Homeownership: Mixed Results and High Costs Raise Concerns About HUD's Mortgage Assignment Program
Published: 1995-10-18T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Pursuant to a congressional request, GAO reviewed whether the Housing and Urban Development's (HUD) mortgage assignment program: (1) helps borrowers avoid foreclosure; (2) reduces the Federal Housing Administration's (FHA) foreclosure losses; and (3) can be improved to reduce such losses.
section_title: What GAO Found
paragraphs: GAO found that: (1) HUD mortgage assignment program helps borrowers avoid immediate foreclosure, but is not successful in helping borrowers avoid foreclosure or retain their homes on a long-term basis; (2) about 52 percent of the 68,700 borrowers in the mortgage program will lose their homes through foreclosure, and the remaining borrowers will pay off their loans after the sale or refinancing of their homes; (3) the mortgage assignment program has not reduced FHA foreclosure losses, since FHA incurs additional costs under the program which more than offset the costs from saving some loans from foreclosure; (4) FHA will incur losses of more than $1.5 billion for those borrowers accepted into the mortgage program since fiscal year 1989; (5) although FHA borrowers' premiums pay for these additional losses, it is more difficult for the single-family insurance program to remain self-sufficient; (6) options that would reduce additional program losses include reducing the 3-year relief period provided to borrowers, setting a time limit on eliminating delinquencies, and accepting borrowers that can pay half or more of their mortgage payment; and (7) FHA would have to require borrowers to begin full mortgage payments within a few months after entering the program to eliminate additional program losses.

section_title: Letter
paragraphs: During the 19-year period ending September 30, 1993, the Department of Housing and Urban Development’s (HUD) Federal Housing Administration (FHA) incurred losses totaling about $12.8 billion in 1994 dollars following foreclosure and the subsequent sale of about 525,000 defaulted single-family housing loans that FHA had insured. However, these losses were offset by insurance premiums paid to FHA by borrowers, not by the U.S. Treasury.
As an alternative to allowing lenders to foreclose on FHA borrowers in default, HUD operates a mortgage assignment program. By taking assignment of mortgages (purchasing mortgages) rather than having lenders foreclose on them, HUD can at times avoid foreclosure losses for FHA, help borrowers retain their homes, and provide borrowers with an opportunity to avoid foreclosure. For borrowers accepted into the program, FHA pays the mortgage debt, takes assignment of the mortgage from the lender, and develops a new repayment plan for the borrower under which monthly mortgage payments can be reduced or suspended for up to 36 months. HUD, acting as mortgagee, collects mortgage payments from the borrowers while allowing them to live in their homes. The number of FHA borrowers participating in this program has tripled in the last 6 years, totaling about 71,500 at the end of fiscal year 1994; their unpaid principal balances total about $3.7 billion. About 1 in 4 defaulted single-family FHA loans are assigned rather than immediately foreclosed.
Concerned about the rising number of loans assigned to HUD and their financial impact, you asked us to determine whether the mortgage assignment program (1) helps borrowers avoid foreclosure, (2) reduces FHA’s foreclosure losses, and (3) can be improved to reduce such losses.
subsections: section_title: Background
paragraphs: The mortgage assignment program was created in 1959 by section 230 of the National Housing Act. However, HUD only began operating the program in 1976 in settlement of a lawsuit. The program, intended to help mortgagors who have defaulted on HUD-insured loans to avoid foreclosure and retain their homes, provides mortgagors with financial relief by reducing or suspending their mortgage payments for up to 36 months until they can resume making regular payments. To enter the program, a mortgagor must apply and meet certain criteria, including that the default must have been caused by circumstances beyond the mortgagor’s control, such as the loss of employment or serious illness. However, after the 36-month period, a mortgagor’s delinquencies are not required to be eliminated or reduced by a specified time other than over the remaining term of the loan, which HUD can extend for up to 10 years.
Most of the mortgages assigned under the program are insured by FHA under its Mutual Mortgage Insurance Fund (Fund). For these mortgages, the cost of the assignment program is financed by the Fund, which insures private lenders against losses on mortgages that finance purchases of one to four housing units. To cover losses, FHA deposits borrowers’ insurance premiums in the Fund. Historically, the Fund has been financially self-sufficient. However, if it were to become exhausted, the U.S. Treasury would have to directly cover lenders’ claims and administrative costs.
We based our analysis of whether the assignment program helps borrowers avoid foreclosure and reduces FHA’s foreclosure losses primarily on data from two of HUD’s national information systems—the Single-Family Mortgage Notes Servicing System and the Single Family Insurance System—as of September 30, 1994. We used these data to analyze foreclosures and delinquencies and forecast the foreclosure rates of the 68,695 mortgages assigned since fiscal year 1989. We also built a cash flow model and prepared analysis to estimate the financial loss to FHA’s Fund from these loans by estimating the revenue and expense flows for these loans over their life. Our data reflect nationwide mortgage assignment statistics on single-family loans that were entered in HUD’s two national data systems as the Fund’s mortgage defaults that were assigned to avoid foreclosure—71,500 mortgage loans as of September 30, 1994. Loans assigned to HUD for other reasons were not included in our analyses. To determine how to improve the program and reduce its losses, we obtained information from four other mortgage assistance institutions that provide foreclosure relief to borrowers in default on single-family housing loans—the Department of Veterans Affairs (VA), Rural Housing and Community Development Service (RHCDS), Federal National Mortgage Association (Fannie Mae), and Federal Home Loan Mortgage Corporation (Freddie Mac). (See app. I for additional details on the scope and methodology of our work.)
