Home Ownership: Limiting Mortgage Assistance Provided to Owners With High-Income Growth

Published by the Government Accountability Office on 1990-09-26.

Below is a raw (and likely hideous) rendition of the original report. (PDF)


                            HOME OWNERSHIP
                            Limiting Mortgage
                            Assistance Provided to
                            Owners With High-
                            Income Growth


~;Ao,‘l2~:Irl:I~-!~o-l 17
    Resources, Community,   and
    Economic Development    Division


    September 26,199O
    The Honorable Lloyd Bentsen
    Chairman, Committee on Finance
    United States Senate
    The Honorable Dan Rostenkowski
    Chairman, Committee on Ways and Means
    House of Representatives
    As required by section 4006(i) of Public Law 100-647,we are reporting on the recapture
    provisions for qualified mortgage bond and mortgage credit certificate assistance.The report
    discusseshow the recapture mechanism is likely to affect assistedhome owners and whether
    it may be expected to limit the home ownership subsidy provided to householdswith rapid
    income growth. Also, the report discussesalternatives to the recapture mechanism that
    might limit the subsidy provided to those with rapid income growth. Chapters 3 and 4
    contain several matters for consideration by the Congress.
    We are sending copies of this report to the Senateand House committees responsible for tax
    and housing matters; the Secretary of the Treasury; the Secretary of Housing and Urban
    Development; the Commissioner of Internal Revenue;the Director, Office of Managementand
    Budget; and other interested parties. We will also make copies available to others upon

    This report was prepared under the direction of John M. Ols, Jr., Director, Housing and
    Community Development Issues,who may be reached at (202) 276-6526.Other major
    contributors to this report are listed in appendix IX.

Y J.Assistant
      Dexter Peach
              Comptroller General
Executive Summary

                   The Congressenacted legislation in 1988 to recapture someor all of the
Purpose            subsidy from first-time home owners who receive qualified mortgage
                   bond assistance.As stated in the conferencereport, the purpose of the
                   recapture mechanismwas to retrieve the subsidy from owners who
                   experience rapid income increasesafter they purchased their assisted
                   home and, as a result, did not need the subsidy to remain home owners.
                   The Congressdelayed the effective date of the recapture provisions
                   until 1991 to enable GAOto report on whether the enacted provisions
                   will accomplish the act’s purpose and to identify alternative

                   State and local government agenciesassist first-time home buyers by
Background         using qualified mortgage bond proceeds(often called mortgage revenue
                   bonds) to provide fixed-payment mortgage loans at below-market
                   interest rates. These loans lower owners’ monthly payments. Assisted
                   buyers must meet income, home purchase price, and other eligibility

                   The recapture provisions were imposed to recover someor all of the
                   assistanceif the owner’s income increasedbeyond certain levels.
                   Assisted owners pay the recapture amount as part of their federal
                   income tax for the year in which the home is sold. The recapture amount
                   is basedon an assumedinterest rate reduction of 126 percentagepoints
                   per year during the first 6 years of ownership. It increaseson a pro
                                                                                    -- rata
                   basis from $0 at the start of the first year to a maximum of 6.26 percent
                   of the mortgage amount for a home sold after 6 years. The recapture
                   amount is then phased out during years 6 to 10, after which no recap-
                   ture amount is due. Also, the recapture amount may be reduced to $0 if
                   the household’s income has not increased by certain amounts, as deter-
                   mined through a complex income test. In any case,the recapture amount
                   cannot exceedSOpercent of the gain on the sale.

                   While the recapture provisions will recover someor all of the subsidy
Results in Brief   received by certain assistedhome owners, it doesnot treat all owners
                   with income increasesequitably. For example, the 1.26 percentagepoint
                   recapture rate may be larger than the interest-rate reduction owners
                   received. Moreover, becausethe recapture amount is computed only
                   after the subsidy is discontinued, someowners will continue to receive
                   the assistanceeven after their income has risen to a level where they
                   could make unassisted housing payments. Finally, assistedloans can be

                   Page2              GAO/RCED-90-117
                                                   Recapturingthe QualifiedMortgageBondSubsidy
                              Executive Summary

                              made to those who could afford market-rate conventional loans with
                              comparable terms, and therefore do not need mortgage bond assistance.
                              Various ways exist to more closely tailor the amount recaptured to the
                              interest-rate reduction received by the owner. A more fundamental
                              changewould be to discontinue the assistancewhen the owner could
                              afford to remain an owner without the reduced-interest-rate loan.
                              Finally, agenciescould limit this assistanceto those who could not ini-
                              tially afford a market-rate conventional loan with comparable terms.

GAO’s Analysis                The recapture formula estimates whether assistedowners would still
                              meet income eligibility standards when they sell their home. If income is
                              less than the estimated eligibility standard, the recapture amount is
                              reduced or eliminated. The income increasesneededto pay any or the
                              maximum recapture amount in any year depend on (1) median income in
                              the area, (2) how the owner’s income compareswith the maximum
                              income eligibility limits when the home was purchased, and (3) changes
                              in household size.

                              GAOdeveloped five   hypothetical recapture situations. Under the most
                              conservative one, income would have to increaseby about 18 percent
                              for the household to pay the full recapture amount in the first year, and
                              an average of 11 percent per year if the home was sold after the second
                              year. The income increasesneededto pay the full recapture amount fur-
                              ther decline from an averageof 9 percent per year after year 3, to an
                              average of 6 percent per year near the end of year 10. For the other
                              cases,the income increasesneededto pay the full recapture amount
                              were almost always higher, and most were significantly higher than the
                              most conservative case.

Recapture Not Tailored   to   Many assistedowners will compute their recapture amount using a
Assistance Received           higher rate than the interest-rate reduction they receive. Others will use
                              a lower rate. These situations occur becausemost assistedowners will
                              have a mortgage interest reduction that is different from the recapture
                              formula’s assumed 1.25 percentagepoint reduction. For example, in a
                              1988 study, GAOfound that one-quarter of the sampled buyers received
                              interest rate reductions of three-quarters of a percentagepoint or less.*

                              ‘Home Ownership: Mortgage Bonds Are Costly and Provide Little Assistance to Those in Need (GAO/
                                   - 8_111, Mar. 28,1988).

                              Page3                    GAO/RCED-90-117
                                                                    Recapturingthe Qualified MortgageBondSubsidy
                                     Summary                                                      I

                            For an $80,000 mortgage in which the owner received a l-percent reduc-
                            tion in the mortgage interest rate, the owner could pay as much as
                            $1,000 more in recapture than the benefit received.

Subsidy Continues Even      Becausethe recapture amount is phased out from years 6 through 10,
When Income Increases       owners with large increasesin income and/or those who receive assis-
                            tance the longest have their recapture amounts reduced and eventually
Significantly               eliminated. This reduction occurs even if owners could afford unassisted
                            housing payments. Also, a recapture amount that is phased out may
                            induce assistedowners to stay in their home longer to avoid or reduce
                            the recapture. As a result, the subsidy period is extended even if the
                            owner could afford unassisted housing payments.

Initially, Many Assisted    Buyers can receive mortgage bond assistanceeven if they may have
Owners May Have Been        been able to afford housing payments on a market-rate loan of compa-
                            rable terms without it. Using two standard mortgage qualification tests,
Able to Afford Unassisted   GAOfound that about half of the assistedhouseholdsmay have been
Housing Payments            able to afford the samehome with a market-rate fixed-rate mortgage.
                            Limiting assistanceto only those who could not afford housing pay-
                            ments on a conventional loan of comparable terms would be a better use
                            of mortgage bond funds,

Alternative to the          An alternative to the recapture mechanism would be to increase an
Recapture Mechanism         owner’s monthly payment for principal and interest (up to the level
                            determined by the market interest rate at the time the loan was made)
                            when the owner’s income has increased sufficiently to afford those pay-
                            ments. One advantage of this approach is that it halts assistancewhen it
                            is no longer needed,rather than when the home is sold. However, this
                            approach would require housing agenciesor their agents to periodically
                            reexamine owners’ income and would make the program administration
                            more complex and costly.

                            The enacted recapture mechanism is preferable to no recapture mecha-
Matters for                 nism at all becausesomeor all of the assistancecould be recovered from
Congressional               at least someof those who probably could have waited a short time and
Consideration               purchased a home without it. However, it is a relatively ineffective way
                            to identify and recapture benefits from those who do not need continued
                            assistancebecausethe recapture requirements are triggered solely by an
                            owner’s decision to move.

                            Page4              GAO/RCED-B&117
                                                           Recapturingthe QualifiedMortgageBondSubsidy


                  If the Congressdecidesto changethe recapture provisions, it could
                  either (1) keep the current mechanism with somerevision or (2) substi-
                  tute a different approach.2Regarding the former, the Congressmay
                  wish to (1) tailor the recapture amount more closely to the interest-rate
                  reduction received and (2) eliminate the phaseout after year five so that
                  those owners who continue to benefit from the assistancehave someor
                  all of it recaptured. If the Congressdecidesto replace the recapture
                  approach, it may wish to enact an alternative that ends assistancewhen
                  owners can afford unassisted housing payments.
                  The proposals discussedabove do not keep those buyers who could
                  afford housing payments with a market-rate loan of comparable terms
                  from initially receiving assistance.The Congressmay wish to require
                  that housing agenciesinitially limit assistanceto buyers who could not
                  otherwise obtain a market-rate loan with comparable terms without
                  qualified mortgage bond assistance.

                  The Association of Local Housing Finance Agencies,National Council of
Agency Comments   State Housing Agencies,and Department of the Treasury commentedon
                  a draft of this report. The Association and the Council disagreed with
                  GAO'S alternatives to the current recapture mechanism. They cited addi-
                  tional administrative complexity of these approacheswith little, if any,
                  perceived gain. GAO agreesthat administrative requirements would
                  increase somewhat. The added requirements should be weighed against
                  better achieving the stated congressionalgoals for the recapture
                  The Association and the Council also stated that an affordability test
                  was not needed,Their disagreementscenter on their belief that current
                  eligibility standards for income and home purchase price are sufficient
                  and that GAO'S analyses are flawed. GAO conducted an additional anal-
                  ysis and continues to believe that about half of the assistedbuyers may
                  have been able to otherwise afford a market-rate loan. Therefore, GAO
                  continues to believe that a conventional affordability test is needed.
                  Treasury did not express support or opposition to GAO'S proposals but
                  emphasizedthe complexity and administrative effort neededto imple-
                  ment them.

                  2GAO's March 1988 report questioned the continued use of qualified mortgage bonds to assist first-
                  time buyers. This report should not be considered as a change in that position.

                  Page6                      GAO/RCED-90-117
                                                          Recapturingthe QuallfledMortgageBondSubsidy
contents                                                                                     ,

Executive Summary                                                                                2

Chapter 1                                                                                     10
Introduction            How QMB and MCC Programs Operate                                      10
                        Serving Lower-Income Households                                       11
                        Tightened Eligibility Standards and a Subsidy Recapture               12
                        Objectives,Scope,and Methodology                                      13

Chapter 2                                                                                     16
Many Owners May         How the Recapture Amount Is Calculated
                        Combined Effect of Several Factors Determines the
Pay a Reduced               Recapture Amount Due
Recapture Amount        State and Local Recapture MechanismsAre Apparently                    24
                        summary                                                               24

Chapter 3                                                                                     26
Changesto the           Increasing Equitable Treatment in the Recapture
Recapture Provisions    Subsidy Allowed to Continue Despite Owners’ Significant              31
to Promote More             Income Increases
Equitable Treatment     A Prospective Affordability Test Is Needed                           33
                        Conclusions                                                          36
of Owners               Matters for Consideration by the Congress                            36
                        Agency Comments                                                      36

Chapter 4                                                                                    39
Alternatives That       Substituting a Roll-Over Approach for the Recapture                  39
Would Better Identify   Income-BasedVariable Payment Loans as an Alternative                 42
and Deny Subsidy to         to the Recapture Mechanism
Those With Rapid        Conclusions                                                          43
                        Matter for Consideration by the Congress                             43
Income Growth           Agency Comments                                                      44

Appendixes              Appendix I: Example of How to Compute the Recapture                  46
          Y             Appendix II: Income IncreasesNeededto Pay the                        47
                           Recapture Amount for an Area With a $26,000
                           Median Income

                        Page6             GAO/RCED-B&117
                                                      Recapturingthe QualifiedMortgageBondSubsidy
 \                     Cmtmta

                       Appendix III: Recapture Mechanismsin Federal, State,                  61
                          and Local Housing Programs
                       Appendix IV: Expected Recapture Effects on Program                    66
                          Participation and Tax Administration Matters
                       Appendix V: Approach Used in Applying a Total-Debt-                   69
                          Expense-to-IncomeTest to Assisted Buyer Data Base
                       Appendix VI: CommentsFrom the Association of Local                    62
                          Housing Finance Agencies
                       Appendix VII: CommentsFrom the National Council of                    72
                          State Housing Agencies
                       Appendix VIII: CommentsFrom the Department of the                     91
                       Appendix IX: Major Contributors to This Report                        98

Related GAO Products                                                                        100

Tables                 Table 2.1: Summary of Recapture Requirements                          17
                       Table 2.2: Dominant Recapture Provision Over Time for                 21
                           HouseholdsA and B
                       Table 3.1: Effect of Uniform Recapture Liability on                   28
                           Assisted Owners Receiving Different Interest Rate
                       Table 3.2: Appreciation Rates of Existing Single-Family               29
                           Homesfor SelectedMetropolitan Areas - 1981-88
                       Table IV. 1: Example of Present Value of QMB Assistance               66
                           With and Without Recapture Provisions
                       Table V. 1: Comparison of QMB-AssistedBuyers to                       60
                           Household Attributes in the Survey ResearchCenter

Figures                Figure 2.1: Expected Recapture Amount for Hypothetical                19
                           HouseholdsWith Relatively Large Income Increases
                       Figure 2.2: Average Annual Income IncreasesNeededfor                  22
                           HouseholdsA and B to Pay the Maximum or Any
                           Recapture Amount
                       Figure 3.1: Alternatives to the Recapture Phaseout                    31
                       Figure II. 1: Average Annual Increase in Income Neededto              48
                           Pay the Recapture Amount for Household C

                       Page7              GAO/lWJD~117 Recaptuhtgthe QualifiedMortgageBondSubsidy
Contents                                                               ,

Figure 11.2:Average Annual Increase in Income Neededto                  49
    Pay the Recapture Amount for Household D
Figure 11.3:Average Annual Increase in Income Neededto                  60
    Pay the Recapture Amount for Household E


FRlHA      Farmers Home Administration
GAO        General Accounting Office
HUD        Department of Housing and Urban Development
MC!C       Mortgage credit certificate
&MB        Qualified mortgage bond

Page8              GAO/RCED-90-117
                                Recapturingthe QualifiedMortgageBondSubsidy
Page9   GAO/RCED-90-117
                     Recapturingthe Qualif¶edMortgageBondSubsidy
Chapter 1

                   A popular form of assistancefor first-time home buyers is a below-
                   market interest rate mortgage loan financed through tax-exempt quali-
                   fied mortgage bonds (QMB).’ A related form of assistanceis the mortgage
                   credit certificate (MCC), which allows first-time buyers to take a credit
                   on their federal income tax for a portion of mortgage interest paid. The
                   Congresshas restricted the eligibility of those receiving QMB loans and
                   MCCS to prevent upper-income households from receiving them.

                   In 1988, the Congressfurther restricted home buyer eligibility require-
                   ments. It also imposed a tax that, under certain circumstances,will
                   recapture someor all of the assistanceprovided. However, the Congress
                   deferred the effective date of the recapture provisions for loans to those
                   made on or after January 1,1991, and required us to assessthe mecha-
                   nism and alternatives that would accomplish its purpose.

                   The issuer of QMBS, usually a state or local government housing finance
How QMB and MCC    agency, issuesthese bonds when it believes that sufficient demand by
Programs Operate   home buyers exists for the resulting mortgage funds. Home buyers are
                   attracted to QMB loans becausethe interest rates are lower than those
                   available on conventional loans.2Typically, the agency issuesbonds
                   when it believes that the resulting &MB mortgage interest rates will be l-
                   l/2 to 2 percentagepoints below the conventional mortgage rate for
                   fixed-rate loans. Depending on the movement of conventional mortgage
                   interest rates between the time the bonds are issued and the time the
                   loans are made, the spread may be higher or lower than the agency
                   attempted to achieve.

                   The reduced payment from the below-market &MB loan benefits the
                   buyer.” However, the effect of this benefit is somewhat reduced since
                   buyers often pay one-time fees to the housing agency to help defray pro-
                   gram coststhat a borrower in the conventional market would not pay.
                   The prospective home buyer executesa purchase contract on a home
                   and applies for assistedfinancing through a mortgage lender acting for
                   the housing agency.The lender makes the fixed-rate QMB loan after
                   determining that the purchaser has not had an ownership interest in a

                   *These bonds are often called “mortgage revenue bonds.”

                   ‘QMB funds may also be used for other kinds of loans, such as home improvement loans; however,
                   home mortgage loans are by far the most prevalent form of assistance.

                   3We found the median reduction to be 1.44 percentage points from January 1983 to June 1987, or
                   about $40 per month after taxes. See p. 38 of Home Ownership: Mortgage Bonds Are Costly and
                   Provide Little Assistance to Those in Need (GA--B&l         11, Mar. 28, 1988).

                   Page10                    GAO/RCED-90-117
                                                          Recapturingthe QualUkl MortgageBondSubsidy
                       chapter 1

                       principal residencefor the 3 previous years (“first-time buyer”), meets
                       income and home purchase price requirements, shows repayment ability
                       at the below-market rate set by the housing agency,is a good credit risk,
                       and meets other qualifying requirements.
                       MCCS, on the other hand, entitle buyers to take a credit against their fed-
                       eral income tax liability (i.e., a dollar-for-dollar reduction in tax lia-
                       bility) for a portion of their mortgage interest paid during the year.4The
                       credit may be from 10 to 60 percent of the interest paid. In taking the
                       credit, home owners must reduce the amount of the home mortgage
                       interest deduction (i.e., a reduction from gross income) taken on their
                       year-end income tax returns by the amount of the credit. If the home
                       owner’s federal income tax liability is less than the amount of the credit,
                       the balance of the credit is lost to the owner in that year (a “nonrefund-
                       able” credit). However, the owner can carry forward any unused por-
                       tion of the credit for 3 years.
                       Loans with MU33 are made through a participating mortgage lender at
                       the market interest rate. The lender checks to make sure that the buyer
                       can afford the home and qualifies the buyer for both the mortgage loan
                       and the certificate. Lenders may or may not use the expected credit to
                       qualify the buyer. Buyers also pay a fee to help defray the cost of the

                       The Mortgage Subsidy Bond Tax Act of 1980 imposed the first statutory
Serving Lower-Income   restrictions on the ability of state and local governments to issue tax-
Households             exempt bonds for financing home mortgages.Generally, these restric-
                       tions limited (1) the dollar volume of bonds that could be issued;
                       (2) those assistedto first-time buyers; and (3) the purchase price of the
                       assistedhome to no more than 90 percent of the area average.In
                       drafting the 1980 act, the Congress,while expecting that lower-income
                       householdsbe the primary beneficiaries, largely allowed the bond
                       issuers to determine the proportion of proceedsthat would be used for
                       lower-income households.
                       The Congressrecognizedthat qualified mortgage bond programs operate
                       in housing markets that differ considerably in affordability, and the

                       4QMBs are one type of *called “private activity bonds.” The Internal Revenue Code (the Code)
                       limits the total amount of private activity bonds that can be issued each year. In lieu of issuing bonds,
                       the agency may convert some or all of its unused bond issuance authority to authority to issue a
                       certain volume of MCCs.

                       Page11                      GAO/RCED-O-117
                                                               Recapturingthe QualifiedMortgageBondSubsidy
                        Chapter1                                                                                      ,

                        broad eligibility standards that it enacted gave state and local govern-
                        ments wide flexibility in structuring their programs. Through legislative
                        changesin 1982 and 1986, this flexibility has remained, although the
                        Congresshas attempted to tighten eligibility requirements by adding a
                        requirement that, generally, assistedbuyers’ household income cannot
                        exceed 116 percent of area median income.

                        With the Technical and MiscellaneousRevenueAct of 1988 (P.L. lOO-
Tightened Eligibility   647, Nov. 10, 1988), the Congresstightened eligibility requirements once
Standards and a         again in responseto evidencethat the (1) program was serving a higher
Subsidy Recapture       proportion of single-personhouseholdsthan the first-time home buyer
                        market servesgenerally and (2) income and purchase price eligibility
                        requirements did not reflect the significant differences in which first
                        homes are affordable in different housing markets.6The act added a
                        household size adjustment to the income eligibility standard. Under the
                        act, household income for household sizesof one or two persons cannot
                        exceed 100 percent of the area median income. The income eligibility
                        standard for householdsof three or more persons remains at the 1986
                        level of 116 percent of area median income. In addition, on a formula
                        basis, the income eligibility standards are adjusted upward or down-
                        ward in areas of high or low housing costs,respectively.
                        The act also imposes a tax on assistedhouseholdsthat is designedto
                        recapture all or a portion of the expected subsidy from someQMB- or
                        Moo-assistedowners. The recapture tax was added becausethe Congress
                        believed that
                        “in those &MB- and MCC-assisted households where income has risen rapidly since
                        acquisition, the special subsidy provided by the program was not necessary in order
                        to become or remain a homeowner.“0

                        6Miscellaneous Revenue Act of 1988, Report of the Committee on Ways and Means, House of Repre-
                        sentatives, U.S. Congress. Report 160-o-796,
                                                                  July 26, 1988, pp. 434-6. See also (GAO/RCEDS&111,
                        Mar.28, 1988) and Home Ownership: Targeting Assistance to Buyers Through Qualified Mortgage
                        Bonds (GAO/RCEr,                 June 27,1988).
                        eTechnica1 and Miscellaneous Revenue Act of 1988, Conference Report to Accompany H.R. 4333.
                        House ot Hepresentatives, U.S. Congress. Report 100-1104, Vol. II, Oct. 21, 1988, p. 86.

                        The House legislative report noted that while home ownership provides the owner both consumption
                        benefits and investment benefits (through house price appreciation), the recapture mechanism was
                        intended to return the consumption assistance received through the reduced-interest QMB loan or
                        MCC tax credit. See Miscellaneous Revenue Act of 1988, p. 436.

                        Page12                    GAO/RCED-SO-117
                                                              Recapturingthe QualifiedMortgageBondSubsidy
                        chaptm 1

                        While the revised eligibility provisions under the 1988 act becameeffec-
                        tive for bonds issued (and elections not to issue bonds in favor of MCCS)
                        after December31,1988, the Congressdelayed the effective date for the
                        recapture provisions until January 1,199l. In the interim, the act
                        requires that we study the enacted recapture mechanism and alterna-
                        tives to it.

Objectives, Scope,and   Section 4006(i) of the 1988 act requires that we report on the enacted
                        provisions and any alternatives that would accomplish the purposes of
Methodology             the section. Accordingly, we studied the formula contained in the
                        enacted legislation and alternatives in terms of how they would be likely
                        to achieve the conferencereport’s stated objective of identifying those
                        with rapid income increasesand recapturing the assistanceprovided by
                        the QMB loan or MCC.' These alternatives include potential modifications
                        to the legislated provisions and substitution of different approachesfor
                        achieving the Congress’goal. We also assessedwhether the recapture
                        mechanismor other legislative provisions would prevent those who
                        could afford a market-rate loan from initially receiving a QMBloan or

                        To determine the recapture requirements for QMB loans and MCCS, we
                        reviewed the pertinent sections of the Technical and MiscellaneousRev-
                        enue Act of 1988 and the legislative reports leading to it. The Internal
                        RevenueService, which has primary regulatory responsibility, told us
                        that the Service plans to have taxpayer guidance completed by
                        To determine how two major federal home ownership programs struc-
                        ture their recapture mechanisms,we reviewed laws, regulations, and
                        program documents, and met with officials at the Department of
                        Housing and Urban Development (HUD) for its section 236 program and
                        the U.S. Department of Agriculture for the Farmers Home Administra-
                        tion’s (FmHA)section 602 program.
                        We also obtained information on the extent that recapture mechanisms
                        are used by state and local housing agenciesand whether potential
                        overlap with the federal recapture mechanism may exist. For state
                        agency practices, we obtained a summary of a 1989 survey of member
                        70ur March 1988 report concluded that the Qh%B-financingmechanism is costly, serves mostly buyers
                        who could afford homes otherwise, and does little to increase affordability for low- and moderate-
                        income buyers (see (GAO/RCED-S%111, Mar. 28,1988)). This report primarily limits its scope to
                        recapture and related issues.

