Recovery Act: Tax Debtors Have Received FHA Mortgage Insurance and First-Time Homebuyer Credits
Released: 2012-06-27T00:00:00

Letter

Background

The Recovery Act of 2009 was enacted in response to significant weakness in the economy to, among other things, help promote economic recovery and assist those most affected by the recession. The Congressional Budget Office (CBO) estimated the Recovery Act’s cost at $825 billion as of August 2011. The Recovery Act included provisions to help stimulate the housing market, including increasing loan limits for FHA-insured mortgages in 669 high-cost counties in calendar year The provision allowed FHA to insure mortgages at a higher 2009.amount than would have been authorized without the Recovery Act. Under this provision, FHA insured over $20 billion in mortgages for 87,000 homeowners who were approved for FHA mortgage insurance in 2009. The Recovery Act also adapted and extended the FTHBC through November 2009. Through July 3, 2010, IRS reported that about 1.7 million individuals claimed more than $12 billion in FTHBCs under the Recovery Act for homes purchased in 2009. Office of Management and Budget (OMB) Circular A-129 states that delinquent tax debtors are ineligible for federal loan insurance, such as FHA mortgage insurance, unless they repaid the debt or were in a valid repayment agreement with IRS, but the FTHBC was available to those who qualified regardless of their tax debt.

FHA Mortgage Insurance

FHA’s single-family programs insure private lenders against 100 percent of the value of the loan for foreclosures on mortgages that meet FHA criteria, including mortgages for initial home purchases, construction rehabilitation, and refinancing. As of September 2011, almost 3,700 lenders were approved to participate in these programs. The insurance covers the principal, interest, and associated foreclosure costs, among other things. Lenders usually require mortgage insurance when a home buyer makes a down payment of less than 20 percent of the value of the home. FHA mortgage insurance allows a home buyer to make a modest down payment—as low as 3.5 percent—and obtain a mortgage for the balance of the purchase price. As the recent housing and economic recession set in, FHA’s share of the market for home purchase mortgages grew sharply due to the contraction of other mortgage market segments—rising from about 5 percent in 2006 to nearly 30 percent in 2009. FHA insured almost 2 million single-family mortgages valued at more than $300 billion in mortgage insurance in 2009. FHA generally is thought to promote stability in the market by ensuring the availability of mortgage credit in areas that may be underserved by the private sector or that are experiencing economic downturns. It has played a particularly large role among minority, lower-income, and first-time home buyers; almost 80 percent of FHA-insured home purchase loans in 2010 went to first-time home buyers.

The FHA home mortgage insurance programs are funded by the FHA Mutual Mortgage Insurance Fund (MMIF), which is supported by insurance premiums charged to borrowers. The MMIF is used to cover claims on foreclosed mortgages, among other things. The Omnibus Budget Reconciliation Act of 1990 required the Secretary of HUD to take steps to ensure that the MMIF attained a capital ratio (i.e., economic value divided by the unamortized insurance-in-force) of at least 2 percent by November 2000 and maintain a 2 percent ratio at all times thereafter.The act also required an annual independent actuarial review of the economic net worth and soundness of the MMIF. The actuarial review estimates the economic value of the MMIF as well as the capital ratio to determine whether the MMIF has met the capital standards in the act. The capital ratio has dropped sharply in recent years due to declines in home prices and increases in seriously delinquent loans and foreclosures. The most recent actuarial study shows that the capital ratio is currently below the statutorily mandated level, at 0.24 percent, representing $2.6 billion in estimated capital resources against an active portfolio of $1.08 trillion. The MMIF has historically been sufficient to fund the FHA home mortgage insurance programs without additional funding from the federal government, but if the reserve were to be depleted, FHA would need to draw on permanent and indefinite budget authority to cover additional increases in estimated losses. A weakening in the performance of FHA-insured loans could increase the possibility that FHA will require additional federal funds. Our work has previously shown that the increased reliance on FHA mortgage insurance highlights the need for FHA to ensure that it has the proper controls in place to minimize financial risks to the federal government while meeting the housing needs of borrowers.

Lenders are responsible for underwriting the loans to determine an applicant’s eligibility for FHA mortgage insurance in accordance with FHA policies. Underwriting is a risk analysis that uses information collected during the loan origination process to decide whether to approve a loan for FHA insurance. Lenders employ automated underwriting— the process by which lenders enter information on potential borrowers into electronic systems that contain an evaluative formula, or algorithm, known as a scorecard. The scorecard attempts to quickly and objectively measure the borrower’s risk of default by examining data such as application information and credit score. Since 2004, FHA has used its own scorecard called Technology Open to Approved Lenders (TOTAL). FHA lenders now use TOTAL in conjunction with automated underwriting systems to determine the likelihood of default. Although TOTAL can assess the credit risk of a borrower, it does not reject a loan outright. Rather, TOTAL will assign a risk assessment of either “accept” or “refer” for each borrower. FHA requires lenders to manually underwrite loans that are assessed as “refer” by TOTAL to give a final determination if the loan should be accepted or rejected. According to FHA policy, a lender remains accountable for compliance with FHA eligibility requirements, regardless of the risk assessment provided by TOTAL.

