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Mandating Their Use Is Questionable' which was released on June 01,
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Report to Congressional Requesters:
April 2004:
HOME INSPECTIONS:
Many Buyers Benefit from Inspections, but Mandating Their Use Is
Questionable:
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-04-462]:
GAO Highlights:
Highlights of GAO-04-462, a report to congressional requesters
Why GAO Did This Study:
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.
What GAO Found:
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.
Buyers’ Opinions on Benefits and Drawback of Home Inspections:
[See PDF for image]
[End of figure]
What GAO Recommends:
GAO is not making any recommendations. We observed, and HUD agreed,
that there appears to be little value to making home inspections
mandatory. Many buyers already get them, there is no significant link
with loan performance, and the resources to enforce an inspection
requirement may well outweigh the benefits.
www.gao.gov/cgi-bin/getrpt?GAO-04-462.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Thomas J. McCool at (202)
512-8678 or mccoolt@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Buyers Frequently Use and Report Benefits from Home Inspections, with
Some Noting Problems with Quality and Cost:
Over One-Third of Homebuyers Understand the Differences between Home
Inspections and Appraisals:
Home Inspections Appear to Have No Significant Association with the
Performance of FHA-Insured Loans:
Enforcing Mandatory Home Inspections Would Pose Significant Challenges
to FHA but Would Offer Varied Results for Homebuyers and Inspectors:
Observations:
Agency Comments and Our Evaluation:
Scope and Methodology:
Appendixes:
Appendix I: Comments from the U.S. Department of Housing and Urban
Development:
Appendix II: Scope and Methodology for GAO Survey of Recent Homebuyers:
Overview:
Scope and Methodology:
Survey Development:
Sampling:
Sampling Error:
Nonsampling Error and Data Quality:
GAO's Decision Rules for Using the Homebuyer Survey to Measure
Respondents' Understanding of the Differences between Inspections and
Appraisals:
Appendix III: Scope and Methodology for GAO Loan Performance Analysis:
FHA-Insured Loans, Fiscal Years 1996-1999:
Overview:
Scope and Methodology:
Appendix IV: Results of GAO's FHA-Insured Loan Performance Analysis,
Fiscal Years 1996-1999:
GAO's Econometric Model for Forecasting the Performance of FHA-Insured
Mortgages:
Reliability of Data GAO's Model Uses to Estimate Foreclosures and
Prepayments:
Appendix V: GAO Survey of Recent Home Buyers:
Appendix VI: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Acknowledgments:
Tables:
Table 1: Home Inspection Components Addressed by FHA Appraisals:
Table 2: Differences in Characteristics of Home Inspections and FHA
Appraisals:
Table 3: Opinions of Buyers Who Got Home Inspections in 2002 (percent
reporting certain answer choices):
Table 4: Differences in Average Borrower and Loan Characteristics
between Buyers Who Did and Did Not Get Home Inspections (FHA-insured
loans, fiscal years 1996-1999):
Table 5: Disposition of Sample Drawn from 2002 FHA Data:
Table 6: Coefficients from Logistic Regression:
Figures:
Figure 1: Common Steps in the Homebuying Process:
Figure 2: Buyers' Opinions on Benefits and Drawbacks of Home
Inspections:
Figure 3: Homeowners Using FHA-Insured Financing in 2002 Who Report
Getting Home Inspections:
Figure 4: Percentage of Homebuyers Whose Inspections Identified
Problems (overall and by type and cost):
Figure 5: Areas Where Buyers Who Got Home Inspections Report Problems
in Their First Year of Homeownership (percent):
Figure 6: GAO Inspection Survey Question:
Figure 7: Responses GAO Considered to Determine Understanding:
Figure 8: GAO Inspection Survey Question:
Figure 9: States That Regulate Home Inspections:
Figure 10: Fixed vs. Minimum Federal Standards:
Figure 11: GAO Decision Rules for Judging Buyers' Understanding of the
Differences between FHA Appraisals and Home Inspections:
Abbreviations:
FHA: Federal Housing Administration:
GAO: General Accounting Office:
HUD: Department of Housing and Urban Development:
Letter April 30, 2004:
The Honorable Robert W. Ney:
Chairman:
Subcommittee on Housing and Community Opportunity:
Committee on Financial Services:
House of Representatives:
The Honorable Doug Bereuter:
House of Representatives:
Every year, nearly one million people buy homes--many for the first
time--using mortgages that the Department of Housing and Urban
Development's (HUD) Federal Housing Administration (FHA) insures. FHA
does not require prospective homeowners to protect their interests by,
for example, getting a home inspection before committing to buying a
house; however, there are requirements, such as getting an appraisal,
to protect the interests of FHA and the lenders who make the loans FHA
insures. Appraisals do this by confirming the home's market value so
that the lender and FHA know they are not lending or insuring more than
the home is worth.