                        Pagela                    GAO/RCJ3D-90-117
                                                               Recapturingthe Qualif’iedMortgage BondSubsidy

agenciesperformed by the National Council of State Housing Agencies.
To learn about local agency recapture practices, we mailed a survey
instrument or telephoned 128 local housing agenciesthat are members
of the Association of Local Housing Finance Agencies.
We reviewed economicand housing literature related to possible alterna-
tive recapture mechanismsand topics related to the behaviors of first-
time buyers. We performed our work between January and August
We sent a draft of this report to the Association of Local Housing
Finance Agencies,National Council of State Housing Agencies,and
Department of the Treasury for their review and comment. The Associa-
tion and the Council disagreed with most aspectsof our draft report.
Treasury did not express support or opposition to GAO'S proposals but
suggestedadditional discussion about the complexity and administrative
effort neededto implement the proposals. Their comments are repro-
duced in appendixes VI through VIII, respectively. Our evaluation of
their comments is set out at the end of chapters 3 and 4 and appendixes
VI through VIII. On the basis of those comments,we performed an addi-
tional test on the extent to which QMB loan recipients may have been
able to purchase the samehome with a market-rate loan (seech. 3 and
wp. VI.

Page14            GAO/NED-90-l17Recapturingthe QualifiedMortgageBondSubsidy
Chapter 2

Many Owners May Pay a Reduced
Recapture Amount

                                 The recapture provisions are a set of complex formulas that are applied
                                 when the owner disposesof the assisted home.’ The provisions are
                                 designedto recoup the assistedowner’s assumedinterest rate reduction
                                 if the owner sells the home during the first 6 years of home ownership
                                 and if income has increasedbeyond established limits. After 6 years, the
                                 recapture amount is gradually phased out until, at the end of the tenth
                                 year, no recapture amount is due,

                                 The increasesin income neededto pay the maximum, or even any,
                                 recapture amount during this period vary by year and household situa-
                                 tion. However, in the initial years the increasesneededare substantial,
                                 suggestingthat many assistedowners may pay a reduced recapture
                                 amount or, perhaps, none at all. And, those who sell their assistedhome
                                 after 6 years will have the recapture amount phased out. Therefore, we
                                 would expect that many owners, including those whose income
                                 increased rapidly after they purchased the assistedhome, will pay less
                                 in recapture than the benefit that they received.

                                 Somestate and local housing agenciesimpose forms of recapture that
                                 are independent of the federal recapture. However, the incidence of
                                 these recaptures is apparently limited. Therefore, few owners may be
                                 subject to multiple recaptures.

                                 The recapture provisions impose a potential federal income tax liability
How the Recapture                on those whose income grows after they purchase the assistedhome.
Amount Is Calculated             The recapture amount is due for the tax year in which the assistedhome
                                 is sold. The maximum recapture amount is 6.26 percent of the owner’s
                                 original mortgage amount (from QMB loans or MCCS) if the home is sold 6
                                 years after it is purchased. The recapture amount is reduced to reflect
                                 periods of time shorter or longer than 6 years (the holding period adjust-
                                 ment). In addition, adjustments for (1) gain on sale of the assistedhome
                                 and (2) changesin household income may reduce or eliminate the

Holding Period Adjustment The recapture amount increaseson a --pro rata basis from $0 to 6.26 per-
                                 cent of the assistedmortgage amount over the first 6 years, according to
                                 the number of months from date of purchase until the home is sold, and
                 Y               similarly decreasesevenly during years 6 to 10. For example, after 1

                                 ‘Dispositions are generally sales, exchanges, or gifts. We refer to dispositions as “sales” throughout
                                 the report.

                                 Page15                      GAO/RCED-90-117
                                                                          Recapturingthe QualifiedMortgageBondSubsidy

                         Chapter2                                                                                            ,
                         ManyOwnen May Paya Reduced

                         year the maximum recapture tax is 1.26 percent of the assistedloan
                         amount (6.26 x 12/60 months); after 2 years the maximum tax is 2.6
                         percent of the assistedloan amount, and so on, up to 6 years.2

Gain-On-SaleAdjustment   The recapture amount cannot exceed60 percent of the gain realized on
                         the sale of the home. The gain is computed by subtracting the basis of
                         the home (purchase price of the home plus cost of improvements and
                         certain purchase costs) from the selling price, less certain selling
                         expenses.For example, if the gain on the sale of the home was $6,000,
                         the amount recaptured could not exceed$2,600.

Income Adjustment        The general nature of the income adjustment is to estimate, at time of
                         sale, whether the assistedowner would still meet the income eligibility
                         limits for a QMB loan or MCC at that time. If the assistedowner’s house-
                         hold income at time of sale is higher than the estimated eligibility limits,
                         then no reductions to the recapture amount (becauseof income) apply.
                         If the owner’s household income is less than the estimated eligibility
                         limit, then the recapture amount is reduced to a lesser amount, as
                         described below.

                         The income adjustment provides that the recapture amount is reduced
                         by 2 percent for every $100 by which the assistedowner’s income
                         (adjusted gross income plus any tax-exempt interest) is less than the
                         estimated income eligibility limit. The estimated income eligibility limit
                         is the highest household income level that would have met the Code’s
                         income eligibility limit in the area where the buyer lived when the loan
                         was made, plus $6,000. The highest household income level is deter-
                         mined after two adjustments.
                         The first adjustment is to reflect the mortgagor’s family size on the date
                         of sale. Generally, the income eligibility limit is 116 percent of area
                         median income for householdsof three or more persons and 100 percent
                         of area median income for householdsof one or two persons.3The
                         secondadjustment is to increasethe highest household income level by 6

                         ZTax writers estimated that the typical after-tax benefit (reduction in mortgage interest rate) seen by
                         assisted buyers was 1.26 percent per year. This estimate was based on a typical before-tax reduction
                         in our March 1988 report. See p. 38 of Home Ownership: Mortgage Bonds Are Costly and Provide
                         Little Assistance to Those in Need (GA&
                         31f the seller’s household size changes, say from a two-person household at time of purchase to a
                         three-person household at time of sale, then the qualifying income dollar amount is based on the 116
                         percent standard, rather than the loo-percent eligibility standard, and vice versa.

                         Page10                     GAO/RCED-90-117
                                                                 Recapturingthe QualifiedMortgageBondSubsidy
                                  ManyOwneraMay Paya Reduced

                                  percent (simple interest) for each full year the assistedloan is out-
                                  standing. The S-percentincrease is a proxy for the amount that income
                                  eligibility limits might increaseeach year.

                                  The Code also contains several exceptions and special provisions to the
                                  computation. Table 2.1 summarizes the primary recapture requirements,
                                  and appendix I provides a detailed example of a recapture calculation.
Table 2.1: Summary of Recapture
Requlrement8                      Condition                          Provlrrion
                                  To whom recapture applies          7; T,rs who receive QMB loans or MCCs starting January 1,
                                  When recapture is due              tfh;i;zein which the owner sells or otherwise disposes of

                                  How much is recaptured             The maximum amount is 6.25 percent of the assisted
                                                                     mortaaae amount.
                                  Reductions and to limitations      The recapture amount increases from $0 the maximum
                                                                     amount over the first 5 years of ownership, and then
                                                                     decreases to $0 after 10 years.
                                                                     The recapture amount cannot exceed 50 percent of the gain
                                                                     realized on sale.
                                                                     The recapture amount is reduced if household income is
                                                                     less than the estimated income eligibility standard, subject
                                                                     to household size and income change adjustments.
                                  How recapture is paid              Recapture is part of the mortgagor’s individual income tax
                                  Other provisions                   The housing agency must inform the mortgagor of the
                                                                     potential recapture amount within 90 days of settlement.
                                                                     Home improvement loans are excepted from recapture.
                                                                     Other requirements, including limited exceptions to those
                                                                     subject to recapture, and refinancing were also enacted.
                                  Source: Section 4005(g) of P.L. 100647, IRC Stn. 143(m).

                                  This section examines how the reductions and limitations affect the
Combined Effect of                recapture amount due on the basis of a hypothetical example. The
Several Factors                   income test and the gain-on-saletest may reduce the recapture amount
Determines the                    due for householdsthat have relatively large increasesin income during
                                  the first 3 to 4 years. After the fifth year, the holding period adjustment
Recapture Amount                  reduces and eventually eliminates the amount due for all assisted
Due                               owners.
                                  Figure 2.1 shows the maximum recapture amount that would be col-
                                  lected over a lo-year period and comparesthat amount with the amount
                                  that would be collected for two householdsthat have relatively large

                                  Page17                     GAO/RCED-90-117
                                                                          Recapturingthe QualifiedMortgageBondSubsidy
Chapter2                                                                                           I
ManyOwnersMayPaya Reduced

increasesin income. For this comparison, we constructed two hypothet-
ical assistedhouseholds.Both householdslive in an area with a median
income of $34,000. Both householdspurchase $94,600 homes and obtain
assistedloans of $85,000.4Both householdshave three members and
both experiencerelatively large annual increasesin income of 10 per-
cent ann~ally.~Both households’ homes have a 7-percent appreciation
rate, which is about equal to the nationwide average for existing single-
family homes for the 1979-88period?

4The numbers chosen are illustrative of recapture provisions only. Incomes and house prices vary
widely across the nation. For this example, the area median income chosen is about equal to HUD’s
estimate of the expected 1989 nationwide household median income and its estimate of statewide
household median income for Ohio, Washington, and Wyoming.
6These increases are larger than the &percent increase in the qualifying income dollar amount built
into the recapture formula income test. They are also larger than the nationwide average increase in
nominal income for all home owners over the last 10 years that we computed from Appendix Table I
of the Joint Center for Housing Studies’ The State of the Nation’s Housing, 1989.
6National Association of Realtors’ data show an average annual appreciation of 6.7 percent on the
sale of existing homes nationwide from 1979-88. To compute the net gain, we assumed that selling
expenses, such as realtors’ commissions, transfer taxes, and other selling expenses, were 8 percent of
the sales price.

Page18                     GAO/RCED-90-117
                                        Recapturingthe QualifiedMortgageBondSubsidy
                                        ManyOwnenMay Paya Reduced

Figure 2.1: Expected Recapture Amount
for Hypothetlcal Howehold, Wlth
Relatively Large Income Increaw8         5500       Amount Recrptumd (Dollars)

                                                                                                                                      : ‘Z
                                         4400                                                                                     i
                                                                                                                           , f’              ,i’
                                                                                                                1’                          I’
                                         aaoo                                                          /                                :
                                                                                                   /                                  I’
                                                                                              /’                                  :
                                                                                        /I’                                 I’
                                                                                  1’                                       P
                                                                               ,,’                                     :
                                         1100                        ,
                                                                       ,’/’                                          r’
                                                                ,/                                              r’
                                                            i                                              r’
                                                    /                                                  z
                                            0 ”
                                                    /                    ---a----

                                                0                    1              2                  a                     4                      5   9   7   8   9   10

                                                    -                    Household A (115% of areamedian income)
                                                    --I.-                Household B (100% of areamedan income)
                                                    m                    Maximum Amount From Holding Period Adjuabnent

                                        Note: After the Household A and B lines intersect the maximum tax line, the amount due in this example
                                        is determined by the holding period adjustment. The recapture amount is based on an $85,000 assisted
                                        loan amount. For other details, see text.

                                        The householdsdiffer only in their income at the time that they
                                        purchase their assistedhomes. Household A has the maximum income to
                                        be eligible to participate, $39,100 (116 percent of the area median
                                        income) and Household B’s income equals the area median, or $34,000.
                                        As the thicker solid line in figure 2.1 shows, the recapture amount due
                                        before the income and gain-on-saleadjustments reachesits apex at the
                                        end of the fifth year and decreasessymmetrically through the tenth
                                        year of ownership. This line also shows that, for a household that
                                        obtains an $86,000 loan, the maximum recapture amount rises from $0
                                        when the home is purchased, to $6,313 at the end of year 6, and then
                                        declines at the samerate until the end of year 10, after which no amount
                                        is due.

                                        Page19                                          GAO/RCED-99-117
                                                                                                     Recapturiugthe QuaUfledMortgageBondSubsidy
                           ManyOwnersMay Paya Reduced

Different Recapture        Figure 2.1 also shows the consolidated effects of the income and gain-
Provisions Dominate Over   on-saletests and the holding period adjustment on HouseholdsA and B,
                           both of which bought homesunder identical terms and have relatively
Time                       large annual increasesin income (10 percent annually). Figure 2.1 shows
                           that, becauseof the income and gain-on-saletests, even those with lo-
                           percent income increasesand averagegains on sale are likely to pay less
                           than the maximum recapture amount if they sell their home before the
                           end of the third year in the caseof Household A and before the end of
                           the fifth year, for Household B.7For example, Household A’s income
                           must rise by 18 percent in the first year to pay the full recapture
                           amount.sSincewe assumeda lesser increase of 10 percent, the income
                           adjustment would reduce the recapture amount due. Also, since we
                           assumedthat selling expenseswould be 8 percent of the salesprice and
                           the home appreciated 7 percent in the first year, no gain on sale would
                           result in the first year, and, hence,no recapture amount would be due
                           even if income had risen by 18 percent or more.
                            In addition, figure 2.1 shows that the recapture amount due dependson
                           the difference between household income at the time of sale and the esti-
                            mated income eligibility standard under the recapture formula. That is,
                            for determining the recapture amount, an assistedowner’s increase in
                           income is measured against the maximum qualifying income. The lower
                           the income of the household when buying the assistedhome in relation
                           to the income eligibility standard, the more income has to rise to be sub-
                           ject to the maximum or any recapture amount. Therefore, the income
                           increasethat Household B must have before it pays any or the max-
                           imum recapture amount is greater than that for Household A since (1)
                           both are tested against the 116-percenteligibility amount of $39,100
                           and (2) Household B has a lower starting amount.0
                           Table 2.2 shows in dollar values the effect of the holding period, income,
                           and gain-on-saleprovisions in determining the recapture amount due for
                           HouseholdsA and B. For most years, the holding period adjustment
                           determines the recapture amount due.

                           ‘Two major federal home ownership programs, HUD’s section 236 and FmHA’s section 602 programs
                           for low- and moderate-income buyers, have recapture provisions. Neither recapture provision makes
                           ah adjustment for changes in the assisted owner’s income in calculating the recapture amount due.
                           (See app. III.)
                           ‘($39,100 x 1.06) + $6,000 = $46,066, which is 18 percent greater than the $39,100 income eligibility

                           ‘The results would have been the same if Household B was a one- or two-person household when it
                           bought the assisted home and a three-person or larger household when it sold it since the qualifying
                           income dollar amount is calculated on the basis of household size at sale.

                           Page20                     GAO/RCED-W-117       RecaptwAng
                                                                                    the QuallfledMortgageBondSubsidy
                                          ManyOwnersMayPaya Reduced

Table 2.2: Domlnant Recapture Provirlon
Over Tlmo for Households A and B                           Maximum
                                                       amount based              Hourehold A                Hourehold B
                                                          on holding       Amow; d;                   Amouum;d;
                                          End of              period                      Dominant                   Dominant
                                          year           ad)urtment         provis Bon8   provision    provis Pon8   provision
                                          1                      $1,063             $0         GOS             $0     GOS,INC
                                          2                       2,125          1,628          INC             0          INC
                                          3                       3,168          3,188         HPP            184          INC
                                          4                       4,250          4,250         HPP          2,430          INC
                                          5                       5,313          5,313         HPP          5,313         HPP
                                          6                       4,250          4,250         HPP          4,250         HPP
                                          7                       3,188          3,188         HPP          3,188         HPP
                                          8                       2,125          2,125         HPP          2,125        HPP
                                          9                       1,063          1,063         HPP          1,063         HPP
                                          10                          0              0         HPP              0        HPP

                                          $E%olciing    period provision
                                          INC - income provision
                                          GOS - gain-on-sale provision

                                          After the fifth year, the holding period adjustment reducesthe recap-
                                          ture amount to levels below the assumedbenefit seenby the assisted
                                          owner. The act’s legislative history doesnot indicate why this phaseout
                                          was enacted.

Income Increases Needed                   Figure 2.2 shows the annual averagepercentageincreasesin income
by Owners to Pay the                      neededin any year to pay both the maximum recapture amount and any
                                          recapture amount. For Household A, the increaseneededto pay the
Maximum or Any                            maximum recapture amount declines from 18 percent for a home sold at
Recapture                                 the end of the first year to just over 6 percent for a home sold before the
                                          end of the tenth year. The declining increasesneededto pay the recap-
                                          ture amount are due to the declining influence over time of the $6,000
                                          amount added to the adjusted qualifying income, since adjusted quali-
                                          fying income is increasedby 6 percent (simple) each year. If the $6,000
                                          amount was eliminated from the formula, income increasesneededto
                                          pay maximum recapture would be constant, that is, 6 percent in any

                                          Page21                     GAO/RCED&L117
                                                                                 Recapturhgthe QualifiedMortgageBondSubsidy
                                        chapter 2
                                        Many OwneraMay Paya Reduced

Figure 2.2: Average Annual Income
Increare8 Needed for Houwholds A and
                                        40       Average Pmconl Incroau in Income
B to Pay the Maxlmum or Any Recapture
                                        35 ’



                                             1             2         3           4          6      6     7         8         9            10

                                                 -         Full recapture amount for household A
                                                 - - - -   Any recapture amount for household A
                                                 m         Full recapture amount for household B
                                                 n n mn    Any recapture amount for household B

                                        Note: Assumes an area median income of $34,000. When it bought the assisted home, Household A’s
                                        income was 115 percent of area median income, or $39,100. Household B’s income matched the area
                                        median. See text for details.

                                        For Household B, the annual income increase neededto pay the max-
                                        imum recapture amount ranges from about 36 percent for a home sold
                                        after the first year to almost 9 percent for a home sold just before the
                                        end of year 10. The results for Household B are larger than for House-
                                        hold A because(1) HouseholdsA and B are both tested against the 116-
                                        percent eligibility amount of $39,100 and (2) Household B has a lower
                                        starting point than Household A. Of course, for both HouseholdsA and
                                        B, the recapture amount computed just before the end of year 10 will be
                                        negligible becauseof the holding period adjustment.
                                        For Household A, the income increaseneededto pay any recapture
                                        amount is slightly more than 6 percent per year. Again, the result is
                                        different for Household B with the average annual income increases
                                        neededto pay any recapture amount decreasingfrom 21 percent at the
                                        end of the first year to about 7 percent near the end of the tenth year.

                                        Page22                           GAO/RCED-!30-117
                                                                                      Recapturingthe QualifiedMortgageBondSubsidy
                          chapter 2
                          ManyOwnersMayPaya Reduced

                          But, the reasoning is the sameas for the determination of income
                          increasesneededto pay the maximum recapture amount.
                          The results that we present here depend upon a number of factors.
                          While the samegeneral results will hold for several different assump-
                          tions, the dollar values derived depend on initial values, such as the area
                          median income. The lower the initial income, the larger the percentage
                          increase in income that must occur to pay the maximum recapture
                          amount. Again, this is the result of the $6,000 constant.1oSeeappendix
                          II for an example of recapture amount calculations using lower area
                          median income levels.

Many Assisted Owners      In our March 1988 report, we found that 66 percent of the assisted
Could Pay Less Than the   buyers in our sample had incomes at or below area median income.ll
                          Also, as discussedabove, those whose incomes at time of purchase were
Maximum Recapture         equal to the area median must have quite large income increasesbefore
Amount                    they pay the maximum, and, in somecases,any recapture amount.
                          Therefore, many assistedbuyers will probably pay less than the max-
                          imum recapture amount. Figure 2.1 and table 2.2 showed how the recap-
                          ture amount would be reduced by the income test for owners whose
                          income was at 100 percent of the area median income level, rather than
                          the maximum of 116 percent of area median income. Appendix II takes
                          this analysis one step further by comparing income increasesneededto
                          pay the maximum or any recapture amount when the owner’s income at
                          time of purchase was 80,100, and 116 percent of area median income,
                          and it uses a lower area income.

                          *‘For example, assume median incomes of $24,000 for Area X and $34,000 for Area Y. Household
                          income in Area X would have to rise by 21 percent to reach $29,000 (Area X median income plus
                          $6,000) and by only 16 percent to reach $39,000 in Area Y (Area Y median income plus $6,000).

                          “Based on 136,000 loans made during the January 1983 through June 1987 period. See (GAO/
                          RCED88-111, Mar. 28,1988), p. 81.

                          Page23                    GAO/RCED-90-117
                                                                           the Qualified MortgageBondSubsidy
                     MauyOwnemMayPaya Reduced

                     Several state and local governments impose someform of recapture on
State and Local      buyers whom they assist. However, these are limited, and any overlap
Recapture            that may exist between them and a recapture of QMB loan or MCC assis-
Mechanisms Are       tance is apparently quite small.
Apparently Limited   A 1989 survey by the National Council of State Housing Agenciesof its
                     national membership showed that eight states had someform of recap-
                     ture mechanism as part of one or more of their home ownership pro-
                     grams. None of the eight members reported that it applies recapture to
                     its QMB loans. Rather, the recapture mechanismsappear to be used only
                     with special programs of limited duration or availability.

                     In 1989, we surveyed 128 membersof the Association of Local Housing
                     Finance Agencies for the samepurpose. Becausenot all local housing
                     agenciesbelong to the association,our survey may not cover all recap-
                     ture approachesin use. Twenty of the responding agenciesindicated
                     that they employed a recapture or recapture-like mechanism.12In a
                     number of cases,these mechanismswere limited to a single development
                     or small set of properties rather than applying to the agencies’housing
                     programs in general. In only a few casesdid the respondents indicate
                     that the recapture mechanismswere applied to QMB loans and/or MCCS,
                     although survey results did not provide details on these situations.

                     Consequently, the home owner, in rare instances,may be subject to mul-
                     tiple recaptures. A multiple recapture could be avoided if state and local
                     governments recaptured only the enhancementsthey add to the QMB
                     loans or MCCS (such as closing cost or down payment assistance).
                     Becausethe federal recapture provisions are effective for loans made
                     starting January 1, 1991, none of the home owners currently receiving
                     state or local assistanceand subject to a state or local recapture provi-
                     sion will be affected by the federally enacted recapture provisions.
                     A description of the state and local recapture mechanismsidentified by
                     the two surveys, as well as descriptions of recapture of subsidies in
                     HUD'S and F&A'S   home ownership programs, are contained in appendix

                     The recapture provisions are a complex set of formulas that impose a
Summary              potential tax liability on assistedowners whose income grows after they

                     12About 91 percent of the 128 members surveyed responded. Also, one of the respondents wss not an
                     Association member, but returned our survey when another agency sent the questionnaire to it.

                     Page24                    GAO/RCED-90-117
                                                            Recapturingthe Qualifbd MortgageBondSubsidy
purchase the assistedhome. Many of those who sell their homes during
the first 6 years may have the recapture amount reduced from the max-
imum amount in any year becauseof the income test and the gain-on-
sale test. During years 6 to 10, the legislated recapture formula reduces
the amount to be recaptured and the recapture amount becomes$0 at
the end of the tenth year.
Although somestate and local agenciesimpose someform of recapture,
the number of owners subject to state and local recapture is apparently
quite limited. Therefore, few assistedowners may be subject to a mul-
tiple recapture when the QMB loan and MCC recapture provisions become
effective starting January 1, 1991.

Page 26            GAO/RCED-90-117 Recapturing the Qualifkl   Mortgage Bond Subsidy
Chapter 3

Changesto the &capture Provisions to Promotk
More Equitable Treament of Owners

                       The recapture provisions will identify and impose a potential recapture
                       payment on certain householdswhose incomesincrease after they pur-
                       chasedtheir assistedhomes.However, several features treat assisted
                       owners differently. For example, the recapture provisions can impose
                       the samerecapture amount on householdsthat receive different
                       amounts of assistance.
                       Further, the recapture provisions do not addresstwo fundamental
                       weaknessesin how QMB loan and MCC assistanceis provided: (1) assis-
                       tance can be provided to those who initially could afford market-rate
                       housing payments without &MB loan or MCC assistanceand (2) once
                       obtained, the assistanceis continued regardlessof the owner’s ability to
                       support unassisted housing payments.

                       Several revisions could be made readily to the current recapture mecha-
                       nism to treat assistedowners more similarly and to ensure that only
                       those who cannot support unassisted housing payments, initially,
                       receive assistance.However, discontinuing assistancewhen the owner
                       could support unassisted housing payments would require a funda-
                       mental changein how assistanceis delivered.

                       Equitable treatment between taxpayers is one goal of tax policy. Two
Increasing muitable    basic conceptsof equity are the “benefits principle” and the “ability-to-
Treatment in the       pay principle.” Under the benefits principle, equity is fostered when
Recapture Provisions   those (1) who benefit more pay more in taxes than those who benefit
                       less and (2) with equal benefits are taxed at the samelevel, all else being
                       equal. However, the recapture legislation contains provisions that treat
                       differently situated assistedhouseholds similarly and similarly situated
                       householdsdifferently. As a result, assistedowners may be treated
                       Under the ability-to-pay principle, equity is fostered when those with
                       greater financial resourcesare taxed more than those with fewer
                       resources.As applied to the recapture provisions, the income adjust-
                       ment provision is generally consistent with this principle, while the
                       gain-on-saleprovision is not.

