Home Improvement: Weaknesses in HUD's Management and Oversight of the
Title I Program (Testimony, 04/30/98, GAO/T-RCED-98-177).

GAO discussed certain aspects of the Department of Housing and Urban
Development's (HUD) management and oversight of its loan insurance
program for home improvements under Title I of the National Housing Act,
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 program lenders; and (3) whether HUD has any ongoing or
planned efforts under way to strengthen its management and oversight.

GAO noted that: (1) its preliminary analysis shows that HUD is not
collecting information needed for managing the program; (2)
specifically, GAO found that HUD collects little information when loans
are made on program borrowers, properties, and loan terms, such as the
borrower's income and the address of the property being improved; (3)
moreover, HUD does not maintain information on why it denies loan claims
or why it subsequently approves some for payment; (4) HUD also provides
limited oversight of lenders' compliance with program regulations,
conducting only 2 on-site lender reviews in fiscal year 1997 of the
approximately 3,700 program lenders; (5) 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, including the original loan applications and
certifications signed by the borrower that the property improvement work
has been completed; (6) in addition, some claims were paid by HUD even
though there were indications that lenders did not comply with required
underwriting standards when insuring the loan; (7) as a result of the
management and oversight weaknesses GAO has observed, its preliminary
work indicates that HUD does not know who the program is serving, if
lenders are complying with program regulations, and whether certain
potential program abuses are occurring, such as violations of the
$25,000 limitation on the amount of Title I loan indebtedness for each
property; (8) HUD officials attributed these weaknesses to the program's
being lender-operated, limited staff resources, and HUD's assignment of
monitoring priorities; (9) under the HUD 2020 Management Reform Plan and
related efforts, HUD is making significant changes in all of its
single-family housing programs, including the Title I property
improvement program; (10) these changes are motivated in part by HUD's
goals to downsize the agency and address long-standing agencywide
management weaknesses; and (11) GAO is assessing the extent to which
these changes may affect the management and oversight weaknesses it
identified.

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

 REPORTNUM:  T-RCED-98-177
     TITLE:  Home Improvement: Weaknesses in HUD's Management and 
             Oversight of the Title I Program
      DATE:  04/30/98
   SUBJECT:  Federal agency reorganization
             Internal controls
             Lending institutions
             Property improvement loans
             Data collection
             Federal aid for housing
             Housing programs
IDENTIFIER:  HUD 2020 Management Reform Plan
             HUD Title I Property Improvement Program
             
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Cover
================================================================ COVER


Before the Subcommittee on Housing and Community Opportunity,
Committee on Banking and Financial Services, House of Representatives

For Release
on Delivery
Expected at
2 p.m.  EDT
Thursday
April 30, 1998

HOME IMPROVEMENT - WEAKNESSES IN
HUD'S MANAGEMENT AND OVERSIGHT OF
THE TITLE I PROGRAM

Statement of Stanley J.  Czerwinski, Associate Director,
Housing and Community Development Issues,
Resources, Community, and Economic
Development Division

GAO/T-RCED-98-177

GAO/RCED-98-177T


(385736)


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

  FHA -
  HUD -

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

We are pleased to be here today to discuss the preliminary results of
our assessment of certain aspects of the Department of Housing and
Urban Development's (HUD) management and oversight of its loan
insurance program for home improvements under Title I of the National
Housing Act.  As you know, we are conducting this assessment at the
request of this Subcommittee and Congressman Kenneth E.  Bentsen,
Jr., and plan to report the results of our assessment this summer. 

Homeowners who have little equity in their home, at times obtain
Title I property improvement loans to make alterations or repairs to
their homes.  These loans are made by banks and other private lenders
from their own funds and are insured by HUD's Federal Housing
Administration (FHA).  If borrowers default on their loans, banks
submit claims to HUD, which approves or denies them. 

Concerned about how well this Title I program was being operated, you
and Congressman Bentsen 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 program lenders, and (3)
whether HUD has any ongoing or planned efforts under way to
strengthen its management and oversight.  To meet these objectives,
we reviewed, among other things, HUD's Title I program regulations
and guidelines, 16,556 claims paid by HUD between January 1994 and
August 1997 to identify if any multiple claims were submitted on the
same borrower for the same property, documents from a random sample
of 53 loan claims paid to lenders by HUD from fiscal years 1995
through July 1997,\1 and interviewed HUD officials in Washington,
D.C., and Albany, New York--the location of the programs' claims
examination unit. 

