Home Inspections: Many Buyers Benefit from Inspections, but Mandating Their Use Is Questionable
Published: 2004-04-30T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In the 1990s, the Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA) dealt with a series of instances where buyers had not been notified of serious problems revealed by their appraisals. This led to several reforms, some of which allegedly may have caused some buyers to forgo home inspections, confusing that service with appraisals. Advocates of mandating home inspections claim that FHA will benefit from fewer foreclosures, and buyers will benefit by avoiding homes with costly problems. GAO was asked to assess (1) how many recent FHA homebuyers got home inspections and what were the perceived benefits, (2) whether homebuyers understand the differences between appraisals and home inspections, (3) whether inspections are associated with loan performance, and (4) the implications of mandating home inspections.
section_title: What GAO Found
paragraphs: From its survey of recent homebuyers, GAO estimates 86 percent of those using FHA-insured mortgages in 2002 got home inspections. These buyers frequently reported the inspections to be positive and beneficial, but occasionally said the inspections had drawbacks, mainly related to their cost and quality. Home inspections do not appear to be associated with loan performance; other factors, such as borrowers' credit scores, are stronger predictors of how FHA-insured loans perform. Because of this, and because mandating inspections for all homebuyers could pose serious resource challenges for FHA, the marginal benefit of requiring inspections is questionable. One of the reasons often cited for getting a home inspection was to ensure there were no serious problems with the house. Homebuyers reported that two-thirds of inspections uncovered problems with homes. As a result, they benefited by being able to renegotiate their purchases. Buyers also reported inspections were worth as much or more than they cost and increased their confidence in their decisions to buy homes. Inspections are a more in-depth review of property condition than FHA appraisals, take longer, and more often give buyers the option to back out of a purchase. GAO estimates 36 percent of FHA homebuyers understand the differences between FHA's mandatory home appraisal and its recommended home inspection. For most of the remaining buyers, GAO was not able to determine definitively the extent to which they understood the differences. Finally, FHA officials believe mandating home inspections would be difficult to enforce because the agency lacks the human capital and other resources to do so effectively. FHA also might see its pool of higher risk borrowers grow, as some buyers go elsewhere for non-FHA financing options available to lower income buyers. Benefits experienced by survey respondents might carry over to all homebuyers, but a mandatory inspection could put them at a disadvantage in highly competitive markets.

section_title: Letter
paragraphs: Every year, nearly one million people buy homes—many for the first  time—using mortgages that the Department of Housing and Urban  Development’s (HUD) Federal Housing Administration (FHA) insures.   FHA does not require prospective homeowners to protect their interests by,  for example, getting a home inspection before committing to buying a  house; however, there are requirements, such as getting an appraisal, to  protect the interests of FHA and the lenders who make the loans FHA  insures.  Appraisals do this by confirming the home’s market value so that  the lender and FHA know they are not lending or insuring more than the  home is worth.
FHA requires that appraisers conduct a limited review of a home’s physical  condition.  In the 1990s, FHA dealt with a series of problems resulting from  owners being unaware of costly problems appraisers identified in the  homes they bought with FHA-insured mortgages.  This led FHA to  emphasize the importance of getting a home inspection by requiring  borrowers to read and sign a form explaining the benefits of inspections.   Because borrowers might not get this information until they apply for  mortgages (after signing purchase contracts), and because getting an  inspection usually requires making a purchase offer contingent on it,  prospective buyers may have made their decisions about inspections  before they get this information.  FHA also began notifying buyers (just  prior to closing on their homes) of any defects documented in the  appraisers’ physical condition reviews.
Because the property condition elements of the FHA appraisal might  appear to be quite similar to a home inspection, some in the home  inspection industry expressed concern that buyers were now confusing  inspections and appraisals and, in some cases, forgoing home inspections  because they mistakenly understood them to be the same thing.  Home  inspection advocates claimed that increasing the number of buyers who get  home inspections would benefit FHA by reducing foreclosures resulting  from costly property condition problems an inspection could have helped  the buyer avoid.  Assessing the validity of the industry’s claims, however,  proved difficult because no one knew with certainty how many buyers get  home inspections and to what extent the buyers and FHA benefit from  them.
To better assess whether more, or possibly all, buyers using FHA-insured  mortgages should get home inspections, you asked us to develop some of  the information necessary to make such a judgment.  As agreed with your  offices, this report answers four questions:  (1) how many recent  homebuyers got home inspections and what do they report as the primary  benefits and drawbacks of the inspections, (2) to what extent and by what  means do recent homebuyers understand the differences between  appraisals and home inspections, (3) to what extent is getting a home  inspection associated with the performance of FHA-insured loans, and (4)  what would be the implications for FHA, homebuyers, and others if home  inspections were made mandatory for FHA-insured mortgages.
We surveyed a representative sample of recent homebuyers (those who  purchased homes in 2002 using FHA-insured financing) to determine (1)  how many got home inspections; (2) what they report as the benefits and  drawbacks of inspections; and (3) the extent to which they understand the  differences between appraisals and inspections.  The response rate for this  survey was 56 percent.  To assess the association home inspections may  have with loan performance, we reviewed a random sample of FHA loan  files from loans insured in fiscal years 1996 through 1999 to determine  whether the file indicated the homebuyer had sought a home inspection;  we then used an econometric model to analyze the association that home  inspections and other information about properties and borrowers, such as  credit scores, might have with the loans’ performance.  To determine the  implications of making home inspections mandatory, we interviewed  officials at FHA, the Department of Veterans Affairs, the Federal National  Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage  Corporation (Freddie Mac); we also consulted with industry association  officials representing home inspectors, appraisers, realtors, and lenders.
Appendixes II and III provide detailed information on the scope and  methodology for our homebuyer survey and loan performance file review.   We present the results of our homebuyer survey in appendix V.  We  conducted our review between April 2003 and April 2004 in accordance  with generally accepted government auditing standards.
subsections: section_title: Background
paragraphs: Annually, nearly 1 million people buy a home using a mortgage that HUD’s  Federal Housing Administration (FHA) insures.  Private lenders, not FHA,  make the loans to borrowers.  FHA insures the lender against losses it may  incur when a borrower defaults on his or her mortgage and the lender has  to foreclose on the home.  FHA provides this insurance through programs  supported by its Mutual Mortgage Insurance Fund (the fund).  It deposits  into the fund the mortgage insurance premiums it collects from borrowers  (when they initially get their loans and then as part of each monthly  mortgage payment), as well as proceeds from the sale of foreclosed  properties.  FHA draws on the fund to reimburse lenders for their losses on  foreclosed properties.
FHA provides this insurance so that lenders will make mortgage loans with  more lenient underwriting standards than “conventional” financing.  FHA  does this to open homeownership opportunities to households unable to  meet the requirements of the private market for mortgages and mortgage  insurance.  For example, FHA insurance allows borrowers to make low  down payments and finance closing costs as part of their loan rather than  pay cash for those expenses.  As a result, FHA plays a particularly  important role among certain groups of potential homeowners, particularly  first time buyers, minorities, and lower-income households.  In fiscal year  2002, for instance, 72 percent of FHA-insured purchase mortgages went to  first-time buyers.
FHA relies on lenders to underwrite the loans it insures.  This means  lenders accept mortgage applications, obtain borrowers’ employment  verifications and credit histories, and perform other tasks in the loan  underwriting process, including ordering an appraisal on the property the  borrower wants to purchase.  FHA appraisals estimate the fair market  value of the home to (1) protect the lender from loaning more than the  home is probably worth (for FHA’s mortgage insurance purposes) and (2)  minimize FHA’s losses when it has to sell foreclosed properties.  According  to FHA, the bulk of an appraiser’s time is spent estimating the property  value.  However, the appraiser must also spend some time performing and  documenting a limited review of the property’s condition to ensure it meets  the agency’s minimum property requirements.  For example, the appraisal  might address the condition of the roof and the operation of certain  mechanical systems, such as the furnace.
Consumers are responsible for protecting their own interests in the  homebuying process.  FHA and lenders expect buyers will gather the  information they need to make informed decisions about home purchases.
FHA encourages buyers to protect their interests by getting a home  inspection before finalizing a contract to purchase a house, but does not  require them to do so.