                       Page26              GAWBcEDI)o-117
                                                        Becspturinethe QualifiedMortgageBondSubsidy
                            Chapter 8
                            Cbangeato the RecapturfProvlsionato
                            of Ownen

Single Recapture Rate Not   The recapture formula is not fully consistent with the benefits principle
Fully Consistent With the   since it uses a single rate that is equal to the presumed benefit, rather
                            than the actual benefit received, as the basis for the recapture amount1
Benefits Principle          In one respect, this approach satisfies equity principles in that assisted
                            owners who have larger loans are subject to a larger recapture amount
                            than those with smaller loans, all else being equal.
                            However, this approach raises other equity considerations because
                            many assistedowners will receive larger or smaller interest-rate reduc-
                            tions from QMB loans than the yearly after-tax 1.26 percentagepoint
                            amount imbedded in the recapture provisions. For example, in March
                            1988 we reported that, while the median before-tax reduction was 1.44
                            percentagepoints, one-fourth of the assistedbuyers we studied received
                            reductions of about three-quarters of a percentagepoint or less from the
                            conventional interest rate.2Similarly, the MCC credit may give a larger or
                            smaller benefit than the after-tax surrogate 1.26 percentagepoint
                            figure, becauseof either the nonrefundability of the credit or the credit
                            rate the MCC bears (see ch. 1).
                            The results of the disparity between the uniform recapture rate and the
                            actual benefit received, all else being equal, is quantified in table 3.1 for
                            three levels of interest-rate reductions.3For example, an assistedowner
                            with an $80,000 QMB loan would be liable for a maximum of $6,000 in
                            recapture amount on the basis of the legislated formula, after 6 years.
                            However, if the owner received an after-tax benefit of 1 percent, then
                            the owner would pay $1,000 more in recapture amount than the benefit
                            received, Similarly, an owner who received an after-tax benefit of 1.S
                            percentagepoints would pay $1,000 less in recapture amount than the
                            benefit received.

                            ‘Home ownership typically conveys several benefits, such as increased equity as a result of house
                            priceappreciation. For this discussion, we use the term “benefits” to mean the interest-rate reduction
                            from a QMB loan and the tax credit received from an MCC by the assisted owner.

                            2Home Ownership: Mortgage Bonds Are Costly and Provide Little Assistance to Those in Need (GAO/
                                 88-l 11, Mar. 28, 1988), p. 38.
                            3This exampleserves as an illustration, only. Therefore, it does not consider the time value of money
                            from the time the assistance is received to the payment of the recapture amount.

                            Page27                     GAO/RCED-90-117
                                                                    Recapturingthe QualifiedMortgageBondSubsidy
                                         Changesto the RecaptureProvisionato
                                         of Ownera

Table 3.1: Effect of Uniform Recapture
Llabillty on Assisted Owners Recelvlng                                                               Additional amount recaptured (not
Different Interest Rate Reduction8                                                                   reca tured) based on an after-tax
                                         Amount of assisted                 Recapture                     Pnterest rate reduction of
                                         mortgage                            amount*                  1%            1.25%            13%
                                         $40,000                                 $2,500             $500                 $0              ($500)
                                         8Qooo                                    3,750              750                  0               (750)
                                         80,000                                   5,000            1,000                   0            (1,0001
                                         @Assumes the home is sold at the end of 5 years and no other reductions apply

                                         To increase equity of treatment between assistedowners, the recapture
                                         provisions could be changedto basethe recapture amount on the
                                         assistedowner’s monthly payment reduction. For example, the partici-
                                         pating lender could document the before-tax monthly payment reduc-
                                         tion due to the QMBloan at the time the loan is closed.This document
                                         could state the difference in monthly principal and interest payments
                                         between a comparable conventional loan and the QMBloan of the same
                                         size. At time of sale, the maximum amount to be recaptured would be
                                         the dollar amount of the reduction (say, $60 per month) times the
                                         number of months that the assistedloan is held. For a loan with a MCC,
                                         the assistedowner could tally the credits taken from prior years’ tax
                                         returns and use that amount as the basis for the recapture amount. As
                                         with the current recapture provisions, the maximum recapture amount
                                         could be capped or phased out, if so desired.4

Moves for Other Than                     Householdsmove for a variety of reasons,including the desire to live in
Housing ReasonsAre Less                  a larger home or reside in another neighborhood. Here, the assisted
                                         owner’s choice is purely voluntary. Other situations, such as moving for
Consistent With the                      employment purposes, are also voluntary, but are not dictated by a
Ability-To-Pay Principle                 changein housing choices.However, under the first situation, an
                                         assistedowner may be more likely to time the move to minimize the
                                         recapture amount (or accumulate the financial resourcesto pay it), all
                                         else being equal. This may not be the situation when the move is made
                                         for reasonsother than housing choice.
                                         From this standpoint, the recapture provisions may not be fully consis-
                                         tent with the ability-to-pay principle since householdsthat move for
                                         other than housing reasonsmay not have set aside financial resources

                                         41ncommenting on a draft of this report, Treasury suggested that, in theory, the appropriate policy
                                         would be to recapture the benefit only for the years in which the assisted owner’s income exceeded
                                         maximum qualifying income. Treasury also acknowledged that this would require constant moni-
                                         toring of owners’ incomes, which would increase administrative and compliance costs.

                                         Page28                     GAO/RCED-90-117
                                                                                 Recapturingthe QualifiedMortgageBondSubsidy
                                            changeeto the ReeaptlmProvMousto
                                            of Ownen

                                            for the changein ownership. However, in this casethe decision to move
                                            and pay a recapture amount is still voluntary. This situation is not
                                            easily remedied. It would not be equitable to forgive the recapture
                                            amount for a voluntary move. Alternatives that do not present this
                                            problem are presented in chapter 4.

Gain-On-SaleProvisions                      The gain-on-saleprovision fulfills a purpose becauseit leaves a portion
Are Not Always Consistent                   of the home owner’s gain on sale available for the purchase of a replace-
                                            ment home. However, the provision is not always consistent with the
With the Ability-To-Pay                     ability-to-pay principle when householdswith rapid income increases
Principle                                   escapepaying recapture becausethey live in areas of low or no housing
                                            price appreciation. Under law, the recapture amount cannot exceed60
                                            percent of the gain on the sale of the assistedhome. In effect, this limita-
                                            tion leaves someof the equity buildup due to appreciation with the
                                            assistedowner, which then can be applied toward the purchase of a
                                            replacement home.6However, different areas of the country and dif-
                                            ferent segmentsof a local housing market experience different rates of
                                            appreciation (seetable 3.2 for examples). Equity considerations occur
                                            becausethe gain-on-saleprovisions may reduce or eliminate the recap-
                                            ture amount for an assistedowner with a rapid increase in income if the
                                            home does not appreciate. Another household with similar income
                                            increaseswould pay a greater recapture amount if it had a greater gain
                                            on sale.
fable 3.2: Appreclatlon Rater of Exirting
Single-Family Homes for Selected                                                                     Median sales price
Metropolitan Areas - 1981-86                                                                  (Percent appreciation from 1981)
                                            Metropolitan area                            1981         1984            1986         1988
                                                                                                    $93,000       $101,200     $132,500
                                            Washington, DC                             $88,300                 (5.3)     (14.6)       (50.1)
                                                                                                            65,100     68,300       75,700
                                            Birmingham, Ala.                            59,200                (10.0)     (15.4)       (27.9)
                                                                                                            68,200     69,900       74,500
                                            Milwaukee, Wis.                             64,500                 (5.7)      (8.4)       (15.5)
                                                                                                            63,900     63,000       56,200
                                            Oklahoma City, Okla.                        54,100                (18.1)     (16.5)         (3.9)
                                                                                                            73,500     70,900       64,700
                                            Baton Rouge, La.                            69,600                 (5.6)      (1.9)      (-7.0)
                                            Source: GAO analysis of National Association of Realtors data

                                            “HUD’s section 236 and FmHA’s section 602 home ownership programs also limit recapture amounts
                                            based on gain on sale (see app. III).

                                            Page29                     GAO/RCED-90-117
                                                                                    Recapturingthe QualifiedMortgageBondSubsidy
                          Changesto the RecaptureProvleionsto
                          of Owners

                          Similar assistedowners would pay different recapture amounts
                          depending on whether their homes appreciated markedly or had low
                          appreciation. In addition, two assistedowners in the samemarket area,
                          one with high income growth and the other with lower income growth,
                          could pay a small recapture amount in areas of low appreciation. This
                          meansthat those who experience rapid increasesin income (but who
                          live in a market area with little or no appreciation) not only pay a
                          reduced recapture amount, but may have less need for the appreciation
                          equity if they chooseto buy a replacement home in the samemarket
                          area, in contrast with an assistedhousehold in higher appreciation mar-
                          kets experiencing a smaller income growth.
                          By allowing owners to retain someequity for a replacement house
                          purchase, the gain-on-saleprovision fulfills a purpose: it does not force
                          these owners to return to renter status becauseof a large recapture
                          amount. As such, the above equity considerations are not easily reme-
                          died, Alternatives to the current recapture provisions that do not create
                          this equity consideration are discussedin the next chapter.

Phaseout Provisions Not   Although the legislative history is silent on the intent of the phaseout of
Consistent With the       the recapture from years 6 to 10, it is an explicit part of the recapture
                          formula. However, the phaseout is not consistent with the benefits prin-
Benefits Principle        ciple since those who receive greater total benefits over time are subject
                          to a lesser recapture amount than those who receive the same annual
                          benefit, but over a shorter period. As shown in table 2.2, the phaseout
                          overrides the income test. Thus, those owners who benefit the most
                          from a lengthy subsidy period and/or who have large increasesin
                          income over this period have their recapture amount reduced and ulti-
                          mately eliminated.
                          The recapture formula could be revised to increaseequity of treatment
                          between two groups of assistedowners who have rapid increasesin
                          income but, in one case,stay in the assistedhome for 6 years or less,
                          and, in the other, more than 6 years. Figure 3.1 shows three alterna-
                          tives. First, the provisions could allow the recapture amount to increase
                          (after 6 years and until the home was sold) at the enacted recapture
                          rate. Second,the recapture amount could increase after a certain period
                          (say, 6 years) but at a somewhat reduced rate. And third, the law could
                          establish a plateau from which the recapture amount would neither
                          increase nor decrease.

                          Page30                GAO/RCED-W117
                                                            Recapturingthe QualifiedMortgageBondSubsidy
                                            chapter 3
                                            Changesto the RecaptureProvisionsto
                                            PromoteMore JSquitable
                                            of Owners

Figure 3.1: AlternatIves to the Recapture
                                            low0 Amountto k RocaDtuNd






                                                   0           1          2         3          4            5   6   7   8    9      10

                                                       -           fbte remains atnatant owr life of loan
                                                       1111        Recapture Increases at a Lower  Rate
                                                                   Enacted Recapture Rate
                                                       nnnn        Recapture Amount WI Plateau

                                            The recapture provisions are imposed after the assistedowner sells the
Subsidy Allowed to                          home. This approach is consistent with the general framework of QMB
Continue Despite                            loans and MCCS,where the continued need for the assistanceis not peri-
Owners’ Significant                         odically determined. It is also easier and less costly to administer since
                                            the amount is computed once, as opposedto periodic testing.
Income Increases
                                            However, someowners’ incomes will increaseto the point that they do
                                            not need continued assistanceto remain home owners. The current
                                            recapture provisions do not addressthis consideration. In this regard,
                                            the recapture provisions (1) test for the increasesin income only after
                                            the assistedhome owner has sold the assistedhome; and (2) may cause
                                            the owner to stay in the home longer and thus extend the length of time
                                            the subsidy is provided.

                                            Page31                            GAO/RCED-30-117
                                                                                           Recapturingthe QualifiedMortgageBondSubsidy
                                3                                                                                               (r
                           Changesto the RecaptureProvisionato
                           PromoteMore EquitableTreatment
                           of Owners

Subsidy Continues          Since the recapture mechanism tests for income growth only at sale, QMB
Regardlessof Household’s   and MCC subsidiescontinue as long as the assistedowner owns the home,
                           or for the life of the mortgage. Thus, those who experience rapid
Income Growth              increasesin income can continue to receive the subsidy when the income
                           increasesmake continued participation unnecessary.Further, unless
                           prospective participants believe that they will be worse off financially
                           with a QMB loan or MCC subject to recapture than with a comparable con-
                           ventional loan, they are likely to participate in the program even when
                           faced with a recapture amount.6
                           While the QMBS are outstanding, the government loses substantial rev-
                           enue from foregone tax revenues.’ Similarly, for MCCS, every dollar in
                           tax credit taken is a dollar of tax revenue foregone. A different
                           approach for testing whether income is sufficient to afford the home
                           without continuing the subsidy would be one in which a home owner’s
                           income is periodically tested to determine continued need for assistance
                           with housing payments. This approach is discussedin chapter 4.

Recapture May Extend       Another result of the recapture mechanism is that assistedowners may
Subsidy Duration for       stay in their homes longer (or sell earlier) to minimize the recapture tax.
                           Potential home buyers often do not know with certainty how long they
Some,But Not for Others    will reside in a housing unit, whether it is subsidized or not. The poten-
                           tial recipient of a QMB loan or MCC with the current recapture mechanism
                           has a relatively small probability of a very low subsidy if the recipient
                           moves within 6 years and a larger probability of a greater subsidy if the
                           recipient stays in the home longer.* As a result, the potential recipient is
                           presented with a “no lose” situation, since the present value of the sub-
                           sidy is greater than the expected present value of the recapture amount.
                           Even though the potential recapture amount increasesduring the first 6
                           years, we would not expect that the recapture amount would create an

                           “In more formal terms, home buyers would choose to participate if they believe that the net present
                           value of their stream of benefits will be greater than zero. The net present benefit to the home buyer
                           is the sum of the annual savings from the reduced interest rate mortgage over a conventional mort-
                           gage, less the anticipated recapture tax, and less additional costs borne by the borrower that the
                           conventional buyer would not incur (participation fees), discounted to reflect the time value of

                           ‘Several studies have estimated that an annual federal tax expenditure of between $20 million to $30
                           million occurs for every $1 billion in QMBs issued, or between $160 million and $200 million in pre-
                           sent value terms. See (GAO/RCED-88-111, Mar. 28,1988), pp. 60-62.

                           *For a general discussion of economic behavior with risk and uncertainty present, see Milton
                           Friedman, Price Theory, 2nd. ed. (Chicago: Aldine Publishing, 1976), pp. 80-84.

                           Page32                     GAO/RCED-!IO-117 Recaptwiugthe Qualified MortgageBondSubsidy
                        Changeato the l&capture Provih9ione
                        of Ownera

                        incentive for owners to move during that period becauseowners who
                        expected the benefit from the QMB loan or MCCto be less than the recap-
                        ture amount (in present value terms) would not be likely to participate
                        in the program. Alternatively, a substantial recapture amount might be
                        expected to motivate assisted owners to remain in their homes for more
                        than 6 years to reduce or eliminate the amount due.” This situation could
                        causesomehouseholdsto receive the subsidy longer than they would
                        have without the enacted recapture mechanism.The reduced mobility
                        would increase federal tax expenditures.
                        Alternatives that do not have these effects on moving behavior are dis-
                        cussedin chapter 4. Additional considerations regarding the recapture
                        provisions’ expected effects on home owner participation are contained
                        in appendix V.

A Prospective           In establishing the recapture provisions, the Congressattempted to iden-
                        tify those assistedowners (1) whose incomes will increase rapidly so
Affordability Test Is   that they could have waited a short period and bought a home without
Needed                  assistanceor (2) who no longer need the assistanceto remain home
                        owners. However, the recapture provisions do not attempt to identify a
                        third group: those who do not need a QMB loan or MCCto afford the
                        assisted home, but are eligible to receive it under Internal RevenueCode
                        eligibility requirements. The Code does not require that QMB loan and
                        MCC assistancebe limited to buyers who cannot afford their first home
                        without this assistance.

                        In March 1988, we reported that only 2 of the 26 agencieswe contacted
                        attempted to limit assistanceto those who could not afford a similarly
                        priced first home without a reduced-interest rate QMB loan. Using
                        housing agency records for over 149,000 buyers who received QMB loans
                        from 1983 through 1987, we estimated that 66 percent of the assisted
                        buyers probably could have bought the samehome at the sametime
                        with a conventional fixed-rate loan of the samesize with comparable
                        terms. The report indicated that even more probably could have
                        afforded the samehome at the sametime if they had chosena conven-
                        tional adjustable-rate loan, which offers lower initial interest rates than

                        *For findings that indicate that two out of three first-time buyers remain in their housing units for
                        over 6 years, see John Simonson, “Prospective First-Time Homebuyers: Salient Characteristics and
                        Their Implications,” National Association of Realtors (Feb. 1939), p. 32.

                        Page33                      GAO/RCEJJ-90417
                                                                 Recaptdng the Qualif¶edMortgageBond Subsidy

chapter 3
Cbangea to the Recapture Provisions to
Promoti More JCquitable Treatment
of Owners

fixed-rate loans. We based this result on the prevailing industry
housing-expense-to-incomequalifying test in making these analyses.‘”

For this report we expanded our affordability test by adding the second
standard qualifying test, the total-debt-expense-to-incometest. This test
measureswhether total debt expense(housing expenseand consumer
installment payments, such as automobile loans) exceedsa certain per-
cent of household income. At the time of our prior review, the 36 per-
cent of income could typically be devoted to debt expense.Becausethis
secondtest acts as an additional screen,it would be expected that some
who probably would have qualified under the first test, might be
screenedout by the secondtest. That is, their added debt expensemight
make them an unacceptable mortgage credit risk.
For this report, we ran the total debt test on those who passedthe
housing expensetest. We found that the total-debt-expense-to-income
test had little effect on the proportion of assisted householdsthat may
have been able to afford the sameprice home at the sametime with a
market-rate, fixed-rate loan, The proportion of householdsthat may
have been able to afford the same home with a market-rate, fixed-rate
loan decreasedslightly, from 66 percent to 61 percent of the over
149,000 householdswe reviewed.” As such, we continue to believe that
most assisted buyers may have been able to buy a home conventionally.

A conventional affordability test could better target QMB loans or MCC
assistanceto those who need assistancewith housing payments to buy
their first home. To determine whether buyers qualifying for &MB loans
could afford the samehouse with a market-rate loan, the lender could
run the samequalifying tests using mortgage interest payments at the
market rate. If prospective buyers could afford a market-rate loan, then
they would not be eligible for a bond-assistedloan. Lenders would con-
tinue to use the prospective borrower’s credit and employment histories
in the sameway that they do for QMB loans and market-rate loans to
determine the expected risk of the loan. For MCCS, the processwould be
similar. Sincethe buyer receives a market-rate loan, the lender would
determine whether it would lend the same amount of money to the
buyer if the MCX were not available.
“‘See (GAO/RCEDSS-111, Mar. 28, 1988), pp. 32-34,46, and 66-68. See also Home Ownershi :
Targeting Assistance to Buyers Through Qualified Mortgage Bonds (GAO/RC@ne                         27,
1988), pp. 16-1’7.We recognize that some owners prefer fixed-rate over adjustable-rate loans to elimi-
nate interest rate variations

“To estimate consumer debt, we used data from a 1987 Federal Reserve System study. See app. V for
a description of how we performed this analysis.

Page 34                    GAO/RCELNO-117 Recapturing the Qualified Mortgage Bond Subsidy
              chapter 3
              changerto the BecaptllreProvlsloluJto
              of Owner9

Conclusions   The legislated recapture formula is consistent with the general design of
              QMBand MCCassistancesince the      assistanceis provided until the home is
              sold and the recapture is imposed only after the home is sold. Although
              the rationale for many of the provisions are not contained in the act’s
              legislative history, the provisions are specific mathematical formulas set
              out in law. However, the effect of the provisions raises considerations of
              equitable treatment between assistedowners since the provisions treat
              differently situated householdssimilarly and similarly situated house-
              holds differently. These differences in treatment are reflected in the (1)
              uniform versus observedbenefit rate, (2) gain-on-saleprovision, and (3)
              phaseout of the recapture amount from years 6 to 10. In particular, the
              uniform (1.25 percentagepoint) recapture rate will recapture more ben-
              efit than someowners received and less than others received. Also, the
              phaseout of the recapture amount reduces and eliminates the recapture
              amount due even though the total benefit received by the owner
              increaseseach year.
              Further, becausethe provisions are triggered only when the home is
              sold, the recapture provisions (1) allow the subsidy to continue when it
              is not neededto support housing payments, if the assistedowner decides
              not to move, and (2) may act as an incentive not to move as soon as may
              have occurred if the recapture was not present.

              While the recapture provisions retrospectively attempt to identify
              owners who no longer need the assistance,no mechanism exists to pre-
              vent agenciesfrom providing QMBloans and MCCSto those who do not
              need it to afford their first home. A conventional affordability test made
              at the time a prospective buyer applies for a &MBloan or MCCwould
              better ensure that only those who need the assistancereceive it.

              The current recapture mechanism is preferable to none at all because
              someor all of the subsidy will be recaptured from at least someowners
              who probably could have waited a short time and bought a home
              without assistancedue to rapid growth in household income. Overall,
              however, the current mechanism is a relatively ineffective way to iden-
              tify and recapture benefits from those who do not continue to need
              assistancewith housing payments becausethe recapture processis trig-
              gered solely by an assistedowner’s decision to move. Without altering
              its basic form, the recapture provisions could be improved if the changes
              discussedin this chapter were made. Other improvements, such as con-
              tinuation of the subsidy when it is no longer needed,would require more
              fundamental changesto the existing framework.

              Page35                 GAO/RCELMtO-117
                                                 Recapturingthe QualifiedMortgageBondSubsidy
                       chapter 3
                       Changesto the RecaptureProvisionsto
                       of Owners

                       Alternatives to the recapture provisions may better achieve the purpose
                       of denying the subsidy to those who no longer need it and increase
                       equity of treatment between assistedowners, although at an increased
                       administrative cost. These alternatives are the subject of chapter 4.

                       If the Congressdesires to retain the existing recapture framework, it
Matters for            could improve equity of treatment between owners by providing that
Consideration by the   the recapture amount be basedon the actual benefit received, rather
Congress               than a uniform rate. For the QMB program, this could be accomplished by
                       basing the rate of recapture on the actual before-tax housing payment
                       reduction realized by the owner over the period of ownership. For the
                       MCC program, the recapture could be based on the amount of the tax
                       credit actually taken.
                       Also, if the Congressdecidesto retain the existing recapture framework
                       and to have the recapture amount better reflect the total amount of ben-
                       efit received from owners with rapid income growth, it may wish to
                       eliminate the phaseout of the recapture amount after year 6. If, how-
                       ever, the Congresswishes to limit overall recapture liability, it could
                       provide for a lesser recapture rate for years 6 and beyond, or cap the
                       recapture amount at the amount determined after year 6, subject to
                       other current adjustments.

                       Further, if the Congresswants to improve the targeting of those who
                       initially receive QMB loans and MCCS, it could require that they be pro-
                       vided only to those who cannot obtain a market-rate loan with compa-
                       rable terms.

                       The Association of Local Housing Finance Agencies,National Council of
Agency Comments        State Housing Agencies,and Department of the Treasury provided com-
                       ments on a draft of this report (see app. VI through VIII, respectively).
                       The Association and the Council objected to basing the recapture rate on
                       the actual interest rate reduction received by the assistedowner, rather
                       than the uniform 1.26 percentagepoint amount. Both groups thought
                       our proposal would needlessly encumber the program and that the
                       single rate was easier to understand and administer. Treasury com-
                       mented that our suggestedapproach was generally appropriate as a
                       matter of fairness. However, as a matter of tax policy, Treasury sug-
                       gestedthat the fairness objective would have to be balanced against
                       associatedadministrative and compliance costs.We agreethat a single
                       rate is easier to administer. However, our concern is that the assisted

                       Page36                GAO/RCEJHO-117
                                                         Recapturingthe Qualified MortgageBondSubsidy
Changes to the
of Owners

owner not be placed in a position of potentially paying more in recap-
ture than the benefit received.

We also do not believe that the administrative requirements for the
assistedowner or lender would be as burdensomeas suggested.While
we did not quantify the added costs involved in tailoring the recapture
formula more to the benefit received, we expect that the additional cost
per home owner would be small. The additional effort would comprise
two steps. First, the lender would determine the monthly principal and
interest payment for a fixed-rate market-rate loan of comparable terms.
Second,the lender would determine the difference between the housing
payment for the market-rate loan and the QMB loan. The results of this
one-time computation would be provided to the assistedowner and
retained by the lender or the housing agency. In deciding whether to
make this revision to law, the Congressmust weigh the effort required
in performing these calculations against the benefit of refining the
recapture mechanism.
Similarly, the Association and the Council objected to our analysis of the
effects of the recapture phaseout provision. The Association believed
that our proposal would discourageowners from remaining in their
home, apparently becausethe recapture would not be phased out. Our
discussionpoints out that the enacted phase-out provision allows the
recapture provision to be reduced to as far as $0 even though the house-
hold (1) continues to receive the benefit from a reduced interest loan for
the life of the loan and (2) has income increasesthat meet or exceed
those in the income test. From a standpoint of achieving the Congress’
stated goals (as set out in the conferencereport), we believe it is appro-
priate to recapture at least someof the benefit from those who continue
to receive it and meet income increasethresholds.
The Council said that the phaseout would have little effect on those
with rapid increasesin income becausethey (1) will move out as soon as
they can afford to and (2) are better off selling earlier, rather than later,
to take advantage of the provision that adds $6,000 to adjusted quali-
fying income.12The Council ignores the fact that the substantial transac-
tion costs involved in selling a home creates significant disincentives to
selling within the first few years of ownership. Treasury had no specific
comments on our phaseout discussion.

