Homeownership: Achievements of and Challenges Faced by FHA's
Single-Family Mortgage Insurance Program (Testimony, 06/02/98,
GAO/T-RCED-98-217).

GAO discussed: (1) the achievements of the Federal Housing
Administration's (FHA) home mortgage insurance program, including the
extent that home buyers use FHA insurance, the characteristics of these
home buyers--including whether they were first-time home buyers--and how
many of them might also qualify for private mortgage insurance; (2) how
the insurance terms available through FHA's principal single-family
mortgage insurance program compare with private mortgage insurance and
guaranties from the Department of Veterans' Affairs (VA); (3) other
federal activities that promote affordable homeownership; and (4)
challenges faced by FHA in ensuring the financial health of its Mutual
Mortgage Insurance Fund--the insurance fund supporting most FHA-insured
single-family mortgages.

GAO noted that: (1) FHA is a major participant in the single-family
housing market; (2) of the approximately 3.8 million home purchase loans
made in fiscal year 1996, FHA insured 16 percent; (3) while most of
these mortgages were not insured, about 39 percent were; (4) FHA insured
42 percent of all home purchase loans in 1996 and fulfilled a larger
role in some specific market segments, particularly low-income home
buyers and minorities; (5) most borrowers were able to obtain a home
purchase mortgage without insurance by either FHA, the private mortgage
insurers, or VA; (6) while a third of the loans FHA insured in 1995
might have qualified for private mortgage insurance, the other
two-thirds probably would not have qualified, on the basis of the
loan-to-value and qualifying ratios of the loans FHA insured; (7) FHA
and VA programs permit borrowers to make smaller down payments and have
higher total-debt-to-income ratios than allowed by private mortgage
insurers; (8) FHA's program differs from private mortgage insurers' and
VA's programs in that it allows closing costs to be financed in the
mortgage; (9) in addition to FHA and VA, the federal government promotes
affordable homeownership through programs run by the Department of
Housing and Urban Development, the Department of Agriculture's Rural
Housing Service, the Federal Home Loan Bank System, state housing
finance agencies, and Neighborhood Reinvestment Corporation; (10)
although these other federal programs share FHA's mission to assist
households who may be underserved by the private mortgage market, none
reach as many households as FHA; (11) several of these other programs
assist home buyers by combining their assistance with FHA mortgage
insurance; (12) the federal government promotes homeownership among
buyers who might otherwise by underserved through requirements placed
upon the Federal National Mortgage Association, Federal Home Loan
Mortgage Corporation, and certain lenders; and (13) although FHA's
single-family program is financially self-sufficient, there are
challenges facing FHA today, including reducing the losses it incurs on
foreclosed properties, maintaining financial self-sufficiency in the
face of economic and other factors that could adversely affect future
program costs, and resolving year 2000 computing risks.

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

 REPORTNUM:  T-RCED-98-217
     TITLE:  Homeownership: Achievements of and Challenges Faced by 
             FHA's Single-Family Mortgage Insurance Program
      DATE:  06/02/98
   SUBJECT:  Lending institutions
             Comparative analysis
             Mortgage protection insurance
             Loan defaults
             Systems conversions
             Mortgage programs
             Mortgage loans
             Housing programs
             Financial management systems
IDENTIFIER:  Mutual Mortgage Insurance Fund
             FHA Single-Family Mortgage Insurance Program
             FHA Section 203(b) Program
             VA Home Loan Guaranty Program
             HUD Title I Housing Loan Program
             Community Development Block Grant
             HUD Home Investment Partnership Program
             HUD Housing Opportunities for People Everywhere Program
             HUD Year 2000 Program
             FHA Year 2000 Program
             
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Cover
================================================================ COVER


Before the Subcommittee on Housing Opportunity and
Community Development, Committee on Banking,
Housing and Urban Affairs
U.S.  Senate

For Release
on Delivery
Expected at
10:30 a.m.  EDT
Tuesday
June 2, 1998

HOMEOWNERSHIP - ACHIEVEMENTS OF
AND CHALLENGES FACED BY FHA'S
SINGLE-FAMILY MORTGAGE INSURANCE
PROGRAM

Statement of Judy A.  England-Joseph, Director
Housing and Community Development Issues,
Resources, Community, and Economic
Development Division

GAO/T-RCED-98-217

GAO/RCED-98-217T


(385734)


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

  ARM -
  FHA -
  HMDA -
  HUD -
  LTV -
  MICA -
  PMI -
  VA -

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

Mr.  Chairman and Members of the Subcommittee: 

We are pleased to be here today to discuss the single-family mortgage
insurance program of the U.S.  Department of Housing and Urban
Development's (HUD) Federal Housing Administration (FHA).  FHA
insured about 740,000 mortgages representing over $61 billion in
single-family mortgage insurance during fiscal year 1997--ending the
fiscal year with a total of about $361 billion in single-family
mortgage insurance outstanding. 

Many changes have occurred in the single-family housing finance
system since FHA was established in 1934 to insure housing loans made
by private lenders.  These changes include the advent of modern
private mortgage insurance, the development of a secondary mortgage
market, and the emergence of a number of public- and private-sector
initiatives designed to expand affordable housing opportunities for
home buyers.  Given these developments, an ongoing debate has
centered on whether there is still a need for FHA's single-family
mortgage insurance program and, if so, what changes, if any, need to
be made to the program.  Critics of FHA contend that other housing
finance players, such as the private mortgage insurers, are filling
the need once filled exclusively by FHA.  Supporters of FHA argue
that its single-family program, which has insured at least 24 million
home mortgages since its inception, remains the only way for some
families to become homeowners and should be expanded. 