Homebuyers, particularly those purchasing their first homes, can face a  daunting array of steps, requirements, and new terminology as they  navigate the homebuying process—many of which they encounter before  they might apply for a FHA-insured mortgage.  For example, prior to  searching for a home, a buyer may choose to work with a lender to obtain  pre-approval for a mortgage, which would involve verifying employment  history and checking credit, similar to what lenders require during  underwriting.  During their search, buyers may begin working with a real  estate agent, looking at numerous homes for sale, and acquainting  themselves with important information they may need to make a purchase  offer, such as the need for an inspection of a particular home they may  want to buy.  After offering to purchase a specific home, a buyer may have  to consider counteroffers from the seller, get a home inspection if they  have insisted on one, and consider the results of the inspection before  finalizing the purchase contract.
In figure 1, we illustrate some of the more common steps in the  homebuying process.  As we illustrate, buyers can be well on the road to  homeownership before they encounter the FHA requirements affecting  them.
FHA requires lenders to provide a disclosure statement to all FHA-insured  mortgage applicants, which we also show in figure 1.  This statement  emphasizes it is the borrower’s responsibility to protect his or her interest,  and one way of doing that is by getting a home inspection.
As FHA’s advisory describes, a home inspection provides detailed  information about the overall condition of the home.  Inspections generally  consist of a visual examination of a home’s readily accessible systems and  components, such as the electrical system and the plumbing, and result in a  report to the buyer describing what the inspector observed.  However,  because some states regulate various aspects of home inspections and  others do not, the actual content of any given buyer’s home inspection may  vary depending on the state in which the buyer lives and the extent to  which individual inspectors may be able to do more (or less) than the state  prescribes.
FHA requires that lenders provide this advisory because it has contractual  relationships with them and can insist that they do so.  FHA does not,  however, have contractual relationships with or oversight authority over  various other parties who deal with potential buyers earlier in the  homebuying process, such as real estate agents.  Consequently, while  borrowers may have seen and read the advisory prior to applying for their  mortgage (e.g., because a realtor provided it), the point at which FHA  requires they see it is no later than the point at which they apply for their  mortgage.  Because getting a home inspection usually requires that a  purchase offer is contingent on the seller allowing the inspection, buyers  have chosen to get (or to forgo) a home inspection before FHA requires  that they read and sign a document explaining the importance of the  inspection and how it differs from the FHA appraisal.
Home inspections and the limited property condition review FHA  appraisers conduct can address or speak about the condition of many of  the same parts in the home.   Table 1 shows a side-by-side comparison of  the various components that may be part of a typical home inspection and where an FHA appraiser would perform a limited property condition  review in those same areas.
Despite their apparent overlap in addressing many of the same parts of a  house, home inspections and FHA appraisals differ substantially in terms  of their purpose and timing, the type and focus of each, the depth of  examination of the home, and the recourse available to the buyer.  Table 2  elaborates on the differences in these characteristics of inspections and  appraisals.
section_title: Buyers Frequently Use and Report Benefits from Home Inspections, with Some Noting Problems with Quality and Cost
paragraphs: A substantial majority of the homebuyers using FHA-insured financing in  2002 report getting home inspections and benefiting from them primarily  by being able to renegotiate their purchases.  Typically, buyers chose to get  home inspections to make sure there were no serious problems with the  homes they were purchasing and most say the inspection was a positive  experience.  Buyers reported that they benefited from the home  inspections because they identified problems that buyers were often able  to get sellers to address before closing.  Buyers did occasionally report  drawbacks to getting home inspections.  These included the cost of the  inspections and problems buyers believe home inspectors missed.  Figure 2  summarizes the benefits and drawbacks homebuyers reported.
subsections: section_title: Many Homebuyers Get Home Inspections, Primarily to Ensure That Houses Are in Adequate Condition
paragraphs: A large majority of homebuyers using FHA-insured financing in 2002 report  getting home inspections (see figure 3), almost always using a referral from  a real estate agent, lender, friend, or relative to find an inspector.  Our  estimates are similar to the findings from a 2001 joint home inspectors’ and  realtors’ industry association survey.  Most inspections cost buyers less  than $400.
Buyers of existing homes get home inspections substantially more often  than do those who buy newly constructed homes.  We estimate that 93  percent of buyers of existing homes get inspections, while more than  one-third fewer (58 percent) of those buying newly constructed homes do  so.  The likelihood that buyers expect they will have to budget for costly  repairs on their homes or want to make sure such repairs will not be  necessary may explain why buyers of existing homes more often get them  inspected.  Almost none of the buyers who bought newly constructed  homes cited this as a reason for getting a home inspection, but 18 percent  of those purchasing existing homes did.
Overall, whether buyers purchased new or existing homes, the most  common reason they cite for getting home inspections is to ensure nothing  serious is wrong with the homes they are purchasing—nearly 8 in 10 cite  this as one factor in their decision to get an inspection.  Even though home  inspections are optional, over 60 percent of all buyers (existing homes and  new construction) believed FHA required them.
section_title: Buyers Are Highly Satisfied with Home Inspections, Reporting Benefits in Negotiating Purchases and Learning about Home Maintenance
paragraphs: Most buyers who got home inspections said they were satisfied with the  service in a variety of ways and that they would almost always get an  inspection for any future home purchase (see table 3).
Nearly half of homebuyers say one reason they liked their inspections is  because sellers made needed repairs before the buyers moved in.  As we  show in figure 4, inspections often identified problems that the buyers  required the sellers fix.
Major(>$500 to fix)
Minor(<$500 to fix)
When the inspections identified either minor or major problems, 30 percent  of the time buyers were able to renegotiate one or more terms of their  purchases.  Most often they did so by convincing sellers to fix problems.   In addition, about one in five buyers report that they benefited from their  home inspection because it allowed them to learn about home  maintenance.  For buyers of existing homes, the inspections also provided  benefits associated with uncertainties about the condition of the home and  the operation of major systems—questions typically of greater concern  with a property likely to have seen more wear and tear than a new home.
Specifically, 11 percent said it identified for them a need to set aside money  for repairs the house would need.
section_title: A Small Minority of Buyers Report the Costs and Quality of Some Inspections Can Be Drawbacks
paragraphs: Even though most homebuyers who got inspections were generally  satisfied with them, some cited concerns with the cost and quality of the  inspections.  Of the buyers who got home inspections, 19 percent disliked  them because of the cost.  In addition, 16 percent of those getting  inspections report that in the first year of owning their homes, they  experienced problems they believe the home inspectors should have  observed.  As we show in figure 5, the areas where buyers most often  report these experiences are the plumbing, appliances, and air conditioning  and electrical systems.
While our survey results do not allow us to judge whether the conditions  buyers cited are, in fact, ones that an inspector should have observed, they  may be indications of a communications gap between the buyers and the  inspectors.  For example, two major home inspectors’ industry  associations exclude appliances from their standards of practice.  This  means inspectors who follow only these standards are not required to  observe or report on the condition of appliances.  In these instances, this  may represent buyers’ or inspectors’ failure to clearly establish in advance  what buyers should and should not expect the inspection to provide.
section_title: Over One-Third of Homebuyers Understand the Differences between Home Inspections and Appraisals
paragraphs: Where we could make a conclusive judgment, we determined that about 36  percent of all homebuyers using FHA-insured financing in 2002 understand  the differences between home inspections and appraisals.  This estimate  changes very little (rising to 42 percent) when we consider only those  buyers who got home inspections.  For the most part, it is unclear to us  whether a substantial number of buyers understand the differences  between inspections and appraisals.  Among those who did not get home  inspections this is most pronounced—we cannot conclusively judge  understanding for any of these buyers.  These results should not  necessarily be interpreted to mean that a substantial number of the buyers  were actually unclear about these differences.  The results may point as  much or more to the difficulty of judging an individual’s understanding with  an instrument such as a survey.
subsections: section_title: More Than One-Third of Homebuyers Understand the Differences between Home Inspections and Appraisals
paragraphs: About 36 percent of all homebuyers appeared to understand the differences  between appraisals and home inspections, according to our analysis of the  answers they gave to certain questions in our survey of recent buyers.   When we consider just those buyers who report they got home inspections,  this figure rises to 42 percent.
To make these judgments about the buyers responding to our survey, we  consulted with a variety of real estate industry experts to develop and build  into our homebuyer survey questions that would collectively address  unique characteristics of each of the two assessments (appraisals and  inspections).  For example, when a respondent said that he or she had  gotten a home inspection, we asked them who arranged for the inspection  (fig. 6).