In summary, our preliminary analysis shows that HUD is not collecting
the information needed for managing the program.  Specifically, we
found that HUD collects little information when loans are made on
program borrowers, properties, and loan terms, such as the borrower's
income and the address of the property being improved.  Moreover, HUD
does not maintain information on why it denies loan claims or why it
subsequently approves some for payment. 

HUD also provides limited oversight of lenders' compliance with
program regulations, conducting only 2 on-site lender reviews in
fiscal year 1997 of the approximately 3,700 program lenders. 
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 borrower
that the property improvement work has been completed.  In addition,
some claims were paid by HUD even though there were indications that
lenders did not comply with required underwriting standards when
insuring the loan. 

As a result of the management and oversight weaknesses we have
observed, our preliminary work indicates that HUD does not know who
the program is serving, if lenders are complying with program
regulations, and whether certain potential program abuses are
occurring, such as violations of the $25,000 limitation on the amount
of Title I loan indebtedness for each property.  HUD officials
attributed these weaknesses to the program's being lender-operated,
limited staff resources, and HUD's assignment of monitoring
priorities. 

Under the HUD 2020 Management Reform Plan and related efforts, HUD is
making significant changes in all of its single-family housing
programs, including the Title I property improvement program.  Theses
changes are motivated in part by HUD's goals to downsize the agency
and address long-standing agencywide management weaknesses.  We are
assessing the extent to which these changes may affect the management
and oversight weaknesses we identified. 

Before I discuss these issues in greater detail, let me briefly
explain how FHA's Title I property improvement insurance program
operates. 


--------------------
\1 We sampled from the 5,646 program claims that were originally
denied and then paid by HUD during the 3-year period. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:1

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 to a
lender is limited to 10 percent of the value of the total program
loans held by each lender.  Today, the value of Title I's outstanding
loans is relatively small compared with other FHA 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 loans in its Mutual Mortgage Insurance Fund totaled
about $360 billion.  Similarly, Title I's share of the
owner-occupied, single-family remodeling market is small--estimated
by the National Association of Home Builders to be about 1 percent in
fiscal year 1997. 

Approximately 3,700 lenders are approved by FHA to make Title I
loans.  Lenders are responsible for managing many aspects of the
program, including 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 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.  Title I program officials
consider lenders to have sole responsibility for program operations
and HUD's role is primarily to oversee lenders and ensure that claims
paid on defaulted loans are proper. 

Homeowners obtain property improvement loans by applying directly to
Title I lenders 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.  During fiscal years
1986 through 1996, about 520,000 direct and 383,000 dealer loans were
made under the program.  By statute, the maximum size of property
improvement loans is $25,000 for single-family loans and the maximum
loan term is about 20 years.  Title I regulations require borrowers
to have an income adequate to meet the periodic payments required by
a property improvement loan.  Most borrowers have low- to moderate
incomes, little equity in their homes, and/or poor credit histories. 

HUD's expenses under the Title I program, such as 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 an August 1997 report on the Title I program,
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.\2 Data from the
Price Waterhouse report on estimated projected termination rates for
program loans made in fiscal year 1996 can be used to calculate an
estimated cumulative claim rate of about 10 percent over the life of
Title I loans insured by FHA in that fiscal year. 


--------------------
\2 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 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 NOT COLLECTED BY
   HUD
---------------------------------------------------------- Chapter 0:2

When FHA-approved Title I lenders make program loans, they collect
information on borrowers, such as age, income, and gender; the
property, such as its address; and loan terms, such as interest rate. 
While lenders are required to report much of this information to
their respective regulatory agencies by the Home Mortgage Disclosure
Act, HUD collects little of this information when Title I loans are
made.  Using information that it requires lenders to provide, HUD
records the lender's and borrower's names, state and county, as well
as the size, term, and purpose of the loan.  Other information
collected by HUD on other single-family loan insurance programs, such
as the borrower's address, Social Security number, income, and debt
are 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 collected little information when loans were
made because they consider the program to be lender-operated. 