My statement will discuss (1) the achievements of FHA's home mortgage
insurance program, including the extent that home buyers use FHA
insurance, the characteristics of these home buyers--including
whether they were first-time home buyers--and how many of them might
also qualify for private mortgage insurance; (2) how the insurance
terms available through FHA's principal single-family mortgage
insurance program compare with private mortgage insurance and
guaranties from the U.S.  Department of Veterans' Affairs; (3) other
federal activities that promote affordable homeownership; and (4)
challenges faced by FHA in ensuring the financial health of its
Mutual Mortgage Insurance Fund--the insurance fund supporting most
FHA-insured single-family mortgages. 

My statement today is based primarily on reports we issued over the
last 2 years.  I will conclude with a brief discussion of the results
of our recent work on two other FHA programs--the multifamily and
Title I home improvement insurance programs.  Although we designated
HUD a high-risk area in 1994, my statement does not cover management
challenges faced by FHA's single-family operations, which we
addressed in three recent testimonies, including one on May 7, 1998,
before this Subcommittee.\1

In summary: 

  -- FHA is a major participant in the single-family housing market. 
     Of the approximately 3.8 million home purchase loans made in
     fiscal year 1996, FHA insured 16 percent.  While most of these
     mortgages were not insured, about 39 percent, or about 1.5
     million, were insured.  FHA insured 42 percent of all insured
     home purchase loans in 1996 and fulfilled an even larger role in
     some specific market segments, particularly low-income home
     buyers and minorities.\2 However, most borrowers were able to
     obtain a home purchase mortgage, including low-income borrowers
     and minorities, without insurance by either FHA, the private
     mortgage insurers, or the Department of Veterans' Affairs.\3
     While about a third of the loans FHA insured in 1995 might have
     qualified for private mortgage insurance, the other two-thirds
     probably would not have qualified, on the basis of the
     loan-to-value--the mortgage amount as a percentage of the value
     of the home--and qualifying ratios of the loans FHA insured. 

  -- The FHA and Department of Veterans' Affairs programs permit
     borrowers to make smaller down payments and have higher
     total-debt-to-income ratios than allowed by private mortgage
     insurers.  FHA's program differs from both the private mortgage
     insurers' and the Department of Veterans' Affairs programs in
     that it allows closing costs to be financed in the mortgage,
     insures loans only up to a maximum amount of $170,362 while
     private mortgage insurers and the Department of Veterans'
     Affairs permit insurance of larger loans, and provides nearly
     full insurance coverage to lenders. 

  -- In addition to FHA and the Department of Veterans' Affairs, the
     federal government promotes affordable homeownership through
     programs run by HUD, the U.S.  Department of Agriculture's Rural
     Housing Service, the Federal Home Loan Bank System,\4 state
     housing finance agencies, and the Neighborhood Reinvestment
     Corporation.  Although these other federal programs share FHA's
     mission to assist households who may be underserved by the
     private mortgage market, none reach as many households as FHA. 
     Several of these other programs assist home buyers by combining
     their assistance with FHA mortgage insurance.  The federal
     government also promotes homeownership among home buyers who
     might otherwise be underserved through requirements placed upon
     the Federal National Mortgage Association, Federal Home Loan
     Mortgage Corporation,\5 and certain lenders. 

  -- Although FHA's single-family program is financially
     self-sufficient, there are challenges facing FHA today,
     including reducing the losses it incurs on foreclosed
     properties, maintaining financial self-sufficiency in the face
     of economic and other factors that could adversely affect future
     program costs, and resolving year 2000 computing risks. 

Before I discuss these issues in greater detail, let me briefly
explain how FHA's single-family mortgage insurance program operates. 


--------------------
\1 HUD Management:  Information and Issues Concerning HUD's
Management Reform Efforts (GAO/T-RCED-98-185, May 7, 1998),
Homeownership:  Management Challenges Facing FHA's Single-Family
Housing Operations (GAO/T-RCED-98-121, Apr.  1, 1998), and Home
Improvement:  Weaknesses in HUD's Management and Oversight of the
Title I Program (GAO/T-RCED-98-177, Apr.  30, 1998). 

\2 "Low-income" refers to a borrower with an income no greater than
80 percent of the median income in the Metropolitan Statistical Area
where the borrower is located. 

\3 Although the Department of Veterans' Affairs actually guarantees
mortgages rather than insuring them, this testimony uses the term
"mortgage insurance" to refer to the mortgage guaranty provided by
the Department of Veterans' Affairs as well as the mortgage insurance
provided by FHA and private mortgage insurers.  The Department of
Veterans' Affairs' guaranty is available only to U.S.  veterans and
their families. 

\4 The Federal Home Loan Bank System is a federally chartered,
privately owned system of 12 banks that exist to facilitate the
extension of mortgage credit. 

\5 Government-sponsored enterprises that provide a secondary market
for many home mortgages. 


   FHA'S SINGLE-FAMILY MORTGAGE
   INSURANCE PROGRAM
---------------------------------------------------------- Chapter 0:1

About 3.8 million borrowers took out mortgages in 1996 for purchasing
homes, according to information collected through requirements
contained in the Home Mortgage Disclosure Act (HMDA).\6 While most of
these mortgages were not insured, about 39 percent, or about 1.5
million, were insured.  FHA's share of the home purchase mortgage
market was 16 percent in fiscal year 1996, the private mortgage
insurers' (PMIs) share was 17 percent, and the Department of
Veterans' Affairs (VA) share was 5 percent.  Lenders usually require
mortgage insurance when a home buyer has a down payment of less than
20 percent of the value of the home.  In these cases, the
loan-to-value (LTV) ratio of the mortgage is higher than 80 percent. 
Most lenders require mortgage insurance for these loans because they
are more likely to default than loans with lower LTV ratios.  If a
loan with mortgage insurance defaults, the lender may foreclose on
the loan and collect all or a portion of the losses from the insurer. 