Virtually all of the lenders that participate in FHA’s mortgage insurance programs for single-family homes have direct endorsement authority. These lenders can underwrite and close mortgage loans without FHA’s prior review or approval. FHA insures lenders against nearly all losses resulting from foreclosed loans and covers 100 percent of the value of the loan. In general, foreclosure may be initiated when three monthly installments are due and unpaid, and it must be initiated when six monthly installments are due and unpaid, except when prohibited by law. To minimize the number of FHA loans entering foreclosure, servicers are responsible for pursuing various loss mitigation strategies, including suspended payments, loan modification, reduced mortgage payments, and sale of the property by the borrower. If, despite these loss mitigation strategies, the lender forecloses on the loan, the lender can file an insurance claim with FHA for the unpaid balance of the loan and other costs. However, FHA reviews a selection of insured loans, including early payment defaults (loans at least 60 days delinquent in the first six payments), in part to minimize potential FHA losses and ensure the underwriting for these mortgages met FHA guidelines. Reviews revealing serious deficiencies may result in FHA requiring the lenders to compensate the department for financial losses, known as indemnification, which requires the lender to repay FHA for any losses that it incurs after a loan has gone into default and the property has been sold.

Congress, through legislation, sets limits on the size of loans that may be insured by FHA. These loan limits vary by county and can change from year to year. To mitigate the effects from the economic downturn and the sharp reduction of mortgage credit availability from private sources, Congress increased FHA loan limits. The Economic Stimulus Act (ESA) enacted in February 2008 stipulated that FHA loan limits be set temporarily at 125 percent of the median house price in each area, with a maximum loan limit of $729,750 for a one-unit home. Immediately prior to ESA’s enactment, the limits had been set at 95 percent of area median house prices. In July 2008, 5 months after passing ESA, Congress passed the Housing and Economic Recovery Act (HERA), which established new statutory limits of 115 percent of area median home prices. Then, in February 2009, Congress passed the Recovery Act, which stipulated that FHA loan limits for 2009 be set in each county at the higher dollar amount when comparing loan limits established under 2008 ESA requirements and limits for 2009 under HERA.

First-Time Homebuyer Credit

Congress passed the FTHBC to assist the struggling real estate market and encourage individuals to purchase their first home. The credit was initially enacted by HERA and later revised by the Recovery Act. The 2008 HERA FTHBC provided taxpayers a credit of up to $7,500 to be paid back over 15 years, essentially serving as an interest-free loan. In 2009, the Recovery Act was enacted and increased the maximum credit for the 2009 FTHBC to $8,000, with no payback required unless the home is sold or ceases to be the taxpayer’s principal residence within 3 years of the purchase. The credit of up to $8,000 was a refundable tax credit paid out to the claimant if there was no tax liability or the credit exceeded the amount of any federal tax due. In July 2010, the Homebuyer Assistance and Improvement Act (HAIA) of 2010 extended the date to close on a home purchase to September 30, 2010.

Federal Policies on Tax Debtors Receiving Federal Loan Insurance

To protect federal government assets and minimize unintended costs to the government, OMB Circular A-129 states that individuals with delinquent federal debts are ineligible for loan insurance and prohibits federal agencies from issuing loans to such applicants; however, OMB’s policy allows individuals with delinquent federal taxes or other federal debt to attain eligibility by repaying their debt in full or entering into a valid repayment plan with the agency they owe. The policy states that agencies should determine if the applicant is eligible by including a question on loan applications asking applicants if they have such delinquencies. The policy also (1) requires agencies and lenders to use credit bureaus as screening tools, because tax liens resulting from delinquent tax debt typically appear on credit reports, and (2) encourages agencies to use HUD’s Credit Alert Interactive Voice Response System (CAIVRS), a database of delinquent federal debtors. CAIVRS contains delinquent debt information for six federal agencies; however, it does not According to OMB policy, if delinquent contain any tax debts from IRS.federal debts are discovered, processing of applications must be suspended until the applicant attains eligibility.