“As discussed in ch. 2, in the first few years of ownership, the $6,000 amount adds significantly to
the amount income must increase before the full recapture amount is due.

Page37                     GAO/RCED-90-117
                                        Recapturingthe QualifiedMortgageBondSubsidy
Changesto the RecaptureProvieIonstn
of Ownere

The Association and the Council strongly disagreed with our analysis of
whether assistedowners probably could have afforded the samehouse
without assistance.Both groups said that if the secondstandard mort-
gagequalifying test (total-debt-expense-to-incometest) was applied, our
results would have been substantially different. As a result, we per-
formed that test and found little changein our results.

Finally, both the Association and the Council stated that an
affordability test was not needed.In its comments,however, the Council
stated that it agreeswith the objective of discouraging those from get-
ting a QMB loan when conventional financing is a reasonablealternative.
Treasury also agreedthat providing assistanceto those who could
otherwise afford a market-rate loan with comparable terms is not con-
sistent with the goals of the QMB and MCC programs. On the basis of our
affordability test in this report, we maintain that this sort of screening
mechanismis neededas a way of demonstrating that potential first-time
home buyers need QMB loans and MCCS to purchase their homes.

Page88                GAO/RCEBf%117
                                  Recapturhgthe QuaUfiedMortgageBondSubsidy
Alternatives That Would Better Idefy                                                                and
Deny Subsidy to Those With Rapid
Income Growth
                        Chapter 3 discussedimprovements that could be made within the frame-
                        work of the enacted recapture provisions to provide more equitable
                        treatment between sets of assistedowners who experienced rapid
                        income growth. As chapter 3 also indicated, the recapture approach
                        does not identify and suspendthe subsidy to those with rising incomes
                        becauseit is triggered only by the recipient’s decision to move.

                        Mortgage loans that discontinue assistancebecauseof pre-established
                        affordability criteria (roll-over loans) and periodically increase housing
                        payments as long as income increases(income-basedvariable payment
                        mortgage loans) are income-driven alternatives to the current recapture
                        approach. These alternatives improve equity of treatment between
                        assistedowners and are not based on an assistedowner’s decision to
                        move. However, these approachesare most likely more complex and
                        costly to administer than the recapture provisions.

                        A roll-over mortgage loan is a mechanism that continues or ends assis-
Substituting a Roll-    tance on the basis of periodic examination of current income. If the
Over Approach for the   owner’s income rises to a point where the owner could afford a compa-
Recapture Mechanism     rable market-rate loan, the owner is required to refinance the assisted
                        loan with a market-rate mortgage loan. If income growth is insufficient
                        for the owner to afford a market-rate loan, then assistanceis continued
                        with no changein monthly payment. The roll-over decision points could
                        come at any time. Roll-over mortgageswith 3- and 5-year intervals are
                        common in the Canadian private mortgage market.’ This approach dif-
                        fers from the recapture approach discussedin the preceding chapters in
                        that the roll-over approach doesnot require that assistancebe paid
                        Since a roll-over decision is driven by income growth, this approach is
                        consistent with the ability-to-pay principle. Similarly, it does not create
                        inequities cited in chapter 3, making it consistent with the benefits prin-
                        ciple. A roll-over mortgage does not require a voluntary move to end
                        assistanceduring the lifetime of the assistedmortgage and, therefore,
                        more efficiently continues assistanceto those who require assistanceto
                        meet monthly payments, while halting assistanceto those who no longer
                        need it. Recipients who do not experience the income growth required
                        for the roll-over to occur are not discouraged from moving as much as if

                        ‘For a further discussion of the roll-over mechanism, see David Ling and Mark Smith, “Another Look
                        at Mortgage Revenue Bonds,” Journal of Policy Analysis and Management, Vol. 7, No. 3 (Spring
                        1988), pp. 662-4.

                        Page 39                   GAO/RCED-99-117     &capturingthe Qualified     Mortgage Bond Subsidy
                            AlternativesThnt WoUrdBetter Identify and
                            DenySubsidyto ThoseWith Rapid

                            they were subject to a recapture. They lose the ongoing subsidy if they
                            move, but they do not becomesubject to the recapture provisions2
                            The current recapture provisions and roll-over loans introduce adminis-
                            trative costs and complexities. The recapture mechanism adds to
                            reporting requirements by assistedowners and others and may increase
                            general Internal RevenueService coststo the extent that the Service
                            audits recapture tax reporting (see app. IV). The use of roll-over loans is
                            likely to incur costs since they require routine examinations that would
                            probably be performed by the mortgage servicer acting for the housing

Refinancing and Other       A loan that “rolls over” to a market-rate loan requires determining what
Costs of a Roll-Over Loan   the market rate should be: either the prevailing rate for similar loans at
                            the time the loan was made or the rate at the time the roll-over occurs.
Could Be Avoided            Also, converting to an unsubsidized conventional loan will entail refi-
                            nancing costs, which are often substantial. Last, periodic examinations
                            of income will require increased administrative activities by the mort-
                            gageservicers and increasethe costs of the program.
                            The easiestmethod, administratively, for determining the market rate
                            and refinancing costs for home owners with QMB loans is to require them
                            to incur refinancing costs and find a market-rate mortgage in the cur-
                            rent mortgage market. This method, however, subjects recipients to one
                            certain and a possible secondcost. First, refinancing chargescan be sub-
                            stantial. Second,if mortgage interests rates in the private market have
                            risen since the time of home acquisition, recipients could becomeworse
                            off than if they had never participated since owners have to pay a
                            higher mortgage interest rates than if they had never participated in the

                            The FIMA section 602 home ownership program handles this situation by
                            establishing a “market rate” when the household becomesa recipient.
                            As the assistedhousehold’s income rises, housing payments increase up
                            to the amount determined by the “market rate.” However, since the loan

                            *Both the roll-over loan and the current recapture provisions treat assisted owners who have little or
                            no income growth similarly. In the former, assistance is continued until the home is disposed of; in the
                            latter, no recapture amount is imposed either during the life of the loan or when it is discontinued.

                            3Roll-over loans and a recapture could be combined but would entail higher governmental administra-
                            tive costs and a greater home owner burden than if only one approach was used. The two combined,
                            however, both limit the duration of assistance and impose a recapture amount on recipients with
                            potentially the greatest ability to pay.

                            Page 40                    GAO/RCED-90-117
                                                                    l&capturing the QualifiedMortgageBondSubsidy
 .                        Chapter4
                          Alt.mnativeeThat WouldBetter IdentLfyand
                          DenySubsidyto ThorreWith Rapid

                          is not converted to a conventional loan, no refinancing costs are gener-
                          ated. A similar mechanism could be set in place for QMBloans to avoid
                          interest-rate risk and refinancing costs4
                          The MCCprogram doesnot create this tradeoff. The recipient already
                          holds a private mortgage instrument made at market-rate interest. The
                          MCCcan be cancelled without triggering a changein the mortgage
                          interest rate or incurring refinancing costs.Therefore, a roll-over mech-
                          anism would involve the ending of the mortgage credit rather than
                          shifting to a new private mortgage instrument.6
                          Finally, periodic reexamination of income leads to increased administra-
                          tive costs.These costs could be paid from participation fees, bond pro-
                          ceedsthat might otherwise be used to make mortgages,or from other
                          (IIOIPQMB or MCC-related)  sourcesavtilable to somehousing agencies.We
                          did not attempt to quantify the likely cost increasesthat would result
                          from the roll-over mechanism. However, a Mortgage Bankers Associa-
                          tion of America official estimated that a lender’s activities relating to
                          roll-over recertification would add about one-eighth of a percentage
                          point to the lender’s servicing fee (or about $100 on an $80,000 mort-
                          gageloan). If roll-over approach replaces the recapture mechanism, the
                          reexamination period could be set at a point, such as every 3 or 6 years
                          rather than annually, to lessenthe burden but still test for sustained
                          income increases.

Shallow Subsidy Reduces   While the roll-over approach halts the subsidy when it is no longer
Roll-Over Impact          neededto afford housing payments on a comparable market-rate loan,
                          the impact is small becausethe original subsidy is relatively small. As
                          discussedearlier in this report and in our March 1988 report, QMBloans
                          provide relatively shahow subsidies-typically a 1.44-percentagepoint
                          reduction in the mortgage interest rate (or about $40 per month, after
                          taxes).” In contrast, HUD and FmHA home ownership programs reduce
                          mortgage interest rates to as low as 1 percent. Clearly, a roll-over mech-
                          anism that operated in a deep subsidy program would have a greater

                          4An income-averaging approach could be used so that increased payments do not result from tempo-
                          rary increases in household income.

                          6Although implementing thii alternative would be much simpler for a MCC loan than for a QMB loan,
                          QMBs form the overwhelming majority of the assistance provided. 8ee Home Ownership: Mortgage
                          Bonds Are Costly and Provide Little Assistance to Those in Need (GAO-W-1         11, Mar. 28,
                          T9W, PP~11 and 66-90.
                          %ee p. 38 of (GAO/RCED-88-111, Mar. 28,1988).

                          Page41                    GAO/RCED-f#117
                                                                 Recapturingthe QualifiedMortgageBondSubsidy
                       AkemativeaThat WouldBetter IdentiQ and
                       DenySubaldyto ThoseWith Rapid

                       potential impact than a similar roll-over for a QMBloan and MCC, which
                       typically provide a much smaller amount of assistance.

                       A secondincome-basedalternative to the recapture provisions is an
Income-BasedVariable   income-basedvariable payment loan. In this type of loan, the owner’s
Payment Loans as an    payments for principal, interest, taxes, and insurance are a fixed per-
Alternative to the     centageof household income. As income increases,so do monthly pay-
                       ments. While the roll-over mortgage caps the mortgage interest rate at
Recapture Mechanism    the market rate, the income-basedvariable payment loan allows the
                       assistedowner’s interest rate to rise above the market rate as income
                       continues to grow. Mortgage payments increase as long as income does.
                       For QMB loans, this mechanismwould motivate recipients to leave the
                       program when their monthly payments for principal and interest
                       becomegreater than payments for an unsubsidized market-rate

                       For variable-payment loans with MC&S, the MCC could be reissued at a
                       decreasedrate (say, a lo-percent credit rather than a 20-percent credit),
                       as warranted by periodic review of income. A MCC reissued at a lower
                       rate would decreasethe subsidy amount and maintain housing pay-
                       ments as a percent of income.

                       The variable payment approach can lead to better targeting of benefits
                       and is similar to the HUD section 236 and MA section 602 home owner-
                       ship programs, except that QMBloans and MCCS provide shallower subsi-
                       dies. (Seeapp. III for descriptions of the HUD and F~HAprograms.) As
                       with the roll-over loan, the income-basedvariable payment loan is con-
                       sistent with the ability-to-pay principle. Also, it tests for income growth
                       periodically, rather than when the home is sold, and it doesnot rely on a
                       voluntary move to halt the subsidy for recipients who no longer need it
                       to afford housing payments. The income-basedvariable payment mort-
                       gagefulfills this objective indirectly by increasing mortgage payments to
                       a level above that which the recipient with rapidly increasing income
                       would pay in the private mortgage market.’

                       ‘The variable payment approach could be combined with a recapture mechanism as the HUD section
                       236 and FmHA section 602 programs do. Regardless of the possibly desirable equity outcomes, such a
                       mechanism would entail administrative complexities and costs that are not part of the current recap-
                       ture approach.

                       Page42                    GAO/RCED-90-117
                                                              Recapturingthe QualifiedMortgageBondSubeidy
                           AlternativesThat WouldBetter Identify and
                           DenySubsidyto ThoseWith Rapid

Increased Administrative   As with the roll-over loan, income-basedvariable payment loans will
Costs and Complexity       increase administrative cost and program complexity over the current
                           recapture approach. As with the roll-over loan, a reexamination at 3- or
                           S-year intervals would be less costly than annual reexaminations.
                           Overall, however, periodic income reexamination and adjustment of
                           mortgage payments for variable payment loans would be more costly
                           than for roll-over loans. These activities must be performed at each des-
                           ignated time interval (say, every 3 years) for each outstanding loan
                           under the variable payment approach. However, under the roll-over
                           approach, loans that had “rolled-over” would not be subject to further
                           examinations and adjustments. It is possible that, over the life of the
                           loans, the increasedcost and effort to reexamine income and adjust vari-
                           able payment loan payment schedulescould make this approach
                           unworkable. The final consideration of how the increased payments are
                           treated by the loan servicer and the housing agency is similar to that of
                           the roll-over loan.

Conclusions                The decision to substitute a roll-over loan for the existing recapture
                           mechanismis not clear-cut. The roll-over mechanism presented in this
                           chapter better achievesthe objective, as stated in the conferencereport,
                           of not providing subsidiesto those who experience rapid income growth.
                           On the other hand, the roll-over approach adds someadministrative
                           costs and complexity. However, the additional cost and effort that
                           would be required could be lessenedif the period for reevaluating need
                           were set at 3- or S-year intervals, rather than annually.
                           A variable payment loan, which is an income-basedalternative to a roll-
                           over loan, would also be more equitable than the present recapture
                           mechanism becauseit would tie the amount of the subsidy directly to
                           income growth. However, becauseit requires constant monitoring of
                           changesin recipient income, it probably is not administratively feasible
                           within the operations of the QMBand MCCprograms.

                           If the Congressdecidesto replace the existing recapture approach with
Matter for                 one that will terminate assistanceto recipients who experience rapid
Consideration by the       income growth and, as a result, can afford housing payments on a
Congress                   market-rate loan of comparable terms, it may wish to enact a roll-over
                           approach that doesnot require external refinancing.

                           Page43                GAO/RCED-90-117
                                                              Recapturingthe QualifiedMortgageBondSubsidy
                  chapter 4
                  Alwnativea That WouldBetter Identify and
                  DenySubsidyto Thaw With Rapid

                  Both the Association of Local Housing Finance Agencies and the
Agency Comments   National Council of State Housing Agencies disagreedwith adopting a
                  roll-over type approach as an alternative to the existing recapture mech-
                  anism. Both cited our discussion of the added administrative burden and
                  complexities in reexamining owners’ incomesin this type of approach.
                  Treasury did not state a position on whether a roll-over approach
                  should be substituted for the recapture mechanism. However, it did sug-
                  gest that our report should discussthe administrative and compliance
                  costs associatedwith a roll-over approach.
                  Both our draft and this report recognizethe additional burden and com-
                  plexity of the roll-over approach and contain an estimate of the cost for
                  periodic recertifications. The added burden and complexity is the trade-
                  off for better identifying those whose income is rising to the point where
                  further assistanceis not warranted. The existing recapture mechanism
                  requires that the home be sold before that examination of income
                  increasestakes place. Under the roll-over approach, that examination
                  would be done periodically.

                  Page44                GAO/RCED-!bO-117
                                                     Recapturingthe QualifiedMortgageBondSubsidy
Page46   GAO/RCED-IH)-117
                      Recapturingthe Qualified MortgageBondSubsidy
Appendix I

Example of How to Compute the
Recapture Amount

              J, a single individual, purchases a home with a $66,000 QMBloan. At the
              time of purchase, the applicable income limit for a single person is
              $20,000. He marries S, and they have two children, E and M. They sell
              their QMB-assisted  home 6 years and 2 months later and realize a gain of
              $12,000 on the sale of the home. In the year of sale, J and S’s household
              income (adjusted gross income plus tax-exempt interest) is $32,000.
              Before adjustments, the maximum recapture amount would be $3,438
              (0.0626 x $66,000).
              However.,becausethe home was held more than 6 years, the holding
              period adjustment reducesthe recapture amount to $2,636 ((120-74)/60
              x $3,438), where the adjustment is based on the number of months (74)
              out of the lo-year period (120 months). The recapture amount is further
              reduced becauseJ and S’s household income ($32,000) is $2,900 less
              than the estimated income eligibility limit of $34,900.’ Sincethe recap-
              ture amount is reduced by 2 percent for every $100 that modified
              adjusted income exceedsJ and S’ household income, the recapture
              amount owed is $1,108. Since $1,108 is less than the amount determined
              by the holding period adjustment, the maximum recapture is $1,108.2
              SinceJ and S realized a $12,000 gain on the sale of their home, the 60-
              percent gain-on-salelimitation did not further reduce the $1,108 recap-
              ture amount due. If the gain on sale had been $2,000 instead of $12,000,
              then the recapture amount would have been $1,000, which is the lesser
              of the computed amount of $1,108 or 60 percent of the gain on sale (0.6
              x $2,000 = $1,000).3

              ‘If $20,000 was the applicable income limit for a one-person household, $23,000 would be the appli-
              cable 3-or-more-person household limit ($20,000 x 116%). The $23,000 amount is increased by 6 per-
              cent per year for each of the 6 full years to $29,900 ($23,000 x 0.06 x 6 = $6,900 and $23,000 +
              $6,900 = $29,900) and $6,000 is added to this amount ($29,900 + $6,000 = $34,900).

              2Multiply 2 percent for every $100 that household income ($32,000) is less than the estimated income
              eligibility limit of $34,900. Since ($34,900 - $32,000)/100 = 29, the reduction to the recapture amount
              is 0.02 x 29 x $2,636 = $1,628. The recapture amount due after this step is $2,636 - $1,628 = $1,108.

              3We were also asked to determine the effect on the marginal tax rate resulting from the recapture
              provisions. Since the provisions do not require any modifications to the taxpayer’s adjusted gross
              income, no tax bracket changes will occur.

              Page46                     GAO/RCED-90-117
                                                      Recapturingthe Qualified MortgageBondSubsidy
Appendix II

Income IncreasesNeededto Pay the Recapture
Amount for an Area With a $26,000
Median Income
              Chapter 2 provides examples of the recapture amount due for hypothet-
              ical householdsin an area in which the median income was $34,000. As
              discussed,the income test is sensitive to the median income level. In this
              appendix, we show how much income would have to increaseto pay the
              recapture amount for three householdsin an area where median income
              is $ZS,OOO.l
              In this example, we use three households,each with three or more mem-
              bers. The householdsdiffer only in their income at the time they
              purchase their assistedhomes. Household C has the maximum income to
              be eligible to participate, $29,900 (116 percent of the area median
              income); Household D has an income at the area median, or $26,000; and
              Household E has an income of $20,800 (80 percent of the area median
              Figures 11.1,11.2,and II.3 show the average annual income increases
              neededto pay the recapture amount for HouseholdsC, D, and E, respec-
              tively. The increasesneededfor HouseholdsA and B in chapter 2, where
              our calculations were basedon an area median income of $34,000, are
              smaller than the increasesneededfor HouseholdsC and D, respectively.
              Average annual income increasesneededto pay the maximum recapture
              are higher the lower the area median income becauseof the $6,000 con-
              stant in the income test formula. The increasesare higher becausethe
              $6,000 amount has a larger influence when the area median income is
              lower: a $6,000 increase from $26,000 to $31,000 is a 19-percent
              increase, and a $6,000 increase from $34,000 to $39,000 is a 16-percent

              1For example, $26,000 is about equal to the estimated 1989 statewide median incomes for Alabama
              and Kentucky, according to HUD.

              Page47                    GAO/RCED-90-117
                                                     Recapturingthe Qualifkd MortgageBondSubsidy
                                         IncomeIncreasesNeededto Paythe
                                         RecaptureAmountfor au AreaWith a 826,000

Figure ll.1: Average Annual Incnsre In
Income Needed to Pay the Recepture
Amount for Houeehold C                   28       Avorago Annual lncnase In Income




                                              1            2         3          4           s      6       7         6          9         10

                                                  -        Full recapture amount for Household C
                                                  -I - -   Any recapture amount for Household C

                                         Note: Household C has an income at time of purchase of 115 percent of the area median and a house-
                                         hold size of three or more. Area median income is $26,000.

                                         Page48                          GAO/RCED-BO-117
                                                                                     Recapturingthe QualifiedMortgageBondSubsidy
                                         Income Incream Neededto Paythe
                                         RecaptureAmountfor an AreaWith a $26,999

Figure 11.2:Average Annual Increase in
Income Needed to Pay the Recapture
                                         Avemgo Annual lncmarc In Income
Amount for Hourehold D


                                                          2         3           4          6      6        7          8         9         10

                                                -         Full recapture amount for Household D
                                                - - - -   Any recapture amount for Household D

                                         Note: Household D has an income at time of purchase of 100 percent of the area median and a house-
                                         hold size of three or more. Area median income is $26,000.

                                         Page49                         GAO/RCED-99-117
                                                                                     Recapturingthe QualifiedMortgageBondSubsidy
                                         AppendixLI                                                                                        .
                                         Income Increaeea        Paythe
                                                               Needed to
                                         RecaptureAmountfor an AreaWith a 826,000

Figure 11.3:Average Annual incresee in
income Needed to Pay the Recapture
                                         80       Avomgo Annual Incnaaa In Income
Amount for Houeehoid E


                                              1          2          3          4          I      6         7          8          9         10

                                                  -       Full recapture for Household E
                                                  ----    Any recapture amount for Household E

                                         Note: Household E has an income at time of purchase of 80 percent of the area median and a household
                                         size of three or more. Area median income is $26,000.

                                         Page60                         GAO/RCEDBO-117
                                                                                    Recapturingthe Qualified MortgageBondSubsidy
Recapture Mechanisms in Federal, State, and
Local Housing Programs

                  Certain federal, state, and local housing programs recapture someor all
                  of the assistancethey provide to home buyers or have recapture-like
                  mechanisms.The recapture may be levied programwide or limited to a
                  specific housing project. This appendix describesseveral housing pro-
                  grams with recapture or recapture-like mechanisms.

                  The HUDsection 236 home ownership        assistanceprogram provides for a
HUD Section 235   mortgage interest reduction for lower-income families. Loans are made
Program           by commercial lenders at market interest rates. Eligible families pay at
                  least 20 percent of their adjusted income toward monthly mortgage pay-
                  ments (or 28 percent, depending on which portion of the program the
                  assistedhousehold is participating in). The difference between the
                  market-rate mortgage payment and the amount that subsidized owners
                  are paying is made up by federal assistancepayments (the “interest sub-
                  sidy” or interest credit). The interest rate may be subsidizedto a level as
                  low as 1 percent. The commercial lender servicesthe loan and reexam-
                  ines the home owner’s income annually, and the recmired home owner
                  payment is increasedor decreasedaccordingly.
                  , Section 206(b)(l)(C) of the Housing and Community Development Act of
                    1980 (P.L. 96-399, Oct. 8, 1080) added a recapture provision for those
                    home owners who disposeof their property or rent it for more than 1
                    year. Under the act, HUD recaptures the lesser of (1) the amount of
                    interest subsidy actually received or (2) 60 percent of the net apprecia-
                    tion of the property.’ The legislative history behind the act doesnot
                    explain why the recapture was added or the problems it was intended to
                    address.On disposition, the recapture due constitutes a hen on the
                  When the assistedowner proposesto disposeof the home, the mortgage
                  lender notifies the local HUD field office of the total amount of assistance
                  payments that HUDprovided. The HUD field office then calculates the
                  recapture amount due and the recapture amount must be paid to convey

                  ‘Net appredation is defined as the increase in value over the original purchase price, less (1) reason-
                  able coets of sale, (2) reasonable costs of home improvements, and (3) certain increasersin the mort-
                  gage amount over the original balance.

                  Page 61                     GAOjRCEDW117         lkaplm’hg     the Qualified Mortgage Bond Subsidy

                                                                                                        ___ ___
                                                                                                              - .- -.-
                    &pendix III
                    RecaptlueM-                in Federal, St&e, and
                    Local Iiontling FrograuM

F’mHA Section 502   FmHA’s section 602 rural home ownership loan program provides low-
Program             and moderate-incomehouseholdswith home purchase loans. F~IIA
                    makes fixed-rate loans to eligible buyers at an interest rate approxi-
                    mately equal to the cost of long-term government borrowing at the time
                    of loan origination. However, most borrowers receive a subsidy, called
                    an interest credit, to reduce the loan’s effective interest rate to as low as
                    1 percent, depending on borrowers’ incomeswhen they receive the
                    Section 602 participants initially pay at least 26 percent of their
                    adjusted income for principal, interest, real estate taxes, and insurance.
                    FMU annually recalculates the borrower’s required payment using the
                    borrower’s current income.

                    Section 606(a)(3) of the Housing and Community Development Amend-
                    ments of 1978 (P.L. 96-667, Oct. 31, 1978) added a recapture provision
                    to the section 602 program. The legislative history behind the act does
                    not explain why the recapture was added or the problems it intended to
                    address.The assistedowner must repay the lesser of (1) the amount of
                    the subsidy received or (2) a percentageof the property’s net apprecia-
                    tion, ranging from 9 to 78 percent (depending on the averageinterest
                    rate paid by the owner over the life of the loan and the number of
                    months that the mortgage was outstanding).2The mortgages or deedsof
                    trust signed by those receiving the interest credit contain a provision
                    making the amount of the subsidy a lien against the property.

