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