Virtually all single-family mortgage insurance is provided by PMIs,
FHA, and VA.  In general, PMIs operate standard programs for typical
borrowers and special affordable programs for qualified borrowers who
have fewer down payment funds and need increased underwriting
flexibility.\7 FHA provides most of its single-family mortgage
insurance through the Section 203(b) program.  The Section 203(b)
program has not required any federal funds to operate because FHA has
collected enough revenue from insurance premiums and foreclosed
property sales to cover claims and other expenses.  FHA also operates
some smaller, specialized single-family mortgage insurance programs. 
A primary goal of FHA's single-family programs is to assist
households that may be underserved by the private market.  VA
provides insurance through its Home Loan Guaranty Program to U.S. 
veterans and their families. 

FHA, VA, and PMIs provide lenders with guidelines for deciding
whether or not a mortgage is eligible for mortgage insurance.  In
addition, the Federal National Mortgage Association (Fannie Mae) and
the Federal Home Loan Mortgage Corporation (Freddie Mac) establish
their own guidelines for the loans they will purchase in the
secondary mortgage market.  A borrower's ability to repay the
mortgage is often evaluated by computing the ratios of the borrower's
total debt burden and housing expenses to his/her income (referred to
as "qualifying ratios").  The "total-debt-to-income ratio" compares
all of the borrower's long-term debt payments, including housing
expenses, with his/her income.  The "housing-expense-to-income ratio"
compares the borrower's expected housing expenses with his/her
income. 

The HMDA database contains information on mortgages insured through
FHA's principal single-family mortgage insurance program--the Section
203(b) program--and loans insured through FHA's smaller single-family
mortgage insurance programs, but does not distinguish between them. 
Consequently, sections of this testimony on FHA's market share, the
characteristics of FHA borrowers, and the borrowers who may have
qualified for private mortgage insurance pertain to all single-family
loans insured by FHA. 


--------------------
\6 This figure is based on mortgages reported by lenders through
HMDA.  However, the number of mortgages written in 1996 is somewhat
higher because HMDA collects information on most but not every
mortgage. 

\7 Underwriting is the process of analyzing a borrower's willingness
and ability to repay a loan. 


   FHA ACHIEVEMENTS IN INSURING
   SINGLE-FAMILY MORTGAGES
---------------------------------------------------------- Chapter 0:2

FHA has been a major player in single-family home financing for over
60 years and it remains so today--particularly in certain market
segments.  Between 1986 and 1990, FHA was the largest insurer of
single-family mortgages.  The factors contributing to FHA's large
market share during these years may include an increase in FHA's
maximum loan limit in 1988 and economic downturns in some areas of
the country that decreased the availability of private mortgage
insurance.  Except for FHA's loan limit,\8 the terms, such as maximum
LTV ratio, under which FHA and VA mortgage insurance are available do
not generally vary across different geographic locations, according
to program guidelines.  However, PMI companies may change the
conditions under which they will provide new insurance in a
particular geographic area to reflect the increased risk of losses in
an area experiencing economic hardship.  By tightening up the terms
of the insurance they would provide, PMIs may have decreased their
share of the market in economically stressed regions of the country. 

However, throughout the period from 1991 through 1996, the PMIs had a
greater share of all insured single-family mortgage originations than
FHA or VA.  This change may be a result, in part, of increased
premiums for FHA insurance implemented as a result of the Omnibus
Budget Reconciliation Act of 1990 (P.L.  101-508).  By 1996, the
PMIs' share of insured home purchase mortgages was 44 percent, FHA's
was 42 percent, and VA's was 13 percent. 


--------------------
\8 FHA's loan limit may differ among geographic areas to reflect
differentials in the cost of housing.  The maximum loan amount
permitted under FHA's program for single-family homes in the
highest-cost areas of the continental United States is currently set
at $170,362.  In its fiscal year 1999 budget, HUD stated it would
seek legislation to increase the maximum mortgage amount insurable
under the FHA single-family program to $227,150 in all areas of the
country. 


      FHA IS AN IMPORTANT SOURCE
      OF MORTGAGE INSURANCE IN
      CERTAIN MARKETS
-------------------------------------------------------- Chapter 0:2.1

In our report on FHA's role,\9 we found that in 1994, FHA-insured
home purchase loans were concentrated to a greater extent on
low-income and minority borrowers, first-time home buyers, and
borrowers with higher LTV ratios than those with loans insured by
private mortgage-insurers.  In addition, solely on the basis of our
analysis of the LTV and qualifying ratios of borrowers who obtained
loans in 1995, 66 percent of FHA's borrowers might not have qualified
for private mortgage insurance for the loans they received.  However,
it is important to note that as with home buyers in general, most
low-income and minority home buyers who obtained mortgages in fiscal
year 1996 did not have insured mortgages. 

Recent HMDA, Mortgage Insurance Companies of America (MICA), and HUD
data show that FHA-insured loans continue to be concentrated to a
greater extent on borrowers with these same characteristics than
those with loans insured by private mortgage-insurers.  Specifically,
we estimate based on HMDA, MICA, and HUD data for loans in 1996
that:\10

  -- FHA insured 23 percent of the 984,495 home purchase loans made
     to low-income home buyers, and such home buyers represented
     about 39 percent of FHA-insured loans.  We also estimate that
     FHA insured more of these loans than the PMIs (14 percent) or VA
     (5 percent). 

  -- FHA insured 30 percent of all loans made to minority home
     buyers, and such home buyers represented about 31 percent of
     FHA-insured loans.  FHA insured more loans for minority
     borrowers in 1996 than the PMIs (14 percent) and substantially
     more than the VA (6 percent). 

  -- About 74 percent of FHA-insured loans in 1996 were made to
     first-time home buyers.  FHA insured a higher percentage of
     loans for first-time home buyers than its overall share of the
     insured home purchase market. 

  -- While 63 percent of FHA-insured loans made in 1996 had LTV
     ratios exceeding 95 percent, only about 7 percent of
     conventional loans below the maximum FHA loan limit had LTV
     ratios exceeding 95 percent in 1997. 


--------------------
\9 Homeownership:  FHA's Role in Helping People Obtain Home Mortgages
(GAO/RCED-96-123, Aug.  13, 1996). 