To improve the administration of the program, HUD recently has initiated changes to the program. These include selling its currently assigned loans; implementing Activity Tracking, an automated collection computer subsystem; studying the costs and benefits of alternatives to foreclosure; permitting lenders to provide relief to borrowers, such as suspending or reducing mortgage payments, without prior approval from HUD; implementing a “compromise offer” program under which borrowers’ loans are considered to be paid off for less than the amount owed; and implementing for a limited period of time a program for reducing interest rates on certain program loans. HUD has also proposed contracting for loan servicing.
The Office of Management and Budget (OMB) considers FHA’s mortgage assignment program to be a high-risk area because controls do not protect the financial interests and resources of the government. In the President’s fiscal year 1996 budget, OMB stated that the servicing of assigned loans was expensive, inefficient, and labor-intensive. Also, OMB noted that there is little evidence that the program achieves its goal of giving homeowners a chance to keep their homes during a temporary interruption of income. According to OMB, legislative changes should be considered to reduce or eliminate the assignment of loans in the future by greater reliance on the private sector as well as legislation to reduce the program’s forbearance period from 3 years to 1 year. To reduce the number of assigned loans and the required servicing of loans, OMB recommended that HUD continue to sell its assigned loans.
section_title: Mixed Results in Avoiding Foreclosures Permanently
paragraphs: We forecast, on the basis of historical data on the disposition of program loans, that about 35,400 (52 percent) of the 68,695 borrowers accepted into the program since fiscal year 1989 will eventually lose their homes through foreclosure. For the remaining loans (48 percent), we forecast that borrowers will pay off the loans and avoid foreclosure by either selling their homes or refinancing their mortgages, often after remaining in the program for a lengthy period of time. Some of these borrowers who eventually pay off their loans may have, under the compromise program, paid HUD an amount less than the total amount owed. (A detailed discussion of our methodology for forecasting the program’s foreclosure rates appears in app. II.)
Figure 1 shows our estimates of conditional foreclosure rates based on loans that remained active until a given year and were assigned during a 17-year period (fiscal years 1977 through 1994). We estimate that conditional foreclosure rates will increase sharply over the first 7 years after a loan is accepted into the program, peaking at about 13 percent. The program’s conditional foreclosure rates substantially exceed those experienced on FHA’s nonassigned single-family loans during the same 17-year period.
HUD’s records show that since fiscal year 1977, at least 96,500 borrowers have been accepted into the assignment program. About 71,500 of these borrowers were still assigned to HUD as of September 30, 1994. A large portion of them—39,603, or 55 percent—have been in the program fewer than 3 years (see fig. 2).
As shown in figure 3, of the approximately 71,500 borrowers in the program as of September 30, 1994, 59 percent were current with forbearance agreements or current with their original mortgage payments. The remaining 41 percent were delinquent or pending foreclosure. Only 5 percent of the program’s borrowers were making full mortgage payments.
When borrowers remained in the program beyond the 3-year relief period and therefore were required to make full mortgage payments, the proportion of borrowers current with repayment agreements dropped and the proportion of borrowers in foreclosure increased. Similarly, the average amount of delinquencies owed by borrowers increased. (See app. III for detailed information on borrowers’ compliance with repayment agreements.)
Most of the 25,041 borrowers who left the program for whom records are available did so following foreclosure, while other borrowers paid off their loans and at times eliminated delinquencies. Of the 25,041 borrowers, HUD foreclosed on 14,707 borrowers (59 percent), while 10,334 borrowers (41 percent) paid off their loans. An example of a borrower who left the program through foreclosure is a Chicago mortgagor who was accepted into the program in November 1990 and was $9,495 behind in payments at that time. The loan’s outstanding principal balance at that time was $34,862. Although HUD determined that the mortgagor’s income was sufficient for him to make more than full mortgage payments, the mortgagor made only five payments over the next 3-1/2 years. By September 1994, when HUD began foreclosure, the borrower was over $25,000 behind in payments.
Borrowers who paid their loans generally did so following the sale of their homes at a price that, in most cases, allowed them to repay the outstanding mortgage and the delinquent amount. For example, a Seattle, Washington, mortgagor defaulted on an $89,890 loan 15 months after obtaining it. The mortgagor found a new job after experiencing a salary cut on his previous job. When the mortgage was assigned in November 1990, the mortgagor was already $6,333 behind in payments. Initially, the mortgagor was allowed to make reduced payments of $400 per month, about half the full payment. After 2 years, the mortgagor was unable to pay off the delinquent amount, which had grown to $19,229 when he sold the house in April 1993. However, the sale proceeds enabled the mortgagor to fully satisfy his obligation to HUD. (See app. IV for cases in which some borrowers paid off mortgages and others did not.)
subsections: section_title: Program’s Operating Procedures Contribute to High Foreclosure Rates
paragraphs: Given the lower income of FHA borrowers, which can make them financially vulnerable, the assignment program’s operating procedures do not provide assurance that delinquent amounts will be repaid and that borrowers will succeed in avoiding foreclosure. These procedures include (1) accepting borrowers into the program after they have accumulated substantial loan delinquencies and therefore have an uncertain repayment ability and (2) a 36-month relief period when payments can be reduced or suspended, which permits outstanding delinquencies to grow even if borrowers are current with repayment agreements. Most FHA home loans are for moderate-income individuals. These individuals are likely to be more financially vulnerable than other mortgagors who are able to obtain home loans without FHA’s assistance.