Industry experts told us that in most instances, borrowers and/or real  estate agents typically arrange for the home inspection, and it is virtually  always the lender who arranges for the appraisal.  Consequently, the  answers to this question (and others) allowed us to judge whether buyers  who reported they had gotten a home inspection might actually be referring  to the appraisal.  In such a case, for a respondent who said the lender or  loan officer had arranged the inspection, we judged this answer indicative  that the respondent likely did not understand the differences.  While we  would not consider that such an answer by itself is sufficient to make such  a judgment, the sum of a respondent’s answers to multiple questions about  the unique characteristics of appraisals and inspections does allow such a  judgment.  We present in appendix II the complete set of survey questions  and decision rules we used to make these judgments about buyers.  Figure  7 presents examples of the answer choices we used to make judgments that  buyers did or did not understand the differences between appraisals and  inspections.
section_title: No Conclusive Judgment Was Possible for Most Homebuyers
paragraphs: For 60 percent of all homebuyers, we found there was insufficient  information to make a conclusive judgment about their understanding,  making it unclear to us whether or to what extent they understand the  differences between appraisals and home inspections.  For the subset of  buyers who reported they got home inspections, we could not make a  judgment about 53 percent of them.  For buyers who reported they did not  get home inspections, we could not conclusively judge understanding for  any of them.  These results may be a reflection of the difficulty of using a  survey to measure understanding or knowledge and, as a result, cannot  necessarily be interpreted to mean that most buyers are themselves unclear  about the differences between inspections and appraisals.
Because there were relatively few survey respondents whom we initially  judged clearly do not understand the differences, we cannot use these  results to estimate with a reasonable confidence interval the percentage of  all homebuyers who do not understand the differences.  Consequently, for  analysis purposes, we combined this group of respondents with those  whose understanding we are unclear about and compared just two sets of  homebuyers—those we judge to understand and all others.
Those buyers whom we judge understand the differences were more likely  to have discussed these differences with someone else during their  homebuying process.  Specifically, comparing the homebuyers who  understand to all others, 77 percent of those who understand the  differences report having such a discussion; for all other buyers, 47  percent report having this discussion.
Buyers typically learned about home inspections from several different  sources, usually doing so before applying for their mortgages (the point at  which they would get FHA’s home inspection advisory).  Most often, buyers  cited real estate agents as a source for information about home inspections  (see fig. 8).
About 57 percent indicated real estate agents, with lenders (38 percent),  friends or relatives (28 percent), and their own research (25 percent) also  figuring prominently.  Just under 19 percent reported they learned about  home inspections by reading FHA materials.  However, our survey results  do not allow us to discern differences in buyers’ understanding between  those who rely on one source of information (e.g., real estate agents)  compared to another or, for example, when they learn about inspections  early in the buying process as opposed to later.  This is because the  confidence interval for any estimate we might make from such an analysis  would be too wide to say definitively that there is some difference between  two sets of homebuyers.
Many homebuyers reported they learned about the purpose of home  inspections before they applied for their FHA-insured mortgage—the point  when FHA requires lenders give them information about the importance of  home inspections.  Specifically, nearly 40 percent of buyers reported they  learned about inspections before they began looking for a home and 43  percent said they learned during the search process.  Our survey did not  define “search process” for the buyers, so we cannot rule out that some  considered applying for a mortgage to be part of that process.  Nonetheless,  substantial numbers of buyers learn about inspections and make their  choices to get or forgo them before that time, meaning FHA cannot be sure  many buyers have the benefit of its advisory in time to factor it into their  decisions.
section_title: Home Inspections Appear to Have No Significant Association with the Performance of FHA-Insured Loans
paragraphs: The differences in loan performance between buyers who did and did not  get home inspections are not significant when we consider the full range  of factors known to predict or have some association with loan  performance.  A side-by-side comparison of foreclosure rates between  those who did and did not get inspections initially shows fewer  foreclosures among those who got inspections, but this comparison can be  misleading.  A large body of research evidence and past GAO work has  shown some factors, such as credit scores and loan-to-value ratios, are  highly predictive of loan performance.  The net effect, when we considered  home inspections and the fuller range of other factors predictive of loan  performance, is that these other factors appear to explain the apparent  differences in foreclosure rates in our sample.  While foreclosures are  costly to FHA’s insurance fund, increasing the number of buyers who get  home inspections by itself may not have a material effect on this fund.
subsections: section_title: The Net Effect of Home Inspections on Loan Performance Is Not Significant
paragraphs: A large body of research evidence from GAO and others has long shown  factors associated with borrowers, their loans, and/or the properties they  buy are highly predictive of loan performance.  For example, recent  research has shown the importance of borrowers’ credit scores in  assessing the likelihood of loans going to foreclosure, noting that those with higher scores tend to have better loan performance.  Certain features  of the loan, such as the loan-to-value ratio, interest rate (fixed or  adjustable) and term (15 or 30 years) can also help predict loan  performance.  For example, lower loan-to-value ratios are often associated  with better loan performance because the borrowers have more equity in  their properties than those with higher ratios.  Greater equity in the home  gives a borrower more incentive to sell rather than fall behind on mortgage  payments and face foreclosure.  Similarly, house price appreciation is  predictive of loan performance because it gives borrowers more equity in  their homes and greater incentives to sell rather than default.
To consider home inspections in conjunction with the factors known to be  predictive of loan performance, we reviewed a stratified random sample of  260 FHA paper loan files for evidence the borrower got a home inspection.   We also collected borrower credit scores where they were present.  This  file review was necessary because FHA does not collect home inspection  or credit score data for all the loans it insures.  We selected loans FHA  insured in fiscal years 1996 through 1999 because prior work by GAO and  others has shown the peak foreclosure period for mortgages is 3 to 8 years  after origination.  We then added the home inspection and credit score  data as well as current information on the performance of these loans (as  of June 2003) to an existing model that predicts prepayments and  foreclosures (see app. IV).
Because other factors have been shown to strongly predict loan  performance, simply comparing the foreclosure rates of borrowers who got  inspections with those who did not could be misleading.  At first glance,  borrowers who get home inspections go to foreclosure about 10 percent  less often (2.6 percent vs. 2.9 percent for those not getting inspections).   However, this comparison can be misleading in important ways.  First, at  conventional levels of significance, this difference is not statistically  significant.  That is, the difference between the two is too small to rule out  that it occurs by chance rather than because of some difference that we  might otherwise link to the home inspections.  Furthermore, when we  performed a regression analysis, we found borrowers who got inspections  have a higher foreclosure rate.  Again, however, the significance of this  difference makes relying on such an analysis misleading—the effect when  we singled out home inspections was not statistically significantly different  from no effect.
section_title: Borrower Characteristics, Loan Features, and House Price Changes Are the Significant Predictors of Loan Performance
paragraphs: Consistent with our past work and the research of others into loan  performance, we found that borrower, loan, and property characteristics  explain the differences in loan performance between borrowers who did  and did not get home inspections.  For example, borrowers who got  inspections were less likely to get adjustable rate mortgages, which could  also explain why they have a lower foreclosure rate.  Also, borrowers who  got home inspections had average credit scores 9 points higher than those  who did not get inspections.
Specifically, we estimate that the difference in mean credit scores explains  about half of the difference in foreclosure rates between those who did and  did not get home inspections.  However, in our sample, borrowers who got  inspections had higher mean loan-to-value ratios, which could increase  their foreclosure rate or counteract the benefits of higher credit scores (see  table 4).
To determine the net effect of differences in a broad range of risk  characteristics, we analyzed a fuller range of factors that may affect loan  performance.  These include measures encompassing the ages and  amounts of loans, the initial loan-to-value ratios, changes in equity over  time due to changes in house prices or interest rates, and the type of loan  (in terms of interest rate—fixed or adjustable—and term—30 or 15 years).   We created a risk measure to encompass these characteristics and then  considered borrowers’ credit scores (where they were present in the FHA  file) and the home inspection data we collected for each loan.