\10 HMDA data were adjusted to compare with MICA data on PMI loans. 
HMDA data include approximately 93 percent of all FHA-insured home
purchase loans.  MICA's data, however, include nearly all loans
insured by PMIs.  To determine the relative share of the market of
loans in the HMDA database held by FHA and PMIs, HMDA data were
increased by a relevant percentage.  Also, some MICA and HMDA data
were deleted because it was not valid or of poor quality. 


      FHA'S INSURANCE FUND EXCEEDS
      STATUTORY RESERVE TARGETS
-------------------------------------------------------- Chapter 0:2.2

Another major achievement of FHA's single-family mortgage insurance
program has been to restore the financial health of the Mutual
Mortgage Insurance Fund (the Fund)--the insurance fund supporting 91
percent of the dollar value of FHA-insured single-family mortgages
outstanding as of the end of fiscal year 1997.  According to Price
Waterhouse's 1998 actuarial study, the Fund had an economic
value/reserves\11 of about $11.3 billion as of September 30, 1997. 
Over time, insurance premiums and other income have more than covered
costs.  The $11.3 billion estimate represents an improvement of about
$14 billion from the lowest level reached by the Fund--a negative
$2.7 billion economic value/reserves estimated by Price Waterhouse at
the end of fiscal year 1990.  Price Waterhouse also reported that the
Fund's capital reserve ratio (economic value/reserves as a percentage
of value of outstanding loans) was 2.81 percent surpassing the
legislative target for reserves (a 2-percent capital ratio by
November 2000).\12 In addition, Price Waterhouse reported that the
Fund will meet the legislative target for fiscal year 2000.  They
estimate that by then the Fund will have a capital ratio of 3.21 and
economic value/reserves of about $15.7 billion. 


--------------------
\11 The current assets available to the Fund, plus the net present
value of all future cash inflows and outflows expected to result from
mortgages insured under the Fund. 

\12 The Omnibus Budget Reconciliation Act of 1990 (P.L.  101-508),
enacted in November 1990, required the Secretary of HUD to endeavor
to ensure a capital ratio of 2 percent by November 2000 and maintain
that ratio or a higher one at all times thereafter. 


   SINGLE-FAMILY MORTGAGE
   INSURANCE TERMS OFFERED BY FHA,
   PMIS, AND VA ARE DIFFERENT
---------------------------------------------------------- Chapter 0:3

In our 1996 report on FHA's role, we reported that the FHA, PMIs, and
VA mortgage insurance programs differed in terms of maximum LTV
ratios and mortgage amounts, the financing of closing costs, and the
amount that each will pay lenders to cover the losses associated with
foreclosed loans, according to the guidance prepared by the insurers
for lenders.  Specifically, in our 1996 report, we reported that
while both FHA and VA could insure loans with effective LTVs ratios
that exceed 100 percent (due to the financing of closing costs or
other fees), PMIs did not offer insurance for loans with LTVs ratios
greater than 97 percent.  Recently, both Fannie Mae and Freddie Mac
announced the introduction of conventional 97 percent LTV mortgage
products that offer many of the advantages of FHA's single-family
program.  Both programs--Fannie Mae's "Flexible 97 Mortgage" and
Freddie Mac's "Alt 97 Mortgage"--allow down payments as low as 3
percent that can be funded through gifts, unsecured loans from
relatives, or grants from nonprofits or local governments. 

With regard to limits on loan size, FHA today may insure loans only
up to a maximum of $170,362 in certain areas with high housing costs,
while PMIs and VA permit insurance of larger loans.  In connection
with settlement costs, FHA allows borrowers to finance most closing
costs, but PMIs and VA do not.  However, both FHA and VA allow
borrowers to finance their insurance premiums.  Finally, while FHA
protects lenders against nearly 100 percent of the loss associated
with a foreclosed mortgage, PMIs and VA limit their coverage to a
portion of the mortgage balance.  PMIs generally cover only 20 to 35
percent, and VA covers only 25 to 50 percent of the mortgage balance,
even if a loss exceeds that amount. 

With regard to underwriting standards used by FHA, PMIs, and VA, we
reported that while there was some differences in qualifying ratios,
the guidance provided by the insurers showed few other clear
differences in the underwriting standards for borrowers.  Each of the
insurers permits the lenders to consider compensating factors, such
as a large down payment, when a borrower does not meet the qualifying
ratios.  In addition, although lenders must apply established credit
standards, each of the insurers relies on the individual judgment and
interpretation of the lenders in evaluating the credit history of
borrowers.  Since the issuance of our 1996 report, automated
underwriting systems that evaluate mortgage applications have been
developed which can reduce processing time significantly.  Under a
joint effort with Freddie Mac, HUD has approved Freddie Mac's Loan
Prospector automated underwriting system to underwrite FHA loans. 


   THE FEDERAL GOVERNMENT PROMOTES
   AFFORDABLE HOMEOWNERSHIP IN
   MANY OTHER WAYS
---------------------------------------------------------- Chapter 0:4

Besides FHA's Section 203(b) and VA's single-family loan programs,
the federal government is involved in many other efforts to make
homeownership affordable.  In our 1996 report on FHA's role, we
reported that HUD at that time operated three grant programs--the
Community Development Block Grant program, the HOME Investment
Partnership program, and Housing Opportunities for People
Everywhere--that promote affordable homeownership.  The Federal Home
Loan Bank System (FHLBank System) has its Affordable Housing Program
and Community Investment Program, which provide subsidies, subsidized
advances, or other advances to member institutions to be used to fund
affordable housing projects and loans to home buyers.  The Department
of Agriculture's Rural Housing Service operates a subsidized direct
loan program for low- and very-low-income rural Americans and a
guaranteed loan program for moderate-income rural Americans.  The
state housing finance agencies, through the use of federal tax-exempt
mortgage revenue bonds, provide financing for affordable
homeownership.  The Neighborhood Reinvestment Corporation, through
its network of local development organizations and its secondary
market organization, promotes affordable homeownership primarily
through second mortgages and home buyer education.  These programs
provide assistance in the form of grants, direct loans, guaranties,
interest subsidies, and other forms.\13