Under the assignment program, a borrower must miss at least three mortgage payments before submitting an application to enter the program. During the acceptance process, additional payments may be missed, and substantial delinquencies may accumulate over a period of 6 months or more. We randomly selected, as case studies, 136 loans from four loan categories—paid-off, current with payments, foreclosed on, and delinquent—from files at four HUD field offices—Boston, Chicago, Ft. Worth, and Spokane—to illustrate, among other things, the amount of delinquencies that borrowers had accumulated when they entered the program. Our review of these loans showed that borrowers were, on average, 8 months behind in mortgage payments of $4,014 on their loans at the time they were accepted into the program. These loans had an average outstanding principal balance of $39,886 at that time. These figures, and others reported later that are based on these case studies, are not projectable to the universe of assigned loans.
The program also allows 3 years of reduced or suspended mortgage payments. For borrowers who qualify for this program feature, delinquencies for unpaid interest and other expenses continue to grow. As shown in figure 4, as of the end of fiscal year 1994, all borrowers in the program for more than 1 year but fewer than 3 years experienced, on average, an increase in delinquent amounts from about $7,000 to $15,000. On average, after 9 years in the program, delinquencies for all borrowers continued to grow, peaking at about $22,000. Similarly, delinquencies for borrowers current with forbearance agreements also grew at about the same rate as those of all borrowers during the first 3 years but began to decline after the borrowers had been in the program for 3 years.
Once the 36-month relief period is completed, borrowers are expected to resume full mortgage payments and, if possible, increase payments to reduce accumulated delinquent amounts. If borrowers cannot make full payments, HUD may initiate foreclosure action. There is no requirement, however, that borrowers pay off their delinquent amounts or leave the program in a specified time period, other than over the remaining term of the loan, which HUD can extend for up to 10 years. About 31,900 (45 percent) of the borrowers in the program as of September 30, 1994, had been in the program for more than 3 years. About 1,000 borrowers had been in the program for over 15 years.
section_title: Assignment Program Increases FHA’s Losses
paragraphs: In assessing the cost to FHA of operating the program, we (1) forecasted the foreclosure and payoff rates for loans assigned since fiscal year 1989 and (2) estimated the expenditure and revenue flows for these loans over their expected life. Using historical data on the performance of individual loans in the assignment program, we developed estimates of loan-servicing costs, acquisition costs, and other costs for all surviving loans over their anticipated life. In addition, we estimated revenues received from loan payoffs, mortgage payments, and the sale of properties after foreclosure. In order to estimate the program’s net loss to FHA, we compared the resulting cost per assigned loan to the average loss that FHA would have experienced on these loans had they gone directly to foreclosure rather than to the assignment program.
Our analysis showed that losses on the 68,695 loans assigned to HUD since fiscal year 1989 will be an estimated average of about $49,000 each. We subtracted from the estimated average loss of $49,000 the estimated $27,000 loss that FHA would have experienced had the loans not entered the assignment program, leaving an estimated net loss to FHA of about $22,000 per assigned loan.
On the basis of this analysis, we estimate that FHA’s Fund will experience additional losses of about $1.5 billion over what it would have incurred if the loans entering the assignment program since fiscal year 1989 had immediately gone to foreclosure instead. Table 1 summarizes our estimates of the expenses and income associated with the program’s 68,695 loans over their life. The additional costs incurred by FHA are primarily attributable to the partial payments it received on mortgage loans; delays in receiving funds from the sale of the assignment program’s properties that are eventually foreclosed; administrative costs; and advances made by HUD for taxes, insurance, and other expenses.
FHA borrowers’ premiums pay for these losses, not the U.S. Treasury. To cover losses, FHA deposits borrowers’ insurance premiums in the Fund. According to 12 U.S.C. 1711, the Fund must meet or endeavor to meet statutory capital ratio requirements designed to achieve actuarial soundness; that is, it must contain sufficient reserves and funding to cover estimated future losses resulting from the payment of claims on defaulted mortgages and administrative costs.
To offset substantial losses to the Fund that were incurred in the 1980s, FHA borrowers were required to pay higher insurance premiums beginning in July 1991. In our recent report and testimony on the actuarial soundness of the Fund, we reported that the economic value of FHA’s Fund clearly has improved significantly in recent years but that the Fund as of the end of fiscal year 1993 had not yet accumulated sufficient capital reserves to cover losses during periods of adverse economic conditions as defined by the law.
section_title: Options Available to Reduce the Program’s Losses
paragraphs: Options are available to the Congress to change the assignment program that would reduce the losses incurred by the program. These options include directing HUD to shorten the 36-month relief period, set a time limit on eliminating delinquencies, and accept into the program only those borrowers who can afford half or more of their mortgage payments.
Information provided by officials from four mortgage lending or purchasing institutions indicates that these institutions provide borowers in default a shorter time period to begin full mortgage payments under the original loan or a modified loan and to repay delinquent amounts. They also use techniques different from HUD’s that could improve the effectiveness and reduce the cost of the program.
VA usually capitalizes the delinquency and reamortizes the new loan balance (i.e. extends the time period for payment of the loan principal) as soon as it acquires the loan. In addition, VA will reduce the interest rate on the reamortized loan to as low as 3 percent below the current market rate if a reduction is necessary to bring the veteran’s payments to an affordable level. VA may also acquire loans for borrowers who are not able to resume payments immediately if they show the ability to be able to do so in a reasonable period of time. VA field stations have significant discretion in deciding what constitutes a reasonable period; however, it is usually not extended beyond the point at which the loans reach a full year’s delinquency. During this period, VA may provide relief by agreeing to accept payments of less than a full installment or by extending complete forbearance. Fannie Mae and Freddie Mac provide relief for up to 18 months. They may extend this period longer under certain circumstances, but during the relief period, the borrower must eliminate the delinquency. Although RHCDS does not have a specified relief period, an RHCDS official told us that its county supervisors provide short-term relief on a case-by-case basis.