We used the risk measure we created, the two credit score variables, and  the home inspection data as independent variables in a regression analysis.   The dependent variable was an indicator for whether the loan went to  foreclosure in a given time period.  Doing so allows us to isolate the effect  getting a home inspection has apart from the borrower, loan, and property  characteristics in the dependent variables.  This analysis showed that the  risk measure (loan and property characteristics) and borrower  characteristics appear to explain the difference in foreclosure rates  between loans in our sample with and without home inspections (see app.  IV for the details of this analysis).  Consequently, based on our analysis,  increasing the number of buyers who get home inspections is not likely to  have a material effect on FHA’s insurance fund.
section_title: Enforcing Mandatory Home Inspections Would Pose Significant Challenges to FHA but Would Offer Varied Results for Homebuyers and Inspectors
paragraphs: The implications for FHA of mandatory home inspections mainly have to  do with the need to set national standards for inspections and the  resources FHA would need to enforce compliance with them.  FHA  believes it does not have the resources to effectively enforce a requirement  for home inspections meeting an appropriate standard.  Also, FHA expects  that more often, capable buyers might choose to pursue other lending  options rather than bear the cost of home inspections, potentially  exacerbating a trend of FHA serving increasing numbers of riskier  borrowers.  For homebuyers, such a requirement would likely bring  benefits to those who would otherwise forgo home inspections, such as  having sellers make repairs on the homes.  However, buyers might also find  the requirement negatively affects their competitiveness in certain real  estate markets or increases the costs of obtaining mortgage loans.  Lastly,  home inspectors might face added costs from meeting or demonstrating  their compliance with new FHA requirements.
subsections: section_title: FHA Believes Mandatory Home Inspections Would Require Setting National Standards
paragraphs: FHA officials believe the first step in implementing a requirement for home  inspections would be to establish national standards.  These standards  would spell out inspectors’ qualifications and list all the required  components of an FHA-sanctioned inspection.  FHA officials believe if it  requires homebuyers to get inspections, the agency has an obligation to  ensure a minimum level of quality of the service.  FHA officials say national  standards are the way to accomplish this, because they would address  variations among home inspections from state to state.
Officials from FHA, the National Association of Realtors, the Mortgage  Bankers Association, and two home inspectors’ industry associations agree  that differences exist in the quality of home inspections as well as the  qualifications of the inspectors from one location to the next.  For the most  part, they attribute these differences to the presence (or absence) of state  regulation of home inspections and, to a certain extent, some variation in  the manner in which states that regulate do so.  As we show in figure 9, 27  states currently regulate home inspections in some way, but the remaining  states and the District of Columbia do not.
We found FHA officials and others are likely correct in asserting that there  can be variations in the manner in which different states regulate home  inspections.  For example, most of the states that regulate home  inspections have standards for inspectors in areas such as experience,  continuing education, and codes of ethics.   However, the states’  requirements in these areas can vary.  For example, in states that require  continuing education, the number of hours required each year ranges from  5 to 20 hours.  In states with a home inspection experience requirement, the  number of inspections each inspector must conduct as an apprentice in  order to meet state requirements varies from 20 to 250 inspections.  Also,  states vary in terms of the extent to which they spell out the contents of  home inspections.  For example, 21 of the 27 states that regulate the home  inspection industry have or plan to develop standards of practice for the  various parts of a home that inspectors must address.  However, 6 states  have no such standards defining the content of home inspections.
Based on FHA’s stated preference for national standards, past GAO work  has suggested that FHA’s choices would likely come down to standards that  are either fixed or minimum.  These choices differ primarily in the way  they preempt existing state regulations (see figure 10).
FHA officials indicated they would likely set minimum federal standards  for home inspections rather than establish a fixed standard.  The flexibility  of minimum standards offers certain attractive features over fixed  standards.  Minimum standards would not prevent states from setting  specific regional requirements, such as wind-resistance standards in  hurricane-prone areas.  Also, inspectors prefer an approach like this  because it would allow them to distinguish their services by offering more  than what FHA might require, and, in doing so, better compete for  homebuyers’ business.
FHA officials would expect to develop the national standards for home  inspections themselves.  However, they stated that another option would  be to contract with a qualified organization to develop standards of  practice.  However, FHA would continue to have an oversight role as  contract administrator and would have to assure itself that any standards  developed under contract are sufficient for its purposes.  FHA could then  establish a requirement that inspections meet these standards or any that  are substantively equivalent to them.
section_title: FHA May Lack the Resources to Effectively Enforce a National Home Inspection Requirement
paragraphs: FHA officials said creating and maintaining an effective enforcement  system would be the most important and resource-intensive part of any  effort to mandate home inspections, but currently the agency has neither  the capacity nor resources to effectively carry out this task.  According to  FHA, past experiences with mandatory appraisals and a lack of sufficient  human capital and other resources are its main concerns with effectively  enforcing such a requirement.
FHA cites the difficulty of regulating the home appraisal industry as the  basis for its concerns about home inspections.  Recent GAO work has  demonstrated various problems FHA and its partners have experienced in  regulating appraisals.  For example, FHA officials acknowledge that they  have lacked sufficient resources to evaluate the quality of many FHA  appraisals and that its procedures for monitoring appraisals were  inadequate and inefficient.  Consequently, according to FHA, its  sanctioning of appraisers was inconsistent.  To address these problems,  FHA restructured its enforcement efforts to focus more on individual  appraisers rather than the content or quality of the appraisals themselves.   According to FHA, it did so in order to adopt a risk-based, more  manageable approach to its oversight responsibilities that allows it to  target only those appraisers whom various indicators show may have a  pattern of poor performance.  For example, FHA now tracks foreclosure  rates by appraiser—that is, it links individual loans for which it has paid  claims to the person who did the appraisal in support of the loan when it  was originated.  FHA does this in order to identify those who may be performing fraudulent, inflated appraisals, which can increase the  likelihood of foreclosure.
FHA officials told us they doubt FHA’s ability to effectively ensure the  quality of home inspections given the agency’s history of struggling to do  this with appraisals (prior to turning its focus to the appraisers).  Because it  has no experience regulating home inspections and inspectors, FHA  officials expect they would have to spend some time evaluating the quality  of home inspections before they could consider turning FHA’s focus to  individual inspectors by adopting the kind of risk-based approach it  adopted for appraisals.
FHA officials said the agency currently does not have the human capital or  other resources it needs to enforce a home inspection requirement.  For  example, FHA officials told us that they do not have enough people with  the right skills to conduct basic enforcement activities, such as quality  control reviews of home inspections or investigating complaints.  They also  indicated an effective enforcement system would require an infrastructure  for approving inspectors to perform FHA-sanctioned inspections and  tracking inspectors’ compliance with standards.  Being able to track  performance is particularly important to FHA officials because lessons  learned from the appraisal industry taught them the necessity of having in  place at the outset an effective system to monitor performance so FHA can  act quickly against poorly performing or fraudulent inspectors.
FHA might be able to reduce the resource demands of a home inspection  requirement by relying on those states that have existing regulatory efforts.   FHA officials indicated that they would likely defer to state standards in  those states that regulate the home inspection industry.  However, FHA  officials say they would need to evaluate each state’s standards and  enforcement efforts to ensure they meet any minimum standard FHA sets.   The extent to which relying on existing state regulatory structures would  help FHA is unclear.  GAO has reported that in situations where the federal  and state governments have overlapping regulatory programs, states might  curtail their efforts in response to new federal regulations.  This  phenomenon, which some term “programmatic displacement,” could make  it necessary for FHA to provide resources to these states to induce or  require them to maintain the level of effort they had been putting into  oversight of the home inspection industry.  In those states currently  without home inspection regulations, the resource implications for FHA  would almost certainly be greater.  FHA officials expect that in these states  the agency would face a choice between finding a way to conduct the  enforcement itself or, possibly, paying the states to do so.  Ultimately, the  extent of programmatic displacement and the resources FHA might need to  deal with it would depend on the nature of a federal home inspection  requirement.
FHA agrees that concerns remain about its appraisal oversight system that  could carry over to any system it develops for home inspections in which it  relies on the states to enforce its requirements.  For example, as part of its  oversight process, FHA requires appraisers to hold state licenses and relies  on the states to report disciplinary actions against appraisers to the  Appraisal Subcommittee.  GAO has reported that this kind of reliance on  the states, particularly for investigating complaints, can prove problematic.   Officials of some appraisal industry associations have also said that state  enforcement efforts can be inconsistent, particularly where enforcement  must compete with other state priorities for resources.
section_title: Homebuyers Might Seek Other Loan Options if FHA Requires a Home Inspection
paragraphs: FHA and real estate industry professionals indicated to us that adding a  home inspection requirement might make FHA-insured loans less attractive  to homebuyers.  The demand for FHA-insured loans sometimes depends, in  part, on what alternatives are available to homebuyers.  In the past, buyers  who did not meet conventional loan underwriting standards had few  financing options other than FHA-insured loans.  However, recently Fannie  Mae and Freddie Mac have started offering loan products that compete  with FHA’s.  Similarly, private mortgage insurers also are attracting  homebuyers who might have used FHA-insured financing by relaxing  underwriting standards for certain lower income borrowers, allowing more  of them to obtain conventional financing.