We also reported that there are several important distinctions
between FHA's single-family mortgage insurance programs and these
other federal programs.  First, FHA serves more homeowners than the
other programs combined.  In 1995, about 570,000 households took out
insured loans through FHA's programs while about 500,000\14

homeowners may have been reached by the other programs.  In addition,
at least half of the other programs require federal funds, while
FHA's Section 203(b) program does not.  Furthermore, the other
programs are generally targeted at borrowers with low incomes or at
borrowers who are otherwise underserved by the private market to a
greater extent than FHA's program.  FHA's Section 203(b) program is
not restricted to low-income or otherwise underserved borrowers.  In
fact, diversifying risk by serving a wide variety of borrowers may
have actually helped the program operate without federal funds,
according to industry officials. 

Several of the other federal programs assist low- and moderate-income
home buyers by combining their assistance with FHA mortgage
insurance.  A substantial portion of the mortgages made through state
housing finance agencies and HUD's Housing Opportunities for People
Everywhere program were insured by FHA in 1994.  Similarly, private
mortgage insurance may also be combined with assistance from federal
housing programs.  For example, one private mortgage insurer that we
reviewed provided insurance for mortgages assisted through a
Neighborhood Reinvestment Corporation program. 

The federal government also promotes homeownership by requiring major
housing finance players to address housing finance needs. 
Specifically, Fannie Mae and Freddie Mac have legislatively-set goals
for affordable homeownership related to their purchase of mortgages
made to low- and moderate-income borrowers and in areas of low- and
moderate-income.  In addition, banks and thrifts are encouraged to
lend in all areas of the communities they serve, including low- and
moderate-income areas, through the Community Reinvestment Act.\15 The
federal government also promotes homeownership for the entire general
public through federal tax provisions, such as the home mortgage
interest deduction.  The Joint Committee on Taxation estimates that,
for 1995, the mortgage interest deduction alone was the second
largest tax expenditure that the government provides to individuals,
totaling an estimated $53.5 billion--exceeding the total tax
expenditures given to corporations.\16


--------------------
\13 In addition, the Federal Deposit Insurance Corporation has a
small affordable housing program and administers the former
Resolution Trust Corporation's affordable housing program. 

\14 It is difficult to estimate the total number of homeowners
assisted because individuals may benefit from more than one program. 
The number presented here is overstated by an unknown amount. 

\15 In addition, the FHLBank System operates a Community Support
Program that, among other things, requires FHLBank members to meet
standards of community investment or service in order to maintain
continued access to long-term FHLBank System advances.  Among other
information, a member is required to provide the public disclosure
portion of the member's most recent CRA evaluation and a description
of how the member assists first-time home buyers. 

\16 A "tax expenditure" is a reduction in individual and corporate
income tax liabilities that result from special tax provisions or
regulations that provide benefits to particular taxpayers. 


   CHALLENGES FACED BY FHA'S
   SINGLE-FAMILY MORTGAGE
   INSURANCE FUND
---------------------------------------------------------- Chapter 0:5

While FHA's Fund is financially healthy and has surpassed the
legislative target for reserves, there are challenges facing FHA
today, including reducing the losses it incurs on foreclosed
properties, maintaining financial self-sufficiency in the face of
economic and other factors that could adversely affect future program
costs, and resolving year 2000 computing risks.  The greater the
extent that FHA can improve the efficiency of its lending operations,
the greater its ability to maintain financial self-sufficiency in an
uncertain future and meet the needs of lower-income borrowers through
either increasing the number of borrowers served or reducing the cost
of their mortgage insurance. 


      LOSSES INCURRED BY FHA ON
      FORECLOSED SINGLE-FAMILY
      PROPERTIES ARE LARGE
-------------------------------------------------------- Chapter 0:5.1

Each year, mortgage lenders foreclose on a portion of the FHA-insured
mortgages that go into default and file insurance claims with HUD for
their losses.  Although FHA has always received enough in premiums
from borrowers and other revenues to more than cover these losses,
losses totaled about $12.8 billion in 1994 dollars, or about $24,400
for each foreclosed and subsequently sold single-family home over the
19-year period ending in 1993.  According to a Price Waterhouse
analysis, cumulative foreclosure rates as of September 30, 1997,
ranged from a low of 4 percent of the loans FHA insured in the
mid-1970s to 19 percent of the loans insured in fiscal year 1981, for
loans insured between fiscal years 1975 and 1991.  Losses sustained
by FHA on foreclosures are financed by the Fund, thereby ultimately
reducing the Fund's ability to withstand economic downturns, and
possibly resulting in higher premiums for FHA borrowers. 

The impact that foreclosures can have on the financial health of the
Fund was demonstrated during the 1980s.  Until that time, the Fund
remained relatively healthy.  However, in the 1980s losses were
substantial primarily because foreclosure rates were high in
economically stressed regions, particularly in the Rocky Mountain and
Southwest regions.  By the end of fiscal year 1990, the Fund's
economic value/reserves were estimated at about a negative $2.7
billion.  If the Fund were unable to finance program and
administrative costs, the U.S.  Treasury would have to directly cover
lenders' claims and administrative costs. 

