.  Borrowers receiving a minimal subsidy but still paying
above-market rates could also qualify and should not be prohibited
from graduating to the guaranteed program if banks are willing to
refinance their loans. 


      ACHIEVE GREATER CONSISTENCY
      WITH FMHA'S FARM PROGRAMS
---------------------------------------------------------- Letter :5.2

FmHA is statutorily prohibited from refinancing direct housing loans
using the guaranteed program.  However, another program, FmHA's farm
loans, allows farmers to refinance their direct farm loans through
FmHA's guaranteed farm loan program.  If properly implemented, this
refinancing process enhances FmHA's mission to supply temporary
credit and makes direct loan funds available for other high-risk
farmers needing financial assistance.  FmHA began to use more
guaranteed farm loans in the mid-1980s, and the Congress has
supported this changed emphasis with increased funding
authorizations.  Granting FmHA the same authority for housing loans
as is currently provided for farm loans could help the agency meet
its goals for providing temporary credit and encouraging
homeownership. 


      REDUCE FMHA'S SERVICING
      COSTS AND WORKLOAD
---------------------------------------------------------- Letter :5.3

Single-family housing loans account for 35 percent of the workload in
FmHA county offices.  Expanding the guaranteed program to refinance
eligible high-interest-rate direct loans should lower servicing costs
and reduce the workload because private banks will originate and
service loans previously serviced by local county offices. 
Refinancings will help FmHA reach its objective to graduate those
direct loan borrowers who qualify for private credit using the
guaranteed program.  Also, because FmHA's guaranteed loan program
does not insure 100 percent of the loan balance, private banks take
on a small share of the risk. 

FmHA National Office officials agree that graduating direct loan
borrowers using the guaranteed loan program would be a desirable
option and would allow many borrowers to graduate.  We interviewed 13
FmHA state Rural Housing Chiefs whose loans make up almost half of
the direct loan portfolio's outstanding principal balance.  The
Chiefs agreed that graduation using the guaranteed program is a good
alternative for those borrowers who meet the eligibility
requirements.  Some estimated that as many as 25 percent of their
outstanding loans would be eligible. 

Banking officials we spoke with agreed with FmHA.  For example,
officials of one bank that handles a large portfolio of
FmHA-guaranteed loans told us that they would be interested in
offering refinancing into the guaranteed program for all borrowers
who meet the program's criteria.  As of September 30, 1994, about
390,000 loans were still held by borrowers who were not receiving
subsidies and might be eligible to refinance using the guaranteed
program.  Many of the loans were owed by moderate-income borrowers
who either originally never received, or later did not qualify for,
any interest subsidy.  Thousands of loans representing billions of
dollars of outstanding principal could potentially qualify for
refinancing using the guaranteed program.  However, allowing direct
loan borrowers to refinance using the guaranteed program would
require a legislative change. 

We believe that thousands of direct loan borrowers could benefit from
refinancing their existing loans through the guaranteed program.  As
noted above, 92,000 FmHA borrowers, whose loans have an outstanding
principal balance of $2.2 billion, do not receive subsidies and are
paying an interest rate at or above the current guaranteed-loan
market rate of 9.5 percent.  As in any refinancing situation, the
greater the interest rate paid, the greater the incentive to
refinance.  An additional 7,200 loans held by borrowers who receive
minimal subsidies but still pay above-market rates may also qualify
and should also be considered for graduation using the guaranteed
program. 

All loans refinanced to the guaranteed program could count as
graduated loans.  Up to $2.2 billion in direct loans paid off would
go back to the Treasury as revenues, but the Treasury would also
forgo future mortgage payments.  The interest rates on the loans that
would be refinanced would likely exceed the interest rates on
government borrowing that could be reduced as a result of the
repayments.  Therefore, the present value of the forgone mortgage
payments would likely exceed the revenues from the loan payoffs. 
However, the reduced workload would free up time for county offices
to deal with more problem loans.  Additional loan authority may be
required to issue new loan guarantees. 