As a result, HUD cannot identify the characteristics of borrowers and
neighborhoods served by the program, nor can it identify certain
potential abuses of the program.  For example, HUD does not collect
borrowers' Social Security numbers and property addresses when loans
are made.  Therefore, HUD would have difficulty determining if some
borrowers are obtaining multiple Title I loans or if some borrowers
are exceeding the maximum amount of Title I loans per property when
loans are made.  HUD regulations limit 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
program 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.  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 may have been for multiple properties,
or multiple loans on the same property that totaled less than
$25,000, they may not have violated program regulations.  Allowing
individual borrowers to accumulate large amounts of Title I HUD
insured debt, however, exposes HUD to large losses in the case of
financial stress on the part of such heavily indebted borrowers.  In
addition, while information available to HUD allows identification of
potential abuses of the $25,000 indebtedness limit after loans have
defaulted, control over the indebtedness limitation is not possible
for 90 percent of the program's loans made that do not default
because borrowers' Social Security numbers and property addresses are
not collected when the loans are made. 


      INFORMATION ON TYPES OF
      LOANS FOR WHICH CLAIMS
      SUBMITTED NOT ALWAYS
      ACCURATE
-------------------------------------------------------- Chapter 0:2.1

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 a claim had been denied and subsequently paid by HUD,
found that 7 loans, or 13 percent, had been miscoded as dealer loans
when they were direct loans, or direct loans when they were dealer
loans.  This is important because HUD recently cited high default
rates on dealer loans, among other reasons, for proposing regulations
to eliminate the dealer loan portion of the program.  Considering the
miscoding on identifying loans as dealer or direct, we question HUD's
ability to identify default experience by loan type. 


      INFORMATION ON WHY CLAIMS
      DENIED AND SUBSEQUENTLY
      APPROVED NOT MAINTAINED
-------------------------------------------------------- Chapter 0:2.2

In addition, HUD's information on claims denied and subsequently
approved was problematic.  Although HUD can deny claims for property
improvement loans for a number of reasons, HUD did 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 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 waiver by HUD.  Such information is important in determining how
well lenders are complying with program regulations, whether internal
controls need to be strengthened, and which lenders should be
targeted for review by HUD's Office of Quality Assurance. 

We also found that files for claims that were initially denied by HUD
and subsequently paid frequently did not contain the names of program
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 provided any basis for
eventually paying the claim.  Unless information on who makes
decisions to deny claims and the reasons for the denial and
subsequent payments are documented, HUD has no basis for reviewing
the reasonableness of those decisions. 

HUD recently made changes to its claims database system to identify
the reasons claims are denied.  Program officials agreed that such
information is important in determining how well program regulations
are being complied with and in targeting lenders for quality
assurance reviews.  Claims examiners are now required to identify
their reasons for denial, including the section of the regulation
that was violated.  However, the change does not address the problem
of missing documentation in the claims file explaining the reasons
for paying claims that were previously denied. 


   LIMITED OVERSIGHT BY HUD OF
   PROGRAM LENDERS
---------------------------------------------------------- Chapter 0:3

HUD's monitoring reviews of Title I lenders to identify compliance
problems have declined substantially in recent years.  Between fiscal
years 1995 and 1997, HUD performed 33 Title I on-site quality
assurance reviews of lenders.  Most of these reviews (26) were
performed in fiscal year 1995.  During fiscal years 1996 and 1997,
HUD performed five and two on-site lender reviews, respectively. 
According to HUD officials, prior to fiscal year 1997, 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 on other FHA insurance programs.  Because of this
limited monitoring resource, HUD decided to focus its lender
monitoring on major high volume FHA programs, according to these HUD
officials.  Monitoring priorities have also led to few follow-up
reviews by HUD.  As a result, it is difficult to determine the impact
of the quality assurance reviews that were performed on improving
lenders' compliance. 


      REQUIRED DOCUMENTS MISSING
      FROM LOAN FILES
-------------------------------------------------------- Chapter 0:3.1

When making Title I loans, lenders are required to ensure that
borrowers represent acceptable credit risks, with 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 required documents needed to
ensure program compliance were missing from more than half (30) of
the files. 

In 12 cases, the required original loan application, signed by the
borrower, was not 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 matches those on
other documents, including the credit report.  Furthermore, for 23 of
the 53 claim files, we found that required completion certificates,
certifying that the property improvement work had been completed,
were missing or were signed but not dated by the borrowers. 
According to program guidelines, claims submitted for payment after
defaults have occurred on dealer loans should not be paid unless a
signed completion certificate is in the file.  We found that
completion certificates were missing from the files for 13 dealer
loans and were not dated for another 4 dealer loans.  Lastly, for 33
loans on which program regulations required that an inspection be
conducted by the lender, 18 loan files did not contain the report. 