More recently, claims paid by FHA in fiscal year 1997 were higher
than expected.  Actual claim payments for single-family insured loans
totaled $4.5 billion, much higher than the $2.4 billion projected for
fiscal year 1997 in the fiscal year 1998 budget.  Similarly, actual
property acquisitions, properties sold, and the end of fiscal year
1997 inventory level of single-family properties owned by HUD were
much higher than projected in the fiscal year 1998 budget.  Actual
property acquisitions were $4.25 billion compared with $1.9 billion
projected, properties sold were $3.8 billion compared with $2.5
billion projected, and the September 30, 1997, inventory of
properties totaled $2 billion compared with $880 million projected. 
HUD attributed these problems in part to increasing claims,
especially those from adjustable-rate-mortgages (ARMs). 
Notwithstanding these unexpected financial results, the present value
of estimated cash inflows to FHA's single-family mortgage insurance
program exceed the present value of cash outflows by $1.8 billion for
fiscal year 1997. 

With regard to FHA's ability to manage risks associated with
defaults, annual audits of FHA's financial statements have identified
weaknesses in FHA's ability to manage risks associated with troubled
single-family insured mortgages.\17 The audit report on FHA's fiscal
year 1997 financial statements\18 --the most recent
available--identified a material internal control weakness
applicable, in varying degrees, to both the single-family and
multifamily programs.  Specifically, the report stated that FHA must
place more emphasis on early warning and loss prevention for insured
mortgages by, among other things, focusing its quality assurance
enforcement actions on the accuracy of delinquency and default data
submitted to FHA.  According to the report, FHA does not have
adequate systems, processes, or resources to effectively identify and
manage risks in its insured portfolios.  Timely identification of
troubled insured mortgages is a key element of FHA's efforts to
target resources on insured high-risk mortgages.  Troubled insured
mortgages must be identified before FHA can institute loss mitigation
techniques that can reduce eventual claims.  The report notes that
although the single-family insured mortgage portfolio is large,
automated monitoring of insured mortgages using statistical and trend
analysis can be used effectively. 


--------------------
\17 The Chief Financial Officers Act of 1990 required HUD and some
other agencies to report annually to the Congress on their financial
status and any other information needed to fairly present the
agencies' financial position and results of operations.  To meet part
of this requirement, HUD's Office of Inspector General contracts with
a public accounting firm to conduct annual audits of FHA's financial
statements. 

\18 Federal Housing Administration Audit of Fiscal Year 1997
Financial Statements, prepared by KPMG Peat Marwick LLP for the
Office of Inspector General (98-FO-131-0003, Mar.  9, 1998). 


      OTHER FACTORS THAT COULD
      AFFECT THE FINANCIAL HEALTH
      OF THE FUND
-------------------------------------------------------- Chapter 0:5.2

As we have reported,\19 the Fund's ability to maintain the target
ratio will depend on many economic, program-related, and other
factors that will affect the financial health of the Fund in the
future.  These factors include (1) economic conditions, (2)
uncertainty surrounding the projections of the performance of FHA's
streamlined refinanced\20 and ARM loans, and (3) risks associated
with the demand for FHA's loans.  We also reported in May 1997,\21
that reducing FHA's insurance coverage to the level permitted for VA
home loans would likely reduce the Fund's exposure to financial
losses, thereby improving its financial health. 

Estimates of economic value/reserves of the Fund are sensitive to
future economic conditions, particularly house price appreciation
rates.  The Fund will not perform as well if the economic conditions
that prevail over the next 30 years replicate those assumed in
pessimistic economic scenarios.  Price Waterhouse's estimate of the
Fund's economic value/reserves for its pessimistic economic scenario
is about $2.4 billion, or 21 percent, less than its estimate of $11.3
billion as of September 30, 1997. 

Also, the substantial refinancing of FHA's loans and the growth in
the number of FHA ARMs insured in recent years has created a growing
class of FHA borrowers whose future behavior is more difficult to
predict than the typical FHA borrower's.  FHA's streamlined
refinanced mortgages and ARMs accounted for about 32 percent of the
dollar value of FHA's loans outstanding at the end of fiscal year
1997--streamlined refinanced mortgages accounted for about 15 percent
of the value of the outstanding loans and ARMs for about 17 percent. 
FHA has little experience with streamlined refinanced mortgages and
ARMs and the tendency for such loans to be foreclosed and/or prepaid. 

Because FHA insured properties for which mortgages were streamlined
refinanced were not required to be appraised, the initial LTV ratio
of these loans--a key predictor of the probability of foreclosure--is
unknown.\22 The impact of these loans on the financial health of the
Fund is probably positive, since they represent preexisting FHA
business whose risk has been reduced through lower interest rates and
lower monthly payments.  However, the lack of experience with these
loans increases the uncertainty associated with their expected
foreclosure rates. 

This refinancing activity also raises questions about the
credit-quality of the loans that were not refinanced despite the fall
in interest rates.  Since, under these circumstances, most borrowers
who could refinance would find it to their financial advantage to do
so, those borrowers who did not refinance may not have been able to
qualify for a new loan.  This suggests that future foreclosure rates
on these loans, which originated in previous years when interest
rates were higher, may be greater than forecasted.  As additional
years of experience with these loans are gained, their effect on the
Fund's financial status will become more certain. 

In addition, new developments in the private mortgage insurance and
secondary mortgage markets may increase the average risk of future
FHA-insured loans.  Home buyers' demand for FHA-insured loans
depends, in part, on the alternatives available to them.  Some PMIs
have begun offering mortgage insurance coverage on conventional
mortgages with a 97-percent LTV ratio, which brings their terms
closer to FHA's 97.75-percent LTV ratio on loans for properties
exceeding $50,000 in appraised value.  In addition, as discussed
previously, Fannie Mae and Freddie Mac recently announced the
introduction of conventional 97 percent LTV mortgage products that
offer many of the advantages of FHA's single-family loans. 

While potential home buyers may consider many other factors when
financing their mortgages, such as the fact that FHA will finance the
up-front premium as part of the mortgage loan,\23 this action by
PMIs, Fannie Mae, and Freddie Mac could reduce the demand for
FHA-insured mortgage loans.  In particular, by lowering the required
down payment, PMIs and others might attract some borrowers who might
have otherwise insured their mortgages with FHA.  If by selectively
offering these low down payment loans, the conventional market is
able to attract FHA's lower-risk borrowers, such as borrowers with
better-than-average credit histories or payment-to-income ratios, new
FHA loans may become more risky on average.  If this effect is
substantial, the economic value/reserves of the Fund may be adversely
affected, and it may be more difficult for the Fund to maintain a
2-percent capital ratio. 