None of FHA’s competitors, such as the Department of Veterans Affairs,  Fannie Mae, Freddie Mac, or private mortgage insurers, require a home  inspection as a condition of (the lenders) making loans.  FHA officials,  agreeing that private mortgage insurance often costs less than FHA’s,  indicated that a home inspection requirement could drive away those  borrowers who can choose between FHA and the affordable products  offered by others.  In doing so, this requirement would, FHA argues,  exacerbate a trend GAO has identified toward increased risk level in the  FHA-insured loan pool.
section_title: More Homebuyers Might Benefit from Inspections, but More Also Might Report Drawbacks from a New Requirement
paragraphs: Mandatory home inspections would likely bring to some homebuyers the  benefits identified by survey respondents, but they would also likely affect  the buyers’ costs, their competitiveness in certain markets, or their ability  to become homeowners.  Similar to survey respondents, homebuyers might  also find that an inspection requirement has drawbacks because the  inspections provide them different assurances than they expected or  because inspectors may fail to observe some problems.  For example, 31  percent of buyers who got inspections reported they had problems with  appliances in the first year of homeownership.  Because some inspectors  adhere to standards that do not require them to report on the condition of  appliances, the buyers who reported these problems may be getting fewer  or different assurances than they expected.  Also, buyers reported  inspectors failed to observe certain conditions that buyers believe the  inspectors should have noticed.  Most often, buyers reported that such  problems had to do with plumbing.
Real estate industry professionals indicated to us that buyers who must  insist on home inspections would be at a disadvantage in highly  competitive real estate markets, particularly when other buyers can make  offers not contingent on an inspection.  The industry professionals and  FHA officials also said that a home inspection requirement could lengthen  search times for buyers who qualify only for FHA-insured financing,  restrict some to looking for homes in certain parts of the market, or delay  the homebuying process.
section_title: Home Inspectors May Do More Inspections but Face Some Additional Costs
paragraphs: Home inspectors would likely see some increase in business because  buyers who might otherwise forgo inspections would have to get them.   The amount of the increase would depend on the number of homes  purchased each year.  According to our survey, in 2002, 14 percent of  homebuyers using FHA-insured financing did not get home inspections.   Consequently, the annual increase in inspectors’ business if such a  requirement had begun in 2002 could have been more than 100,000  inspections (assuming that no buyers opted for conventional financing or  delayed their purchases).
Home inspectors might also incur additional costs from an FHA  requirement, but the extent to which this might be the case would depend  on the standards and various related requirements that FHA might set.  At a  minimum, officials of one inspectors’ association expect that their  membership would find it costly to adapt to a standardized reporting  format for home inspection reports.  FHA officials confirmed that a  standardized format would be necessary in order for it to manage the  workload associated with requiring and enforcing standards for hundreds  of thousands of home inspections each year.  To a lesser extent, inspectors  might also face new costs from the requirements FHA sets for the  inspections.  Specifically, home inspectors, particularly those in states that  regulate their industry, may already be paying for licenses, continuing  education, insurance, or membership in a professional association.  To the  extent that FHA adopts requirements more stringent than those of the  states or professional associations, inspectors would face additional costs  to comply with FHA’s standards.
section_title: Observations
paragraphs: For the most part, mandating home inspections for buyers using  FHA-insured mortgages would have little added value for FHA or the  buyers.  The most compelling case for making home inspections mandatory  would be a substantial, material effect on FHA’s insurance fund, but  demonstrating such an effect has proven illusory.  While most buyers  already get inspections and say they reap a number of benefits from them,  those benefits apparently have little to do with nor do they extend to FHA’s  insurance fund.  The resources necessary to enforce the requirement could  easily more than offset the small marginal benefits of such a requirement,  while causing unintended consequences, such as placing a burden on  homebuyers in some housing markets.
FHA’s reliance on lenders to provide buyers with information about the  importance of home inspections is understandable.  FHA has authority to  hold lenders accountable for doing so but has no such influence over most  others involved in the homebuying process.  However, buyers often turn to  sources other than lenders to learn about home inspections, and many do  so before they apply for their FHA-insured mortgages.  Consequently,  relying solely on lenders means FHA cannot be sure that all buyers have the  benefit of its advice to get home inspections at the point when buyers  typically would choose to get them.  Nonetheless, the response rate to our  survey precludes us from concluding that FHA's advisory has an effect on  the frequency of home inspections or that providing the FHA advisory  sooner would have a measurable effect on buyers’ choices about  inspections.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided HUD with a draft of this report for review and comment.  In a  letter from the Assistant Secretary for Housing (see app. I), HUD agreed  with our findings and observations.  HUD also suggested several technical  clarifications, which we have incorporated as appropriate.
section_title: Scope and Methodology
paragraphs: To determine how many homebuyers got home inspections, what they  report as benefits and drawbacks of the inspections, and the extent to  which they understand the differences between appraisals and inspections,  we surveyed a representative sample of buyers who purchased homes in  2002.  To assess the association home inspections may have with loan  performance, we reviewed a representative sample of FHA loan files from  loans insured in fiscal years 1996 through 1999 to determine whether the  homebuyer had sought a home inspection.  We used this information,  combined with data on loan performance and borrower characteristics,  such as credit scores, to determine the association home inspections may  have with loan performance.  In appendixes II and III we present in greater  detail the methodologies we used for developing, administering, and  analyzing the results of the homebuyer survey and the loan performance  file review.
To determine the implications of making home inspections mandatory, we  interviewed officials at FHA, the Department of Veterans Affairs, Fannie  Mae, and Freddie Mac.  We also interviewed industry association officials  representing home inspectors, appraisers, real estate agents, and lenders.   We reviewed reports that GAO, the HUD Inspector General, and others  have issued addressing various aspects of FHA’s oversight of the appraisal  industry to identify implications that experience might suggest for a home  inspection requirement.  We also drew on work GAO has done in recent  years on intergovernmental relations issues to identify and discuss with  FHA and others the implications of a federal home inspection requirement  in relation to the states’ inspection regulations.  To determine which states  regulate home inspections as of the end of calendar year 2003, we verified  the results of an industry association’s analysis by visiting each state’s web  site to confirm the presence or absence of state regulations, as well as  confirm the details of the regulations the states have in place.  We  corroborated with a home inspectors association the information on the  number of states that regulate inspections.
We conducted our review between April 2003 and April 2004 in accordance  with generally accepted government auditing standards.
As arranged with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 30 days after the  date of this letter.  At that time, we will send copies to the appropriate  congressional committees and to the Secretary of Housing and Urban  Development; it will also be available at no charge on GAO’s Web site at  http://www.gao.gov.
If you or your staff have any questions about this report, please call me at  (202) 512-8678.  Key contributors to this report are listed in appendix VI.
section_title: Comments from the U.S. Department of Housing and Urban Development
section_title: Scope and Methodology for GAO Survey of Recent Homebuyers
subsections: section_title: Overview
paragraphs: GAO conducted a general population survey of homeowners who closed on  their home purchases in calendar year 2002 to determine:  (1) how many  recent homebuyers got home inspections, (2) what recent buyers report as  the primary benefits and drawbacks of the inspections, (3) the extent that  recent homebuyers understand the differences between appraisals and  inspections, and (4) by what means buyers develop their understanding of  these differences.  We present the survey itself in appendix V.
section_title: Scope and Methodology
paragraphs: The population for the homebuyer survey consisted of buyers who bought  their homes in 2002 using a mortgage FHA endorsed for insurance that  same year.  We chose 2002, as opposed to earlier or later years, for two  reasons: (1) buyers would likely still remember key aspects of their  homebuying experience, such as the home inspection and (2) buyers would  have experienced full heating and cooling seasons and be able to report on  the condition of their homes and the major systems during their first year  of homeownership.