FHA requires that appraisers conduct a limited review of a home's
physical condition. In the 1990s, FHA dealt with a series of problems
resulting from owners being unaware of costly problems appraisers
identified in the homes they bought with FHA-insured mortgages. This
led FHA to emphasize the importance of getting a home inspection by
requiring borrowers to read and sign a form explaining the benefits of
inspections. Because borrowers might not get this information until
they apply for mortgages (after signing purchase contracts), and
because getting an inspection usually requires making a purchase offer
contingent on it, prospective buyers may have made their decisions
about inspections before they get this information. FHA also began
notifying buyers (just prior to closing on their homes) of any defects
documented in the appraisers' physical condition reviews.
Because the property condition elements of the FHA appraisal might
appear to be quite similar to a home inspection, some in the home
inspection industry expressed concern that buyers were now confusing
inspections and appraisals and, in some cases, forgoing home
inspections because they mistakenly understood them to be the same
thing. Home inspection advocates claimed that increasing the number of
buyers who get home inspections would benefit FHA by reducing
foreclosures resulting from costly property condition problems an
inspection could have helped the buyer avoid. Assessing the validity of
the industry's claims, however, proved difficult because no one knew
with certainty how many buyers get home inspections and to what extent
the buyers and FHA benefit from them.
To better assess whether more, or possibly all, buyers using FHA-
insured mortgages should get home inspections, you asked us to develop
some of the information necessary to make such a judgment. As agreed
with your offices, this report answers four questions: (1) how many
recent homebuyers got home inspections and what do they report as the
primary benefits and drawbacks of the inspections, (2) to what extent
and by what means do recent homebuyers understand the differences
between appraisals and home inspections, (3) to what extent is getting
a home inspection associated with the performance of FHA-insured loans,
and (4) what would be the implications for FHA, homebuyers, and others
if home inspections were made mandatory for FHA-insured mortgages.
We surveyed a representative sample of recent homebuyers[Footnote 1]
(those who purchased homes in 2002 using FHA-insured financing) to
determine (1) how many got home inspections; (2) what they report as
the benefits and drawbacks of inspections; and (3) the extent to which
they understand the differences between appraisals and inspections. The
response rate for this survey was 56 percent.[Footnote 2] To assess the
association home inspections may have with loan performance, we
reviewed a random sample of FHA loan files from loans insured in fiscal
years 1996 through 1999 to determine whether the file indicated the
homebuyer had sought a home inspection; we then used an econometric
model to analyze the association that home inspections and other
information about properties and borrowers, such as credit scores,
might have with the loans' performance. To determine the implications
of making home inspections mandatory, we interviewed officials at FHA,
the Department of Veterans Affairs, the Federal National Mortgage
Association (Fannie Mae), and the Federal Home Loan Mortgage
Corporation (Freddie Mac); we also consulted with industry association
officials representing home inspectors, appraisers, realtors, and
lenders.
Appendixes II and III provide detailed information on the scope and
methodology for our homebuyer survey and loan performance file review.
We present the results of our homebuyer survey in appendix V. We
conducted our review between April 2003 and April 2004 in accordance
with generally accepted government auditing standards.
Results in Brief:
The vast majority of buyers using FHA-insured financing in 2002 got
home inspections and benefited from them in ways such as getting
sellers to fix minor problems before closing, but they occasionally
reported certain drawbacks related to the cost and quality of the
inspections. We estimate 86 percent of buyers got home inspections for
the homes they purchased using FHA-insured financing in 2002. Most
often, buyers got the inspections because they wanted to ensure there
were no serious problems with the homes they were purchasing or because
they believed FHA required an inspection. Homebuyers reported several
ways in which they benefited from getting home inspections, which
typically cost less than $400. Two-thirds of the inspections identified
problems with homes, most of which buyers characterized as minor
(costing less than $500 to address). This benefited buyers by allowing
them to renegotiate the terms of their purchases so that sellers fixed
these problems before closing. Some buyers also benefited from their
inspections by learning about home maintenance. While most buyers
characterized their experience as generally positive, some identified
drawbacks. About 16 percent reported that in the first year they owned
their homes, they experienced problems that they believe inspectors
should have identified but did not (most commonly in the plumbing and
appliances).
About 36 percent of all homebuyers using FHA-insured financing in 2002
appear to understand the differences between appraisals and home
inspections,[Footnote 3] but it is unclear to us to what extent most
homebuyers understand the differences between the two. Home inspections
and appraisals differ in substantial ways. Inspections protect buyers'
interests, involve in-depth observations of a home's major systems, and
can allow buyers to cancel a purchase. Appraisals protect FHA's
financial interests, involve a visual observation of readily observable
conditions, and give buyers fewer options for canceling a purchase.