FHA’s policies for lenders dictate that an FHA mortgage insurance applicant must be rejected if he or she is delinquent on any federal debt, including tax debt, or has a lien placed against his or her property for a debt owed to the federal government. Like OMB’s policy, FHA policy states that an applicant with federal debt may become eligible for mortgage insurance by repaying the debt in full or by entering into a valid repayment agreement with the federal agency owed, which must be verified in writing. Such repayment plans include IRS-accepted installment agreements and offers in compromise. To identify individuals with tax debt, FHA requires mortgage insurance applicants to declare whether they are delinquent or in default on any federal debt on their insurance application, the Uniform Residential Loan Application (URLA). As printed on the application, knowingly making any false statement on the URLA is a federal crime punishable by fine or imprisonment. FHA also requires that lenders review credit reports for all applicants to identify tax liens and other potential derogatory credit information.

FHA Insured over $1.44 Billion in Mortgages for Thousands of Recovery Act Beneficiaries with Federal Tax Debt

In 2009, FHA insured over $1.44 billion in mortgages for 6,327 borrowers who at the same time had delinquent tax debt and benefited from the Recovery Act. According to IRS records, these borrowers had an estimated $77.6 million in unpaid federal taxes as of June 30, 2010. As figure 1 illustrates, our analysis included tax debtors who either benefited from FHA’s increased loan limits or who claimed the FTHBC and received FHA mortgage insurance of any value. Although federal policies did not prohibit tax debtors from claiming the FTHBC, they were ineligible for FHA mortgage insurance unless their delinquent federal taxes and other federal debt had been fully repaid or otherwise addressed through a repayment agreement. We could not determine the proportion of borrowers who were ineligible because we could not systematically identify which of the 6,327 borrowers had valid repayment agreements at the time of the mortgage approval using IRS’s data; however, we found that five of our eight selected borrowers were not in valid repayment agreements at the time they obtained FHA mortgage insurance. In addition, FHA records indicate that borrowers with tax debt had serious delinquency (in default for 90 days or more) and foreclosure rates two to three times greater than borrowers without tax debt, which potentially represents an increased risk to FHA.

In 2009, FHA insured $759.3 million in mortgages for 2,646 individuals who owed $35.5 million in unpaid federal taxes as of June 30, 2010, under the Recovery Act’s provision for increased loan limits. These borrowers and coborrowers obtained 1,913 insured mortgages with a median value of $352,309 and had a median tax debt of $6,290 per person. Their mortgages accounted for 3.7 percent of the 52,006 mortgages FHA insured under Recovery Act provisions for increased limits in 2009, which in turn represented 2.5 percent of all mortgages insured by FHA in 2009. Our analysis likely understates the amount of unpaid federal taxes because IRS data do not cover individuals who fail to file tax returns or who understate their income. Of the 18 selected individuals who benefitted from increased loan limits for FHA mortgage insurance or received the FTHBC under the Recovery Act, we found that 11 had not filed all of their federal tax returns.

Using IRS data, we cannot systematically determine which of these individuals was in a valid repayment agreement at the time of the mortgage, and therefore cannot determine whether insuring each of these 1,913 mortgages was improper, but it is possible that borrowers with tax debt represent a greater financial risk to the federal government. As illustrated in figure 2, serious delinquency and foreclosure rates among Recovery Act borrowers with unpaid federal taxes were at least twice as high as the rates for other borrowers. As of September 2011, 32 percent of the 1,913 mortgages made to borrowers with tax debt were seriously delinquent on their payments, compared with 15.4 percent of other FHA- insured mortgages. About 6.3 percent of the mortgages for borrowers with tax debt went into foreclosure since the home was purchased in 2009, compared with 2.4 percent for others. The homes foreclosed after they were purchased by tax debtors were insured for $44.9 million, potentially leaving FHA responsible for paying claims for the remaining loan balance and certain interest and foreclosure costs. FHA recovers some of these costs when it sells the property.

Finally, FHA’s increased exposure to risk from insuring tax debtors is unlikely to be limited to Recovery Act beneficiaries. Because FHA uses identical methods to insure non-Recovery Act mortgages, it is reasonable to assume that some portion of FHA borrowers for the remaining 97.5 percent of mortgages we did not analyze as part of this review are tax debtors.

$717.2 Million in FHA Mortgage Insurance Was Provided to Tax Debtors Who Claimed $27.4 Million in Recovery Act FTHBCs

In 2009, $717.2 million in FHA mortgage insurance and $27.4 million in Recovery Act FTHBCs were provided to 3,815 individuals who owed an estimated $43.5 million in unpaid federal taxes. These borrowers obtained 3,812 insured mortgages with a median value of $167,887 and had a median unpaid tax amount of $5,044 per person. Their mortgages represented 0.5 percent of the 700,003 mortgages insured by FHA for borrowers who claimed the FTHBC. As discussed above, we were unable to determine the proportion of the mortgage insurance that was provided to borrowers who were, in fact, eligible as a result of entering into a valid repayment agreement with IRS. We found that three of our eight selected borrowers were in valid repayment agreements at the time they obtained FHA mortgage insurance.