                    In 1989, the National Council of State Housing Agenciessurveyed its
State Housing       membership to determine the extent to which recapture mechanismsare
Programs            used and how they are structured. The Council reported that eight of its
                    members had someform of recapture mechanism as part of one or more
                    of their home ownership programs. None of the eight applies recapture
                    to its QMBprograms. Rather, the Council reported, the recapture mecha-
                    nisms appear to be used only with special programs of limited duration
                    or availability.
                    The Council reported the predominant objective of the state recaptures
                    was to recapture funds for future program use. Four states had a sec-
                    ondary objective of preventing speculation. Two states had a third

                    2Net appreciation is defined ss market value of the home, less the amount of non-FmHA prior loans,
                    unpaid balance of FInHA liens, sales expenses, principal paid at note rate, principal reduction attrib-
                    uted to subsidy, and original equity.

                    Page 62                     GAO/WED-fMb117 Recapturing the Qualified Mortgage Bond Subsidy
                    RecaptureMechanisms in Federal,State,and

                    objective of removing the subsidy when borrowers were no longer eli-
                    gible for it.
                    The Council’s summary included a short description of the recapture
                    provisions in sevenstates:3
                . The amount recaptured is the amount of down payment and/or interest
                  rate subsidy or a portion of the net appreciation of the property (Massa-
                  chusetts, Minnesota, North Carolina).
                . During a specified control period, 95 percent of the appreciation of the
                  home salesprice (net of capital improvements) is recaptured (New
                . If the assistedowner sells or transfers the house within the first 16
                  years, any proceedsin excessof the state’s home ownership
                  affordability index must be paid at a rate of 2 percent of the salesprice
                  or appraised value (Rhode Island).
                . At time of sale, an owner receiving state-funded down payment assis-
                  tance in conjunction with QMB loans must pay 20 percent of gained
                  equity during years 1 to 6, 10 percent in years 6 to 10, 6 percent from
                  years 11 to 20, and 2.6 percent from year 21 to loan maturity (New
                l If a home is sold within 7 years, the assistedowner must pay (1) the
                  interest rate differential between the (assisted) note rate and 8 percent
                  and (2) on a sliding scale,a percentageof the original salesprice. The
                  recapture cannot exceedthe gain realized on sale (Connecticut).

                    We surveyed 128 local housing agenciesthat are membersof the Associ-
Local Housing       ation of Local Housing Finance Agencies.We (1) asked the agenciesto
Programs            tell us if they recaptured someor all of a subsidy they provided and (2)
                    allowed the agenciesto define what recapture might entail. Because
                    there are other local housing agenciesthat do not belong to the Associa-
                    tion, our survey was not meant to be statistically representative of local
                    housing agency practices. Rather, the survey was meant to provide some
                    insight into how somelocal agenciesstructure recapture mechanisms.

                    3Alaska, one of the eight states with recapture mechanisms, did not provide a program description.

                    Page63                     GAO/RCED-90-117
                                                            Recapturingthe QualifiedMortgageBondSubsidy
    RecaptureMechauiemain Federal,State,and

    Twenty of the agenciesthat returned our survey indicated that they
    employed a recapture mechanism.4Thesemechanismstook five forms,
    and three agenciesuse more than one technique. In a number of cases,
    the documents sent to us showed that the recapture was limited to a
    single development or small set of properties rather than being applied
    to the agencies’housing programs in general. Also, several of the recap-
    ture mechanismswere applied to non-oMBand -MCC programs. The fol-
    lowing mechanismsare used:
l   Limitations      on resale price (eight agencies).The assistedowner agrees
  to resell the house at no more than the original purchase price plus the
  value of improvements, plus someor all of the percentageincrease in
  the area’s median income (or increase in the salesprice for existing
  homes in the area) for the period that the home was owned.
l Shared appreciation loans (seven agencies).Most frequently, these
  loans were deferred payment secondtrusts. For example, when the
  assistedhome is resold, the owner pays the agency the principal amount
  and the lesser of (1) 10 percent simple interest on the loan or (2) 60
  percent of the net appreciation on the home. Several programs have pro-
  visions that reduce the proportion of appreciation taken the longer the
  assistedowner holds the assistedunit.
. Equity appreciation loans (five agencies).The loans are somewhat
  similar to shared appreciation loans, but the amount recaptured is based
  on the contribution made by the housing agency.For example, if the
  agency made a secondtrust loan that represented 16 percent of the total
  loan amount received by the assistedowner, then the amount to be
  recaptured at time of sale would be the outstanding principal balance
  and 16 percent of the appreciation of the property.
l Roll-over loans (two agencies).If periodic examination of the bor-
  rower’s income shows that the subsidy is no longer needed,then the
  owner is required to refinance the loan or pay it off. Otherwise, the sub-
  sidy is extended.
. An interest rate surcharge (one agency). Assisted owners receive a
  subsidy that is repaid as a S-percent(simple interest) loan. If the home
  is sold within the first 6 years to other than a low- or moderate-income
  buyer, a S-percentsurcharge is added (total of 10 percent). The
  surcharge declines to 4,3, 2, 1 and 0 percent in years 6 to 10,

    4About 91 percent of those surveyed responded, although not all operated home ownership programs.
    We did not consider the simple repayment of principal and interest to be a recapture mechanism, as
    indicated by several agencies. Also, one of the respondents was not an Association member, but
    returned our survey when another agency sent the questionnaire to it.

    Page54                    GAO/RCED-90-117
                                           Recapturingthe QualifiedMortgageBondSubsidy
RecaptureMecWm6 In Federal,State,and

In addition, several agenciesrestricted resale of the assistedunits to
low- and moderate-incomebuyers. While this is not a recapture, per- se -’
it may tend to keep resale prices somewhat lower than if the restriction
were not in place, effectively limiting the gain on sale.
The local jurisdictions using the limitation on resale price were Fremont,
San Mateo County, San Francisco,Santa Barbara, and Palo Alto, Cali-
fornia; Boulder, Colorado; Montgomery County, Maryland; and Fairfax
County, Virginia.
The jurisdictions using shared appreciation loans were Hayward, San
Francisco, and two agencieswithin the city of Los Angeles, California;
Baltimore and Montgomery County, Maryland; and Seattle, Washington.
Thosejurisdictions using equity appreciation recaptures were Sacra-
mento, California; Minneapolis and St. Paul, Minnesota; Raleigh, North
Carolina; and Portland, Oregon.
The localities using a roll-over provision were Anaheim, California, and
Baltimore, Maryland. The city of Santa Ana, California, used the
interest-rate surcharge mechanism.

PageI56             GAO/RCED90-117
                                Recapturingthe QualifiedMortgageBondSubsidy
Appendix IV

Ekpected Recapture Effects on Program        .
Participation and Tax Administration Matters

                                          This appendix discusseswhether the (1) imposition of a recapture mech-
                                          anism will be likely to affect a household’s decision to apply for the
                                          assistance,(2) assistedowner will have sufficient liquid assetsto pay
                                          the recapture amount when due, and (3) IRS will be able to identify
                                          those who sold their assistedhome and are subject to recapture.

                                          Our earlier report and the example in table IV. 1 indicate that the QMB
No Expected Adverse                       program generatesrelatively small subsidy levels.’ In the former, the
Effect on Program                         participating population was found to be fairly typical of first-time
Participation                             home buyers. In the latter, the present value of the subsidy that is con-
                                          tinued for 10 years is only $6,989. Even with relatively small subsidy
                                          levels, home buyers who do not have to changetheir housing choicesto
                                          receive a subsidy would be expected to participate in the program
                                          becauseit would be in their financial interest. If a larger subsidy were
                                          provided through an MCCor other form, potential recipients who would
                                          line up to participate would be likely to include this group plus others
                                          who may be willing to make someadjustments in their housing choices
                                          to receive the (larger) subsidy.
Table IV.l: Example of Present Value of
QMB Assistance Wlth and Without                                                                                    Present value of subsidy
Recapture Provisions                                                                                                  at time of purchase
                                                                                                   Nominal             Without            With
                                          Time In housing unit                                     subsidy           recapture      recapture0
                                          5 years                                                    $5,542               $4,347            $i,04ab
                                          IO vears                                                   i I ,083              6.989             6.989C
                                          Note: The example is based on an $85,000, 30.year, fixed-rate mortgage. The market and QMB mort-
                                          gage interest rates are 10 percent and 8.5 percent, respectively. Present values are calculated by dis-
                                          counting with the lo-percent rate.
                                          aAssumes no reductions due to income or gain-on-sale provisions.

                                          bAt time of sale, the recapture amount equals the amount collected at that time, or $5,313.
                                          CAfter 10 years, no recapture is due.

                                          We would expect that potential recipients who could afford and would
                                          choosehome ownership will participate as long as the expected present

                                          ‘Home Ownership:   Mortgage Bonds Are Costly and Provide Little Assistance to Those in Need (GAO/
                                                         , al-.2% 198% PP. x-38.

                                          Page56                       GAO/RCED-90-117
                                                                                    Recapturingthe Qualified MortgageBondSubsidy
                               ExpectedRecaptureEffectson Program

                               value of participation, net of recapture amounts and other program-spe-
                               cific costs, is positive.2Economic theory suggeststhat even the hypo-
                               thetical recipient characterized in table IV. 1 who would receive a
                               subsidy stream net of recapture with a present value of about $1,000
                               would still probably participate in the program, as long as the recipient’s
                               housing choicesdid not have to be altered.

                               While someassistedowners’ recapture liability could be several hun-
Ability to Pay                 dred dollars or less, for others it might be several thousand dollars. The
Recapture With                 recapture amount would probably be paid anywhere from several
Income Tax Filing              months to over a year after the assistedhome is sold. For those with
                               substantial liability, the recapture amount might present payment
                               problems unless owners set aside funds from the sale of the assisted
                               home or have other financial assetsto enable them to pay the recapture
                               amount when due. Alternatives that do not present cash flow problems
                               are discussedin chapter 4.

IRS’ Ability to Identify       The Internal RevenueService needsto be able to identify assisted
                               owners subject to recapture to ensure that they will pay the appropriate
Owners Subject to              recapture amount. To accomplish this, the recapture provisions in the
Recapture                      1988 act require that the real estate broker must send an information
                               return to the IRS stating whether or not the seller’s financing was from
                               a &MBloan or a loan with a MCC.The Code defines “broker” to include
                               any person who acts as a middleman with respect to property and ser-
                               vices. The American Land Title Association expressedconcern that the
                               broker, in many instances,may find it difficult to comply with the
                               reporting requirements3 We contacted officials at three state housing
                               agencieswho tended to mirror the Association’s concerns.These are as
                           l   The information submitted to brokers is often not substantial. They may
                               not have the original loan commitment to determine whether the seller
                               haa a QMBloan or a MCCprovided along with the conventional loan,

                               2This suggests that people make decisions using the best financial information available to them.
                               However, the (1) smaller the subsidy, and (2) greater the uncertainty of the expected recapture
                               amount, the more likely it will be for households not to participate.
                               3The Association is a trade association whose goal is to promote the safe and efficient transfer of
                               ownership of real property. It represents about 2,300 abstracters and agents, title insurance compa-
                               nies, and associated members nationwide.

                               Page57                     GAO/RCED-90.117
                                                                       Recapturingthe QualifiedMortgageBondSubsidy
  Exgmctd RecaptureEffectaon Program

. Even if the seller’s loan documents are available to the broker, the loan
  documents will not always contain the necessaryinformation to deter-
  mine whether the seller Is subject to recapture.
. To the extent that a principal in the real estate transaction choosesto
  withhold information not necessaryto the closing of the transaction, the
  broker will be unable to comply with the reporting requirement.

  One approach to foster identification of assistedloans would be for
  mortgage lenders making loans for housing agenciesto “flag” loan files,
  so that a notice that the owner is subject to recapture is provided to the
  broker. A secondapproach would be for housing agenciesto add
  wording to their loan documents (or in amendments)that the loan is a
  QMBloan and the owner is subject to recapture. However, the second
  approach would not be effective for those settlements in which loan doc-
  uments are not submitted. Also, both approachesrequire the voluntary
  cooperation of all state and local governments making these loans, since
  the act’s reporting requirement doesnot require these actions.

  A third approach would be for brokers to request that lenders identify
  whether the loan was a &MB loan or made with a MCCwhen it makes its
  request for information relevant to the transaction. However, if lenders
  (1) do not flag their files to identify loans as &MBloans or loans with
  MCCsand/or (2) choosenot to comply with the broker’s request, then the
  approach will not work.

  Page68              GAO/RCJD90.117
                                   Recapturingthe QualifiedMortgageBondSubsidy
Appendix V

Approach Used in Applying a Total-Debt-
Expense-to-IncomeTest to Assisted Buyer
Data Base
               In our March 1988 report, we found that over half of the assistedbuyers
               covered in our review probably could have purchased the samepriced
               home with a conventional fixed-rate mortgage loan.1This result was
               basedon a housing-expense-to-incomequalifying test. For this report,
               we performed a secondtest, the total-debt-expense-to-incometest, to
               determine the extent to which performing a secondqualifying test to
               those who passedthe first test affected our earlier finding. This stan-
               dard determines whether total debt payments (housing expenseand
               other debt, such as automobile loan payments) exceed36 percent of
               income. For the “other debt” amount, we assumedthat each of the
               assistedhouseholdsthat passedthe housing-expense-to-incometest had
               monthly “other debt” payments of $160. This amount is equal to the
               median dollar amount of installment payments for home owners in a
               survey conducted by the Survey ResearchCenter of the University of
               Michigan.2The Center’s survey data were basedon statistical samplesof
               householdsacrossthe country.

               The median $160 installment payment is for all home owners, rather
               than for first-time buyers alone. However, the Center’s results for three
               reported measures(age of head of household, race, and income) suggest
               that the $160 median installment payment amount for all home owners
               is likely to be a fair approximation of the payment amount for &MB loan
               recipients. In this regard, our March 1988 report showed that QMB-
               assistedbuyers were typically younger, white, and had a median income
               of $26,000 (seetable V.l below). In comparing the Center’s reported
               monthly debt payments for those with similar age,race, and income
               range to QMB-assisted   buyers, the monthly installment credit payment
               amounts cluster around the Center’s $160 figure for all home owners. As
               such, we believe the Center’s estimate is a reasonableapproximation for
               use in our total-debt-to-income test.

               ‘See pp. 30-36 of Home Ownership: Mortgage Bonds Are Costly and Provide Little Assistance to
               ThoseinNeed(Gwll,M        - -       al,. 28t 19881.
               2SeeRobert B. Avery, et. al., “Changes in Consumer Installment Debt: Evidence from the 1983 and
               lQS6 Surveys of Consumer Finances,” Federal Reserve Bulletin, vol. 73, no. 10, Oct. 1987, pp. 761-78.

               Page69                                 Recapturing
                                          GAO/RCED-O-117       the QualifiedMortgageBondSubsidy
                                        Appendix    V
                                        ApproachUsedin Applyinga Total-Debt-
                                        Expenseto&womeTestto AssistedBuyer

Table V.l: Compariron of QMB-Aa8irted
Buyers to Hourehold Attributer in the                                                        Median installment payment in Survey
Survey Research Center Survey                                         QAO’a March 1988       Rerearch Center resultr (monthly
                                        Household attribute           report                 payment,)
                                        Median installment            (Not reported)         $160, for all home owners
                                        Income                        Median income was      $150, for all households with incomes of
                                                                      $26.000                $20.000-$34.999a
                                        Age of head of                61 percent of          $173, for all households of age 25~34~
                                        household                     assisted buyers
                                                                      were age 25-34
                                        Race                          82 percent of          $150, for all white households8
                                                                      assisted buyers
                                                                      were white
                                        aHome owner and renter households.
                                        Note: All dollar amounts are in 1986 dollars.
                                        Sources: See text

                                        Use of the median value for debt payments implies that half of those in
                                        the Survey’s results had consumer payments in excessof $160 per
                                        month. As such, a closer estimate of the extent to which consumer debt
                                        payments would affect our test results would be to apply the distribu-
                                        tion of higher debt payment amounts to assistedowners in our data
                                        base.However, we did not have the Survey data from which to make
                                        such a distribution. Nor did we have a way to allocate higher debt pay-
                                        ments to those in our data base.

                                        Instead, we performed our debt test again to determine how the results
                                        would change if all assistedbuyers had debt payments in excessof the
                                        $160 median value using three different amounts. We found that, if all
                                        buyers in our data basehad consumer debt payments of $180 per -
                                        month, the percentageof assistedowners passing this test decreased
                                        only slightly from 61 percent (if all assistedbuyers had installment pay-
                                        ments of $160 monthly) to 49 percent. Increasing the debt payments to
                                        $200 per month and $220 per month reduced the number of households
                                        passing the debt test to 46 percent and 41 percent, respectively. Since it
                                        is unlikely that all buyers had debt payments of this magnitude, we
                                        believe that our results are reasonable.
                                        To determine the effect of this secondtest on the assistedowners, we
                                        applied it only to those owners who had a housing-expense-to-income
                                        ratio of 28 percent or less, using the samegeneral procedure outlined in
                                        our March 1988 report3 If the assistedowner’s (1) housing-expense-to-

                                        3Seepp. 79-80 of (GAO/RCED-88-111, Mar. 28, 1988).

                                        Page00                      GAO/RCED-90417
                                                                                Recapturingthe QualifiedMortgageBondSubeidy
ApproachUeedin ApplySnga Total-Debb
Expens&o-IncomeTestto AssistedBuyer

income ratio was 28 percent or less and (2) total-debt-expense-to-income
ratio was 36 percent or less, we then concluded that the assistedbuyer
may have been able to afford the samehome at the sametime with a
conventional fixed-rate loan.
Housing agency files that we obtained for our March 1988 report sizable
amounts of missing data and often required substantial effort to make
them usable. As a result, we elected to use the Center’s data rather than
trying to obtain a complete data set for the total debt expensevariable
from housing agency files.

Page01              GAO/RCED-ftO-117
                                 Recapturingthe QualifiedMortgageBondSubsidy
Appendix VI

Comments From the Association of Local
Housing F’inanceAgencies

Note: GAO comments
supplementing those in the
report text appear at the
end of this appendix.

                                                    alhfa             ASSOCIATION OF LOCAL HOUSING FINANCE AGENCIES
                                                                      1101 Connecticut   Ave.. N.W.. Suite 700.   Washington,   D.C. 20036 * 202/857-1197

                                                                      May 30, 1990
                             omurs                                    Mr. John M. Ols, Jr.
                             P188ldBnl                                Director,   Housing and Community
                             Walter D Webdalo                              Development Issues
                             Fa~rlax County, Varginta                 U.S. General Accounting Office
                             Vice President
                                                                      Washington, DC 20548
                             Charles Brass
                             New York, New York                       Dear Mr. 01s:
                             Jay Jensen                               This letter   responds to your invitation    to
                             Muvuapolis,   Mnnesola                   the Association    of Local Housing Finance
                             TlClilSW3~                               Agencies (ALHFA) to provide comments on GAO's
                             Barbara T Smllh                          draft report "Limiting    Mortgage Assistance to
                             San Frsrwsco. Cal~lorn~e                 Owners with Rapid Income Growth."
                             lmmedlale Past President
                             Kennelh Johnson                          The report           makes several               findings:
                             St Paul. Mlnnasola

                             DIrectora                                o The current recapture mechanism does not
                                                                        treat equitably      all owners with income
                             George Arendas
                             Allegheny County, Pennsylvania
                                                                      o Some owners with large increases in income
                             WIlllam R Bruce                            will continue to receive assistance after
                             Memphis, Tennessee                         their incomes could support housing
                             Darlene K&da                               payments without it; and
                             P~nellas County, FlorIda                 o Bond-assisted     loans are made to those who
                             Angus   1  Olson
                                                                        could afford market-rate conventional
                             Alexand,,a. V,rgin,s                       loans with comparable terms, the mortgage
                                                                        bond program imposes high costs on the
                             David Perel
                             Los Angeles. Caklorn~a
                                                                        Treasury,   and the program benefits are
                                                                        relatively    small.
                             Robert L (Robb) PII&
                             Atlanta. Georgia

                             Macheel F Schubert                       “Promam Not Needed”
                             ChIcago. lll,no,s

                             Charles Taylor
                                                                     This last finding is a reiteration     of that
See comment 1.               Los Angeles County. CaMorrva            which GAO made in its 1988 report, "Home
                                                                     Ownership:     Mortgage Bonds Are Costly and
                             ALHFA Slall                             Provide Little    Assistance to Those in Need."
                             John C Murphy                           ALHFA challenged that finding then and does
                             Execuwe D~reclor                        so again.
                             Mary Kale Unbe
                             DlreClOr                                Conventional             Underwriting               Criteria
                             Program Development

                             Kalher~ne E Llboro
                                                                     Apart from mentioning a 28-percent mortgage
                             Admux%wve     Aswanl                    payment-to-income   ratio, the GAO staff in
                                                                     1988 did not enumerate any other criteria.
                             Wdkam F N,emeyer
                             Prqecl Assislanl
                                                                     It appears that on this basis alone, GAO

                       Y                                SPRING EDUCATIONAL CONFERENCE.               MAY 9-l 1, 1990. WASHINGTON, D.C.

                                            Page62                       GAO/RCED-90-117
                                                                                      Recapturingthe QualifiedMortgageBondSubsidy
     Comment-gFkomthe Associationof Local


concluded that fully         67 percent of assisted homebuyers could have
purchased homes with unassisted conventional               financing     (56
percent with 30-year fixed-rate           loans, and 11 percent with
adjustable-rate       loans).    How did GAOqualify        these assisted
buyers for conventional         mortgages? Did GAOuse the different
underwriting     criteria     applicable    to adjustable-rate       loans? Did
GAO consider     credit histories,       employment histories,         and other
financial    obligations?       Did GAO calculate     the standard second
ratio that compares the mortgage payment and other regular
monthly expenses with income? Did GAO actually                 determine that
mortgage bankers would have extended the conventional                   mortgages
to assisted buyers simply because they had a front ratio of 20
percent or below?
     The conclusion reached by this dubious methodology is even
more lacking in validity  today because of the income limits
imposed by the 1986 and 1988 Tax Acts.
       ALHFA contends that this simplified    qualifying       procedure
reflects   the GAO's failure  to perform reality      testing on its
conclusions.    Based on our conversations    with association         members
contacted by GAO for this report, we learned that the study
amounted to an exercise in data gathering and manipulation,                 in
other words a preoccupation    with data files.       Regretfully,       it
appears that the study group made little      or no effort         to learn
the program content or context in the individual           localities.
ALHFA maintains that a methodology reliant       entirely      on numbers is
inadequate and inappropriate    for such program analysis.

Revenue Loss Estimates
The GAO staff reported in 1988 that they referred to work done by
the Joint Tax Committee staff and "others" to estimate revenue
losses from tax exemptions on the bonds. Who are the other
sources? What are their assumptions and methodologies?     What are
their predispositions  regarding bond-financed  housing programs?
       Interested  parties often use these revenue loss estimates to
comment on the relative        efficiency      of bond-financed    programs in
promoting homeownership.          ALHFA contends that GAO's revenue loss
discussion missed an important efficiency             consideration.      Housing
finance agencies make carefully            informed decisions to issue
housing bonds at very specific           times when they perceive a demand
for affordable    mortgage financing.           In the absence of this
demand, agencies do not issue bonds; they take action that
results in federal revenue loss only in an economic environment
that otherwise discourages homeownership opportunities                 for low-
and moderate-income,      first-time       homebuyers.
      In some instances, the economic environment in which
agencies issued mortgage revenue bonds changes so that the

    Page83                   GAO/RCEDSO-117
                                         Recapturingthe QualifiedMortgageBondSubsidy
     CkmunentvFromthe Association of Local


affordability       of assisted mortgages resemble that of conventional
mortgages.      This results from unexpected falling     interest    rates,
over which housing finance agencies have no control.            In this
environment,      first-time   buyers tend to opt for the
administratively-simpler        conventional loans; the assisted loan
funds do not move, the agency calls the bonds, and the federal
revenue loss related to that issue ceases once the bonds are
      Federal revenue loss discussions      should not ignore or
underestimate     the ability  of housing finance,agencies   to make
responsible    economic decisions about issuing bonds; they do not
compulsively     or carelessly  issue housing bonds. Likewise, such
discussions     should not ignore the fact that Congress and the
President accepted revenue losses generated from this program as
a tradeoff    for the public gains also generated.