Most homebuyers, regardless of their understanding, report that they
learn about home inspections and appraisals from real estate agents and
lenders. We believe it is likely that buyers more often understand the
differences between appraisals and inspections when they report someone
has discussed these differences with them. However, the response rate
for our homebuyer survey precludes us from identifying additional
distinctions about the various ways homebuyers may have developed their
understanding of the differences between appraisals and inspections.
We found no significant relationship between getting a home inspection
and loan performance. Other factors that have long been recognized as
strong predictors of loan performance explain most, if not all, of any
apparent difference in how often borrowers who got inspections and
those who did not defaulted on their mortgages. For example, research
indicates homebuyers who have higher mean credit scores or less often
use adjustable rate mortgages tend to default on their loans at lower
rates than other buyers and we found this held true for the loans we
analyzed. Other factors that also had measurable effects on loan
performance included the age and size of the loans, the initial loan-
to-value ratio,[Footnote 4] and house price appreciation. A simple
comparison of foreclosure rates between borrowers who did and did not
get inspections can be misleading. The net effect of a variety of
factors, including home inspections, is that borrower, loan, and
property characteristics explain the apparent difference in foreclosure
rates in our sample, not the inspections. Therefore, based on our
analysis, increasing the number of buyers who get inspections would
likely not have a material effect on FHA's financial health.
The implications for FHA of making home inspections mandatory primarily
concern setting national standards for the inspections and the
resources it would need to enforce such a requirement. For other
concerned parties, such as homebuyers, making home inspections
mandatory would have mixed results--more might reap the benefits of
home inspections, but some buyers might also find the requirement hurts
their ability to compete in certain markets while driving up costs for
them and, possibly, home inspectors. FHA officials consider an
effective enforcement system for any home inspection requirement would
be the most important and resource-intensive part of any new regulatory
effort. These officials indicate FHA does not have the resources it
would need to do this job well and stress that without them any such
requirement would have little benefit. FHA might be able to mitigate
the resource requirements by working through the states, 27 of which
have in place varying degrees of regulatory structures and enforcement
capacity. Doing so might require that FHA devote resources to support
these 27 states' efforts. In the 23 states that do not currently
regulate home inspections, FHA would face a choice between finding a
way to conduct the enforcement itself or, for example, paying those
states to do so. FHA might also find the requirement hurts its
competitiveness as more buyers who can pursue other lending options do
so, potentially exacerbating a trend of FHA serving increasing numbers
of riskier borrowers. Homebuyers would likely see mixed results from
such a requirement, reaping benefits similar to those recent homebuyers
reported in our survey but also facing some of the same drawbacks
associated with the quality of some inspections. The home inspectors
could face added costs associated with any FHA requirements that exceed
those they may already be meeting (such as a state continuing education
requirement).
In comments on a draft of this report, HUD characterized it as a
comprehensive analysis and agreed with our findings and observations.
Background:
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.[Footnote 5]
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.
Figure 1: Common Steps in the Homebuying Process:
[See PDF for image]
[End of figure]
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.[Footnote 6]
Table 1: Home Inspection Components Addressed by FHA Appraisals:
Home inspection component: Water pressure/flow;
Addressed by appraisers for compliance with FHA's minimum
property requirements? Yes.
Home inspection component: Electrical panel box;
Addressed by appraisers for compliance with FHA's minimum
property requirements? Yes.
Home inspection component: Attic;
Addressed by appraisers for compliance with FHA's minimum
property requirements? Yes.
Home inspection component: Roof;
Addressed by appraisers for compliance with FHA's minimum
property requirements? Yes.
Home inspection component: Cooling system;
Addressed by appraisers for compliance with FHA's minimum
property requirements? Yes.
Home inspection component: Heating System;
Addressed by appraisers for compliance with FHA's minimum
property requirements? Yes.
Home inspection component: Structure of home;
Addressed by appraisers for compliance with FHA's minimum
property requirements? Yes.
Home inspection component: Interior (e.g., walls, stairways);
Addressed by appraisers for compliance with FHA's minimum
property requirements? Yes.
Home inspection component: Exterior (e.g., grading, drainage);
Addressed by appraisers for compliance with FHA's minimum
property requirements? Yes.
Home inspection component: Fireplace/solid fuel burning appliances;
Addressed by appraisers for compliance with FHA's minimum
property requirements? No.
Home inspection component: Garage doors;
Addressed by appraisers for compliance with FHA's minimum
property requirements? Yes.
Source: FHA valuation conditions; National Association of Home
Inspectors Standards of Practice and Code of Ethics, 1990-2003.7
edition, © NAHI; and The Standards of Practice and Code of Ethics of
the American Society of Home Inspectors, January 1, 2000, © ASHI.
[End of table]
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.
Table 2: Differences in Characteristics of Home Inspections and FHA
Appraisals:
Characteristic: Purpose;
Home inspection: Protects buyers' interests;
FHA appraisal: Protects lenders' and FHA's financial interests; ensures
compliance with FHA minimum property requirements.