As illustrated in figure 3, we found that serious delinquency and foreclosure rates for mortgages obtained by FHA borrowers with federal tax debts who received the FTHBC were two to three times higher than the rates for other borrowers. As of September 2011, 26.9 percent of the 3,812 mortgages made to borrowers with unpaid tax debts were seriously delinquent on their payments, compared with 11.9 percent of borrowers without tax debt who received the FTHBC and FHA mortgage insurance. About 4.7 percent of the mortgages of borrowers with tax debt were foreclosed, compared with 1.4 percent for other borrowers. The 181 foreclosed homes purchased by tax debtors had a total mortgage insurance value of $36.5 million, potentially resulting in a loss to the MMIF.

The FTHBC is a refundable credit, meaning taxpayers could receive payments in excess of their tax liability. Federal law typically requires that any federal tax refund be offset to pay down an individual’s unpaid taxes. Of the 3,815 borrowers we identified with tax debt, 233 received a federal tax refund after claiming the FTHBC. We selected 9 of these borrowers for a detailed review and found that all 9 were issued refunds in accordance with federal law. For example, three of these cases had filed bankruptcy prior to receiving the refund. Federal bankruptcy law prevents IRS from taking collections actions, such as offsetting postpetition refunds, against individuals undergoing bankruptcy proceedings.

The amounts of unpaid federal taxes, mortgage insurance, and FTHBCs we identified are likely understated for the following reasons:

Certain individuals did not file tax returns or underreported their income, and therefore are not included in our analysis.

Data limitations in the FTHBC data prevented us from isolating all individuals who benefitted from the FTHBC under the Recovery Act.

Any Recovery Act FTHBC recipient whose FTHBC was greater than their outstanding tax liability would not be included in our analysis because the refundable credit would have offset their outstanding tax liability. Federal law generally requires that IRS offset any refund against an individual’s tax liability.

Shortcomings in the Capacity of FHA- Required Documentation to Identify Tax Debts and in Certain Policies Allow Tax Debtors to Obtain Mortgage Insurance

Some ineligible tax debtors received FHA mortgage insurance, in part, due to shortcomings in the capacity of FHA-required documentation to identify tax debts and shortcomings in other policies that lenders may misinterpret. Lenders are required by FHA policy to perform steps to identify an applicant’s federal debt status, but the information provided by these steps does not reliably indicate an applicant’s tax debt. Statutory restrictions limit the disclosure of taxpayer information without the taxpayer’s consent. Lenders are already required to obtain such consent through an IRS form they use to validate the income of some applicants. This same form could also be used to obtain permission from applicants to access reliable tax-debt information directly from IRS, but doing so is not addressed in FHA’s policies. Requiring lenders to collect more reliable information on tax debts could better prevent ineligible tax debtors from obtaining FHA mortgage insurance. Further, FHA’s policies requiring lenders to investigate whether tax liens indicate unresolved tax debt are unclear and may be misinterpreted. The lenders we spoke with believed they were in compliance with FHA policies when they provided FHA- insured loans to applicants with tax liens, but FHA officials indicated otherwise. As a result of these shortcomings, lenders may approve federally insured mortgages for ineligible applicants with delinquent tax debt in violation of federal policies.

Information That FHA Requires Lenders to Collect on Mortgage Applicants Does Not Reliably Indicate the Existence of Federal Tax Debt

Consistent with OMB policies, FHA has lender policies intended to prevent ineligible tax debtors from obtaining FHA mortgage insurance; however, the information the agency requires lenders to collect does not reliably indicate the existence of federal tax debt. The three sources of information FHA requires lenders to obtain each have shortcomings in their capacity to identify borrowers’ tax debts:

Uniform Residential Loan Application (URLA). The URLA requires that applicants declare any federal debt that is delinquent or in default. The URLA also requires applicants to disclose any liabilities, including tax debt, so a lender can assess the applicant’s ability to repay the proposed mortgage. While knowingly making false statements on an URLA is a federal crime and may deter some from lying about their tax debt, much of our work has focused on the inadequacies of self- reported information without independent verification. In fact, our comparison of the URLAs in eight mortgage files with IRS tax data revealed that five borrowers wrongly declared they were not, by FHA’s definition, delinquent or in default on federal tax debt (e.g., not in a valid IRS repayment agreement). In addition, six of the borrowers did not properly disclose the tax debts on the liabilities section of the URLA. Because of the federal statute that prohibits the disclosure of taxpayer information, we are unable to refer these cases to FHA for further investigation. Excerpts of the URLA where applicants are required to disclose any debts that may affect their eligibility for FHA mortgage insurance or their ability to repay the proposed mortgage are illustrated in appendix II.