Benefit   Estimates
ALHFA believes that the analysis in 1988 emphasized "statistical
significance"     at the expense of what is really "important."   GAO
must not lose sight of the fact that Congress created the MRB
program for housing finance agencies to achieve public policy
objectives     and to create public benefits.   Over the years,
Congress has modified the program to further ensure this public
purpose.      ALHFA contends that GAO largely ignored this public
character in its analysis,      as revealed most vividly in the
program benefit estimates.
       It does not appear that GAO considered the intangible
benefits   of homeownership - improved self-esteem,      self-worth,
pride, and sense of responsibility     and of the community; the
benefits   from achieving public policy objectives     such as
increasing    homeownership rates, improving affordability,       and
expanding the housing stock; the community development impacts of
the MRB program; or the value of rejuvenating      residential
neighborhoods in distressed     areas.
       GAO did not count the employment, income, and tax revenue
benefits     generated by new housing construction.         GAO’s data
indicate     that over 100,OO units of new construction         occurred,
creating approximately        176,000 jobs as estimated by the National
Association       of Homebuilders.   It did  not  estimate   the   value of
protecting      low- and moderate-income first-time       buyers from
interest-rate       risk inherent in the conventional      market.     GAO did
not address the counter-cyclical        benefits yielded by bond-
financed homeownership programs.          It even underestimated       the
buyers' direct economic benefit by focusing on monthly payment
savings alone and ignoring the up-front          benefits   associated with
the program.        In fact, lenders are the first      to observe that the
downpayment and points are more critical          factors than interest

    Page64                  GAO/RCED-90-117
                                         Recapturingthe QoalifiedMortgageBondSubsidy
          Comment4Fromthe Aawciation of Local


    rate8 in determining      affordability.      The MRB program further
    enhances affordability       by permitting    these things to be financed
    in the loan.
           Assertingthat the MRB program         yields only lower monthly
    mortgage        - as implied in GAO’s
                coats                              benefit estimate - grossly
    underestimates  the economic, public         policy,   and personal benefits
    which our agencies have observed in          their communities over the
    life of their bond-financed mortgage          programs.
          It should also be noted as ALHFA did in 1988 that the 1988
    GAO  study included findings which reflected favorably on MRB
           o Most assisted buyers were in the "25 to 29" age category
             and lived in a household comprised of two people;               this
             suggests    that single-family      bond programs bring low- and
             moderate-income individuals         into the housing market early
             in their adult years permitting          them to enjoy
             homeownership benefits       sooner than the conventional
             market permits;
           o Forty percent of assisted buyers purchased new homes and
             80 percent of bond issuers eet aside some portion of bond
             proceeds for developers;         this demonstrates that single-
             family   bond programs add significantly          to new housing
             construction    and the nation's       overall affordable     housing
             stock, providing     increased homeownership opportunitiest
           o Assisted homebuyers purchased homes that cost 70 percent
             of the average purchase price and 80 percent of assisted
             buyers had incomes at or below 11.5 percent of the area
             median income; this suggests that housing finance
             agencies administered      single-family      programs before    the
             1986 Tax Act in a manner that generally            complied with the
             Act's new income and price restrictions.
           These findings   suggest that housing finance agencies have
    largely succeeded in achieving the very fundamental objectives       of
    the Mortgage Revenue Bond Program enunciated by Congress:         to
    encourage homeownership among low- and moderate-income households
    by providing    an incentive   to purchase in the form of an
    affordable mortgage, and to expand homeownership opportunities
    for such households by expanding the affordable       housing stock.
           It is not surprising    then that the MRB program enjoys
    widespread, bipartisan      support within Congress.   H.R. 1200, the
    bill  to extend the sunset on authority     to issue MRBs/MCCs,
    currently   has 364 cosponsors while its companion, 5.355, has 85
    cosponsors.    The GAO should recognize this fact and lay to rest
    its notion that the program is somehow not needed.


          Page85                GAO/RCED-80417
                                            Recapturingthe QualifiedMorrgageBondSuMdy
                     APPsndix M
                     C!ammente Prom the Auodation        of Imal
                     HolmingFlnrnee AgencIee


                  “RWaRtwe       Does   Not   Treat   Euuitsblv     Those with      Income    Increaseegg
                 GAO states     that,     while the recapture         provisions      will    recover     some
                 or all of the subsidy           received      by assisted      homeowners, it does
                 not treat    equitably       all owners with income increases.                   Some
                 owners will      receive     benefit     larger   than the uniform          1.25-percent
                 interest   rate differential,           while others       will   receive      less
                 benefit.     In such cases the owner could                pay more in recapture
                 than the owner received            in subsidy.       GAO suggests        that this
                 situation   could be overcome            by basing the recapture            amount on the
                 monthly payment reduction.
                         Of all the elements           of the recapture        mechanism,    the 1.25-
                 percent    differential       is perhaps the simplest,             easy to understand
                 by borrower       and lender      alike.       The situation      which GAO
See comment 2.   ;~~thseisee         of a borrower receiving a subsidy of less than 1.25
                     . ., 1.00 percent)        is not likely         to occur.      Housing finance
                 agencie8     simply     would not irsue bonds when the spread between
                 tax-exempt      and conventional          rates is this small.           In instances
                 where the subsidy         was greater        than 1.25 percent,        the public
                 purpose of assisting         homebuyers through providing                a meaningful
                 oubeidy would be achieved.                Therefore,      ALHFA does not believe      any
                 change in the 1.2%percent                assumed subsidy differential            is
                 warranted.       Requiring      lenders      to calculate      the actual     benefit
                 against    some measure of conventional               interest     rates would
                 needlessly      enaumber the program.
                         GAO also aassrte          that the limitation       of the recapture       amount
                 to no more than 50 percent               of the gain-on-sale      is inequitable
                 "because those with rapid income increases                   may escape paying it
                 if they live in areas with low or no housing price                     appreciation."
                 The Report goes on to say "by allowing                 owners to retain       some
                 equity    for     a rsplacement       house purchase,     the gain-on-sale
                 provision       fulfills     a purpose:       it does not force the owners to
                 return    to renter       status     because of a large recapture        amount."
                 ALHFA could not agree more that denial                 of some share of the gain-
                 on-sale     to the owner could very well return               such owner to renter
                 status.       This event would be completely            contrary    to the
                 fundamental         purpose of the MRB program!           to stimulate
                 homeownership.           Permitting      the owner to retain      50 percent     of the
                 home's appreciation           does enable the owner to move up, thereby
                 freeing     up his/her       more modestly      priced  home for potentially
                 another     first-time       homebuyer.
                         That the gain-on-sale   provisions            treats    those in high
                 appreciation      versus low/no appreciation             housing markets
                 differsntly     is no reason to eliminate             the gain-on-sale    provision.
See comment 3.           GAO then asserts      that the phaseout of the recapture       from
                 years 6 to 10 'I...      is not consistent       with the benefits  principle
                 since those who receive          greater   total  benefits over time are
                 subject    to a lesser     recapture     amount than those who receive      the

                    Page66                      GAO/RCED-9lH17RecapturingtbeQuaMedMortgageBondSul~idy


                 same annual benefit,   but over a shorter period of time."    GAO
                 suggests the this situation   could be remedied by reversing the
                 recapture provision  to allow the recapture amount after 5 years
                 to increase at the full recapture rate until    the home was sold,
                 allow it to increase at a reduced rate, or establish    a plateau
                 from which the amount would neither increase nor decrease.
                         GAO’s discussion   of the phaseout treats it as a negative
                 effect:      that persons assisted should be discouraged from
                 remaining in their home. Recapture should have the opposite
                 public policy objective      as the phaseout has -- encouraging
See comment 4.   neighborhood stabilization       through long-term homeownership.

                 "Subsidy Allowed to Continue Despite Obvious Significant       Income
                 GAO states that, because recapture        is imposed after the owner
                 sells the house, it is easier and       less costly to administer,
                 since the amount is computed once,        as opposed to periodic
                 determination(s)     of whether there   is a continuing   need for
                 assistance.      ALHFA agrees that it   is easier and less costly to
                         GAO goes on to say that some owners' income will increase to
                 the point where they do not need continued assistance to remain
                 homeowners. Again, ALHFA agrees with this statement.       However,
                 ALHFA sees one of two things happening in such a situation:      one,
                 the owner sells the home and pays off the MRB-financed loan.
                 These proceeds are then used to retire    the bonds, thereby saving
                 the federal government money, or the proceeds are relent to a
                 qualifying    homebuyer; or, two, the owner remains in the home
                 lending the stability    of homeownership to the neighborhood.   In
                 either case a proper public purpose is served.

                 “A   Prospective Affordability   Test is Needed"
                 The Report again notes that GAO's 1988 study concluded that a
                 majority of those assisted between 1983 and 1986 would have
                 obtained fixed-rate    conventional   loans at the time they received
                 MRB assistance.     Even more could have qualified    for adjustable-
                 rate mortgages.     GAO then asserts that to remedy this situation
                 lenders would have to determine whether those applying for MRB
                 loans could qualify    for conventional    loans.  If they could, they
                 would be denied the MRB assistance.
                        GAO admits in a footnote,    as it did in 1988, that it reached
                 its conclusion that most of those receiving        MRB assistance could
                 have qualified   for a conventional    loan, based solely on the
                 industry housing-expense-to-income       test.  It readily concedes
                 that it @I... did not use other information       used in the loan-

                      Page67                GAO/RCEIHO-lI7RecapturingtheQualifiedMortgageRondSuhsidy
                       Cvmmenta From the Atmoeiationof Local


                 making     process, such as housing-expense-total-debt       ratios, credit
                 histories,      and employment records, " dismissing their importance
                 by saying that the housing finance agencies computerized records
                 did not contain it and that regardless it would not have changed
See comment 5.   the outcome.       This statement is so incredible     that it calls into
                 question the validity       of the 1988 report as well as this draft
                 report.      These additional    factors are critical    and are often the
                 deciding factor in helping low- and moderate-income households
                 who cannot qualify       for conventional  loans.
                         Housing finance agencies use private lenders to originate
                 loans and to work with borrowers to make loans.               MRB-financed
                 loans have more qualifying         and administrative    requirements than
                 conventional       loans with which both lenders and borrowers must
                 comply.      Given a choice between a conventional         loan and a MRB-
                 financed loan, we believe that the borrower who anticipates                a
                 near-future      rise in income will choose the conventional          loan to
                 avoid the administrative         and programmatic complexities       associated
                 with an MRB-financed loan.          ALHFA contends that they have made
                 this choice all along considering           that, as GAO pointed out in the
                 1988 study, the average life of an MRB-assisted loan was 7 years.
                 This relatively        long tenure, coupled with the targeting
                 restrictions       enacted in 1986 and 1988, makes the MRB program one
                 not for the 'tyuppie*V as GAO would have us believe,           but for owners
                 who cannot qualify         for a conventional     loan. ALHFA concludes
                 therefore     that such an affordability        test is unnecessary and
See comment 6.   would further complicate rather than simplify            the program.

                 %lternatives       to the Rxisting   Recapture MechanisW
                 GAO  asserts that "the current recapture mechanism is preferable
                 to none at all because some or all of the subsidy will be
                 recaptured from at least some owners who probably could have
                 waited a short time and bought a home without assistance due to
                 rapid income growth."    GAO suggests two alternatives:         a roll-
                 over loan where assistance is discontinued,       after periodic
                 reviews, based on preestablished    affordability     criteria,   and
                 income-based variable payment mortgage loans whereby housing
                 payments are increased periodically     as long as income increases.
                       In the former alternative,    "if     the owner's       income rises to a
                 point where the owner could afford        a comparable        market-rate   loan,
                 the owner is required to refinance        the assisted        loan with a
                 market-rate  loan.   If income growth       is insufficient         for the owner
                 to afford a market-rate    loan, then     assistance is         continued."
                       GAO correctly   states that a roll-over   loan introduces costs
                 and other complexities     to the program for both borrowers and
                 lenders.    Borrowers must bear refinancing    costs which might be
                 substantial   and more than the subsidy received.      It will also
                 increase administrative     burdens for the lender by (rejcertifying

                       Page08                GAO/RCED-90-117
                                                          Recapturingthe QualifiedMortgageBond Subsidy


                 income and determining what the market rate should be. ALHFA
                 finds no justification   for Congress to choose this as a
See comment 7.   preferred alternative  to the existing  recapture mechanism.
                        In the second alternative,     the owner's payment for
                 principal,   interest,    taxes, and insurance are a fixed percentage
                 of household income. As income increases,         so do monthly payments
                 even to the point where the interest       rate exceeds the
                 conventional    rate.   At this point, according to GAO, there would
                 be an incentive     for the household to leave the program.
                       GAO again correctly    asserts that this alternative    'I... will
                 increase administrative     cost and program complexity over the
                 current recapture approach."       It would even be more costly than
                 the roll-over    approach due to the continuing   need to adjust loan
                 payment schedules leading to increased costs.        Here again ALHFA
                 finds no justification    for Congress to choee this alternative
                 over the current recapture.
                       Moreover, such a requirement would conflict       with normal
                 mortgage underwriting    practices whereby lenders assume some
                 income growth over time on the part of the borrowers,        thereby
                 increasing  the loan's security.      If the payment-to-income    ratio
See comment 8.   were held constant through an adjustment to the interest         rate,
                 lenders would compensate by imposing lower credit-to-income
                 ratios thereby targeting     away from lower-income to higher-income
                 borrowers, which would not be a desirable public policy outcome.
                        In wnmary, ALHFA finds no recommendation in the report
                 which would make the recapture mechanism, or alternatives
                 thereto,   simpler or easier to administer.     We find too that GAO's
                 continued assertions    that the program is not needed based on
                 faulty and aged data are inaccurate,      and a disservice   to the
                 program's congressional     supporters, the local and state agencies
                 which administer   the program, and to the first-time      homebuyers
                 whom Congresa has chosen to assist.

                     Page69                GAO/RCED-~117Recapturingtl1eQualWiedMortgageBondSubsidy
                        Fromthe Aeeoclationof Lintal

               The following are GAO'S comments on the Association of Local Housing
               Finance Agencies’ letter dated May 30, 1990.

                1. The first four pagesof the Association’s comments reiterate, mostly
GAO Comments   word-for-word, its 1988 comments disagreeing with most aspectsof our
               March 1988 report. The comments largely relate to topics in our earlier
               report and not to those in this report. Seepp. 94-106 of Home Owner-
               ship: Mortgage Bonds Are Costly and Provide Little Assistance to Those
               in Need (GAO/RCED-88-111, Mar. 28,1988) for the Association’s comments
               and our responses.
               2. The Association states that home owners are not likely to receive an
               (after-tax) subsidy of less than 1.26 percent becausehousing agencies
               will not issue bonds when the interest rate-spread between tax-exempt
               bonds and conventional mortgage rates is this small. The Association’s
               comments ignore the fact that interest rates sometimesdecline after the
               bonds are issued and before loans are made, thus reducing the interest
               rate differential the home owner can achieve. The 1982-87period was
               one of generally declining interest rates. Our 1988 report estimated that
               one-quarter of the buyers in our 1988 study received interest rate reduc-
               tions of three-quarters of a percentagepoint or less from the conven-
               tional interest rate.

               Finally, the Association believes that tailoring the recapture amount
               more closely to the actual interest-rate reduction would needlessly
               encumber the program. We believe that the procedure we propose in
               chapter 3 would only minimally increase administrative requirements.
               The alternative is to decreasethe attractiveness of the program to some
               prospective buyers who learn that the recapture mechanism may, in
               someinstances,take away more than the subsidy they are likely to
               3. Neither GAO'S draft report nor this final report recommendedelimi-
               nating or changing the gain-on-saleprovision.
               4. The Association n&characterizes our discussion.The enacted phase-
               out mechanism reducesthe recapture amount for those who benefit the
               most (as measured by length of time in the assistedhome) and who
               exceedthe income test thresholds.

               6. We added an analysis of housing agency loan files using a total debt-
               expense-to-incometest in this final report. Mortgage lenders qualifying

               Page70                             Becspturjng
                                     GAO/RCED-90-117       the QuaUf’ied
Chnment.8   From the Association   of Local

prospective QMBloan and MCCrecipients review credit histories and
employment histories to ensure that the applicants are good credit risks.
We did not need to do so again.

6. As discussedin appendix IV, a typical prospective buyer may find it
financially worthwhile to obtain a QMBloan, no matter what the buyer’s
income expectations, even with the imposition of a potential recapture.
7. Our draft report outlined an approach that would not have required
loans to be refinanced. The approach we suggestedfollows that of
FII-IHA’Ssection 602 program and avoids interest-rate risk on the part of
the assistedbuyer and the imposition of refinancing costs.The Associa-
tion is incorrect in suggestingthat our approach would require refi-
nancing and the attendant costs to do so. However, we have reworded
our discussionto further clarify this point.
8. Adjustable rate mortgages,which can result in increasedmonthly
payments-even if income does not increase-are used widely in the
conventional marketplace. Thus, the assertedconflict does not exist.
Roll-over approachesare also used elsewhere.Seeappendix IV of this
report for a description of HUD'Ssection 236 and F’mHA’Ssection 602
home ownership programs and two local housing finance agenciesthat
use a roll-over loan mechanism.

Page71                    GAO/RCED-O-117
                                      Recapturingthe Qualified MortgageBondSubsidy
Appendix     VII

Comments From the National Council of State
Housing Agencies

Note: GAO comments
supplementing those in the
report text appear at the
end of this appendix.

                                                                                        June 5, 1990

                             Mr. John M. Ols, Jr.
                             Director. Houslng and Community
                                Development Issues
                             Unit;;eStates  General Accounting
                             Washington,      D.C. 20548
                             Dear Mr. 01s:
                                    Thank you for providing the National Council of State Housing
                             Agencies    (NCSHA) the opportunity       to comment   on the General
                             Accounting    Office’s draft report, “Homeownership: Limiting Mortgage
                             Assistance    Provided to Owners With Rapid Income Growth.”         The
                             enclosed comments are submitted          to you on behalf of NCSHA’s
                             member State Housing Finance Agencies.
                                    If you have any questions    on our comments,       please                           do not
                             hesitate to call me. We look forward to your final report.

                                                                                        John T. McEvoy
                                                                                        Executive Director

                             cc:     James Ratzenberger
                                     Dennis Fricke


                               444 North Gpitol Street, N. W., Suite 118, Washington. D.C. 20001 (202) 624.7710 fix (202) 624.7719

                                   Page 72                        GAO/RCED-!30-117 Recapturing the Qualified Mortgage Bond Subsidy
           Comments Fromthe NationalCouncilof

           Comments on the General Accounting Of&x’s Draft Report,
     “Homeownership:  Limiting Mortgage Assistance Provided to Owners With
                              Rapid Income Growth”
           Submitted by the National Council of State Housing Agencies
                                   June 1.1990

           The National Council of State Housing Agencies (NCSHA) is pleased to
    be able to submit these comments on behalf of our member Housing Finance
    Agencies (HFAs) on the General Accounting          Office’s (GAO’s) report,
    “Homeownership:      Limiting Mortgage Assistance Provided to Owners With
    Rapid Income Growth.”        That report comments upon the MRB recapture
    provision of the current Internal Revenue Code.
            NCSHA considers that the MRB recapture provision represents a
    highly complex overreaction which burdens the entire MRS program to
    penalize a few theoretical homebuyers whose existence is documented only
    anecdotally     at best.      Because the recapture provision is expensive to
    administer, raises difficult issuer and lender liability questions, and may
    frighten eligible homebuyers away from buying their first home, we believe it
    should be repealed.          If it is not repealed, we believe it urgently needs
    substantial    simplification.       These NCSHA comments are limited to the
    simplification    issue, since they are a response to the GAO report on
    improving the existing recapture provision.
            NCSHA is a national, not-for-profit organization created in 1970 to
    represent the interests of State HFAs in low and moderate income housing.
    HFAs in every state, the District of Columbia, Puerto Rico, and the Virgin
    Islands respond to low and moderate income housing needs through the
    financing, development, and preservation of affordable rental and ownership
    housing. HFAs collectively     operate more than 350 affordable housing
    programs, which range from homeownership to homeless initiatives.
          NCSHA members have helped more than l.OOO,OOO low and moderate
    income Americans buy their first home through Mortgage Revenue Bond
    (MRBl programs in every state. These HFAs issued approximately $6 billion
    in MFtE3s in 1989 under the private activity bond cap which strictly limits
    the overall volume of such bonds. In 19 states, these HFAs also administer
    Mortgage Credit Certificate (MCC) programs.     Local government agencies
    also administer MRS and MCC programs in several parts of the country.
          NCSHA’s member HFAs have also financed over 500,000 units of rental
    housing for low and moderate income tenants through reduced interest rate
    mortgages financed by tax-exempt bonds. Since 1986, NCSHA members
    have financed 235.000 low income rental units with the Low-Income
    Houslng Tax Credit for households with Incomes at 60 percent or less of
    area median.


           Page73                GAO/WED-99-117
                                              Recapturingthe Qualifkd MortgageBondSubsidy
          Append&   VU
          CommentaFromthe NationalCouncilof

        The MRB/MCC (MRBl program, which is scheduled to expire this
year, is the only generally available federal mortgage payment assistance
program in today’s disheartening environment of climbing home prices and
declining homeownership     rates. An overwhelming 85 percent majority of
the Congress -- 454 of the 535 House and Senate members, including 70
percent of the members of both tax-writing         committees   -- have co-
sponsored legislation in this Congress to extend this time-honored,    well-
tested, and Congressionally    limited program to make the national goal of
homeownership attainable by lower income Americans.
        The NCSHA and its member agencies hope that Congress will this year
extend MRBs permanently to eliminate what has become a pointless and
time-consuming        review for both Congress and MRB issuers of a program
which has been tightly targeted by Congress and has proved its value and
popularity      in the states.     At the same time, we hope Congress will
substantially simplify the program’s recapture requirement. found in Section
 143(m) of the Internal Revenue Code, which becomes effective for MRB
loans made and MCCs issued after December 31. 1989. Without such a
simplification,      the cost of administering      the MRB program will be
significantly     increased without     any benefit to the federal government.
Moreover, deserving, but unsophisticated,      borrowers may be frightened away
by the complexity         of the recapture provision, and many MRB-assisted
homebuyers will face the need to obtain professional assistance to file their
tax returns when they sell their homes.
      This response to the GAO report is divided into three parts:
      l     First. analysis of the goals and complexity of Section 143(m) of the
            Internal Revenue Code, the “MRB recapture” provision enacted in
            1988. which is the subject of the GAO report.
      l     Second, a discussion       of the unfounded   bias against the MRB
            program displayed in the GAO report which undermines            the
            credibility of its recapture recommendations.
      l     Third, an analysis of the GAO’s recapture recommendations.

                         Section XWfml:   The Recwture   Provision
       Existing provisions of the tax code limit MRB assistance to lower
income purchasers who buy less than average priced homes. The price of an
MRB-financed    home cannot exceed 90 percent of the average area home
purchase price. MRB borrower income may not’ exceed 115 percent (100
percent for families of fewer than three persons) of the higher of the area or
statewide median gross incomes for the area in which the residence is


          Page74                  GAO/RCED-90-117
                                               Recapturingthe QualifiedMortgageBondSubsidy
      Appendix VII
      Comments Fromthe NationalCkmncilof

       In practice, HFAs frequently      set their MRB-assisted home prices and
  urchaser incomes well below the        federal limits. In many areas, however,
Rousing costs are high relative to       incomes.     In such areas, incomes even
hlgher than the federal limits are        frequently necessary to purchase even
lower priced homes, so the MRB           program limits inhibit use of MRRs in
these markets.
      Last year, conventionally financed home prices averaged 37 percent
more than State HFA MRB-financed         homes. Conventional  borrowers’
incomes averaged 44 percent above MRB borrowers’ average incomes.
       Congress enacted Section 143(m) of the Internal Revenue Code in
 1988 to discourage buyers who expect their income to increase faster than a
simple five percent per year above the MRB program limits from using MRB
mortgages. When an MRB-assisted home is resold, Section 143(m) requires
MRB-assisted owners to repay to the federal government some or all of any
MRB benefit they obtained while they owned the home. The amount of
recapture    penalty MRB purchasers       might owe under Section 143(m)
depends upon how much their incomes have risen, their family size at the
time of sale, the size of their mortgages, and the length of time they owned
their home.
       NCSHA believes that the recapture proposal represents a highly
complex solution to a problem of minor proportions, if a problem exists at
all. Thus, NCSHA believes that the recapture provision should be simply
        NCSIiA agrees with the objective of discouraging those from getting an
MRB mortgage for whom conventional financing is a reasonable alternative.
However, the Congress has made no finding beyond anecdotal evidence of
significant   and rapid income growth among MRB beneficiaries.               Nor has
NCSHA found evidence to support the perception that MRB beneficiaries
experience significant       and rapid income growth.        In fact, occupational
surveys conducted by several HFAs suggest that MRB borrowers are not
upwardly mobile families whose salaries climb rapidly, but instead are
teachers, firemen, factory workers, and service industry               people whose
salaries rise, if at all, only at approximately the rate of inflation.
       We agree that recapture may be appropriate for those whose incomes
rise outside the MRB eligibility  range while occupying an MRB-assisted
residence. The current provision, however, is like a cannon trained upon a
gnat, in terms of the complexity imposed upon the entire MRR program, to
“catch” a few buyers whose incomes may rise rapidly and who may exist
more in anecdote than in reality.     For these reasons, we are urging the
Congress to consider simplifying     current law without   diminishing   the
intended effect of recapture and to avoid adding additional complexities to
the law which meet no demonstrated need.