Characteristic: Timing;
Home inspection: Usually less than 2 weeks after seller accepts a
purchase offer;
FHA appraisal: After loan application; may be ordered by the lender
more than several weeks after seller accepts purchase offer.
Characteristic: Type/focus;
Home inspection: Detailed report on the structural and functional
condition of the property;
FHA appraisal: Market value assessment (based on conditions observable
to the naked eye).
Characteristic: Depth;
Home inspection: In-depth, invasive observations of readily accessible
systems and components; can take 2 hours or longer;
FHA appraisal: Readily observable conditions; 30 minutes to 1 hour on
site.
Characteristic: Recourse for buyer;
Home inspection: Renegotiate or cancel purchase offer (if a contract
contingency requires the inspection and allows recourse for the buyer);
FHA appraisal: Limited options--mainly applicable if (1) appraised
market value is lower than purchase price or (2) property does not meet
FHA's minimum property requirements.
Source: GAO.
[End of table]
Buyers Frequently Use and Report Benefits from Home Inspections, with
Some Noting Problems with Quality and Cost:
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.
Figure 2: Buyers' Opinions on Benefits and Drawbacks of Home
Inspections:
[See PDF for image]
[End of figure]
Many Homebuyers Get Home Inspections, Primarily to Ensure That Houses
Are in Adequate Condition:
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.[Footnote 7] Most inspections cost buyers less than $400.
Figure 3: Homeowners Using FHA-Insured Financing in 2002 Who Report
Getting Home Inspections:
[See PDF for image]
[End of figure]
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.
Buyers Are Highly Satisfied with Home Inspections, Reporting Benefits
in Negotiating Purchases and Learning about Home Maintenance:
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).
Table 3: Opinions of Buyers Who Got Home Inspections in 2002 (percent
reporting certain answer choices):
Buyer is likely to get a home inspection for future purchases; 94%.
Inspections were worth as much or more than buyers paid for them; 85%.
Increased the buyer's confidence in their purchase; 80%.
Inspection gave buyers peace of mind that homes had no major problems;
74%.
Experience was somewhat or very positive; 73%.
Source: GAO analysis of survey respondent data.
[End of table]
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.
Figure 4: Percentage of Homebuyers Whose Inspections Identified
Problems (overall and by type and cost):
[See PDF for image]
[A] The 95 percent confidence interval exceeds +/-10 percent of the
estimate (lower and upper bounds are 53 percent and 76 percent).
[B] The 95 percent confidence interval exceeds +/-10 percent of the
estimate (lower and upper bounds are 19 percent and 41 percent).
[End of figure]
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.[Footnote 8] In addition, about one in five buyers report that
they benefited from their home inspection because it allowed them to
learn about home maintenance.[Footnote 9] 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.
A Small Minority of Buyers Report the Costs and Quality of Some
Inspections Can Be Drawbacks:
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.
Figure 5: Areas Where Buyers Who Got Home Inspections Report Problems
in Their First Year of Homeownership (percent):
[See PDF for image]
Note: Row percentages may not add due to rounding.
[End of figure]
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.
Over One-Third of Homebuyers Understand the Differences between Home
Inspections and Appraisals:
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.
More Than One-Third of Homebuyers Understand the Differences between
Home Inspections and Appraisals:
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).
Figure 6: GAO Inspection Survey Question:
[See PDF for image]
[End of figure]
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.
Figure 7: Responses GAO Considered to Determine Understanding:
[See PDF for image]
[End of figure]
No Conclusive Judgment Was Possible for Most Homebuyers:
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.[Footnote 10] 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;[Footnote 11] for all other
buyers, 47 percent report having this discussion.[Footnote 12]
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).
Figure 8: GAO Inspection Survey Question:
[See PDF for image]
[End of figure]
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.[Footnote
13]
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.
Home Inspections Appear to Have No Significant Association with the
Performance of FHA-Insured Loans:
The differences in loan performance between buyers who did and did not
get home inspections[Footnote 14] 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.
The Net Effect of Home Inspections on Loan Performance Is Not
Significant:
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.[Footnote 15] For
example, recent research[Footnote 16] 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.[Footnote 17] 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.[Footnote 18] 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).[Footnote 19]
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,[Footnote 20] 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.
Borrower Characteristics, Loan Features, and House Price Changes Are
the Significant Predictors of Loan Performance:
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).
Table 4: Differences in Average Borrower and Loan Characteristics
between Buyers Who Did and Did Not Get Home Inspections (FHA-insured
loans, fiscal years 1996-1999):
Variable (percent): Foreclosure rate;
Home inspections: 2.64%;
No home inspection: 2.95%.
Variable (percent): Loan-to-value ratio;
Home inspections: 95.7%;
No home inspection: 93%.
Variable (percent): Adjustable rate mortgage;
Home inspections: 10%;
No home inspection: 19%.