CAIVRS. FHA requires that lenders check all applicants against CAIVRS, HUD’s database of delinquent federal debtors, to identify federal debts. While it contains delinquent debt information from six agencies, such as the Department of Education and the Small Business Administration, CAIVRS does not contain federal tax information from IRS because statutory restrictions generally prohibit IRS from disclosing taxpayer information without the taxpayer’s consent. Two of the three lenders we spoke with mistakenly believed CAIVRS could be used to identify federal tax debt.

Credit reports. Lenders told us that credit reports, which contain public records such as federal tax liens, were a primary method of identifying liens to indicate certain tax debts. However, delinquent federal taxes do not always appear on credit reports because IRS does not file liens on all tax debtors with property. In addition, many FHA borrowers are first-time home buyers and may not have real property on which IRS can place a lien. IRS records indicated that only two of our eight selected borrowers had tax liens filed against them at the time they obtained FHA mortgage insurance.

Lenders using only these FHA-required methods for identifying tax debt are missing an opportunity to more accurately determine whether applicants are eligible for FHA-insured mortgages, in part, because they do not have access to certain information. Access to the federal tax information needed to obtain the tax payment status of applicants is restricted under section 6103 of the Internal Revenue Code, which prohibits disclosure of taxpayer data to lenders in most instances. However, lenders may request information on federal tax debts directly from IRS if the applicant provides consent. To verify the income of self- employed and commission-income applicants, FHA requires that lenders obtain an applicant-signed consent form allowing the lender to verify the applicant’s income directly with IRS.

The three lenders we spoke with indicated they use IRS form 4506-T Request for Transcript of Tax Return to satisfy this requirement. FHA could also compel lenders to use this form or otherwise obtain borrower consent to identify tax debts. Files for four of our eight selected borrowers had a copy of the IRS Form 4506-T in their FHA mortgage files. The lenders for these borrowers used the 4506-T only to validate income by requesting federal tax return transcripts and did not use the form to request account transcripts that would have disclosed tax debt information. None of the eight mortgage files contained IRS tax account transcripts. Officials from each of the lenders we interviewed said it is their policy to use the 4506-T only to validate the income of these applicants, as this is the requirement under FHA policies. Officials from In two of the lenders used the form to verify income for all borrowers.contrast, officials from the third lender stated that they executed this form for a random sample of additional applicants for income verification, but noted that doing so for every applicant would be too burdensome.

As shown in figure 4, checking box 6a on the form allows a lender to obtain tax return transcripts for applicants, which do not disclose tax debt information. Checking box 6b would allow a lender to request and receive account transcripts. Account transcripts contain information on the financial status of the account, including information on any existing tax These transcripts would allow a lender to identify federal taxes debts. owed by any applicant, including debts not found on credit reports because a federal tax lien does not exist. Checking box 6c would allow a lender to obtain both tax return transcripts and account transcripts, which the lender could use to verify the income of an applicant as well as identify whether the applicant has federal tax debt. The lender may request account transcripts only for the current year and up to 3 prior years and must state the requested years on the form; transcripts beyond this are generally unavailable. Despite this limitation, the IRS form 4506-T could serve as a method for lenders to identify loan applicants with unpaid debt. Without such a method, lenders may approve federally insured mortgages for ineligible applicants with delinquent tax debt in violation of OMB and FHA policies.

IRS returns the information requested on IRS form 4506-T within 10 business days at no expense to the requester, or within 48 hours through the IRS Income Verification Express Service (IVES) at an expense of $2.00, according to IRS officials.

Shortcomings in FHA Policies May Have Led to Ineligible Tax Debtors Obtaining Mortgage Insurance

All three lenders we spoke with unknowingly violated FHA policies on requirements to investigate tax liens. Federal tax liens remain on a property until the associated tax debt has been paid in full or otherwise satisfied. The presence of a lien does not prevent an applicant from receiving FHA mortgage insurance because, per OMB and FHA policies, applicants are eligible for mortgage insurance if they are in a valid repayment agreement. However, according to FHA officials, FHA requires lenders to investigate whether the tax debt that caused the lien has been resolved or brought current under a repayment plan. If it has not, insurance must be denied. Lenders understood these policies to have exemptions for some applicants. FHA officials told us that endorsing a mortgage without determining applicant eligibility by investigating the status of tax debts related to federal tax liens for any applicant is improper due diligence.

Specifically, officials from two of the three lenders said they would approve FHA insurance for applicants with a federal tax lien on their credit report if IRS agreed to subordinate the lien to FHA. The lenders believed this was in accordance with FHA policy that indicates that tax liens may remain unpaid if the lien holder subordinates the lien to FHA. One of the lenders told us that this policy could potentially allow ineligible applicants with delinquent federal tax debt to obtain FHA mortgage insurance. However, FHA officials told us that this policy is only applicable if the lender has previously determined the applicant is eligible by investigating the lien (i.e., requesting verification from IRS that they have repaid their debt or are in a repayment agreement). See figure 5 for FHA policy excerpts.