   CONCLUSIONS
------------------------------------------------------------ Letter :6

Allowing FmHA's direct loan borrowers to graduate using the
guaranteed program as a means of refinancing existing loans would be
a logical progression for borrowers whose financial condition has
improved but is still not sufficient to qualify them for
nonguaranteed private credit.  Refinancing through the guaranteed
program would also be an effective way to help FmHA continue to
promote its homeownership objectives and would help meet the direct
loan program's temporary credit goals.  However, FmHA is statutorily
prohibited from refinancing direct housing loans using the guaranteed
program. 

FmHA plans to change its regulations to allow interest rates to be
lowered within the direct loan single-family housing program.  Such
interest rate reductions within the direct loan program can help
homeowners better meet their monthly payments but will result in
reduced federal revenues because of lower interest payments.  Such
refinancings also may reduce the borrowers' incentives to voluntarily
graduate.  Therefore, we believe that any action by FmHA to lower
interest rates on existing loans within the direct program should be
pursued only after all other graduation options have been exhausted. 


   MATTER FOR CONGRESSIONAL
   CONSIDERATION
------------------------------------------------------------ Letter :7

The Congress should consider amending the Housing Act of 1949 to
allow FmHA's direct loan borrowers to refinance their loans using the
guaranteed program.  Additional budget authority may be required to
issue these loan guarantees. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :8

To determine the status of FmHA's loan portfolio and the mix of loans
at approximately 1,700 county offices, we analyzed files and records
as of September 30, 1994, from FmHA's Finance Office in St.  Louis,
Missouri.  To evaluate FmHA's refinancing policy, including the
merits of allowing borrowers with direct loans to refinance through
the guaranteed program, we interviewed personnel from FmHA's National
Office and Finance Office.  We also polled the FmHA Rural Housing
Chiefs in the 13 states whose combined loans make up almost 50
percent of the total portfolio, and we discussed the issues with
private banks and financial trade associations.  We could not
independently evaluate the potential universe of borrowers who could
graduate to private credit or to the guaranteed program because
FmHA's automated data base does not include key credit eligibility
factors, such as property values and borrowers' incomes.  Our review
was conducted between March and November 1994 in accordance with
generally accepted government auditing standards. 


---------------------------------------------------------- Letter :8.1

As requested, we did not obtain written agency comments on a draft of
this report, but we discussed the report's contents with senior FmHA
officials, including the Assistant Administrator for Housing.  These
officials fully agreed with our matter for congressional
consideration.  We have incorporated their comments in the report as
appropriate. 

As arranged with your offices, unless you publicly announce its
contents earlier, we will make no further distribution of this report
until 7 days after the date of this letter.  At that time, we will
send copies of this report to the Secretary of Agriculture; the
Director, Office of Management and Budget; and interested
congressional committees and Members of Congress.  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
II. 

Judy A.  England-Joseph
Director, Housing and Community
 Development Issues


STATUS OF SINGLE-FAMILY HOUSING
PROGRAM'S DIRECT LOAN PORTFOLIO
=========================================================== Appendix I

   Figure 1:  Single-Family
   Housing Direct Loan Portfolio,
   by Dollars and Interest Rates
   (Sept.  30, 1994)

   (See figure in printed
   edition.)

The Farmers Home Administration (FmHA) has a large direct loan
portfolio for single-family housing.  As of September 30, 1994, the
outstanding principal balance on single-family housing loans was
$18.6 billion.  Since the program was first authorized in the Housing
Act of 1949, as amended, FmHA has made almost 2.2 million direct
loans for single-family housing for over $48 billion.  In fiscal
years 1988 through 1993, funding obligated for new loans has remained
fairly constant at approximately $1.3 billion annually.  In fiscal
year 1994, funding was increased to $1.7 billion. 