Variable (percent): No credit score present;
Home inspections: 21%;
No home inspection: 30%.
Source: GAO.
[End of table]
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.
Enforcing Mandatory Home Inspections Would Pose Significant Challenges
to FHA but Would Offer Varied Results for Homebuyers and Inspectors:
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 Believes Mandatory Home Inspections Would Require Setting National
Standards:
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.
Figure 9: States That Regulate Home Inspections:
[See PDF for image]
Note: The District of Columbia does not regulate home inspections.
[End of figure]
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.[Footnote 21] These choices differ
primarily in the way they preempt existing state regulations (see
figure 10).
Figure 10: Fixed vs. Minimum Federal Standards:
[See PDF for image]
[End of figure]
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 May Lack the Resources to Effectively Enforce a National Home
Inspection Requirement:
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.[Footnote 22]
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.[Footnote 23] 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.[Footnote 24] 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.[Footnote 25]
Homebuyers Might Seek Other Loan Options if FHA Requires a Home
Inspection:
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.[Footnote 26]
More Homebuyers Might Benefit from Inspections, but More Also Might
Report Drawbacks from a New Requirement:
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 May Do More Inspections but Face Some Additional Costs:
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).[Footnote 27]
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.
Observations:
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.
Agency Comments and Our Evaluation:
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.
Scope and Methodology:
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 [Hyperlink, 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.
Signed by:
Thomas J. McCool:
Managing Director, Financial Markets and Community Investment:
[End of section]
Appendixes:
Appendix I: Comments from the U.S. Department of Housing and Urban
Development:
U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
WASHINGTON, DC 20410.8000:
ASSISTANT SECRETARY FOR HOUSING-FEDERAL HOUSING COMMISSIONER:
Mr. Mathew J. Scire
Assistant Director
Financial Markets and Community Investment
General Accounting Office:
441 G Street NW, Room 2440-B
Washington, DC 20548:
Dear Mr. Scire:
The Department of Housing and Urban Development's Federal Housing
Administration (FHA) has reviewed the draft report entitled Home
Inspections: Many Buyers Benefit from Inspections, but Mandating Their
Use is Questionable (GAO-04-462). FHA appreciates the General
Accounting Office's (GAO) comprehensive analysis of the issue and
concurs with the findings and conclusions outlined in the draft report.
FHA has identified a few minor errors and is recommending revisions for
accuracy and clarification. The proposed edits are listed below:
Page 1: 2nd paragraph, 4th sentence, recommend the description be
expanded and the sentence split into several sentences to read as
follows: "Borrowers are required to read and sign "For Your Protection:
Get a Home Inspection" at or before the sales contract is ratified.
However, in some cases, the borrower does not receive the information
from their realtor at the time the sales contract is executed. In these
cases, at loan application, the lender would direct the borrower to
review and sign the form and would have the sales contract re-executed.
When borrowers signs the form at loan application, rather than at the
time the sales contract is executed, they may have made their decisions
about inspections before they read and signed the form.":
Page 7: 1st paragraph, end of last sentence should read as follows: "In
Fiscal Year 2002, for instance, 72 percent of FHA-insured purchase
mortgages went to first time buyers.":
Page 7: 2rd paragraph, 3rd and 4th sentences, recommend the words
"confirm" and "confirming" be changed to "estimate" and "estimating,"
respectively.
Page 9: the For Your Protection: Get a Home Inspection form (HUD-92564-
CN) was updated and made mandatory on February 22, 2004.
Page 11: heading on right hand side of Table 1, recommend the phrase
"minimum property standards" be changed to read "minimum property
requirements.":
Page 12: upper right and lower right boxes in right hand column of
Table 2, recommend the phrase "minimum property standards" be changed
to read "minimum property requirements.":
Page 33: 3rd paragraph, 2nd sentence, recommend sentence be changed to
read as follows: "In the past, HUD's procedures for monitoring
appraisals were inadequate and inefficient. The Department was
reviewing a random sample of 10 percent of the program's activity,
rather than identifying particular appraisers or targeting riskier
types of loans for review. Consequently, the sanctioning of FHA
appraisers was inconsistent.":
Page 36: 1st paragraph, 2nd sentence, recommend sentence be changed to
read as follows: "As part of the oversight process, FHA requires
appraisers to hold state licenses and relies on the states' reporting
of disciplinary actions to the Appraisal Subcommittee (ASC).":
If you have any questions or comments pertaining to these suggested
changes, please contact Vance T. Morris, Director of the Office of
Single Family Program Development at 202-708-2121.
Sincerely,
Signed by:
John C. Weiche:
Assistant Secretary for Housing-Federal Housing Commissioner:
[End of section]
Appendix II: Scope and Methodology for GAO Survey of Recent Homebuyers:
Overview:
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.
Scope and Methodology:
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.
Survey Development:
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.