Officials from the third lender said they would approve any applicant rated as “accept” by TOTAL without additional review or manual underwriting, even if the applicant’s credit report showed a tax lien. The officials believed this was consistent with FHA policy because TOTAL would not have granted an “accept” unless the application met FHA requirements. However, FHA officials told us that while TOTAL considers an applicant’s credit score in its risk evaluation, it does not consider other factors such as tax liens. FHA guidance states that the lender remains accountable for compliance with FHA eligibility requirements, regardless of the risk assessment provided by TOTAL.

Due to potential shortcomings in FHA policies, lenders may misinterpret them, which could result in lenders approving federally insured mortgages for ineligible applicants with delinquent tax debt in violation of OMB and FHA policies. Our review was limited to mortgages obtained under the Recovery Act provisions; however, these policies are the same for all FHA mortgages. Our review included only a small percentage of all mortgages insured by FHA in 2009, and it is likely that FHA’s unclear policies may negatively affect some of the other mortgages.

Conclusion

FHA has helped millions of families purchase homes through its single- family mortgage insurance programs. As more and more Americans turn to FHA to finance their homes, it is critical for FHA to ensure that it has policies in place to minimize financial risks to the federal government while meeting the housing needs of borrowers. Tax debtors who were ineligible for FHA mortgage insurance were still able to obtain insurance, despite FHA policies intended to prohibit this. Our review focused exclusively on individuals who benefitted from the Recovery Act, which only accounted for a small percentage of FHA borrowers in 2009; nevertheless we were able to identify thousands of tax debtors who obtained insurance. These debtors became seriously delinquent in their payments and lost their homes to foreclosures at a higher rate than those without tax debt.

Current shortcomings we found in the capacity of available information sources to identify applicants’ tax debts could be addressed by improved access to federal tax information. But because FHA’s underwriting policies apply equally to all mortgage insurance applicants, it is likely that loans we did not review also included tax debtors. To ensure compliance with the confidentiality requirements associated with the disclosure of taxpayer information, FHA would need to consult with IRS to take action to identify tax debtors who are ineligible for FHA mortgage insurance, as has been done to verify the income of certain applicants. This would include developing appropriate criteria and safeguards to ensure taxpayer privacy and minimize undue approval delays. In addition, strengthening FHA policies and their interpretation by lenders can help prevent ineligible tax debtors from continuing to receive the benefit of FHA insurance. To the extent that borrowers with tax debt represent additional risk, FHA could minimize the potential for this risk by taking steps to address the issues identified in this report.

Recommendations for Executive Action

The Secretary of HUD should direct the Assistant Secretary for Housing (Federal Housing Commissioner) to implement the following two recommendations:

Consult with IRS to develop written policies requiring lenders to collect and evaluate IRS documentation appropriate for identifying ineligible applicants with unpaid federal taxes, while fully complying with the statutory restriction on disclosure of taxpayer information. For example, FHA could require lenders to obtain consent from borrowers to allow FHA and its lenders to verify with IRS whether recipients of FHA insurance have unpaid federal taxes.

Provide FHA lenders with revised policies or additional guidance on borrower ineligibility due to delinquent federal debts and tax liens to more clearly distinguish requirements for lenders to investigate any indication that an applicant has federal tax debt (such as a federal tax lien) to provide reasonable assurance that ineligible borrowers do not receive FHA mortgage insurance.

Agency Comments and Our Evaluation

We provided a draft of this report to IRS and HUD for review and comment. IRS did not have any comments in response to the draft report. The Acting Assistant Secretary for Housing (Federal Housing Commissioner) provided a written response which is reprinted in appendix III.

In HUD’s response, the agency agreed with our recommendations and acknowledged that current policies and procedures may fail to identify all potential borrowers with delinquent tax debt. To address our recommendations, FHA stated that it would contact IRS in an effort to establish executable policy that may identify delinquent tax debtors. Further, the agency affirmed that it would execute changes to current FHA requirements for lenders in order to address the concerns discovered through the audit. Included in its written response, HUD provided technical comments which were incorporated into this report. Specifically, HUD recommended that we change the terminology used to characterize federal tax debts. According to HUD, this suggested change would provide clarity and avoid the appearance that FHA knew of delinquent tax debts. We agreed to make the recommended change. However, for certain cases included in our review, evidence indicates that FHA-approved lenders were aware of tax debts.