Another option for reducing the program’s losses would require borrowers to pay half or more in monthly mortgage payments. We estimate that if all 68,695 borrowers who have entered the program since fiscal year 1989 had paid and continue to pay 50 percent of their original mortgage payments, the program would lose about $433 million more than what would have occurred if the loans had gone immediately to foreclosure, or substantially less than our estimated loss of $1.5 billion. The mortgage payments being made by borrowers as of September 30, 1994, averaged about a third of the original mortgage payments. These borrowers would have to pay 67 percent of their original mortgage payments for the program to break even.
In addition to a shorter period of relief, other mortgage assistance institutions stress resolving the delinquency by the end of the relief period. In contrast, the mortgage assignment program gives borrowers many years beyond the relief period to repay a delinquency, as evidenced by some borrowers who have been in the program for 15 years. If the borrower is unable to pay the delinquency within the 3-year relief period, HUD’s regulations require that the borrower must repay the delinquency on or before the mortgage maturity date, but the borrower may be given up to 10 years beyond the maturity date.
Freddie Mac, Fannie Mae, and VA also work closely with borrowers to provide long-term solutions, such as modifying the structure of a loan to resolve delinquencies. Officials from these organizations told us that they believe techniques such as refinancing and reducing interest rates to reduce monthly mortgage payments are successful alternatives to costly foreclosure. However, HUD seldom uses its authority to modify borrowers’ mortgage loans. Rather, HUD uses repayment agreements both before and after the 36-month relief period to secure repayment of outstanding delinquencies. These are generally 1-year term agreements based on the borrowers’ estimated income and expenses to repay a debt. HUD field office officials told us that the preparation and monitoring of these agreements requires extensive staff resources.
According to HUD’s Director, Single-Family Servicing Division, the primary strategy HUD plans to follow to reduce the program’s losses is to sell its assigned loans and thereby reduce the number of loans it holds and services. In June 1994, HUD sold at auction about 15,000 performing and nonperforming (loans in compliance with repayment agreements and those not in compliance) single-family loans that were not in default when assigned, including 357 loans that were facing foreclosure. FHA received about $12.6 million from the sale of the 357 loans, which represents about 70 percent of the unpaid principal balance on these loans. FHA officials consider these results encouraging and believe that future sales will provide significant relief to field offices that have a large number of assigned loans. FHA plans to sell an additional 15,000 loans in calendar year 1995 and most of the remaining assigned loans over the next 2 years. By fiscal year 1997, HUD expects its inventory to consist only of newly accepted assigned loans that would be held by HUD for a short time before being sold. The purchasers of these loans would be required to comply with HUD’s assignment program’s servicing standards, including permitting 3 years of reduced or suspended mortgage payments.
section_title: Conclusions
paragraphs: The assignment program operates at a high cost to FHA’s Fund and has not been very successful helping borrowers avoid foreclosure in the long run. The program helps about half of the financially troubled homeowners to avoid foreclosure permanently. However, the costs incurred by HUD to achieve this result exceed the costs that would have been incurred if all assigned loans had gone immediately to foreclosure without assignment. While FHA borrowers’ premiums pay these costs, not the U.S. Treasury, the program’s costs lessen the Fund’s ability to build reserves.
Options are available to the Congress to make changes to the program to reduce its losses. The options, such as requiring borrowers to pay more in monthly mortgage payments, would reduce but not eliminate the program’s additional losses. The assignment program would have to require borrowers to begin full mortgage payments within a few months after entering the program in order to nearly eliminate the additional losses incurred by the program.
All of these options pose the trade-off of preventing some individuals and families from entering the program who would eventually bring their loans current and/or avoid foreclosure. However, unless changes are made to the present assignment program, its costs will continue to make it more difficult for the Fund to maintain financial self-sufficiency.
section_title: Matters for Congressional Consideration
paragraphs: If the Congress believes that the additional losses incurred by the assignment program are excessive in relation to the number of borrowers that avoid foreclosure, it could consider eliminating the program. However, since some borrowers who default on their FHA mortgages can avoid foreclosure with some assistance, the Congress could consider establishing a short-term, temporary relief program of a few months for such borrowers to replace the mortgage assignment program.
If, however, the Congress believes that the borrowers served by FHA’s single-family program are at high risk and therefore in need of additional assistance in the form of forbearance, changes to the program should be considered that would reduce but not eliminate additional future losses. The following are options that the Congress could consider:
Require borrowers to (1) resume full mortgage payments within a shorter time period than the 36 months currently allowed and/or (2) eliminate outstanding delinquency amounts within a specified period. For example, the Congress may wish to require that borrowers resume full mortgage payments within 1 year of entering the program and eliminate outstanding delinquencies within 2 years. If borrowers are unable to bring their loan payments current and/or eliminate delinquencies within the specified time, the Congress may wish to consider requiring that HUD foreclose.
Require that only borrowers who can pay half their original mortgage amount or more be assigned to the program.
section_title: Agency Comments
paragraphs: We provided a draft of this report to HUD, VA, RHCDS, Fannie Mae, and Freddie Mac officials to obtain their comments. We met with HUD and VA officials and obtained their comments.