      LENDERS NOT ALWAYS COMPLYING
      WITH PROGRAM REGULATIONS
-------------------------------------------------------- Chapter 0:3.2

We also reviewed the 53 claim files to determine how well lenders
were complying with underwriting standards.  All documentation
supporting the underwriting determination should be retained in the
loan file, according to HUD regulations.  HUD can deny a lender's
claim if the lender has not followed HUD underwriting standards in
making the loan.  However, HUD does not examine the quality of a
lender's loan underwriting during the claims process if 12 loan
payments were made by the borrower 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 loan origination and were subject to an underwriting review
by HUD.  We focused our underwriting examination on these 13 loan
claim files. 

We found that for 4 of the 13 loans, on which HUD eventually paid
claims, lenders made questionable underwriting decisions.  Title I
program regulations require that the credit application and review by
the lender must establish that the borrower, is an acceptable credit
risk, had 2 years of stable employment, and that his/her income will
be adequate to meet the periodic payments required by the loan, as
well as the borrower's other housing expenses and recurring charges. 
However, for four of these loans, information in the files indicated
that the borrowers may not have had sufficient income to qualify for
the loan 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.  However, the pay stub also showed that for
the 2-week period in March, the borrower worked a full week with
overtime and only earned $725, or 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.  Program officials told us that it was acceptable to
use one pay stub to calculate monthly income; however, the "yearly
earnings to date" figure should not be used because it can at times
inflate 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 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 out the (mis-calculated) 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. 

Similar problems with lenders' noncompliance with Title I program
regulations have been identified by HUD.  As noted previously,
between fiscal years 1995 and 1997, HUD performed 33 Title I on-site
quality assurance reviews of lenders.  Among other things, HUD cited
lenders for engaging in poor credit underwriting practices and having
loan files with missing inspection reports or inspection reports that
were not signed or dated.  HUD sent the lenders letters detailing its
findings and requested a written response addressing the findings. 
HUD, however, did not perform follow-up, on-site reviews on 32
lenders to ensure that they had taken corrective actions.  For the 33
on-site reviews, nine lenders were referred to HUD's Mortgagee Review
Board for further action.  The Board assessed four of these lenders a
total of $23,500 in civil penalties. 


   RECENT AND PROPOSED CHANGES TO
   THE TITLE I PROGRAM
---------------------------------------------------------- Chapter 0:4

Under its HUD 2020 Management Reform Plan and related efforts, HUD
has been making changes to the Title I program operations.  HUD has
relocated its claims examination unit to the Albany (New York)
Financial Operations Center and contracted with Price Waterhouse to
develop claims examination guidelines.  According to program
officials in Albany, the new claims process will be more streamlined
and automated and include lenders filing 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 other program participants such as contractors
and loan officers, (3) issue limited denials of program participation
against program participants, and (4) refer lenders for
audits/investigations.  However, since HUD's quality assurance staff
will monitor lenders involved in all FHA single-family programs, the
impact of this change on improving HUD's oversight of Title 1 lenders
is unclear.  Overall, by the end of fiscal year 1998, the quality
assurance staff will increase to 76, up from 43 in February 1998. 
HUD expects that the addition of more quality assurance staff will
increase the number of reviews of lenders and allow more
comprehensive reviews of lender operations. 


-------------------------------------------------------- Chapter 0:4.1

In closing, Mr.  Chairman, our preliminary analysis shows weaknesses
in HUD's management of its Title I property improvement loan
insurance program and oversight of program lenders.  These weaknesses
center on the absence of information needed to manage the program and
HUD's oversight of lenders' compliance with program regulations.  HUD
officials attributed these weaknesses to the program's being
lender-operated, limited staff resources, and HUD's assignment of
monitoring priorities.  Because of these weaknesses, we are concerned
that HUD may have little assurance that the property improvement
program is operating efficiently and free of abuse.  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 this program, which is
relatively small compared with other FHA housing insurance programs. 
Our report will include any recommendations or options we have to
offer to strengthen HUD's management and oversight of the program. 

Mr.  Chairman, this concludes my statement.  We would be pleased to
respond to any questions that you or Members of the Subcommittee may
have. 


*** End of document. ***