The survey addressed the number of buyers who reported getting  inspections and allowed them to indicate what they believe were the  benefits and drawbacks of inspections.  The survey also asked respondents  about key aspects of inspections and appraisals so that we could use  responses to individual questions or combinations of questions to  determine whether the answers reflect an accurate understanding of the  two processes.  Examples of the key aspects of home inspections and  appraisals include how and when the buyer paid for the inspection, when  the inspection and appraisal took place, whether the buyer was present for  the inspection, and who arranged for the inspection.
section_title: Survey Development
paragraphs: To develop areas of inquiry for the survey, we reviewed previous GAO work  related to appraisals, FHA materials, and literature from industry  associations related to issues about the homebuying process.  We used  these sources and our own analysis to develop an initial set of questions.   We further developed and refined the questions by holding discussion  sessions with GAO employees who had recently bought homes using FHA- insured financing.
In an effort to include the most relevant questions in a clear and concise  manner, we consulted with a variety of real estate industry professional  associations to discuss and improve the clarity of the questions.  We also  relied on these groups to confirm and/or identify for us the characteristics  unique to inspections or appraisals around which we framed questions to  allow us to make judgments about homebuyers’ understanding of the  differences between home inspections and appraisals.  These groups  included the American Society of Home Inspectors, the National  Association of Home Inspectors, the National Association of Realtors, the  National Association of Hispanic Real Estate Professionals, the Appraisal  Institute, and the American Society of Appraisers.
In addition to an internal expert technical review by GAO’s Survey  Coordination Group, we pretested the survey with individuals who used  FHA-insured financing in 2002 to verify the clarity and suitability of the  questions and determine how long it would take respondents to complete  the survey.  We identified pretest subjects through members of the National  Association of Realtors as well as personal contacts with real estate agents;  we also telephoned some individuals whose names we obtained from FHA’s  information systems.
FHA’s data indicated that 19 percent of homebuyers identified themselves  as Hispanic.  For this reason, we translated the survey into Spanish to  improve our response rate by making it easier for those who might prefer  to answer our questions in Spanish.  We also pretested the survey with  native Spanish speakers who used FHA-insured financing in 2002.  For  buyers in our sample who had indicated to FHA that they are Hispanic, as  well as buyers with clearly Hispanic surnames, we sent both English and  Spanish language surveys, instructing them to use the version with which  they were most comfortable.
section_title: Sampling
paragraphs: We conducted the survey between October 2003 and February 2004 using a  self-administered mail-out questionnaire to a random sample of 261  homebuyers.  We drew the names of these buyers from a FHA database of  all new 203(b) loans insured in calendar year 2002.  We stratified this  sample by region (using four geographic areas of the United States) and by  whether or not the state in which the buyer lives regulated home  inspections as of the time we drew our sample.  We did this in order to  control for variations in respondents’ answers that may have been related  to location or state regulation.  A sample size of 261 allows for estimates  within plus or minus 5 percent about the population of all buyers using  FHA-insured loans (at the 95 percent level of confidence).  We performed  basic tests to ensure the reliability and usefulness of the data FHA provided  us.  These included computer analyses to identify inconsistencies and other  errors in the data set from which we drew our sample of homebuyers.
The combination of regulatory status and geographic region created a  stratified random sample with eight strata in total.  We drew a stratified  random sample using the licensure regulatory status/regional scheme.  For  purposes of inclusion in the population frame, only loans for purchases  made in the fifty states and the District of Columbia were included.  We  excluded loans for purchases of condominiums and loans for mortgage  refinancing.
We mailed the survey on October 14, 2003, and, to maximize the response  rate, sent three subsequent follow-up mailings of the survey in November,  December, and January.  After the second mailing, we also telephoned  many of the nonrespondents to encourage them to complete the survey.   Follow-up mailings and telephone calls went only to those who had not  responded.  We ended data collection on February 2, 2004.
We received 150 of the 261 surveys mailed out.  We deemed 9 of these to be  outside of the scope of our survey and did not include them in any analysis  because the respondents indicated that they either did not buy their homes  in 2002 or they did not use FHA-insured financing.  Disregarding these 9  surveys, our overall response rate was  56 percent.  Table 5 shows the final  disposition of the sample (the 261 surveys initially mailed) by strata.
The estimates we make in this report are the result of weighting the survey  responses to account for effective sampling rates in each stratum.  These  weights reflect both the initial sampling rate and the response rate for each  stratum.  As with many surveys, our estimation method assumes that  nonrespondents would have answered like the respondents.
section_title: Sampling Error
paragraphs: For the estimates we present in this report, due to some survey  nonresponse, we are 95 percent confident that the results we would have  obtained had we studied the entire population are within +/- 10 or fewer  percentage points of our estimates (unless otherwise noted).  Because we  surveyed a sample of recent homebuyers, our results are estimates of  homebuyer characteristics and thus are subject to sampling errors.  Our  confidence in the precision of the results from this sample is expressed in  95 percent confidence intervals, which are expected to include the actual  results for 95 percent of the samples of this type.  We calculated confidence  intervals for our results using methods appropriate for a stratified  probability sample.
section_title: Nonsampling Error and Data Quality
paragraphs: We conducted in-depth pretesting of the questionnaire to minimize  measurement error.  However, the practical difficulties in conducting  surveys of this type may introduce other types of errors, commonly known  as nonsampling errors.  For example, measurement errors can be  introduced if (1) respondents have difficulty interpreting a particular  question, (2) respondents have access to different amounts of information  in answering a question, or (3) those entering raw survey data make  keypunching errors.  We took extensive steps to minimize such errors in  developing the questionnaire, collecting the data, and editing and analyzing  the information.  For example, we edited all surveys for consistency before  sending them for keypunching.  All questionnaire responses were double  key-entered into our database (that is, the entries were 100 percent  verified), and a random sample of the questionnaires was further verified  for completeness and accuracy.  In addition, we performed computer  analyses to identify inconsistencies and other indicators of errors.
section_title: GAO’s Decision Rules for Using the Homebuyer Survey to Measure Respondents’ Understanding of the Differences between Inspections and Appraisals
paragraphs: To make judgments about buyers’ understanding of the differences  between appraisals and inspections, we built into our survey questions  focusing on characteristics that are closely associated with either  inspections or appraisals.  We consulted with industry experts and FHA  officials to identify these characteristics, which included the timing,  financing (method of payment), referral source (how buyers found  inspectors or appraisers), and outcome of each assessment.  For example,  home inspections typically occur much closer to the time sellers accept  purchase offers than do appraisals (survey question 28); also, the costs of  appraisals are commonly rolled into the closing costs for mortgages,  whereas this is rarely the case for home inspections (survey question 39).   (See app. IV for the homebuyer survey and the individual questions to  which this appendix refers).
Members of the audit team then reviewed the survey questions to make  independent judgments about which answer choices to various survey  questions were most or somewhat indicative of whether or not buyers do  or do not understand the differences between inspections and appraisals.   The team then developed a consensus on the answer choices we would use  to make judgments about buyers.  In doing so, we arrayed these answer  choices according to whether or not the buyer first reported having gotten  a home inspection and then divided these groups into those who likely do  (or do not) understand the differences.
We applied the decision rules we illustrate in figure 11 to make our  judgments about buyers’ understanding, first considering the answer  choices that indicate that the buyer understands the differences between  appraisals and home inspections.  Where no determination about the  buyer’s understanding was possible, we then considered the answer  choices that indicated that the buyer did not understand.  For any  remaining respondents about whom we could not make a determination,  we concluded there was insufficient information to make a judgment about  their understanding because they had given too few answers indicative of a  level of understanding and/or gave too many inconsistent answers.
section_title: Scope and Methodology for GAO Loan Performance Analysis: FHA-Insured Loans, Fiscal Years 1996-1999
subsections: section_title: Overview
paragraphs: For an earlier report, we built econometric models to capture the  probabilities that a borrower might default on a loan (and result in a claim  on FHA's Mutual Mortgage Insurance Fund) or prepay the loan (e.g., by  refinancing).  For this analysis, we assessed whether there is evidence that  factors not captured in our previous model—credit scores and home  inspection contingencies—may exert independent effects on the credit risk  of FHA-insured single-family mortgages.  In this appendix, we describe how  we conducted that assessment.