The loans are typically made for 33 years at a fixed interest rate
based on the cost of the federal government's borrowing (8 percent on
September 30, 1994).  Loan terms may be extended up to a maximum of
38 years for applicants whose adjusted annual income does not exceed
60 percent of the area's median income and who need the extra term to
show repayment ability.  Loans may not require a down payment, and
FmHA can lend up to 100 percent of the property's market value. 

FmHA's loans are processed and serviced through the 1,700 FmHA county
offices and account for about 35 percent of those offices' workloads. 

FmHA experienced increased refinancings to private sector credit when
interest rates dropped from late 1992 to early 1994.  As shown in
figure 2, interest rates for FmHA's single-family housing direct loan
program dropped as low as 6.5 percent in 1993. 

   Figure 2:  Interest Rates for
   FmHA's Single- Family Housing
   Direct Loan Program, 1980-94

   (See figure in printed
   edition.)

But as of September 30, 1994, 248,000 loans were still outstanding at
9.5 percent or above, including 101,000 at 11.5 percent or above. 

   Figure 3:  Subsidy Status of
   Direct Single- Family Housing
   Loans

   (See figure in printed
   edition.)

About two-thirds of single-family housing direct loan borrowers
($12.2 billion principal outstanding) receive subsidies, which may
reduce the effective interest rates on their mortgages to as low as 1
percent.  Interest subsidies are available to qualified very-low- and
low-income borrowers in order to make the housing payments fall
within the borrowers' means.  The amount of subsidy is based on the
borrower's verified income, real estate taxes, and property
insurance.  Under the program's current policy, FmHA makes loans only
to borrowers who qualify for subsidy. 

The remaining third of single-family housing direct loan borrowers
($6.4 billion principal outstanding) either never received subsidies
or no longer qualify because of increased income. 

   Figure 4:  Nonsubsidized Loans
   by Dollars and Interest Rates
   (Sept.  30, 1994)

   (See figure in printed
   edition.)

The $6.4 billion principal outstanding is made up of 390,000
nonsubsidized loans to borrowers who never received or no longer
qualify for interest credit.  As of September 30, 1994

211,000 loans with principal outstanding of $4.8 billion carried
rates above 8 percent,

92,000 loans with principal outstanding of $2.2 billion carried rates
of 9.5 percent or above, and

33,000 loans with principal outstanding of $700 million carried rates
of 11.5 percent or above. 

   Figure 5:  Subsidized Loan
   Effective Rates With Interest
   Credit by Loans and Dollars
   (Sept.  30, 1994)

   (See figure in printed
   edition.)

Almost half of the subsidized borrowers receive interest subsidies
that lower their effective mortgage interest rates to as low as 1
percent.\1 Subsidy payments can be for as little as $10 per month. 
As a result, about 21,000 partially subsidized loans with principal
outstanding of about $600 million were still paying an effective
interest rate on September 30, 1994, that exceeded FmHA's 8 percent
interest rate for new loans as of that date.  About 7,200 partially
subsidized loans with principal outstanding of about $180 million
were still paying an effective interest rate of over 9.5 percent, the
FmHA-guaranteed loan rate as of November 30, 1994. 


--------------------
\1 Subsidies provided to FmHA single-family housing borrowers are
subject to repayment to the government upon disposition of the
property.  The amount of recapture is based on a formula established
by FmHA that factor the total subsidy provided and home price
appreciation. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix II


   RESOURCES, COMMUNITY, AND
   ECONOMIC DEVELOPMENT DIVISION,
   WASHINGTON, D.C. 
-------------------------------------------------------- Appendix II:1

Andrew E.  Finkel, Assignment Manager
Patrick B.  Doerning, Senior Operations Research Analyst


   KANSAS CITY REGIONAL OFFICE
-------------------------------------------------------- Appendix II:2

Arthur W.  Brouk, Evaluator-in-Charge
Christie M.  Arends, Evaluator
Robert G.  Sommer, Computer Analyst
Annetta L.  Flowers, Computer Analyst
Nelson R.  Wicker, Intern