Sampling:
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)[Footnote 28] 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.
Table 5: Disposition of Sample Drawn from 2002 FHA Data:
Strata ID: 1;
Population size: 21,863;
Sampled: 12;
In scope: 5;
Out-of-scope: 0;
Nonrespondents: 7.
Strata ID: 2;
Population size: 42,027;
Sampled: 23;
In scope: 14;
Out-of-scope: 1;
Nonrespondents: 8.
Strata ID: 3;
Population size: 190,775;
Sampled: 80;
In scope: 43;
Out-of-scope: 2;
Nonrespondents: 35.
Strata ID: 4;
Population size: 64,032;
Sampled: 49;
In scope: 22;
Out-of-scope: 3;
Nonrespondents: 24.
Strata ID: 5;
Population size: 97,252;
Sampled: 41;
In scope: 24;
Out-of-scope: 1;
Nonrespondents: 16.
Strata ID: 6;
Population size: 20,321;
Sampled: 10;
In scope: 5;
Out-of-scope: 1;
Nonrespondents: 4.
Strata ID: 7;
Population size: 43,028;
Sampled: 21;
In scope: 12;
Out-of-scope: 1;
Nonrespondents: 8.
Strata ID: 8;
Population size: 70,285;
Sampled: 25;
In scope: 16;
Out-of-scope: 0;
Nonrespondents: 9.
Strata ID: Total;
Population size: 549,583;
Sampled: 261;
In scope: 141;
Out-of-scope: 9;
Nonrespondents: 111.
[End of table]
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.
Sampling Error:
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.
Nonsampling Error and Data Quality:
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.
GAO's Decision Rules for Using the Homebuyer Survey to Measure
Respondents' Understanding of the Differences between Inspections and
Appraisals:
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.[Footnote 29]
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.[Footnote 30]
Figure 11: GAO Decision Rules for Judging Buyers' Understanding of the
Differences between FHA Appraisals and Home Inspections:
[See PDF for image]
Note: Survey question numbers with decimals refer to a specific answer
choice for a question; for example, 29.5 refers to the fifth answer
choice for question 29; see appendix V for a copy of the survey
instrument.
[End of figure]
[End of section]
Appendix III: Scope and Methodology for GAO Loan Performance Analysis:
FHA-Insured Loans, Fiscal Years 1996-1999:
Overview:
For an earlier report,[Footnote 31] 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.
Scope and Methodology:
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.[Footnote 32] 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.[Footnote 33] 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.[Footnote 34] 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.[Footnote 35]
[End of section]
Appendix IV: Results of GAO's FHA-Insured Loan Performance Analysis,
Fiscal Years 1996-1999:
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.[Footnote 36]
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.[Footnote 37] 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.[Footnote 38] 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 [Footnote 39] As we show in table 6, these effects are
statistically significant.
Table 6: Coefficients from Logistic Regression:
Variable: Intercept;
Estimate: -2.3430;
Standard error: 1.2118;
P- value: 0.0532.
Variable: Risk;
Estimate: 0.2511;
Standard error: 0.0487;
P-value: 0.0001.
Variable: Median credit score;
Estimate: -0.00469;
Standard error: 0.00186;
P-value: 0.0116.
Variable: No credit score;
Estimate: -2.8584;
Standard error: 1.1812;
P-value: 0.0155.
Variable: Inspection;
Estimate: 0.0795;
Standard error: 0.1839;
P- value: 0.6655.
Source: GAO.
[End of table]
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.[Footnote 40]
GAO's Econometric Model for Forecasting the Performance of FHA-Insured
Mortgages:
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,[Footnote 41] 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,[Footnote 42] as are tables of
coefficients for the independent variables.
Reliability of Data GAO's Model Uses to Estimate Foreclosures and
Prepayments:
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.
[End of section]
Appendix V: GAO Survey of Recent Home Buyers:
[See PDF for image]
[End of figure]
[End of section]
Appendix VI: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Thomas J. McCool, (202) 512-8678 Mathew J. Scirè, (202) 512-6794:
Acknowledgments:
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.
(250096):
FOOTNOTES
[1] Throughout this report, we generally use the term "homebuyers" to
mean those who bought homes using FHA-insured financing. In any
instance where we include others in this description, such as those
using conventional financing, we note that it includes these types of
buyers.
[2] The estimates we report from the homebuyer survey are subject to
sampling error. Except where noted, all percentage estimates have 95
percent confidence intervals within +/-10 percentage points. See
appendix V for more information on each survey question.
[3] We base this estimate on our analysis of and judgments about the
respondents' answers in our survey of recent buyers, drawing on survey
questions dealing with characteristics that are closely associated with
either inspections or appraisals. These characteristics include things
like timing (inspections usually happen soon after signing a purchase
offer); who arranged for the service (lenders arrange for appraisals,
buyers and/or real estate agents usually arrange inspections); and
method of payment (appraisal costs can be included in the mortgage;
inspections generally are not).
