Failure to fund system upgrades at the FHA could cost taxpayers $41 million
In 2016, the Federal Housing Administration (FHA) insured approximately 9,507 mortgages it should not have insured. Our analysis shows this could cost the FHA approximately $41 million in losses.
If the US Department of Housing and Urban Development (HUD) had been granted adequate funding to upgrade a 30 year old IT database, the FHA might have avoided insuring these ineligible loans. Although the FHA has agreed to address this gap subject to availability of funds, this episode offers yet another reminder that the agency’s need for funding is urgent.
How the FHA insured mortgages for 9,507 ineligible borrowers
On March 26, the Office of the Inspector General (OIG) at HUD released a detailed audit report concluding that in 2016, the FHA inappropriately insured 9,507 mortgages with a total mortgage amount of $1.9 billion for borrowers ineligible for FHA-insured loans.
The OIG found two types of ineligible borrowers among the 2016 FHA-insured loans.
- Borrowers with delinquent federal debt. By law, the FHA cannot insure loans to borrowers with delinquent outstanding federal debt. Federal Housing Administration guidance prohibits lenders from originating FHA-insured loans to such borrowers. The FHA strives to mitigate this risk by using the Credit Alert Interactive Voice Response System (CAIVRS), a database of ineligible borrowers that HUD developed in 1987.
- Borrowers with delinquent child support payments. Federal regulation prohibits the issuance of federally insured loans (and other federal financial assistance) to people with certain delinquent child support (child support that is subject to a federal administrative offset that allows future federal payments to be withheld to collect past-due amounts).
The OIG cross-checked 1.8 million FHA borrowers against the Do Not Pay system, a collection of databases housed within the US Treasury’s Bureau of Fiscal Service that contains information on federal debt and child support delinquencies. This database allows federal agencies to verify eligibility for federal assistance programs and to avoid making payments to ineligible people. Under current practice, FHA lenders are required to cross-check mortgage applicants against HUD’s CAIVRS system but not against the Do Not Pay database.
Of the 1.8 million borrowers that were cross-checked against the Do Not Pay database, 13,927 had one or both types of delinquencies. To verify the accuracy of these matches, the OIG examined a statistical sample of 60 loans from this universe and found that 47 loans had one or both types of delinquencies. The OIG extrapolated that 9,507 FHA loans from 2016 with an aggregate loan balance of $1.9 billion were ineligible for FHA insurance.
The OIG’s chief recommendation is that the FHA should rely on the Do Not Pay system to identify delinquent borrowers, which the FHA has agreed to pursue once it secures funding to make the updates and replace the 30-year-old CAIVRS system.
These 9,507 ineligible mortgages could create a $41 million loss for the FHA
The FHA must comply with all statutory requirements. But beyond that, these loans are riskier. The OIG report found that the ineligible loans had 90-day delinquency rates twice the average for all FHA loans insured in 2016 and claim rates three times the average.
To estimate how much these loans would eventually cost taxpayers, we use the negative subsidy from HUD’s report to Congress of 4.42 percent (the difference between expected premium revenues and claim expenses). The present value of the premiums is approximately 175 basis points (bps) of the up-front mortgage insurance premium, plus an average (economic) life of seven years times the annual mortgage insurance premium of 85 bps, or 770 bps (175 plus 7 times 85). The expected claim cost is 770 minus 442, or 328 bps. If the ineligible loans have three times the expected claim costs, these loans will have cost the FHA 984 bps but will have income of only 770 bps. That results in a net loss of 214 bps. On the $1.9 billion of inappropriate loans, that equates to about $41 million in net losses for the FHA. This is just one example of the economic consequences of relying on an outdated system.
HUD has, for many years, requested additional funding to ensure the FHA has the resources it needs to carry out its mission. Additional funding would allow the FHA to update its antiquated information technology systems, such as CAIVRS, and hire additional staff.
For fiscal year 2018, HUD requested $30 million for this purpose, far less than the estimated $41 million in losses from the ineligible loans because of this one issue. With adequate resources and systems, the FHA might have avoided insuring the ineligible loans and the $41 million in estimated losses for taxpayers. The $30 million in funding would have more than paid for itself.
Illustration by retrorocket/Getty Images.