      Page75                  GAO/RCED-90-117
                                           Recapturingthe QualifiedMortgageBondSubsidy
      0xnmenta Fromthe NationalCouncilof

       Section 143(m) involves a process of computation which contains up
to 13 sometimes complicated mathematical computations to determine the
recapture amount. A summary example of how Section 143(m) would work
in an ordinary home sale consumes a single-space page of the GAO report,
complete with two footnotes.
       When the Congress enacted the recapture provision          in 1988. it
delayed the effective date in order to permit consideration of alternatives to
attain its policy goal. As part of that review, Congress asked GAO to study
the recapture provision’s effectiveness and administrability.  GAO has now
rendered its report.
       We commend GAO for acknowledging the complexity of the recapture
mechanism in that report. However, we are disappointed that GAO offers no
solution to this complexity, which will confound borrowers and lenders alike
and discourage their participation in the program.
        The GAO suggests no simplification of the current recapture provision.
Instead, demonstrating the truth of the axiom “the perfect is the enemy of
the good,” the GAO report poses new reca ture alternatives,            the cost,
inconvenience, and complexity of which dwar P those of the existing version
of Section 143(m) without any assurance of improving its results.         In fact,
GAO’s proposed revisions and alternatives to the current provision would
further complicate its application and are completely unworkable.        Each of
the GAO suggestions would add additional layers of complexity to a provision
whose intended purpose can be well served by a limited simplification       of its
existing provisions, without the introduction of still new complications.

                       possible RcCaDttW   SimDlification
       The current recapture provision contains up to 13 mathematical
calculations to determine the recapture amount. At least one simplification
(described   below) of Section      143(m) reaches   virtually  the same
mathematical     result as the current    law, but reduces the required
mathematical computations to a maximum of eight.
        Under current law, recapture is assumed to be potentially payable by
all MRB purchasers,      but the amount is reduced potentially        to zero by
application   of a set of complex calculations      involving up to 13 separate
computations.     Under a possible simplification,   no recapture would be owed
unless income exceeded a certain threshold level in the year of, sale. That
Threshold    Income would be determined           by multiplying  .05 times the
number of years the home was owned and further multiplying that result by
the maximum eligible income which would have been available to a family
the size of the MRB seller at the time he or she purchased the home
(maximum eligible income) and adding that product to the maximum
eligible income.


       Page70                 GAO/RCED-90-117
                                           Recapturingthe Qualifkd MortgageBondSubsidy
      CommentsPromthe NationalCouncilof

        The current law provision calculates the maximum recapture amount
by multiplying      6.25 percent times the amount of the MRB mortgage and
multiplying     that result by a “holding period percentage” which is derived
through a two or three step calculation, depending on whether the home is
sold in years one through five or In years six through ten. Under the
simplification      alternative, the maximum     recapture  amount would be
determined by multiplying         the origlnal mortgage amount by ,001 and
multiplying    that result by the number of months the home is owned up to
60. (The ,001 is the result of dividing 1.25 by 12 months. Sixty months is
the period during which current law recapture rises to its maximum
possible amount.)
        The simplification    proposal differs significantly from current law in
its application after year five. Current law increases the recapture amount by
 1.25 percent per year to a maximum of 6.25 in year five, reduces the
maximum amount by 1.25 percent per year in years six through ten and
eliminates recapture after year ten. Like current law, the simplification
proposal assesses the maximum recapture amount in year five, but that
amount remains constant in years six and seven and recapture is eliminated
in year eight. The reason for this change is that the targeted “yuppie”
population will not remain in their homes beyond seven years, if they stay
that long. In fact, MRB mortgage prepayment statistics indicate that the
vast majority of MRB homeowners sell their homes between years five and
seven.     The Congress recognized this in the softening of the current
recapture penalty in years five through ten. The simplification     proposal just
eliminates these additional and unnecessary computations.
        Under current law, the actual amount of recapture is determined by
adding $5000 to an income level determined in exactly the same fashion as
in the simplified alternative and then reducing the total recapture amount
otherwise payable by two percent for every $100 the owner’s income is
below this amount.         Additionally, the recapture actually owed could not
exceed one-half the MRB seller’s net gain on the sale.                Under the
simplification    proposal, no recapture would be owed if income did not rise
over the Threshold Income. If the owner’s income exceeded the threshold,
recapture would equal the lowest of the following:             (1) the maximum
recapture amount, (2) 50 percent of the net gain on sale, or (31 .0002 times
the amount of income over the threshold times the maximum recapture
amount.        The effect of both current law and the simplification   is that for
every $100 the seller’s income Is above the Threshold Income, the seller
would pay 2 percent more of the maximum recapture amount, until it is
$5,000 above the Threshold Income, at which point the seller would pay full
     The actual operation of current law and the possible simplification       are
demonstrated in the example set out below.
      The following     description illustrates how      current   law   and   the
proposed simplification would apply to the “Example      of How to Compute     the


      Page77                 GAO/RCED-90-117
                                          Recapturingthe QualifiedMortgageBondSubsidy
       CvnuuentePromthe NationalCouncilof

Recapture Amount” contained in’ Appendix I to the GAO Re ort (page 52).
In the example, the MRB Mortgage is $55,000; the applicab Pe income level
for the seller’s household is $23.000; the home is held 6 years and 2
months: the seller’s income at time of sale is $32.000; and the gain on the
sale is $12,000.

w                - Thirteen Steps to Determine Recapture
Maxtmum Recapture Equals:     $55.000 x .0625 = $3.438
(one step)
Holding Pertod AdJustment:    ((120-741/60)x $3.438 = $2,636
(three steps)
Income Eltgibtllty   Llmlt:   ($23.000x .05 x 6) + $23,COO+ &WXIO= &34SXl
(four steps)
Recapture Reductton:          (($34,ooo- $32.000)/ 100)x .02 x $2,636 = $1.528
Recapture Computatlon:        $2,636 - $1.528= $1,108
(one step)
Recapture equals lesser of the Recapture Computation ($1.108). the Hotding
Period Adjustment ($3.6361, or one-half the gain on the house ($6.0001.

                     - Three to Eight Steps (No Recapture below Threshold

Threshold Income:             ($23.W x .05 x 6) + $23.000 = $29.900
(three steps)
M&mum       Recapture:        $55.OKJx ,001 x 60 = $3,300
(two steps)
AdJusted Recapture:           0002 x @32.000 - $29.900) x $3.300 = $1.386
(three steps)
Recapture   equals lesser of Adjusted      Recapture  ($1.3861,                  Maximum
Recapture ($3,300). or one-half the gain on the house ($6.0001.

       In this example, the recapture under the simplification      proposal
($1.3861 actually exceeds the recapture under current law, because current
law ($1.108) reduces the recapture amount for each year over iIve the house
is held, whereas the simplification proposal does not.


       Page78                   GAO/RCED-SO-117
                                            Recapturingthe QualUledMortgage BondSubsidy
      CommentsFkomthe NationalCouncilof

                  The Unfortunate       Bias in the Q,AO Resort.
        The GAO approach to the recapture            issue not only overlooks
simplification alternatives to existing law. but also reflects an unfounded and
undocumented assertion that most MRB-assisted buyers need no assistance
and, hence, should have to prove they cannot get credit elsewhere before
they get an MRB loan.
       The GAO has traditionally   opposed the MRB program, which is the
only federal homeownership mortgage assistance program generally available
to lower income individuals     and families. Today’s MRB program is the
product of a decade of Congressional refinement designed to tighten the
MRl3 program as far as practicable to assure that MRB benefits are targeted
to those who need them in order to qualify for homeownership at all.
       Because the MRB program has been caught up with a number of other
tax programs - popularly known as “the extenders” -- which have been
continued   from year to year during the 1980’s for revenue accounting
reasons, it has been reviewed about as often - five times - and amended to
assure its cost-effectiveness   - four times - as any tax provision ever
considered.    And a nearly unprecedented majority of the Congress - more
than 80 percent of all Members in both Houses and 70 percent of each
House’s tax-writing committees - have co-sponsored legislation to continue
the MRB program in its present form.
      As a matter of fact, the MRB program is one of the least expensive of
the “extenders” or many other provisions of the Internal Revenue Code. The
Joint Tax Committee staff estimates that the MRB extension represents only
about three percent of the aggregate cost of all 12 extenders.
        In light of these refinements   and overwhelming     Congressional
support. the Senate Finance Committee last year reported a permanent
extension of the MRB program as part of its version of the 1989 Tax Act,
notwithstanding    the Gramm/Rudman      Act, which has led Congress to
provide only short-term extensions for other “extenders,” in order to meet
deficit reduction targets. That permanent MRB extension, however, along
with most of the rest of the Finance Committee bill, was dropped in the
subsequent maneuvering over the capital gains issue.
        But just as Congress has consistently   found the highly targeted,
recapture-limited  MRB program to be overwhelmingly      worthwhile. some
academic critics have persisted in comparing it to goals Congress does not
share and ignoring the bulk of all the evidence which impeaches their
        Regrettably, the GAO study of Section 143(m) partakes richly in this
prejudice. It ignores the Congressional determination embodied in the MRB
program to provide a limited chance for homeownership       to lower income
families. The GAO report is undermined by repeated reference to a previous


      Page79                GAO/RCED-90-117
                                         Recapturingthe QualifiedMortgageBondSubsidy
                       CommentsProm the National Council of
                       State Housing Agencies

                 GAO report, “Homeownership:      Mortgage Bonds Are Costly and Provide Little
                 Assistance to Those In Need,” in which GAO criticized the MRB program.
                 But this 1988 report was fatally flawed, because it was based on data the GAO
See comment 1    gathered selectively and admitted was at best inconclusive and manipulated
                 with invalidly hypothesized assumptions about the actual real world practice
                 of making MRB mortgages.
                         Proceeding on this unfounded prejudgement that the MRF3 program is
                 full of undeserving participants, the GAO unsurprisingly   finds fault with the
                 recapture mechanism Congress enacted in 1988 to discourage buyers from
                 the program who expect an extraordinary income increase or to recover the
                 benefit from others who receive such an increase unexpectedly while MRB
                 owners.     Surprising,  however, is the additional   complexity and further
                 burden GAO asks the Congress to consider imposing on the MRB program
                 for all buyers, without any convincing statement of need for such steps based
                 on any serious examination of current or statistically    valid MRB program

                        We strongly object to GAO’s repeated assertion throughout its report
                 that a majority of MRB beneficiaries could have purchased the same house
                 without help. using a conventional mortgage. We are dlsmayed that GAO
                 continues to rely on a view first expressed in its dated 1988 report, which
                 was based on incomplete         and obsolete information,  contained  highly
                 controversial conclusions. and became completely irrelevant after Congress
                 further restricted MRB eligibility and enacted the recapture provision later
                 that same year.
                         NCSHA successfully rebutted the conclusions of GAO’s 1988 study in a
                  1988 Occasional Paper of Georgetown University’s Center for Public Policy
                 prepared by Dr. Margaret Wrightson and funded by NCSHA and in a 1988
                 report -- A Referendum on the American Dream -- prepared in cooperation
                 with the Association     of Local Housing Finance Agencies, the National
                 Association of Realtors, and the National Association of Home Builders. The
                 flndings of these reports have been supported by data collected by NCSHA in
                 the years since their release. GAO has never updated its 1988 report to
                 reflect   the MRB program        tightening  Congress   enacted that year,
                 acknowledged     the thorough rebuttal provided by the Georgetown and
                 NCSHA responses, or seriously addressed the inaccuracies those studies
                 demonstrated in GAO’s conclusions regarding MRBs.
                        We are aware of no credible evidence that MRB beneficiaries could, as
                 GAO claims, buy a home without help. The 1988 GAO report containing
See comment 2.   these assertions was not based on a random or impartial selection of state
                 program data, but instead, by GAO’s own admission, was conducted with a
                 skewed methodology. As the 1988 report stated on page 16 . . .“Because we
                 selected housing agencies judgmentally,   we cannot assert that our findings
See comment 3.   are representative of qualified mortgage bond activity nationwide.”


                       Page80                GAO/RCED-90-117
                                                          Recapturingthe QualifiedMortgage BondSubsidy

                           CommentsFromthe NationalCouucUof

                            GAO’s conclusions are contradicted by any impartial, statistically valid
                     review of the same and comparable data. The Georgetown study used data
                     from the same years as the GAO study, collected from an unbiased sampling
                     of data from 17 HFAs. The Georgetown study included eight of the states
                     GAO studied whose data was sufficient to permit a statistically valid review
                     and an additional nine states selected to replace the states in the GAO study
                     in which the data was inadequate to support a statistically       valid review.
                     These replacement states, if anything, tended to be “high cost areas,” data
                     from which would tend to support GAO’s conclusions more strongly, if,
                     indeed, those conclusions were correct.
                            The Georgetown study found that MRB household           income and
                     purchase price limitations established by Congress in 1980 (and gradually
                     made more stringent since) have been very effective in targeting MRB
See comment 4        assistance to lower income homebuyers.     It revealed that many states are
                     serving even lower income people than mandated by the federal guidelines.
                     It found that the incomes of the population served and the prtces of the
                     homes financed      with MRBs are well below those represented           by
                     conventional, or even FHA or VA, sales. According to the Georgetown study,
                     in 1987 (the last year studied by either GAO or Georgetown). the median
                     income of an MRB recipient was $27,000, compared to the 47 percent
                     higher $39.600 income of the conventional buyer. The average price of a
                     MRB-assisted    home was $62.000, compared to the 34 percent higher
                     average conventional buyer purchase price of $82.900.
                           The gap between MRB and conventional       borrower home purchase
                     prices and income continued to widen in 1988 and 1989. According to data
                     compiled by the NCSHA in its Annual Survey of the 58 State HFAs, the
                     average purchase price of an MRB-assisted home was $52,597 in 1988 and
                     $59,377 in 1989, compared to conventionally   financed average first-time
                     buyer prices of $94,400 in 1988 and $95.000 in 1989.         The average
                     income of an MRB borrower was $23.071 in 1988 and $25.019 in 1989.
                     compared to conventional    borrower incomes of $44,200 in 1988 and
                     $45,000 in 1989.
                            In addition,    GAO’s conclusions     were based on underwriting
                     assumptions which it invented and did not reflect actual market practice,
                     such as the FHA underwriting       standards used at that time which were
                     commonplace in the MRB program.          The underwriting  ratio of permitted
See comment 5.       expenses-to-income      GAO used in its study helped predetermine           its
                     conclusion that MRB recipients could have qualified for conventional loans.
                     Standard underwriting ratios, on both conventional loans and adjustable rate
                     mortgages, are stricter than those used by GAO. These standard ratios
                     include a formula that penalizes the amount of the borrower’s household
                     debt in determining mortgage credit worthiness.      This debt factor is often
                     the toughest hurdle for first-time homebuyers to jump. Yet, GAO did not
                     include it in its underwriting assumptions.


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                       CommentsFromthe NationalCouncilof

                        As an consequence of this bias, the GAO recommends requiring that
                 potential MRB borrowers first obtain proof that they could not qualify for a
                 conventional   loan before receiving MRB assistance.     NCSHA believes that
See comment 6.   such a requirement is unwarranted, as the existing law recapture provision
                 is effectively designed to discourage participation  in the MFLB program by
                 any potential buyers who are within the MRB income eligibility range and
                 who may also qualify for a conventional loan. The threat of recapture will
                 outweigh any possible MRB interest rate advantage for such buyers.
                        To require  lenders to essentially    deny conventional     credit to
                 borrowers as a precondition for making an MRB loan, could potentially cause
                 them to issue adverse actions against borrowers which may become part of
                 the borrowers’ credit histories and may leave lenders vulnerable to legal
See comment 7.   action. Even a lesser requirement of prequalifying borrowers for both MRE3
                 and conventional loans would impose additional administrative requirements
                 on lenders, who already have little incentive to participate   in the MRB
                                                         and Alternatives   Are Unworkable
                        GAO suggests that the Congress either retain the current recapture
                 mechanism with some modifications or replace it with one of two alternative
                 approaches. The proposed modifications to the existing recapture provision
                 would further complicate it and make its administration           more difficult
                 without furthering recapture’s public policy objective. The alternatives GAO
                 suggests are even more complex than the current law recapture provision
                 and would impose insurmountable      administrative  and financial burdens on
                 MRB borrowers and housing agencies alike, wfthout measurably improving
                 recapture efficiency.

                        GAO suggests that the current law recapture provision be modified to
                 base the recapture amount on the actual interest rate benefit received by
                 MRB borrowers compared to conventional rates. The 1.25 percent per year
                 provided in current law is an approximation of that benefit. Under the GAO
                 proposal, lenders would have to document the difference in monthly
                 principal and interest payments between the MRE3 loan and a comparable
                 conventional  loan at the time the MRB loan is closed. When the MRJ3-
                 assisted home was later sold, the amount of recapture would be the amount
                 of that monthly     savings times the number of months the loan was
                         We strongly object to this approach. First of all, it is unworkable since
                 there is no single conventional rate to which MRB rates can be compared in
                 most real estate markets. Rates vary from bank to bank on a daily basis. For
                 example, the May 26 Washfngton Post survey of 19 lenders in the D.C.
See comment 8    metropolitan    area showed that these institutions   offered as many as eight
                 different effective interest rates with differences as great as 5/8 percent on


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                                                          Recapturingthe QualifiedMortgageBondSubsidy
                        CommentaFrom the National Council of

                  a 30-year conformlng     conventional loan on a single day. Thus, two
                  Identically situated borrowers could be subject to significantly  different
                  recapture amounts If they borrowed from different banks on the same day or
                  even the same bank on different days in the same week. This is an absurd
                  result Congress should not allow.
                         It is important to note that the basis for this GAO suggestion is that
                  the present recapture provlsion might take loo rnti      recapture from some
                  MRB-assisted buyers, not too little. The GAO points out that the arbitrary
                   1.25 percent per year recapture formula of current law overstates the
                  benefit actually received by many MFtB borrowers.
                          GAO’s attempt to achieve mathematical     perfection would, however,
                  only further complicate an already exceedingly complex recapture formula.
See comment 9.    It would replace current law’s standard calculation applicable to all MFW-
                  assisted     purchasers    with documentation    which would have to be
                  individualized   for each and every borrower and which would require further
                  administrative    and record keeping requirements of lenders.
                         Moreover, GAO would fall to obtain the parity it seeks, for some MREi
                  owners would be required to return every dollar of MRB benefit even if they
                  legitimately qualified for the benefit for most of the time. For example, a
                  borrower’s income could remain well within the MRB eligibility range for
                  the first three years of owning the home and then jump considerably in the
See comment 10.   fourth year due to a change in employment or the addition of a second
                  household Income.        In the year of sale, the total interest rate benefit
                  recefved over the life of the loan would be recaptured, even though the
                  beneflt was deserved in at least years one through three.    GAO’s solution to
                  this problem -- suspending or adjusting the benefit as income rises over the
                  life of the mortgage-- introduces     a whole new set of complexities      and
                  admlnistratlve hurdles which are discussed further on.
                          GAO is also concerned that MRB owners who experience large income
                  increases might remain in their homes for long periods in order to continue
                  receiving a benefit which they do not deserve. In addition, some MRB
                  owners may pay little or no recapture, because the recapture penalty is
                  phased out under existing law during the second five years of ownership and
                  eliminated after ten. GAO also argues that this phase-out will prompt
                  owners to stay in their homes for longer periods than they would otherwise,
                  They suggest that the recapture amount should either increase through year
                  ten, increase through year ten at a reduced rate, or plateau in year five and
                  remain constant through year ten.
                          NCSHA believes that the so-called “yuppies.” the upwardly mobile
                  families with rapidly increasing incomes that recapture was designed to
See comment 11    “catch,” are unlikely to remain In their homes after they can afford to move.
                  They will not stay long periods Just to avoid paying recapture and, in fact,
                  are better off selling in the early years to take advantage of the one-time


                       Page83                  GAO/RCED-90-117
                                                            Recapturingthe QualifiedMortgageBondSubsidy
                        CommentsFromthe NationalQmncil of

                  $5,000 factor added to income under current         law to compute    the actual
                  recapture total.
                           Finally, GAO suggests that the 50 percent of “gain-on-sale” recapture
                  limitation      will cause households in low-appreciation     areas to pay less
                  recapture than comparable households in high-appreciation         areas. GAO at
                  least concedes that this result is not easily remedied for the purpose of the
                  limitation      1s to leave a portion of the home equity to be applied to the
                    urchase of a replacement home. It does not recognize that the 50 percent
                  Pimitation       is essentially a protection  for those living in the poorest
                  neighborhoods        that they may have something left to move on with after
See comment 12.   recapture is paid.
                          We strongly advise the Congress to leave this protection in place.
                  Recapture was never intended to prevent households         from eventually
                  moving up in the housing market and certainly was not designed to return
                  owners in the poorest, least likely to appreciate neighborhoods, to renter
                  status.   Lower-income households’ ability to move up is already strained
                  under the current recapture requirement.

                           The GAO suggests two possible alternatives to the current recapture
                    rovision: a “roll-over” loan approach and an income-based variable payment
                  Poan approach. The “roll-over loan” would dtscontinue MRB assistance when
                  the owner’s income rose by raising the interest rate on the loan to
                  conventional rates in subsequent years. Under the income-based variable
                  payment loan approach, housing payments would increase as a fixed
                  percentage of income, if income rose.
                          Both approaches would require housing agencies or their lenders or
                  servicers to establish a system for monitoring the income of every MRB
                  borrower. Borrowers would be required to disclose their federal tax returns
                  periodically.    This process would be an extremely intensive, costly, and
                  administratively     complex task for servicers who must service hundreds of
                  thousands of loans. Those servicers would have to make sure borrowers’ tax
                  returns are actually collected and reviewed, determine if the borrowers’
                  incomes could support higher monthly payments, and when necessary.
                  dispatch a new payment schedules to the borrowers.
                         Another serious problem with these approaches is that increases in
                  income are incorrectly      presumed to mean increased “ability to pay.”
See comment 13.   Increased tax withholdings,   utility costs, property taxes and other household
                  costs must be considered to avoid financially overburdening         homeowners
                  and potentially  triggering a loan default.      To take such increased costs
                  properly into account, a lender would have to completely re-underwrite          a
                  homeowner’s loan each and every time his or her income was reviewed.
                  This would require substantial financial information       from the homeowner


                        Page84                 GAO/RCED-90-117
                                                            Recap-         the QuaUf’iedMortgage BondSubsidy
                        CkmuuentuFromthe NationalCouncilof

                  and significant    time and financial analysis from the lender.   This is a task
                  unprecedented     in mortgage servicing.
                          Under the Section 8 Certificate program, income monitoring         and
                  verification is required, but the administering    agency is paid a fee by the
                  federal government to cover such costs. Moreover, unlike Section 8 where
                  only the amount of tenant income is in question, the servicer under the GAO
                  approach would be required to analyze the owner’s income against the
                  income which would be required to support a conventional              housing
                  payment.     The substantial cost of administering   such an MRB monitoring
                  program would be passed on to all borrowers in the form of increased loan
                  points or servicing fees.
                          Neither approach is practically workable, and neither improves on the
                  falrness or effectiveness of the current law provision.      The GAO suggests
                  testing income under either approach at three and five year intervals. Since
                  exlstlng law recapture peaks after five years and ends after ten, these
                  approaches would provide less disincentive         for purchasers who expect
                  extraordinary    income increases than current law does, since current, law
See comment 14.   Imposes a definite. unavoidable penalty for any sale within ten years. In
                  contrast, the periodic income testing approach would not impose any
                  penalty until the year income is tested, which might be years after the
                  assisted buyer’s income rose substantially,    with no recapture of the benefit
                  received in those prior years.
                         Under the roll-over loan approach, as GAO acknowledges, borrowers
                  could be required to refinance thelr loans, at potentially higher conventional
                  rates than prevailed when they first took their MRB loan and, in any case,
                  with the payment of points which might well exceed the value of any MRB
                  subsidy received. Their inability to pay could force them out of their homes.
                  Thla risk would be particularly    acute when the income increase was only
                  temporary.   Establishing a market-rate at the time the borrower enters the
                  MRB program and adjusting the original mortgage to that rate without
                  refinancing  when the borrower’s income rises could overcome some of
See comment 15.   these risks.   However, the difficulties   involved in determining   what the
                  conventional rate is at any particular time which has already been discussed
                  and the periodic need to examine income and all its associated costs and
                  complexities would remain.
                         Under the variable payment loan approach, housing payments for
                  principal, interest, taxes and insurance would be set at a flxed percentage of
                  household income.       As income increased, so would monthly payments.
                  Unlike    the roll-over    loan which    caps the interest     rate at some
                  predetermined rate, the variable payment loan allows the owner’s effective
                  Interest rate to rise above the market as income continues to increase. Of
                  course, the owner would have the option of refinancing when his or her
                  payments exceeded payments on a conventional loan, but then would incur
                  all of the associated costs of refinancing which might exceed the MRB


                        Page86                 GAO/RCED-90-117
                                                            Recapturingthe QualifiedMortgageBondSubsidy
                        CommentsPromthe NationalCouncilof

                  benefit received and would    face the risk of not being able to service the
                  refinanced loan.
                         Both of these alternatlves would Impose recapture on all Ml3B
                  borrowers whose incomes rise steadlly and conservatively over the life of
                  their mortgage and not just the “yuppie” population Congress intended to
See comment 16.   target with recapture.