Our basic approach was to (1) use the results of the econometric models  built for our previous report to produce a measure of the overall credit risk  on a particular loan; (2) add two additional types of variables, reflecting the  borrower's credit score and the presence of a home inspection contingency  in the loan file; and (3) estimate a new regression to predict claim (or  prepayment) as a function of our risk estimate from the previous model  combined with the newly added variables.
section_title: Scope and Methodology
paragraphs: To determine the extent to which getting a home inspection might affect  the performance of FHA-insured loans, we reviewed a random sample of  loan files for FHA-insured mortgages originated in fiscal years 1996 through  1999 to (1) determine whether the buyer(s) got a home inspection and what  credit score(s), if any, the lender considered in underwriting the loan and  (2) assess the reliability of selected key data elements whose original  source(s) are the documents in the loan file and which FHA provided us  from its electronic databases.  The first step (home inspection and credit  scores) required original data collection; the second required verification  of data FHA collected.
We selected loans that FHA insured in these years because prior work by  GAO and others has shown the peak foreclosure period for mortgages to be  3 to 8 years after origination.  We focused on those in FHA’s 203(b)  program (single-family, one-to-four-unit dwelling) and excluded  condominiums and mortgage refinancings because (1) for condominiums,  many of the major areas and systems that home inspections cover are  typically the responsibility of a homeowner’s association, not the property  owner and (2) refinancings are not purchases and thus would not present  the owner an option to obtain an inspection as a condition of the purchase.
We drew a random sample of 300 loans from the fiscal years 1996-1999  period consisting of two strata:  loans with no claim and loans with a claim  (i.e., the loans had gone to foreclosure).  Because relatively few mortgages  end in foreclosure, we over-sampled that strata (relative to its proportion in  the loan database) in order to have enough observations in each strata to  determine whether there is a statistically significant relationship between  getting a home inspection and loan performance.  FHA provided us  information on the status of these loans as of June 2003.
We reviewed 260 paper loan files for these loans to record whether a home  inspection occurred by examining the purchase contracts for evidence of  home inspection contingencies.  Generally, if the contract contained a  contingency requiring the seller to allow the buyer to have a professional  home inspection, we concluded that this buyer got a home inspection.  We  also collected from these files information on borrowers’ credit scores in  order to perform a secondary analysis on whether there is a relationship  between credit scores and loan performance.  We verified 100 percent of  the data we collected from these files by having a second person compare the record we created during initial data collection to the original paper  loan files.
section_title: Results of GAO’s FHA-Insured Loan Performance Analysis, Fiscal Years 1996-1999
paragraphs: We had to modify the calculation of variables we used in the prior report  before applying the results to the current model.  For example, the 2001  model used annual observations by fiscal year.  Because the data in the  present analysis was current as of June 30, 2003, which was not the end of a  fiscal year, we modified the calculations to produce quarterly data and used  the results of the model to predict quarterly, instead of annual, termination  probabilities.  Instead of using an estimate of borrower’s equity at the end  of the previous fiscal year, we used an estimate of equity from the four  quarters prior to the current quarter.  The logistic regressions estimated the  conditional probability of a loan being foreclosed in each quarter.
We combined the variables and coefficients from our 2001 report into a  combined risk measurement variable, which we defined as the sum of the  independent variables multiplied by their respective coefficients.  This  variable was used as a key independent variable for the logistic regression  that predicted the probability of a loan resulting in a claim during a given  quarter.  Two independent variables related to the credit score were also  used as explanatory variables in the claim regression.  First, we created a  0-1 dummy variable from our review of the paper files, reflecting whether  or not a home inspection contingency was found in the paper file review.   Second, we created variables for the median credit score for the borrower,  which was set to zero if the borrower did not have at least one score in the  paper files.  We also created a dummy variable reflecting whether the file  contained at least one credit score.  Other researchers have found credit  scores to be predictive of credit risk.  Borrowers with no score may be at  higher risk than borrowers with an average score because these may be  borrowers with very little experience with credit.  However, in this analysis  a borrower may have no credit score either because a score could not be  calculated or simply because a score was not included in the paper file.
In general, our results are consistent with the economic reasoning that  underlies our models.  Most important, the probability of foreclosure  increases as our combined risk measurement increases, and the coefficient  on this variable is very close to 0.25, which is what we would expect from  applying an annual risk variable to quarterly claim probabilities.   Additionally, the coefficient on the credit score variable implies that a 10  point increase in credit scores results in about a 5 percent (10 times  -0.00469) reduction in foreclosure probability, similar to but somewhat  lower than the 9 percent reduction for a 10 point increase effect found in  Cotterman’s research on FHA mortgages.  Additionally, a borrower who  has no credit score has about the same probability of foreclosure as does a  borrower with a credit score somewhat less than the typical credit score in  the paper files   As we show in table 6, these effects are statistically  significant.
The coefficient on the home inspection contingency variable indicates an  impact that is the opposite of our expectation.  The positive coefficient of  0.0795 implies that borrowers with inspection contingencies actually have  higher credit risk, after controlling for other risk characteristics.  This is the  only variable in the regression that is not statistically significant at  conventional levels.  The standard error on this variable indicates that the  effect of a home inspection could be to  reduce foreclosure probabilities by  as much as 28 percent or raise foreclosure probabilities by as much as 44  percent.
subsections: section_title: GAO’s Econometric Model for Forecasting the Performance of FHA-Insured Mortgages
paragraphs: The econometric models in our previous report used observations on loan  years—that is, information on the characteristics and status of an insured  loan during each year of its life—to estimate conditional foreclosure and  prepayment probabilities.  These probabilities were estimated using  observed patterns of prepayments and foreclosures in a large set of FHA- insured loans.  More specifically, our models used logistic equations to  estimate the logarithm of the odds ratio, from which the probability of a  loan’s payment (or a loan’s prepayment) in a given year could be calculated.   These equations were expressed as a function of interest and  unemployment rates, the borrower’s equity (computed using a home’s sales  price and current and contract interest rates as well as a loan’s duration),  the loan-to-value (LTV) ratio, the loan’s size, the geographic location of the  home, and the number of years that the loan had been active.  The results  of the logistic regressions were used to estimate the probabilities of a loan  being foreclosed or prepaid in each year.  Details concerning the estimation  of these regressions are contained in appendix II of our 2001 report, as are  tables of coefficients for the independent variables.
section_title: Reliability of Data GAO’s Model Uses to Estimate Foreclosures and Prepayments
paragraphs: To ensure that data contained in FHA’s information systems were reliable,  we compared seven elements of the paper loan file to the electronic file to  determine if they matched.  These data elements included the address of  the property, the closing date, loan amount, appraised market value, sales  price, interest rate, and whether the loan’s interest rate was fixed or  variable.  We selected these elements because of their importance in  ensuring that our model (to predict loan performance) is using accurate  data.  Specifically, we assessed a random sample of 30 files for data  reliability and found no significant or material errors; we also reviewed  several years’ worth of FHA financial statements audits and found no  known or suspected problems with the relevant FHA information systems.   From these steps, we concluded these data are sufficiently reliable for our  analyses in this review.
section_title: GAO Survey of Recent Home Buyers
paragraphs: Directions for Completing this Questionnaire  10 minutes: This survey should not take longer than 10 minutes to complete.
Your answers are important: They’re what we’ll use to figure out ways to improve the  home buying process for people like yourself.  Your “lessons learned” will benefit future buyers, but for  that to happen, we need everyone who gets this survey to fill it out and return it.
Go to question 1: That’s it—please begin!  There is some important information below— mainly where to send this and whom to call if you have a question—so you may want to refer back to  this when you’re done.
Thank you!
Or, you may fax a copy of your completed survey to 202-512- survey—it helps us take your name off our mailing  2502 or 202-512-2514. list so we know you’ve helped us (and so we don’t  send reminders thinking we’ve not heard from you).
95% confidence interval exceeds +10% of estimate;  95% confidence interval exceeds +30% of estimate.
subsections: section_title: 1. Did you buy your home (go to settlement) in
paragraphs: 6.  Approximately how many homes did you  2002? look at before deciding on this one?
section_title: 100% Yes
paragraphs: 7.  Besides the one you bought, did you make a  2.  Did you use FHA financing? written offer on any others?
section_title: 100% Yes
paragraphs: 33%  Yes 68%  No (Skip to question #12)
0%  Unsure/Don’t recall  8.  How many?
If you answered “No” to  question #1 or question #2,  please do not continue.  Place  the survey in the return  envelope and mail it back to us  9.  Which of the following reasons were factors  so we’ll know this survey does  not apply to you. in why you didn’t buy that house(s)?  (Mark all that apply )
Question #3.