[4] The loan-to-value ratio is the amount of the loan as a percentage
of the property's value. For example, a buyer with a $94,000 loan on a
home valued at $100,000 would have a 94 percent loan-to-value ratio.
[5] FHA also uses the fund to pay refunds of up-front premiums on
mortgages that buyers prepay, as well as administrative expenses for
managing the program.
[6] We describe the typical components of a home inspection by using
the model standards of practice of two industry associations: the
National Association of Home Inspectors (NAHI) and the American Society
of Home Inspectors (ASHI). Both sets of standards establish, for the
associations' members, the minimum standards of performance for
residential home inspections including, for example, the various
systems and components that should be part of a home inspection.
[7] That survey, by the National Association of Realtors and the
American Society of Home Inspectors, found that 77 percent of all
buyers (those using FHA-insured loans, conventional financing, or no
loans at all) got home inspections.
[8] The 95 percent confidence interval exceeds +/-10 percent of the
estimate (lower and upper bounds are 69 percent and 95 percent).
[9] There were instances where buyers reported using home inspections
to avoid buying homes altogether. About 17 percent indicated the
results of a home inspection were one reason they chose not to buy a
home they considered before they found the one they currently own (95
percent confidence interval exceeds +/-10 percent of the estimate;
lower and upper bounds are 7.3 percent and 30.9 percent).
[10] Relatively fewer buyers report they did not get inspections, and
these buyers answered fewer survey questions than did those who got the
inspections (see app. V). As a result, there were fewer questions from
which to attempt a judgment about these buyers' understanding, which
increased the possibility that these buyers gave too few answer choices
for us to make a judgment.
[11] The 95 percent confidence interval exceeds +/-10 percent of the
estimate (lower and upper bounds are 63 percent and 88 percent).
[12] The 95 percent confidence interval exceeds +/-10 percent of the
estimate (lower and upper bounds are 37 percent and 58 percent).
[13] For example, it initially appeared that those who understand more
often reported they got information about the purpose of home
inspections from real estate agents than all other buyers (67 percent
vs. 51 percent). However, the upper and lower bounds for this estimate
at the 95 percent confidence interval overlap, making it possible that
there is, in fact, no difference in this instance. For those who
understand, the interval ranges from 52 to 80 percent; for all other
buyers, the range is 39 to 62 percent.
[14] We determined that borrowers had gotten home inspections when we
found evidence of a home inspection contingency in their purchase
contracts, recognizing that, in some instances, buyers may not have
exercised their rights from such contingencies or may have gotten
inspections without evidence of them in the contracts. See appendix III
for a complete discussion of the methodology for this analysis. Details
from this analysis appear in appendix IV.
[15] For example, see U.S. General Accounting Office, Mortgage
Financing: Changes in the Performance of FHA-Insured Loans, GAO-02-773
(Washington, D.C.: July 2002); or U.S. General Accounting Office, Loan
Policy Changes Made to Strengthen FHA's Mortgage Insurance Program,
GAO/RCED-91-61 (Washington, D.C.: March 1991); or An Actuarial Review
for Fiscal Year 1998 of the Federal Housing Administration's Mutual
Mortgage Insurance Fund Final Report, PriceWaterhouseCoopers LLP, March
1, 1999; or Cotterman, Robert F., "New Evidence on the Relationship
Between Race and Mortgage Default: the Importance of Credit History
Data", Unicon Research Corporation, May 23, 2002.
[16] Cotterman, Robert F.
[17] Credit scores are a tool creditors can use to measure the
likelihood that a borrower will repay a debt. The scores, typically
three digit numbers, represent a snapshot of credit risk for a
particular point in time. According to the Federal Trade Commission,
the use of credit scoring allows lenders to make underwriting decisions
faster and more objectively.
[18] Fiscal year 1996 began on October 1, 1995, and fiscal year 1999
ran through September 30, 1999. Because we used the loans' status as of
June 2003, our analysis covers loans that may be as old as 8 years
(early fiscal year 1996) or as recent as 4 years ago (late fiscal year
1999).
[19] See U.S. General Accounting Office, Mortgage Financing: FHA's Fund
Has Grown, but Options for Drawing on the Fund Have Uncertain Outcomes,
GAO-01-460 (Washington, D.C.: February 2001).
[20] Regression analysis is a technique that allows us to single out
the effect one factor might have in explaining an observation, such as
differences in foreclosure rates (see app. IV).
[21] See U.S. General Accounting Office, Regulatory Programs: Balancing
Federal and State Responsibilities for Standard Setting and
Implementation, GAO-02-495 (Washington, D.C.: March 2002).