As agreed with your offices, unless you publicly release its contents earlier we plan no further distribution of this report until 30 days from its issue date. At that time, we will send copies of this report to interested congressional committees, the Secretary of the Treasury, the Secretary of Housing and Urban Development, the Commissioner of Internal Revenue, the Acting Assistant Secretary for Housing (Federal Housing Commissioner), and other interested parties. The report is also available at no charge on the GAO Web site at http://www.gao.gov. If you have any questions concerning this report, please contact Gregory D. Kutz at (202) 512-6722 or kutzg@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Major contributors to this report are acknowledged in appendix IV.

Appendix I: Objectives, Scope, and Methodology

Our objectives were to determine: (1) the extent to which tax debtors benefited from the Recovery Act’s provisions for increased Federal Housing Administration (FHA) loan limits and the First-Time Homebuyer Credit (FTHBC); and (2) what challenges, if any, FHA faces in preventing ineligible tax debtors from receiving mortgage insurance.

To determine the extent to which individuals with unpaid tax debt benefited from the Recovery Act’s provision for increased loan limits on FHA mortgage insurance, we obtained and analyzed electronic data from FHA’s Single Family Data Warehouse (SFDW) as of September 2011. We also obtained and analyzed tax debt data from the Internal Revenue Service (IRS) as of June 30, 2010. Using the taxpayer identification numbers (TIN) present in these data, we electronically matched IRS’s tax debt data to the population we identified of Recovery Act borrower Social Security numbers (SSN) from the SFDW. The Recovery Act stipulated that revised FHA loan limits for 2009 be set in each county at the higher of the loan limits established under the Economic Stimulus Act of 2008 (ESA) or those established under the Housing and Economic Recovery Act of 2009 (HERA). Since loan limits would have reverted to HERA- established rates if the Recovery Act had not been promulgated, we considered an FHA borrower to be part of our Recovery Act population if he or she obtained mortgage insurance in 2009 at a value greater than would have been authorized under HERA. FHA officials agreed with this methodology.

To determine the extent to which individuals with unpaid taxes received the FTHBC under the Recovery Act, we obtained and analyzed FTHBC transaction data from IRS as of July 10, 2010, and then electronically matched IRS’s tax debt data to the population of individuals who claimed the FTHBC under the Recovery Act. Since IRS’s FTHBC data do not contain home purchase dates, we were unable to isolate all individuals who benefitted from the FTHBC under the Recovery Act. As a result, we used the SFDW to obtain home purchase dates to determine which FTHBCs were awarded under the Recovery Act. We electronically matched the FTHBC transaction data TINs with the SSNs in the SFDW and extracted mortgages with closing dates from January 1, 2009, through November 30, 2009, to identify a population of Recovery Act FTHBC recipients with FHA mortgage insurance. We identified 722,003 FTHBC claims associated with the Recovery Act for individuals who financed their home using FHA mortgage insurance, and in our prior work we found that there were 1,669,081 FTHBC claims filed under the Recovery Act.approximately 43 percent of all FTHBCs claimed under the Recovery Act.

Therefore, our analysis includes two groups: 1. individuals who received FHA mortgage insurance under the higher limits authorized under the Recovery Act, and 2. individuals who received the FTHBC under the Recovery Act and obtained FHA mortgage insurance of any value.

Further, to determine the extent to which these Recovery Act FTHBC recipients with unpaid tax debt received federal tax refunds in the same year they claimed the FTHBC, we obtained and analyzed federal tax refund data from IRS from fiscal years 2009 and 2010.matched the refund data TINs with the TINs we identified to be FHA We electronically mortgage insurance borrowers who claimed the FTHBC under the Recovery Act while having unpaid federal tax debt.

To avoid overestimating the amount owed by borrowers who benefitted from the increased loan limits for FHA mortgage insurance under the Recovery Act and FTHBC recipients with unpaid federal tax debts, and to capture only significant tax debts, we excluded from our analysis tax debts meeting specific criteria to establish a minimum threshold in the amount of tax debt to be considered when determining whether a tax debt is significant. The criteria we used to exclude tax debts are as follows: tax debts IRS classified as compliance assessments or memo accounts for financial reporting, tax debts from calendar years 2009 and 2010 tax periods, tax debts that were assessed by IRS after the mortgage insurance was issued, and tax debts from individuals with total unpaid taxes of less than $100.

The criteria above were used to exclude tax debts that might be under dispute or generally duplicative or invalid, and tax debts that were recently incurred. Specifically, compliance assessments or memo accounts were excluded because these taxes have neither been agreed to by the taxpayers nor affirmed by the court, or these taxes could be invalid or duplicative of other taxes already reported. We also excluded tax debts from calendar years 2009 and 2010 tax periods to eliminate tax debt that may involve matters that are routinely resolved between the taxpayers and IRS, with the taxes paid or abated within a short time. We excluded any debts that were assessed by IRS after the mortgage insurance was received because those debts would not have been included in IRS records at the time the mortgage insurance was issued. We also excluded tax debts of less than $100 because we considered them insignificant for the purpose of determining the extent of taxes owed by Recovery Act recipients. Using these criteria, we identified at least 6,327 Recovery Act recipients with federal tax debt.