In a meeting with a HUD Special Assistant to the Assistant Secretary for Housing-Federal Housing Commissioner, HUD’s Director of the Single-Family Servicing Division, and officials from HUD’s Offices of General Counsel and Policy Development and Research, we obtained HUD’s comments. The comments focused on (1) the effects of past litigation efforts on HUD’s management of its mortgage assignment program and (2) alternatives available to prevent foreclosure other than the options we suggest for changing forbearance relief (reducing or suspending monthly mortgage payments for a certain period of time) provided through the assignment program.
Specifically, HUD commented that litigation has affected the evolution and operation of the assignment program. According to HUD officials, a consent decree, which the Department entered into in 1979, and litigation preceding and subsequent to entering the consent decree known collectively as the Ferrell v. Pierce litigation have limited HUD’s options to modify the assignment program. The Department believes the Congress needs to understand these limitations when it considers changing the program. Under the consent decree, HUD agreed to, among other things, (1) operate the assignment program for 5 years in compliance with its January 1979 handbook without any modification that would curtail the rights of the mortgagors under the program and (2) after the 5-year period, operate either the present assignment program or an equivalent substitute to help mortgagors avoid foreclosure during periods of temporary financial distress. A series of lawsuits concerning HUD’s implementation of the consent decree followed.
We agree that the consent decree and the Ferrell v. Pierce litigation have limited HUD’s options to change the program. It is because of this limitation that the forbearance relief options we present were addressed to the Congress and not to the Secretary of HUD. So that the Congress has a full understanding of the litigation’s effects when considering options to forbearance relief provided through the mortgage assignment program, HUD’s description of the current operation of the assignment program and the effect of past litigation on that program is provided in appendix V.
HUD also commented that if the Congress were to consider alternative relief measures for borrowers, there are methods widely used to prevent foreclosure by the private sector that are not discussed in our report. The alternatives to forbearance relief cited by HUD included (1) “modifying defaulted borrowers’ mortgage loans by reducing interest rates, (2) extending the remaining period of the loans, and/or (3) paying partial claims to remedy default with a new obligation from the borrower to repay FHA the amount of the claim.” HUD noted that while our report discusses some relief options used with other federally related mortgages, the options we present to the Congress for change do not include such options. HUD also commented that pursuant to section 918 of the Housing and Community Development Act of 1992, it is studying the adequacy of existing programs authorized to help FHA borrowers avoid foreclosure and alternatives to foreclosure being used with other federally related mortgages. HUD expects to issue this study shortly.
We agree that there are alternatives to foreclosure other than the forbearance relief measure provided through HUD’s assignment program. In fact, our report points out that Freddie Mac, Fannie Mae, and VA provide borrowers long-term solutions, such as modifying the structure of their loans to resolve delinquencies. Officials from these organizations told us that they believe techniques such as refinancing and reducing interest rates to reduce monthly mortgage payments are successful alternatives to costly foreclosure.
However, this report did not seek to analyze all possible alternatives to the mortgage assignment program because of the focus of our work and our desire not to duplicate HUD’s efforts in studying such alternatives. However, it should be noted that HUD has seldom made use of modified mortgage loans. Consequently, assessing the merits of modifying financially troubled FHA loans to single-family borrowers in lieu of the forbearance that HUD currently provides is difficult. In addition, no matter how successful other alternatives are in avoiding foreclosure, not all borrowers will be able to resume mortgage payments immediately, which is required under such options as refinancing, reducing interest rates, and extending the period of the loan.
We recognize, however, that to the extent that such alternatives are effective in helping borrowers retain their homes without entering HUD’s assignment program, they could be a more effective way to avoid costly foreclosure than the current assignment program. HUD’s study on alternatives to foreclosure should be helpful to the Congress in assessing these alternatives. Our report should be helpful to the Congress in assessing changes needed to HUD’s mortgage assignment program to reduce losses on those mortgages that enter the program, regardless of other alternatives that may be used to prevent assignment.
While HUD officials agreed that the program’s losses have exceeded those that would have been incurred if loans had gone immediately to foreclosure without assignment, they did not agree with the magnitude of our estimate of the additional cost that FHA incurs. We received no official estimate from HUD of the additional cost, although one HUD analyst said that he believes the additional cost is about one-third of our estimate. HUD currently has a contracted study under way that will produce an estimate of the additional cost to FHA of the program.
HUD also provided clarifying information and technical and editorial comments for our consideration in completing our report, which we incorporated where appropriate.
VA’s Assistant Director for Loan Management, Loan Guaranty Service, generally agreed with the factual information presented in this report on that agency. We incorporated suggestions by VA to further clarify our report as appropriate.
In telephone conversations with RHCDS, Fannie Mae, and Freddie Mac officials, they told us that they agreed with the factual information presented in this report on their organizations and had no further comments.
We conducted our work between October 1993 and October 1995 in accordance with generally accepted government auditing standards.
Unless you announce its contents earlier, we plan no further distribution of this report until 10 days from the date of this letter. At that time, we will send copies to interested congressional committees; the Secretary of HUD; the Director, Office of Management and Budget; and other interested parties. We will also make copies available to others on request.
Please call me at (202) 512-7631 if you or your staff have further questions. Major contributors to this report are listed in appendix VI.
section_title: Objectives, Scope, and Methodology
paragraphs: Concerned about the rising number of loans assigned to the Department of Housing and Urban Development (HUD) and their financial impact, the Chairman, Subcommittee on Housing and Community Opportunity, House Committee on Banking and Financial Services, asked us to determine whether the mortgage assignment program (1) helps borrowers avoid foreclosure, (2) reduces the Federal Housing Administration’s (FHA) losses, and (3) can be improved to reduce losses.
