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.