To provide examples of Recovery Act recipients who have unpaid federal taxes, we selected a non-probability sample of Recovery Act beneficiaries for a detailed review. We used the selection criteria below to provide examples that illustrate the sizeable amounts of taxes owed by some individuals who benefitted from the Recovery Act:

We selected nine individuals who benefitted from increased FHA mortgage limits who had (1) large amounts of unpaid federal tax debt (at least $100,000), (2) at least three delinquent tax periods, and (3) indications of IRS penalties or home foreclosures.

We also selected nine individuals who benefitted from the FTHBC and obtained FHA mortgage insurance of any value who had (1) large amounts of unpaid federal tax debt (at least $50,000), (2) at least five delinquent tax periods, (3) FHA mortgage insurance of $200,000 or more, and (4) indications of IRS penalties or home foreclosures.

We requested IRS notes, detailed account transcripts, and other records from IRS as well as mortgage files from FHA for these 18 individuals. Of the 18 total requested cases, FHA provided us information that only allowed us to fully analyze 8 of them. Although we did not receive complete information necessary to fully analyze the remaining cases, we were able to assess all 18 for limited purposes (e.g., nonfiling of tax returns). We also selected 9 additional cases of FTHBC recipients who received tax refunds to determine how they were able to receive federal tax refunds while having unpaid federal taxes. For these 9, we selected individuals who had (1) at least $5,000 in unpaid federal tax debt, (2) at least three delinquent tax periods, and (3) a federal tax refund value of at least $5,000. All of our cases were selected to illustrate the sizeable amounts of taxes owed by some individuals who benefitted from the Recovery Act. None of our case selections provide information that can be generalized beyond the specific cases presented.

To analyze the controls FHA has in place to prevent ineligible individuals with unpaid federal tax debt from receiving mortgage insurance, we reviewed FHA’s lender credit analysis and underwriting handbook, mortgagee letters, and reports from GAO and HUD’s Office of Inspector General. We also interviewed officials from FHA’s Office of Single Family Housing and Office of the Chief Information Officer.

To understand how private lenders interpret and implement FHA’s guidelines for preventing individuals with delinquent federal tax debt from receiving mortgage insurance, we interviewed senior-level officials from three large FHA-approved lenders. We selected four lenders based on the following criteria: (1) we selected the two largest lenders in terms of the number of FHA loans approved in 2009, and (2) we selected 2 of the top 10 largest FHA lenders that approved a comparable number of FHA loans in 2009 but varied in proportion of loans awarded to individuals with federal tax debt. However, the lender chosen for having a high proportion of loans awarded to individuals with federal tax debt declined to speak with GAO officials. In total, the three lenders we interviewed endorsed about 15 percent of all FHA mortgages for homes purchased in 2009.

Data Reliability Assessment

To assess the reliability of record-level IRS unpaid assessments and FTHBC data, we relied on the work we performed during our annual audit of IRS’s financial statements and interviewed knowledgeable IRS officials We also performed electronic testing of about any data reliability issues.required FTHBC elements. While our financial statement audits have identified some data reliability problems associated with tracing IRS’s tax records to source records and including errors and delays in recording taxpayer information and payments, we determined that the data were sufficiently reliable to address this report’s objectives.

To assess the reliability of record-level FHA mortgage insurance data, we reviewed documentation from FHA, interviewed FHA officials who administer these information systems and officials who routinely use these systems for mortgage insurance management, verified selected data across multiple sources, and performed electronic testing of required elements. We determined that the data were sufficiently reliable for our purposes.

We conducted this performance audit and related investigations from April 2011 through May 2012. We performed this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our audit findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

Appendix II: Excerpts of the Uniform Residential Loan Application

Two of the three figures below represent sections of the Uniform Residential Loan Application (URLA) where applicant’s are required to disclose any debts that may affect their eligibility for FHA mortgage insurance or their ability to repay the proposed mortgage. The third excerpt lists the consequences of making a false statement on the URLA. Knowingly making any false statement on the URLA is a federal crime punishable by fine or imprisonment.

Appendix III: Comments from the Federal Housing Administration

Appendix IV: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact named above, Matthew Valenta, Assistant Director; Emily C.B. Wold, Analyst-in-Charge; Jamie L. Berryhill; Jeff McDermott; Maria McMullen; Wayne Turowski; Susan B. Wallace; and Timothy Walker made significant contributions to this report.