To determine whether the program helps borrowers avoid foreclosures, we analyzed information on foreclosures, delinquencies, and borrowers’ compliance with repayment agreements contained in two of HUD’s national information systems—the Single-Family Mortgage Notes Servicing System and the Single Family Insurance System—as of September 30, 1994. Our data reflect nationwide mortgage assignment statistics on single-family loans that entered these systems as section 203(b) mortgage defaults to avoid foreclosure. Loans assigned to HUD for other reasons were not included in our analyses. We did not perform a reliability assessment of controls over the data in the systems; however, we checked our data results through discussions with HUD personnel, making comparisons to related automated accounting and financial reports and reviewing sampled mortgagors’ repayment files. We randomly selected and examined 136 case example assigned loans from four loan categories—paid-off, current with payments, foreclosed on, and delinquent—from files at four HUD field offices—Boston, Chicago, Ft. Worth, and Spokane—to illustrate, among other things, cases in which some borrowers were able to and chose to pay off their mortgages or become current with their payments and others did not. We selected these field offices to obtain geographic diversity to recognize differences in real estate markets.
To determine whether the program reduces losses, we used the data systems mentioned above as well as HUD’s Single-Family Accounting and Management System to estimate the foreclosure rates of mortgages assigned since 1989 and revenue and expense flows for these loans over their life. We used this historical mortgage data to estimate loan servicing, acquisition, and other costs of surviving mortgages. We also assessed revenues received from early loan payoffs, mortgage payments, and sales of properties following foreclosure. We further compared the cost per assigned mortgage loan to the average loss experienced by FHA on mortgages that went directly to foreclosure rather than being accepted into the program. A detailed discussion of our methodology for forecasting program foreclosure rates and estimating program costs appears in appendix II.
To determine how to improve the program and reduce program losses, we obtained records, reports, and studies from HUD, the Department of Veterans Affairs (VA), Rural Housing and Community Development Service (RHCDS), Federal National Mortgage Association (Fannie Mae), and Federal Home Loan Mortgage Corporation (Freddie Mac) and analyzed appropriate loan servicing guidelines and foreclosure prevention options. We also interviewed HUD (including HUD’s Office of the Inspector General), VA, RHCDS, Fannie Mae, and Freddie Mac officials at their headquarters locations in Washington, D.C., and local HUD officials in Boston, Chicago, Dallas, and Spokane. We also interviewed officials of five organizations concerned with defaulted loans—the Mortgage Bankers’ Association in Washington, D.C., Legal Assistance Foundation, Public Action Housing Policy Center, Community and Economic Development Corporation of Cook County, Inc., and the Spanish Coalition for Housing.
section_title: GAO’s Cash Flow Model Used to Forecast Financial Loss
paragraphs: This appendix describes the cash flow model we built and the analysis we conducted to estimate the financial loss to FHA’s Fund for program loans assigned during fiscal years 1989 through 1994. We estimated the loss the Fund will incur on the 68,695 loans that entered the program during this period on the basis of assumptions stated in this appendix. To do so, we (1) estimated the costs that FHA has incurred on and revenues it has received from these loans as of September 30, 1994, and (2) forecasted future costs and revenues during the remaining life of these loans. We converted all cash flow estimates to 1994 present values using an annual discount rate of 7 percent.
The largest element of cost to the Fund is the cost associated with settling the lender’s claim on the mortgage, a cost that FHA must pay whether or not the foreclosure occurs immediately or the mortgage enters the assignment program. FHA incurs additional costs while loans are in the program, including the administrative costs to operate the program. Revenues received by FHA, including proceeds from the sale of properties following foreclosure and borrowers’ loan payments, partially offset program costs.
The following sections of this appendix contain a detailed description of the data we used and how we estimated the costs and revenues associated with the program.
subsections: section_title: Data We Used in Our Estimates
paragraphs: In our analysis, we used three of HUD’s computerized databases—the F-60 database that provides current and historical information on all mortgage loans that HUD services under the assignment program, the A-43 database that provides historical information on mortgages insured under the Fund before assignment, and the Single-Family Accounting and Management System (SAMS) database that tracks properties held and eventually sold by HUD following foreclosure. From these databases, we obtained information on the initial characteristics of each loan, such as the year the loan was assigned, the initial unpaid principal and delinquency amount, and the loan interest rate and term. We also obtained information on the current status of each loan, such as the current unpaid balance, the last payment date, and the delinquency status. We categorized the loans as either foreclosed, prepaid, or active as of the end of fiscal year 1994.
section_title: How We Estimated the Program’s Costs and Revenues
paragraphs: We estimated the financial losses for program loans by examining all loans by the year assigned. Costs and revenues were computed for each year’s group of assigned loans over the life of the loans in the program.
Cash flows out of the Fund when FHA pays (1) lenders’ mortgage claims, (2) taxes and insurance on properties, and (3) salaries and other administrative costs. Cash flows into the Fund when FHA collects revenues from (1) the sale of properties following foreclosure, (2) the early payoff of loans, and (3) payments made by mortgagors (borrowers). All cash flows are discounted at 7 percent to a 1994 base year.
We assumed that the net cost to the Fund was partially a function of foreclosure and payoff rates. Other factors that affected costs included the percentages of unpaid principal to original loan amount, receivables due FHA to original loan amount, advances to original loan amount, and the policy year of the loans. In addition, we assumed that FHA would continue to receive partial and delayed payments for some mortgages assigned and that both foreclosure and prepayment behavior will remain the same in future years as it has been in the past. This is a critical assumption because of data limitations. As a result, our analysis does not take into account that the loans assigned from fiscal years 1989 through 1994 may differ from earlier loans in ways that affect their prepayment and foreclosure probabilities beyond 6 years from the date of assignment.