Lastly, FHA insures private lenders against nearly all losses
resulting from foreclosures on single-family homes it insures. 
However, VA under its single-family mortgage guaranty program covers
only 25 to 50 percent of the original loan amount against losses
incurred when borrowers default on loans, leaving lenders responsible
for any remaining losses.  In our May 1997 report, we concluded that
reducing FHA's insurance coverage to the level permitted for VA home
loans would likely reduce the Fund's exposure to financial losses,
thereby improving its financial health.  As a result, the Fund's
ability to maintain financial self-sufficiency in an uncertain future
would be enhanced.  However, reducing FHA's insurance coverage does
pose trade-offs affecting lenders, borrowers, and FHA's role such as
diminishing the federal role in stabilizing markets.  Borrowers most
likely affected would be low-income, first-time, and minority home
buyers and those individuals purchasing older homes. 

To illustrate the financial impact of reducing FHA's insurance
coverage, our report pointed out that if insurance coverage on FHA's
1995 loans were reduced to VA's levels and a reduction in FHA lending
volume assumed, the economic value of the loans we estimate would be
$52 million to $79 million greater than our estimate assuming no
coverage and volume reductions.  Reducing FHA's insurance coverage
would likely improve the financial health of the Fund because the
reduction in claim payments resulting from lowered insurance coverage
would more than offset the decrease in premium income resulting from
reduced lending volume. 

The amount of savings that would be realized by reducing FHA's
insurance coverage would depend on future economic conditions, the
volume of loans made, the relationship of the number of higher-risk
and lower-risk borrowers that would leave the program, and whether
some losses may be shifted from FHA to the Government National
Mortgage Association. 


--------------------
\19 Mortgage Financing:  FHA Has Achieved Its Home Mortgage Capital
Reserve Target (GAO/RCED-96-50, Apr.  12, 1996). 

\20 FHA's streamlined refinanced mortgages are those for which an
FHA-insured mortgage loan has been repaid from the proceeds of a new
FHA-insured loan using the same property as security.  Borrowers
often refinance mortgage loans to lower their monthly principal and
interest payments when interest rates decline.  Appraisals and credit
checks are not required by FHA on these loans, and borrowers cannot
obtain cash from the transaction except for minor adjustments not
exceeding $250 at closing. 

\21 Homeownership:  Potential Effects of Reducing FHA's Insurance
Coverage for Home Mortgages (GAO/RCED-97-93, May 1, 1997). 

\22 Also, FHA's data do not indicate whether there are any existing
second mortgages on these properties. 

\23 Because FHA will finance the up-front portion of the premium, the
effective LTV ratio on FHA-insured loans can be higher than 100
percent. 


      FHA FACES YEAR 2000 RISKS
-------------------------------------------------------- Chapter 0:5.3

The financial health of FHA's Fund could also be adversely affected
by Year 2000 computing risks.  In March 1998, we testified\24 on the
nation's Year 2000 computing crisis as well as our initial assessment
of HUD's Year 2000 program.  The upcoming change of century is a
sweeping and urgent challenge for public and private-sector
organizations.\25

We reported that, among other things, HUD is behind schedule on a
number of its mission-critical systems.  While the delays on some of
these systems are of only a few days, some are experiencing delays of
2 months or more.  This is significant because HUD is reporting that
5 of its mission-critical systems have "failure dates"--the first
date that a system will fail to recognize and process dates
correctly--between August 1, 1998, and January 1, 1999. 

In this regard, we reported that HUD's system for processing claims
made by lenders on defaulted single-family-home loans is 75 days
behind schedule for renovation.  The system is now scheduled to be
implemented on November 4--only 58 days shy of January 1, 1999, the
date that HUD has determined the current system will fail.  In fiscal
year 1997, this system processed, on average, a reported $354 million
of lenders' claims each month for defaulted insured loans.  If this
system fails, these lenders will not be paid on a timely basis; the
economic repercussions could be widespread. 

To better ensure completion of work on mission-critical systems, HUD
officials have recently decided to halt routine maintenance on five
of its largest systems.  Further, according to Year 2000 project
officials, if more delays threaten key implementation deadlines for
mission-critical systems, they will stop work on nonmission-critical
systems in order to focus all resources on the most important ones. 
We concurred with HUD's plans to devote additional attention to its
mission-critical systems. 


--------------------
\24 Year 2000 Computing Crisis:  Strong Leadership Needed to Avoid
Disruption of Essential Services (GAO/T-AIMD-98-117, Mar.  24, 1998). 

\25 For the past several decades, automated information systems have
typically represented the year using two digits rather than four in
order to conserve electronic data storage space and reduce operating
costs.  In this format, however, 2000 is indistinguishable from 1900
because both are represented only as 00.  As a result, if not
modified, computer systems or applications that use dates or perform
date- or time-sensitive calculations may generate incorrect results
beyond 1999. 


   RECENT GAO WORK ON OTHER FHA
   PROGRAMS
---------------------------------------------------------- Chapter 0:6

Before closing, Mr.  Chairman, I will discuss two other FHA issues
that I understand are of interest to the Subcommittee. 

In April 1998, we reported on our review of two risk-demonstration
programs aimed at facilitating the financing of affordable
multifamily housing and HUD's administration of them.\26 The two
risk-sharing demonstration programs established by the Housing and
Community Development Act of 1992 offer incentives to financial
institutions to facilitate the financing of affordable multifamily
housing and to make that financing available in a timely manner.  One
program provides credit enhancement\27 to state and local housing
finance agencies, while the other provides reinsurance\28 to
qualified financial institutions. 