[22] An inflated appraisal increases the likelihood a borrower will
default on the mortgage because the market value of the house is less
than the buyer paid for it and/or owes on the mortgage. As a result,
the buyer may have no (or negative) equity in the house because the
loan amount exceeds the sales price the buyer would probably get (the
actual market value, as opposed to the value the inflated appraisal
determined). Buyers who encounter difficulty making loan payments may
be more likely to default in such a situation because selling the home
would be costly (unlike, e.g., a buyer with positive equity who would
profit from selling the home).
[23] GAO-02-495.
[24] The Appraisal Subcommittee is responsible for monitoring the
implementation of Title XI of the Financial Institutions Reform,
Recovery, and Enforcement Act of 1989 (FIRREA), which addresses both
the quality of appraisals and the qualifications of appraisers involved
in federally related transactions. Subcommittee members are appointed
by the federal financial institution regulators (the Federal Reserve
System, the Federal Deposit Insurance Corporation, the Office of the
Comptroller of the Currency, the Office of Thrift Supervision, and the
National Credit Union Administration).
[25] Some states have funding mechanisms that rely on appraiser license
fees rather than an appropriation in the state's budget process.
Because some states dedicate these fees to enforcement, enforcement
efforts do not have to compete for resources as they may have to do in
other states.
[26] GAO-02-773.
[27] FHA insured about 730,000 purchase money mortgages on single-
family homes purchased in 2002 ("purchase money" means this figure
excludes mortgage refinancings--this figure also excludes
condominiums) and 14 percent of 730,000 is 102,200. We estimate that
the increase in the number of inspections may be greater than 100,000
because the requirement could extend to more homes than those included
in the scope of our homebuyer survey, such as condominiums.
[28] 203(b) refers to single-family homes and excludes, for example,
condominiums.
[29] The set of questions we used to judge buyers' understanding is
different depending on whether or not the buyer reported getting a home
inspection (early in the survey). It was necessary to use different
lists for each set of buyers because respondents answered different
sets of questions via survey skip patterns, depending on whether or not
each reports they got a home inspection.
[30] An inconsistent answer would be, for instance, a buyer who
reported contacting a professional home inspector organization to find
an inspector (answer choice 29.5) who also reported the inspector did
not provide a written report or binder with the results of the
inspection (30.2). These answers are inconsistent because the
professional inspector organizations almost always require the
inspector provide a written report summarizing the results of the
inspection.
[31] GAO-01-460.
[32] Because we obtained from FHA the loans' status as of June 2003,
their "age" relative to origination ranged from almost 8 years (loans
from early fiscal year 1996 would have been originated late in calendar
year 1995) to over 3 years (loans from late fiscal year 1999 would have
been originated as late as September 1999).
[33] We recognize that there may be occasions where such a contingency
exists and the buyer did not obtain the inspection; similarly, there
may be occasions where we find no such contingency but there was, in
fact, a home inspection. A realtor with whom we consulted, among
others, indicated that there are likely few of these instances and
agreed that it is a reasonable judgment to conclude that the presence
of a home inspection contingency indicates that the buyer obtained the
inspection.
[34] When files contained (1) scores for both the borrower and a
coborrower, we used the scores of the borrower; (2) multiple credit
reports, we used the scores from the most recent report; (3) scores
from more than one source, we used the median of these scores.
[35] Just under 50 percent of the loan files we reviewed contained
evidence that the borrower got a home inspection, less than the 86
percent who reported getting inspections in our survey of recent
buyers. A number of factors may explain this difference. For example,
76 percent of the buyers we surveyed indicated they had inspection
contingencies in their purchase contracts, which means that 10 percent
of borrowers surveyed said they did not include such contingencies.
Also, because FHA does not require home inspections, these loan files
do not have to contain evidence that one took place. For over half of
the buyers responding to our survey, we could not judge whether or to
what extent they understood the differences between inspections and
appraisals; presumably some of these buyers may have erroneously
reported getting inspections. Finally, we do not know the extent to
which the purchase contracts in the FHA loan files may have been
preceded by offers and counter-offers that included inspection
contingencies but which did not include them after the parties had
exercised all of their options and finalized the terms of the sale.
[36] These probabilities are conditional because they are subject to
the condition that the loan has remained active until a given quarter.
[37] Cotterman.
[38] Cotterman.
[39] This is calculated by dividing the coefficient on the no credit
score variable, -2.8584, by -0.00469, the coefficient on the credit
score variable.
[40] These impacts are for percentage changes, not percentage point
changes. A claim rate of about 3 percent in this sample implies that
the effect could be anywhere from a three-quarters of a percentage
point reduction in claims to a one-and-a-half percentage point increase
in claims.
[41] If P is the probability that an event will occur, the "odds ratio"
is defined as P/(1-P). The logistic transformation is the natural
logarithm of the odds ratio. See G.S. Maddala, Limited Dependent
Variables and Quantitative Variables in Econometrics (Cambridge:
Cambridge University Press, 1983).
[42] GAO-01-460.
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