Given these assumptions, we projected future loan activity for foreclosures, prepayments, and surviving loans. Because of inadequate historical data, it was not possible to rigorously estimate foreclosure and prepayment probabilities incorporating economic indicators, such as unemployment rates, payment-to-income ratios, current interest rate, and house price appreciation rates.
subsections: section_title: Determining Costs
paragraphs: The Fund incurs a number of costs associated with operating the program, including the costs to acquire loans following default, to administer the program, and for property expenses. The largest cost relates to the acquisition of loans before they enter the program. Acquisition costs were compiled for each year’s book of business. The total acquisition costs for all 68,695 loans is about $4.9 billion, about 89 percent of the total cost of $5.5 billion incurred by FHA’s Fund on these loans.
Administrative costs include staff salaries for those servicing program loans and other costs related to the program’s application approval process and the processing of defaulted loans for foreclosure. Administrative costs used in our estimates were those developed by the Congressional Budget Office (CBO). CBO estimated the assignment program’s administrative costs and staffing needs—full-time equivalents (FTE)—for each phase of the loan assignment process: assignment requests, endorsements, servicing, and defaulting mortgages.
First we used CBO’s estimates for the costs of each administrative function in 1994 to estimate the cost per loan for each function. We then applied this figure to each year’s loan activity to estimate the costs incurred in that year for each function. Next, we used a real discount rate of 3.5 percent per year to convert the estimates to 1994 present values. CBO’s FTE estimates and GAO’s cost per loan and total cost estimates are shown in table II.1, which illustrates that the administrative cost for the 68,695 loans assigned between fiscal year 1989 and the end of fiscal year 1994 totals about $451 million over the life of these loans, about 8 percent of the costs incurred by FHA’s Fund.
Total cost (in millions over the life of the loan)
Salary costs, which averaged $48,017 per FTE in fiscal year 1994, are used for all FTEs listed. Assignment request costs were allocated to all program loans, although the majority of these costs were for processing loans that were not accepted into the program. Endorsement costs were computed for all 68,695 loans. Servicing costs were applied every year for as long as the loan remained in the program. Default costs were computed for foreclosed loans by year of default.
When borrowers are not current on their mortgages, additional costs are often incurred by FHA, including advances for property taxes, insurance, and other costs. HUD makes these payments to ensure clear title to the property and to protect its investment in case of fire. These costs totaled about $100 million, about 2 percent of the costs incurred by the Fund on these loans, and at times are not recovered from the borrower.
section_title: Forecasting the Program’s Revenues
paragraphs: To estimate the program’s revenues, we recorded the characteristics and status of loans for each year’s book of business. These data were used to estimate ultimate foreclosure and prepayment probabilities of 52 percent and 48 percent, respectively. The conditional foreclosure and prepayment probabilities for each year were based on the actual number of loans that were foreclosed on and paid off between fiscal year 1989 and the end of fiscal year 1994. We estimated these conditional probabilities using data for the 6-year period ended September 30, 1994. These probabilities were for loans entering the program during a 17-year period (fiscal years 1977 through 1994) and represented loan years 1 through 17. We assumed that the conditional foreclosure and prepayment rates for years beyond 1994 (18-30) were the same as for loan year 17. Figures II.1 and II.2 illustrate the estimated conditional foreclosure and prepayment probability rates by loan year.
Revenue estimates were based on the percentage of loans in five loan status categories—current, current with forbearance, delinquent with forbearance, delinquent with no forbearance, and pending foreclosure—and their expected performance in the future. For each year’s book of business, we analyzed the unpaid balance to loan amount, the amount of receivables outstanding, the amortized payment amounts, and the actual payments made for each loan category. We also included the amount of advances owed and original loan amounts in the estimates.
section_title: Foreclosure Revenues
paragraphs: To estimate foreclosure revenues, an average recovery rate for loans foreclosed and sold was obtained from the SAMS data on 203b loans foreclosed during fiscal years 1983-94. Recovery rates ranged between 43 and 67 percent of acquisition costs each year, averaging 59 percent. The average recovery rate of 59 percent was applied to the acquisition costs of all foreclosed loans. Average acquisition costs were used in estimating foreclosure revenues. Specifically, the average acquisition costs for each year times the recovery rate for each foreclosed loan results in the estimated total foreclosure revenue of about $1 billion, about 48 percent of the $2.1 billion in revenues to be obtained by FHA’s Fund on these mortgages.
section_title: Prepayment Revenues
paragraphs: Prepayment revenues are based on data for all loans. Using the number of loans that paid off and those forecasted to be paid off, the unpaid principal balance at the time of payoff was estimated and summed for all loans, totaling about $955 million, about 45 percent of the revenues to be obtained by FHA. In estimating the unpaid principal balance, we used the ratio of unpaid balance to original loan amount for each year. Using the average loan amount, year in program, and the number of expected prepayments, we estimated prepayment revenues for each year.
For years 19 through 30, we assumed that the unpaid balance to original loan amount will continue to decrease at an accelerated rate. To determine the unpaid balance for years 19 through 30, a simple regression was applied to the unpaid balance to original loan amount ratio for years 1-18, in which each year’s ratio is dependent on the previous year’s ratio. The resulting parameters were used to estimate the unpaid balance to loan amount schedule for years 19-30.
section_title: Payment Revenues
paragraphs: We forecasted loan payment revenues using the estimated number of loans remaining in the program and the actual and scheduled payments made for each loan category. Actual loan payments averaged about 34 percent of scheduled payments. It was assumed that the assigned loans will have the same distribution over the loan categories that they did in fiscal year 1994 but that the length of time in the program varies. Actual to scheduled payment ratios were also assumed to vary by time in program. As loans age, payment ratios rise, indicating that older loans are paying a higher percentage of scheduled payments.
