United States General Accounting Office

GAO Testimony

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

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.

1

We sampled from the 5,646 program claims that were originally denied and then paid by HUD during

the 3-year period.

Page 1 GAO/T-RCED-98-177
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.

Background 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

Page 2 GAO/T-RCED-98-177
$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

Page 3 GAO/T-RCED-98-177
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.

Information Needed

to Manage the

Program Not

Collected by HUD

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

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.

Page 4 GAO/T-RCED-98-177
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

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

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

Page 5 GAO/T-RCED-98-177
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

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.

Page 6 GAO/T-RCED-98-177
Required Documents

Missing From Loan Files

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

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

Page 7 GAO/T-RCED-98-177
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.

Page 8 GAO/T-RCED-98-177
Recent and Proposed

Changes to the Title I

Program

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.

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.

(385736) Page 9 GAO/T-RCED-98-177
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