Could not sell the home I owned at the  3.  Is the address where we mailed this survey  the address of the home you bought in 2002?   99%  Yes   1%  No (Skip to question #5)
My contract was not accepted   Had a home inspection done on the  Other (specify):  _______________  4.  Do you still live at this address?
section_title: 1% No
paragraphs: of the house(s) that you did not buy?
5.  What month in 2002 did you go to closing?
No (Skip to question #12) 11. Did you try to negotiate with the seller  further before choosing not to purchase that  house(s)?
Page 2  17. Why did you choose to use FHA financing? (Mark all that apply )
12. Have you (or your co-borrower) ever  64%  Low down payment  purchased a home before?
section_title: 28% Yes
paragraphs: 19%  I could use gift funds for the down  13. What kind of home did you end up  38%  Better interest rate  purchasing in 2002?
4%  Builder offered incentives tied to FHA    5%  Recommended by builder/developer  29%  Recommended by real estate agent  59%  Recommended by lender/loan officer  90%  Single Family detached house  (the bank or mortgage company)
4%  Duplex or Multiplex  20%  It was the only type of loan I qualified for    2%  Other, please specify:  ___________  14. Was your home newly constructed (you were  the first to live there) or an existing home?
18. When you applied to your lender for a  mortgage loan to buy your house, did that  lender provide information on home  inspections or home appraisals?  (Mark all  that apply )
15. Approximately what year was your home  built?
57%  Information on home inspections  52%  Information on appraisals  11%  No information on either  27%  Unsure/Don’t recall  19. At any time in the process of buying your  home did anyone give to you and require you  16. When did you decide to use FHA financing? to read and sign a document about home  inspections?
14%  I only considered FHA financing  48%  When I pre-qualified for my loan    8%  Before I began looking for a home  53%  Yes 10%  No  (Skip to question #22) 37%  Unsure/Don’t recall  (Skip to question  15%  During the search process  #22)
6%  After I signed the sales contract    6%  Other, please specify:  __________  20. Who?
3%  (MULTIPLE ANSWERS)
Lender/Loan Officer (the bank or  mortgage company)  36%Real Estate Agent    4%  Builder/Developer    3%  Other, please specify:  __________  18%  (MULTIPLE RESPONSES)
Page 3  21. When did you receive this document?
24. How did you learn about the purpose of a  home inspection?   (Mark all that apply )
38%  Informed by lender/loan officer (the  bank or mortgage company)
22. Often, purchase offers or sales contracts    2%  Informed by seller  require that certain conditions or    3%  Other, please specify:  __________  “contingencies” must be met before the  purchase of the home is final.  Which of the  following types of contingencies, if any, were  25. Did you get a home inspection? included in your sales contract?  (Mark all  that apply )
86%  Yes 14%  No (Skip to question #47) 26. Why did you choose to get a home  inspection?  (Mark all that apply ) 79%  Make sure nothing serious was wrong    6%  Selling another property    9%  Other, please specify:  ___________    4%  Previously had a good experience with a    5%  The appraisal made me want an  28%  Someone recommended it  23. When, if applicable, did you learn about the  61%  FHA required me to get an inspection in  purpose of a home inspection? order to get the loan  40%  Before I began looking for my current  16%  Make sure I knew to budget for costly  repairs the house will need  43%  During the search process for my current    4%  Other, please specify:  __________   9%  After I closed on my current home  27. Who arranged for the inspection?
8%  I do not know the purpose of a home   25%  Myself (or co-borrower)
Page 4  28. From the time the seller or builder accepted  31. Did you observe the inspector checking any  your offer to buy the house, how long was it  of the following components? before you had the home inspection done?  21%  Within 3 days  27%  4 to 6 days  32%  7 to 13 days  a)  Main water shut- 29. How did you find the inspector you hired?  49%  A referral from the real estate agent  24%  A referral from the lender/loan officer  (the bank or mortgage company)    3%  A referral from a friend/relative    2%  Telephone book or Internet    2%  Contacted a professional home inspector  g)  Structure of home  h)  Interior (e.g, walls,    1%  I performed the inspection myself  stairways)
1%  A friend/relative performed the  i)  Exterior (e.g.,  deck, siding)
11%  Other (specify):  _______________  30. Were you present for the home inspection?  54%  Yes 45%  No  (Skip to question #32)   1%  Unsure/Don’t recall  (Skip to question  32. Did the inspector provide you with any of the  following materials? #32)
38. Who paid for the home inspection?  73%  Myself (or co-borrower)
33. Did the home inspection identify any  problems with the home?
5%  My lender/loan officer (the bank or  67%  Yes 33%  No  (Skip to question #35) mortgage company)    7%  Unsure/Don’t recall    2%  (MULTIPLE RESPONSES)
34. Were the problems major or minor?
39. How did you pay for the home inspection?
section_title: 29%65% 6% Unsure
paragraphs: Major (total cost $500 or more)
Minor (less than $500)
66%  Cash/Check or credit card at or near the    4%  Paid at closing separately  20%  Paid at closing as part of closing costs  35. Did you renegotiate the sale as a result of the  10%  Other, please specify:  ____________  home inspection?  30%  Yes 70%  No  (Skip to question #37)
40. Was your experience with a home inspection  generally positive or generally negative?
36. What happened?  (Mark all that apply )
Seller agreed to fix problems the  Seller added a home warranty  Seller added a warranty on certain items  41. When you consider the price, would you say  (such as an appliance) increased or decreased your confidence in  this purchase?
Page 6  43. What things about getting a home inspection  45. In the future, if you ever buy another home,  did you like?  (Mark all that apply ) how likely will you be to get a home    3%  Got a better deal on the house  inspection?
48%  Seller made repairs before I moved in  74%  Gave me peace of mind that the house    4%  As likely as unlikely  10%  Knew to set aside money for repairs the  21%  Learned about home maintenance and  46. How likely is it that you would choose the    4%  I liked nothing about it  same home inspector if you bought another    3%  Other, please specify:  ____________  home in this geographic area?
44. What things about getting a home inspection  did you NOT like?  (Mark all that apply )
23%  As likely as unlikely  15%  Inspector failed to identify problems he  or she should have found    6%  Hard to find a good inspector  10%  No problems with the house—did not  need to spend the money  54%  There was not anything that I disliked     3%  Other, please specify:  ______________  Living in the Home You Own  47. In the first 12 months after you first moved in, what problems, if any, have you had with the following  items?   (Mark one box in each row ) ($0) (< $100) ($100 to $500) ($500 or more)
section_title: Electrical
paragraphs: Page 7  48. Were any of the problems listed in  question #47 problems that you  think the home inspector should  51.  Was an appraisal done on your  have observed but did not? home?
16%  Yes  61%  No  (Skip to Question #51) 10%  Unsure  (Skip to Question  #51) 12%  I did not get a home inspection  52. Were you present for the   (Skip to Question #50) appraisal? with you the differences between a  50. ANSWER THIS QUESTION  ONLY IF YOU DID NOT GET A  appraisal?
HOME INSPECTION.  Why did  you NOT get a home inspection? (Mark all that apply )
There was not enough time  58%  Yes 32%  No (Skip to Question #55) 11%  Unsure (Skip to Question #55)
Bought new home with warranty  54. Who?  (Mark all that apply )
Didn’t think there was any risk  38%  Lender/loan officer (the bank  or mortgage company)
I already lost out on a home  to any of the items discussed in this  because seller refused to allow  questionnaire, please write them  here.
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Acknowledgments
paragraphs: In addition to those named above, Carl S. Barden, Stefanie A. Bzdusek,  Robin Eddington, Benjamin A. Federlein, Catherine M. Hurley, Austin J.  Kelly, Bill MacBlane, Marc W. Molino, David M. Pittman, and Terry L.  Richardson made key contributions to this report.
We also acknowledge the GAO staff who provided invaluable assistance  translating our homebuyer survey into Spanish:  Suzanne Dove, Daniel  Garcia-Diaz, Jose Martinez-Fabre, Roberto Piñero, Jonathan Rose, Josie  Sigl, and Tomas Ramirez, Jr.
section_title: GAO’s Mission
paragraphs: The General Accounting Office, the audit, evaluation and investigative arm of  Congress, exists to support Congress in meeting its constitutional responsibilities  and to help improve the performance and accountability of the federal government  for the American people. GAO examines the use of public funds; evaluates federal  programs and policies; and provides analyses, recommendations, and other  assistance to help Congress make informed oversight, policy, and funding  decisions. GAO’s commitment to good government is reflected in its core values of  accountability, integrity, and reliability.
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