Mortgagors’ total payments for each year through the year 2023 for each year’s book of business were summed to obtain the estimated total payment revenue of about $152 million, about 7 percent of the revenues obtained by FHA’s Fund for loans assigned since the beginning of fiscal year 1989.
section_title: Borrowers’ Compliance With Program Repayment Agreements
paragraphs: Approximately 39,600 (55 percent) of the 71,500 borrowers in the program as of September 30, 1994, had been in the program 3 years or fewer. HUD’s records show that of the 39,600 borrowers, 26,000 (66 percent) are current with repayment agreements while the remaining 34 percent are not current. Of the 26,000 borrowers who are current with repayment agreements, 36 percent are current with original mortgage payments. The remaining borrowers (64 percent) are current with repayment agreements that call for reduced or suspended payments.
When borrowers remain in the program beyond the 3-year relief period and therefore are required to make full mortgage payments, the proportion of borrowers current with repayment agreements drops and the proportion of borrowers in foreclosure increases. Similarly, the average amount of delinquencies owed by borrowers increases (see figs. III.1 and III.2). Of the approximately 31,900 borrowers who have been in the program more than 3 years and are required to make full mortgage payments, 38 percent are current on their repayment agreements.
section_title: Cases in Which Some Borrowers Paid Off Mortgages and Others Did Not
paragraphs: People buy homes for shelter and investment purposes. Normally, they do not plan to default on a loan. However, conditions that lead to defaults occur. Defaults may be triggered by a number of events: unemployment, divorce, death, etc. These events are not likely to trigger foreclosure if the home can be sold for more than the mortgage balance and selling expenses. However, if the property is worth less than the mortgage, these events may trigger a foreclosure. Prepayments may be triggered by other events such as declining interest rates or rising house prices, which in turn may result in the refinancing or sale of a residence.
To illustrate that some borrowers were able to and chose to pay their mortgages while others did not, we randomly selected 136 case example loans from four loan categories—paid-off, current with payments, foreclosed on, and delinquent—from files at four HUD field offices—Boston, Chicago, Ft. Worth, and Spokane. Of the 136 borrowers, 78 had paid off their loans, 34 were current with their mortgages, and 24 had either been foreclosed on, provided HUD with a deed in lieu of foreclosure, or were delinquent on their loans.
Borrowers who had been foreclosed on, had given FHA a deed in lieu of foreclosure, or had experienced growing delinquencies were generally unable to resume full payments, and they experienced additional problems after assignment that intensified their financial difficulties. These borrowers generally encountered one or more of the following situations after assignment: (1) intermittent job loss with a reduction in income, (2) reduction in income due to divorce, (3) one or more serious illnesses or injuries, (4) loss of a high paying job and reduced income from a new job, and/or (5) unanticipated housing repairs. Only a few borrowers did not make their mortgage payments because they had high installment debt.
While FHA does not keep track of borrowers after foreclosure, FHA loan servicers familiar with foreclosures told us that after foreclosure, borrowers generally either rent an apartment or are able to stay with relatives. Furthermore, program borrowers who experience foreclosures have experiences that are similar to those of FHA borrowers who experience foreclosures immediately without assignment, according to the servicers. However, officials from two housing counseling agencies told us that some borrowers could become homeless after foreclosure.
In contrast, the 34 borrowers who were able to become current with their loans generally did not experience such a litany of problems. Although their incomes also declined, they either still had jobs, found new jobs by the time HUD accepted their loans for assignment, or were able to obtain second jobs to supplement their incomes. As a result, 25 (about 73 percent) of the borrowers who became current were able to resume full or increased mortgage payments immediately upon entering the program. Of the 34 borrowers who became current on their loans, 13 cured their delinquencies in less than 2 years. However, the remaining 21 borrowers took 92 months on average to cure their delinquencies. Seven borrowers took over 10 years to become current with their original mortgage payments.
Almost all of the 78 borrowers included in our case studies who had already paid their mortgages did so by selling their homes or refinancing their mortgages. Of the 78 borrowers, 71 sold or refinanced their homes, 4 paid mortgages from insurance settlement payments, and 3 paid through regular or increased payments. Borrowers who sold their homes were, on average, 8 months behind in mortgage payments of $4,169 at the time their loans were assigned, which increased to $6,088 when they sold or refinanced their homes. However, the proceeds from the sales were generally sufficient for these borrowers to pay off their original notes and the delinquencies. Generally, these borrowers had either held the properties for more than 10 years or lived in areas where housing had significantly appreciated in value since the homes were purchased. For example, according to a HUD field office official, housing in Spokane has almost doubled in value since 1985. In contrast, the value of homes in the Fort Worth area did not significantly appreciate during this period. Thus, mortgagors in areas where housing had significantly appreciated in value who sold their homes had equity in their homes when they defaulted on their mortgages. Almost half of the 78 borrowers who paid off their mortgages did so within 2 years of assignment, and almost two-thirds did so within 3 years of assignment.
section_title: HUD’s Description of the Current Operations and Effects of Past Litigation on the Mortgage Assignment Program
section_title: Major Contributors to This Report
subsections: section_title: Resources, Community, and Economic Development Division, Washington, D.C.
section_title: Chicago/Detroit Field Office
section_title: Dallas Field Office
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