We reported that the credit enhancement program is meeting these
goals.  As of September 1997, the 32 participating state and local
housing finance agencies had reserved\29 about 84 percent of the
risk-sharing units allocated to these agencies through March 1996. 
Most of the insured loans are financing properties that serve more
low-income households than required, apparently because the credit
enhancement is being used with other subsidies, particularly
low-income housing tax credits.  While it is still too soon to
evaluate the financial performance of the insured loans, the
available financial indicators reflect sound underwriting standards. 
Participation in the credit enhancement program has enabled the
housing finance agencies to leverage their reserves and insure loans
more quickly.  According to the participating agencies, the program
would be improved if it were made permanent and the current limits on
the number of available risk-sharing units were lifted.  These
changes, they said, would enable them to market the program and
manage their resources for multifamily programs more effectively. 

Activity in the reinsurance program has been so limited that the
program remains largely untested.  Only one institution--Fannie
Mae--has participated extensively in the program, and one
lender--Banc One Capital Funding Corporation--has originated over
half of the loans that Fannie Mae has reinsured.  Banc One's activity
has demonstrated that the risk-sharing reinsurance program can expand
participation in mortgage lending, including lending for smaller
properties in rural areas--an unmet capital need, according to HUD's
studies.  However, for a variety of reasons, HUD's other risk-sharing
partners have reserved few or none of their risk-sharing units. 
Opportunities to expand participation include reallocating unused
units to Fannie Mae and allowing the use of risk-sharing reinsurance
(1) with 18-year balloon mortgages--an option that is currently
available only to Fannie Mae--and (2) with loan pools as well as
individual loans. 

Participation in the demonstration programs has enabled HUD to
facilitate the financing of affordable multifamily housing while
limiting its loss exposure through risk sharing.  Participation has
also allowed HUD to increase the efficiency and reduce the costs of
its operations through delegation, compared with FHA's traditional
multifamily programs.  HUD has retained responsibility for monitoring
its risk-sharing partners' performance, but its data system for
monitoring the progress of credit enhancement projects is unreliable. 
HUD is aware of the system's problems and plans to resolve them in
the course of overhauling all of its management information systems. 
HUD has also retained responsibility for overseeing its risk-sharing
partners' compliance with the demonstration programs' requirements;
however, our review identified one default that was not reported to
HUD headquarters for over a year.  HUD recognizes that effective
oversight is critical, particularly if one or both of the
demonstration programs are made permanent and lenders' activity
increases. 

Our report makes recommendations designed to encourage greater
activity in the reinsurance program and to improve HUD's monitoring
and oversight of the federal government's risk-sharing partners.  HUD
agreed with our recommendations and said that it was taking or
planned to take steps to implement them. 

We also testified recently on the preliminary results of our
assessment of certain aspects of HUD management and oversight of its
loan insurance program for home improvements under Title I of the
National Housing Act.\30 We reported that our preliminary analysis
shows that HUD is not collecting the information needed for managing
the program and provides limited oversight of lenders' compliance
with program regulations.  We reported 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 four on-site lender reviews in
fiscal year 1997 of the approximately 3,700 program lenders. 
Regarding the need for oversight of lenders' compliance, we reported
that loan claim files submitted by lenders to HUD following loan
defaults often do not contain required loan documents, including the
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 observed,
we reported that 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.  We plan to report on the results of our assessment this
summer. 


--------------------
\26 Housing Finance:  FHA's Risk-Sharing Programs Offer Alternatives
for Financing Affordable Multifamily Housing (GAO/RCED-98-117, Apr. 
23, 1998). 

\27 A credit enhancement, such as mortgage insurance, transfers some
of the risk of loss from the lender to the credit enhancer.  When the
federal government assumes a portion of a lender's risk under a
risk-sharing agreement, the lender may derive benefits, such as a
higher bond rating, that may be passed on to borrowers and tenants in
the form of lower costs. 

\28 Reinsurance is a form of credit enhancement that occurs after the
original financing has taken place.  Like mortgage insurance, it
increases a loan's security by committing the federal government to
pay a portion of any losses incurred through default. 

\29 Because insurance authority is provided in risk-sharing units
rather than dollars, HUD allocates a fixed number of units to a
participating financial institution, and the institution then
reserves these units for properties whose loans it decides to insure
or reinsure.  For each property, the number of risk-sharing units
reserved is equal to the number of dwelling units. 

\30 Home Improvement:  Weaknesses in HUD's Management and Oversight
of the Title I Program (GAO/T-RCED-98-177, Apr.  30, 1998). 


-------------------------------------------------------- Chapter 0:6.1

In closing, Mr.  Chairman, FHA is a prominent player in the home
mortgage loan market, particularly for low-income and minority
borrowers, first-time home buyers, and borrowers with high LTV
ratios.  The mortgage loan terms offered by FHA as well as VA still
differ in important ways from those offered by PMIs.  Solely on the
basis of the LTV and qualifying ratios of borrowers, many FHA
borrowers in 1995 may not have been able to obtain or could have been
delayed in obtaining a home mortgage without the more lenient terms
offered by FHA.  Also, FHA has been able to serve such borrowers
without the need for any federal funds. 

While FHA's Mutual Mortgage Insurance Fund, which supports nearly all
of FHA's single-family mortgages, is financially healthy and is
projected to continue to improve at least in the near term, improving
FHA's efficiency over its single-family mortgage insurance operation
would enhance the Fund's ability to maintain financial
self-sufficiency in an uncertain future and meet the needs of
lower-income borrowers through either increasing the number of
borrowers served or reducing the cost of insurance for those FHA
serves.  This is important because forecasts to determine whether FHA
will have the funds it needs to cover its losses over the 30-year
life of an FHA mortgage are uncertain.  Loan performance will depend
on a number of economic and other factors over that period, such as
uncertainty surrounding the projections of the performance of FHA's
streamlined refinanced and ARM loans. 

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. ***