                         In conclusion, the current recapture provision must be substantially
                  revised. so that it is simple, administrable,    dlscloseable and does not
                  adversely affect lower income borrowers.    An alternative along the lines of
                  the simplification    proposal contalned In these comments would achieve
                  these goals. The rev&ions and alternatlves GAO poses in Its report would
See comment 17    not accomplish these objectives, would In no way increase the effectiveness
                  of recapture       and in fact, would alter Congressional      intent.  These
                  recommendations should be soundly rejected. The NCSHA Is committed to
                  working with the Congress to achieve a slmpllficatlon         of the current
                  recapture provision which presences Congresstonal Intent.


                        Page86                 GAO/RCED-80-117&capturing the QualifiedMortgageBondSubsidy
              CommentaFromthe NationalCouncilof

              The following are GAO'Scomments on the National Council of State
              Housing Agencies’ letter dated June 6, 1990.

              1. We disagree with the Council’s characterization of our report1 The
GAOComments   Council’s characterization of our report ignores other supporting anal-
              yses contained in the report that reached similar conclusionsusing dif-
              ferent data sourcesand analytical techniques.
              2. The studies cited by the Council do not offer an assessmentof the
              extent to which owners could have purchased homeswithout &MB assis-
              tance. To our knowledge, this type of analysis has not been undertaken
              on a widespread basis elsewhere. We have conducted an additional anal-
              ysis that further supports our earlier results. We continue to believe
              that many assistedowners may have been able to purchase their first
              homes without QMB loans.

              As a piece of anecdotal evidence, a Rhode Island mortgage lender stated
              that its analyses of its loan files showed that at least 26 percent of
              approved QMBloan applicants would have been able to obtain an alterna-
              tive mortgage from that lender.2Additionally, it believed that 20 percent
              of all Rhode Island participants could have purchased a home without a
              QMBloan. Since Rhode Island was not included in our review, we cannot
              specifically comment on the numbers derived. However, while their
              results are less striking than ours, they do show a significant portion of
              buyers served were not in need of the assistancethey received.
              3. We object to the Council’s characterization that by “GAO'S own admis-
              sion, [its 1988 study] was conducted with a skewed methodology.” We
              believe that the approach we used was appropriate to provide an esti-
              mate of conventional affordability. In addition, the home ownership test
              was one of several analyses contained in the report using different
              approachesand data sources.All reached the sameconclusion.

              ‘For the Council’s prior comments in this vein, and our discussion, see pp. 107-l 11 of Home Owner-
                                            ly and Provide Little Assistance to Those in Need (GAO7

              2”Expiring Tax Provisions,” Hearings Before the Subcommittee on Taxation and Debt Management of
              the Committee on Finance, United States Senate. S. Hrg. 100-1002, Mar. 28, 1988. Pp. 86-91.

              Page87                     GAO/RCED-90-117
                                                      Recapturingthe QualifiedMortgageBondSubsidy
CommentsFromthe NationalCouncilof

The Council objects to our use of a judgmental sample of about 178,000
loan files.3The Council essentially argues that decisionsabout the effec-
tiveness of the QMBprogram can only be answered by statistically reli-
able studies. If that is so, the studies cited by the Council do not meet
that test. For example, in claiming statistical validity of the studies it
supported, the Council substantially misrepresented the statistical
nature of these studies. First, it claims that the study conducted by Dr.
Wrightson was a “statistically valid review.” However, disclaimers in
that study specifically state that it was not and should not be taken as
such.4Second,notably omitted from the Council’s statement is any refer-
enceto local housing finance agency performance. Neither of the studies
cited by the Council analyze local housing agency &MBloan performance.
As such, these studies can hardly be consideredto be statistically valid
reviews of QMBloan activity.
Finally, many policy questions do not lend themselvesto statistical anal-
yses for a number of reasons,including the onesthat hampered us from
obtaining a statistical sample of buyers. In addition, even those analyses
conducted under statistical procedures are often open to different inter-
pretations. In the absenceof iron-clad proof, which the Council suggests
is the only basis from which to judge the merits of QMB loan activity,
policy makers make their decisionsby weighing the merits of available
4. Our 1988 report recognizedthe efforts of several housing agenciesto
target assistancemore strictly than required by the Code.However, the
question central to the affordability test is the extent to which QMBloans
increase home ownership opportunities to first-time buyers. A finding
that someagenciesprovide set stringent eligibility requirements does
not addressthe question of whether the assistedowners could not have
purchased their home without QMBloan assistance.
6. We added an analysis of housing agency loan files using a total debt-
expense-to-incometest to chapter 3 of this final report. Our results did
not change markedly.

“These files represented home purchase loans made by 29 state and local housing agencies and in
their automated files for the January 1983-June 1987 period. These were the latest data available
at the time of our review. We did not perform a statistical sample of state and local housing agency
loan activity because of the lack of a central data base from which to do so. Nonetheless, we believe
that these loans represented about one-third of the loans made during that period.

4The “Referendum” paper also cited by the Council relies heavily on Dr. Wrightson’s study.

Page88                     GAO/RCED-90-117
                                        Recapturingthe QualifiedMortgageBondSubsidy
Appendix   VU
Comment     From the Natsonal Council   of

6. We disagree.The recapture mechanism,either as enacted in law or
proposed by the Council, tests for certain income increasesafter an
assistedhome is sold. As we discussin appendix IV, the recapture
formula would not be expected to induce buyers to decline to
7. We seeno basis for the Council’s contention that affordability testing
would subject lenders to lawsuits. If the applicant could afford a con-
ventional loan of comparable terms, then the lender would be agreeable
to making a loan to the applicant. If, as a result of the affordability test,
the applicant could not afford the conventional loan, then the applicant
would be offered a QMBloan (assuming the applicant met eligibility
requirements and was a good credit risk). Therefore, applicants meeting
either conventional or &MB loan-making requirements would not be
denied credit becauseof the affordability test. If they are not denied
credit, then a lawsuit would be groundless. Finally, if the applicant sued
on the basis that he or she was denied the lower-interest rate QMBloan,
the suit would likely be dismissed as long as the lender acted in good
faith in that the lender was following affordability test requirements set
out in law.

8. The terms that lenders offer are those at which they are willing to
make loans. For that lender at that time, the stated rate for the prospec-
tive buyer is “the rate.” That interest rates changeover time or differ
between lenders is the basis of our proposal. The QMBloan rate is fixed,
while conventional interest rates change.In this environment, the
enacted recapture formula will almost always recapture more or less
than the assumedinterest rate reduction.

9. We believe that the Council overstates the administrative burden
involved. Seechapter 3 for a discussionof the steps involved.
10. We would not support the Council’s concept becausewe believe that
it would be too difficult to administer. Rather, the approachesthat we
suggestform a middle ground between “real time” testing and the
enacted version. Chapters 3 and 4 discusswhat we believe are the bene-
fits from the approacheswe suggest,as well as the increased adminis-
trative effort, relative to the enacted version. In deciding whether to
changethe recapture formula, the Congressmust weigh these expected
benefits against the increased administrative effort.
11. The Council ignores the fact that substantial transaction costs in
selling a home can substantially eliminate gains on salesin early years

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                                     Recapturingthe QualifiedMortgageBondSubsidy
CommentsFromthe NationalCouncilof

creating a disincentive to sell within the first several years of
12. Neither our draft report nor this final report advocate eliminating
the gain-on-saleprovision. However, the gain-on-saleprovision benefits
all assistedowners, not just “those living in the poorest neighborhoods.”

13. We disagreethat additional underwriting would have to occur. See
our discussion in chapter 4 which describeshow assistedowners’ loan
payments could be increased administratively without underwriting or
refinancing the loan. It is interesting to note that conventional fixed-rate
loans are not underwritten again when home owner costs increase or if
an owner’s income remains flat or decreases.Similarly, conventional
adjustable-rate loans that can result in higher housing payments when
interest rates rise are not underwritten again, even if other costs
increase and income remains stable or decreases.

14. The 3- or S-year testing period is presented as a trade-off between
examining income changesat the time of sale or doing so more fre-
quently, say, annually.
16. The Council has misstated our suggestion.The roll-over approach
that we discussedin our draft report doesnot involve refinancing of
loans, including interest-rate risk, or the payment of refinancing costs.
In fact, our suggestionspecifically stops this from occurring. However,
we have added further clarifying language.Seealso comment 8, above,
for our view on determining a market interest rate when the loan is
16. The Council has misstated our approach. The roll-over approach
tests for whether an assistedowner no longer needsthe subsidy.
Whether income increased “slowly and conservatively” or more quickly,
we seeno public purpose being served in continuing the assistancewhen
those receiving QMBloan or MCCassistancecould remain home owners
without it. A roll-over approach satisfies that goal.
17. We disagree with the Council’s assertion that our proposals alter
congressionalintent. The intent is quoted in chapter one of this report,
and our analyses clearly fall within the language contained in the con-
gressional conferencestatement.

Page90               GAO/RCED-W-117
                                 Recapturingthe Qualified MortgageBondSubsidy
Appendix VIII

Comments From the Department of
the Treasury

Note: GAO comments
supplementing those in the
report text appear at the
end of this appendix.                                                        DEPARTMENT      OF THE TREASURY
                                                                                         July    9, 1990
                                 A88ISTANT      8CCRCTARY

                                             John M. 016, Jr.
                                             Director,    Housing   and
                                                Community   Development              Issues
                                             U.S. General    Accounting              Office
                                             Washington,    D.C.    20540
                                             Dear    Hr.    01s:
                                                    Thank you for       providing       the Department         of    the Treasury     with
                                             the op ortunit           to comment on the draft              GAO report,       “Home
                                             Owners It ipr Lim r: ting     Mortgage       Assistance       Provided       to Owners With
                                             Rapid Income Growth.”              The report        evaluates       the recapture
                                             provision       of   the Qualified       Mortgage       Bond (QMB) and Mortgage
                                             Credit     Certificate       (NC)     programs       in terms of how effectively              it
                                             limits     the homeownership          subsidy      to households          with  rapid  income
                                                           The recapture        provision       was enacted         and the report
                                             %%d           by the Technical         and Miscellaneous            Revenue Act of 1988
                                             (P.L. 100-647).
                                                    The QMS program          assists      first-time        homebuyers          with below
                                             market      interest       rate loans      financed        with the proceeds               of
                                             tax-exempt         mortgage     bonds issued          by state        and local        housing
                                             a encies.          The WCC program         also assists          first-time          homebuyers         by
                                             a f lowing      them to claim        a credit        against     their       Federal       income tax
                                             equal     to between         10 and 50 percent           of the mortgage             interest       paid
                                             during      the year on a market             rate loan.          Those who claim               a credit,
                                             howeve f , must reduce their               home mortgage            interest       deduction        by
                                             the amount of the credit.                  Under both programs,                homebuyers         must
                                             meet income,          purchase     price,      and other       eligibility           requirements.
                                             In the 1988 Act,            Congress      added a provision              designed        to recapture
                                             tha sirtsidy         provided    by these progrsme             from households               that
                                             experienced          ra id increases         in income subsequent                to their
                                             purchase       of a f: ome.      This provision            becomes effective               on
                                             January       1, 1991.
                                                   An assisted     homebuyer      may become subject        to recapture        only in
                                             the year in which he disposes               of his home, and only if his income
                                             in that year exceeds         the maximum amount of income that would have
                                             allowed   him to qualify        for the assistance          in that year.         The
                                             recapture    amount increases          from zero to the full        recapture       amount
                                             on a pro rata basis as the homebuyer’s                 income increases         from the
                                             maximum qualifying        income to the maximum qualifying               income plus
                                             $5,000.     During    the first      five    years of the mortgage,         the full
                                             recapture    amount is equal to the product               of 1.25 percent         of the
                                             original   mortgage      amount and the number of years             since     the home
                             Y               was purchased.        The full     recapture      amount decreases      by 1.25
                                             percent   of the original         mortgage      amount for each year thereafter
                                             so that after      year ten there         is no recapture.        In addition,        the

                                                    Page91                        GAO/RCED-90-117
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            CbmmenteFromthe Departmentof
            the Treasury


 racapture      amount is capped at 50 percent     of the gain on
 disposition      of the home.    The recapture   amount is added to
 federal     income tax liability    for  the year in which the homebuyer
 disposes      of his home,
        The report        concludes      that     the proposed      recapture       mechanism       is
  referable        to no recapture           mechanism,     because      it would recover           at
Peast some of the subsidy                  from those who would have delayed                     home
purchases        for a short        time until       they could have afforded                 an
unassisted         loan.       The report       recommends that Congress              consider
tailoring        the recapture          amount to the actual           amount of assistance
received       and eliminating           the phaseout       of the recapture            after     year
five.       It also recommends that Congress                   consider      limiting         QMB and
HCC program          assistance       to individuals       who could not otherwise
obtain      a market rate loan with comparable                    terms.       Finally,        the
report      discusses        two alternatives          to recapture:       a “roll-over’
loan and an income-based                 variable     payment loan.
Comments         on GAO Recommendations
GAO Recommendation:             With respect   to the QMB program,                      Congress
should     consider     basing   the recapture   rate on the actual
difference       between     the market  and below market   interest                     rates     at
the time the home was purchased.
Comment:          It is inappropriate              as a matter      of fairness         to
mre               an amount which exceeds                the actual      subsidy      received      by
a homebuye r . The report                  cites     a 1988 GAO report*/          which
estimated         that     the actual        median difference         between      the market
and below-market              interest       rates    received     was 1.44 percent.             This
translates          into an actual          median after-tax         benefit      of 1.22
  ercent       assuming       the marginal         income tax rate of the homebuyer                   is
L35 percent.            This is less than the after-tax                 benefit       of 1.25
percent        assumed under the current                 law recapture       provision.          While
this     difference         would not be important              if there     were little
variability           in the actual          subsidies,      it appears      that     there    is a
substantial           amount of variability.                The report     cites      the 1988 GAO
report       which estimated            that 25 percent         of the assisted          buyers
received        reductions         of about three-quarters             of a percentage           point
or less.          The implication           is that      the recapture       amount could
exceed the actual               subsidy     by a significant         amount in a
significant          number of cases.

I/    V    S General   Accounting       Office,      Home Ownership:             Mortgage  Bonds
Xre       Coitly  and Provide    Little      Assistance    to Those            in Need (GAO/
          - -     ) March 28, 19SS # hereinafter             referred            t o as the 1988
GAO       Report.  ’

            Page 92                  GAO/RCED-90-117 Recapturing the Qualified           MortgageBondSubsidy
   .                       AppendixVIII
                           Comments From the Department of
                           the Treasury

                       Equating      the recapture            amount with the actual              benefit    would
                 generally       be appropriate           as a matter        of fairness,         but as a matter
                 of tax policy,           this    objective        would have to be balanced               against
                 the associated           administrative           and compliance         costs.      The report
                 would be improved              by the addition          of a discussion          of the
See comment 1    magnitude       of these costs           in comparison          with the potential           recap-
                 ture amount.          The report         might also indicate             that    the recapture
                 amount may understate               the benefit         of below-market          rate financing
See comment 2.   because     of the assumption              implicit       in its calculation           that   the
                 current     value     of     the benefit        received      in any given year is
                 constant.        While the benefit              of below-market          rate financing          in
                 any given year may be 1.25 percent                       of the mortgage           amount,    it
                 must be compounded at the prevailing                        interest       rate over the
                 rubsequent       years of the mortgage                to obtain       the true economic
See comment 3.   benefit.        In addition,          it would be helpful             to clarify       whether
                 interest      rates      are before-        or after-tax         rates.
                 GAO    Recommendation:     Congress   should   consider     the following
                 alternatives     to the phaseout     of recapture     after    year five:
                 eliminate    the phaseout8     reduce the rate at which the recapture
                 phases out; and cap the recapture          amount at year five.
                 Comment:       The report     argues   that because    the recapture     amount
                 decreases      after   year five,    the homebuyer     has the opportunity      to
                 reduce or eliminate         the recapture      amount by choosing     when he
                 sells      his home.    A related    concern,    not addressed    in the report,
                 la that homebuyers         whose income remains       below the maximum
                 qualifying      income in the earlier         years of the mortgage but whose
                 income increases        in the later      years may be subject      to the full
                 recapture      amount.
                        In theory,       the appropriate      policy      would be to recapture
                 the benefit        only for the years        in which a homebuyer’s           income
                 exceeded     the maximum qualifying            income.       This would require       a
See comment 4.   continuous       monitoring       of a homebuyer’s        income which would
                 increase     administrative         and compliance        costs.     The report    might
                 acknowledge        this    problem   and discuss       the administrative        and
                 compliance       costs associated       with     recapturing      the benefit     only for
                 the years      in which the homebuyer’s             income exceeds        the maximum
                 qualifying       income.
                 GAO      Recommendation:         Congress   should  consider     requiring             that QMB
                 loans and MCCsonly              be provided   to those who could not                 otherwise
                 obtain      a market       rate loan with comparable       terms.
                 Comment: Providing              assistance       to those who could otherwise
                 affora     market        rate loan with comparable              terms is not consistent
                 with the goals        of    the QRB and MCC programs.               The report     cites    the
                 1988 GAO report         which estimated            that over half     of the assisted
                 homebuyers    could have obtained                a market    rate mortgage      with
                 comparable    terms to purchase              the same home.         The report,      however,
                 does not explain          how this       recommendation       would be implemented.
                 The report    ml ht, for example,                address    how much tighter       the
See comment 5    income eligib    9 lity       requirements        would have to be to target            the
                 assistance    to those Congress              intended     to benefit.

                           Page93                    GAO/RCED-99-117
                                                                  Recapturingthe QualifiedMortgageBondSubsidy
                           Appendix VlIl
                           Commenta Prom the Department of

                 GAO Recommendation:                Congress   should   consider              “roll-over”        loans
                 as an alternative             to   the recapture     mechanism.
                 Comment : A roll-over                  loan would require              a homebuyer        to refinance
                 mrket                 rate if his income increased                     above the maximum
                 qualifying          income.        This would require               continuous      monitoring         of a
                 homebuyer’s           income and would impose substantial                        administrative
                 and compliance            coats.         In addition,         if a homebuyer          were forced         to
                 refinance,          he would bear substantial                   refinancing        costs.
                 Moreover,         if interest          rates     were to rise during             the period        in
                 which he owned his home, then requiring                              a homebuyer        to refinance
                 at a higher           rate could make him worse off than he would have been
                 if he had originally                 financed       his home with a market                rate loan.
                 There considerations                 suggest      that     the roll-over         loan be
                 pre-approved,            so there        would be minimal            refinancing        costs,     and
                 that     the rate on the roll-over                    loan be capped at the market                   rate
                 in existence            when the homebuyer              purchased        his home.        The report
                 should       discuss      the administrative               and compliance          costs     associated
                 with continuously              monitoring         income , pre-approved             refinancing
See comment 6.   costs      for roll-over           loans,      and the costs          associated       with
                 capping        the refinancing             rate at the market              rate in existence          when
                 the individual            originally          purchased       his home.
                 GAO Recommendation:                Congress   should         consider  an income-based
                 variable   payment          loan    as an alternative            to the recapture
See comment 7.   mechanism.
                 Comment:        An income-based        variable       payment loan would establish             a
                 -or’s               mortgage     payments      at a fixed     percent       of his income.
                 This a f ternative         could allow       the implicit       rate to rise        above the
                 market      rate that existed         when the home was originally                 purchased.
                 It also could allow            the implicit        rate to drop below the
                 subsidized        rate if the homebuyer            were to experience           a drop in
                 income.        The appropriate        policy      might be to allow          the implicit
                 interest       rate to vary between            the subsidized         rate and the market
                 rate that existed           when the home was originally                 purchased.       This
                 alternative        would impose additional             administrative          and compliance
                 coats on the homebuyer              and the administrative             agency.
                 General      Comments
                        The report        might consider        the alternative          of having      no re-
                 capture      mechanism       (if only for the purpose               of exposition).         In-
                 deed,     it is     oasible      that    the administrative            and compliance       costs
See comment 8    associated        wP th recapturing         an amount which is close               to the actu-
                 al benefit        may exceed       the actual        recapture      amount.     The report
                 cites     the 1988 GAO report           which estimates           that    the after-tax
                 value     of the subsidy         to the typical          homebuyer      is $40 a month.
                 Assuming      this     is the potential          recapture      rate,     the maximum
                   oeaible     recapture        amount will       increase      on a pro rata basis          to
                 $ 2,400 at the end of year five                  and then will         decrease      to zero at
                 the end of year ten.               Unless    the recapture          phaseout    is

                           Page 94                      GAO/RCED-fJO-117 Recapturing the Qualified Mortgage Bond Subsidy
    .                                      Appendix VIII
                                           Comments From the Department of
                                           the Treasury

                                eliminated,      the amount by which the recapture      amount exceeds                      the
                                administrative       and compliance    costs may not be substantial,
                                especially     since   the recapture    amount is capped at 50 percent                       of
                                the gain on dieposition         of the home.
                                        The QMB and MCC programs            may also be inherently
                                self-policing.            This is in part due to the fact              that     there    is a
                                ceiling       on the amount of QMBs and MCCs that a state                      or local
                                houain        agent     may issue,     which suggests       that    states      have an
                                incent 9 ve to x nsure that the subsidy               goes to those for whom it
                                was intended.           It is also in part due to the fact                 that the
                                eligibility         requirements     limit    the pool of potential
                                beneficiaries          and the value       of purchased     housing.         In general,
See comment 9.                  beneficiariee          must be first-time        homebuyers      with    incomes that do
                                not exceed 115 percent             of the area median income,              and assisted
                                mortgages        can be used only to purchase           a home that          costs    less
                                than 90 percent           of the area average.
                                      The report       should    clarify    whether income eligibility      refers
                                to the maximum amount of income that a homebuyer                   could have and
See comment 10. (Page           still   qualify      for   assistance      or the amount of income that would
reference in final report       subject       a homebuyer     to full    recapture  (see,  for   example,   the
                                firet    full    paragraph      on p. 19).
is p.16.)
                                        Finally,        the analysis       of the percent      by which income must
                                increase          in order     to trigger      recapture    under different    scenarios
                                could also be clarified.                   Because recapture      is triggered    if
                                income exceeds             the maximum qualifying         income in the year of
                                dis osition,            the percent      by which income must increase         is
                                obv ousl            dependent    on the amount of starting           income.   The
See comment 11.                 h othet
                                     ‘I        II cal scenarios       included     in the report    may only confuse
                                t KP s straightforward            issue.
                                      If     you have   any questions     concerning       these comments,         please
                                contact       William   Trautman   of   my staff    at    566-2203.

                                                                         Kanneth W. Gideon
                                                                        Assistant    Secretary
                                                                           (Tax Policy)


                                           Page 96               GAO/RCED-90-117 Recapturing the Qualified Mortgage Bond Subsidy
               CommentaPromthe Departmentof
               the Treasury

               The following are GAO'Scomments on the Department of the Treasury’s
               letter dated July 9, 1990.

GAO Comments   1. While we did not attempt to quantify the added costs involved in tai-
               loring the recapture formula more to the benefit received, we expect
               that the additional cost per home owner would be small. The additional
               effort would entail computing the difference in monthly housing costs
               between the reduced interest-rate QMBloan and a market-rate loan of
               comparable terms. The results of this computation would be provided to
               the assistedowner and retained by the lender or the housing agency.
               The cost of this approach should be weighed against the benefits
               derived from it.
               Regarding compliance, the seller’s tax return could, at the Internal Rev-
               enue Service’s discretion, identify the dollar amount of the monthly
               reduction, the number of months the home was held, and the product of
               these two amounts as the unreduced recapture amount. Should the Ser-
               vice decide to audit a taxpayer’s return, it would request all pertinent
               documentation, as it does for other taxpayer audits.
               2. Treasury’s observation is correct if the only alternative to the QMB
               loan is an adjustable-rate mortgage that provides for annual adjust-
               ments. However, the fixed-rate, market-rate loan provides for a constant
               differential over the life of the loan.
               3. This final report clarifies this point.
               4. We added Treasury’s comment to this final report.

               6. We believe that the draft that we provided to Treasury and this final
               report outline how this approach could be implemented. Changesto
               income eligibility limits are not necessaryto carry out the conventional
               affordability test described in this report.
               6. Both the draft report provided to Treasury and this final report dis-
               cuss that refinancing is not necessaryunder the approach we present.
               We have added languagethat further clarifies this point. Also discussed
               is the administrative cost trade-off between annual income reexamina-
               tions and less frequent reexaminations. Finally, both the draft report
               and this final report provide an estimate, based on similar activities, of
               the administrative cost of the roll-over approach.

               Page96               GAO/RCED-O-117
                                                Recapturingthe QualifledMortgageBondSubsidy
CommentaFromthe Departmentof
the Treasury

7. Neither our draft report nor this final report recommendthat the
Congresssubstitute an income-basedvariable payment loan as an alter-
native to the recapture mechanism.

8. We did not consider the alternative of having no recapture require-
ment becausethe statutory study requirement was clear in its charge
that we study recapture and other alternatives that would achieve the
congressionalobjectives set out for it.
9. We agreethat state and local agencieshave an incentive to make
loans to those who meet the first-time buyer, income, and home
purchase price requirements. If these requirements were not met (and if
the Service enforced these provisions), then the underlying bonds would
lose their tax-exempt status. If a bond losesits tax-exempt status, it
would becometaxable. On future issues,investors would require higher
interest rates becauseof the uncertainty over the tax-exempt status of
the bonds. This discussion was included in our March 1988 report1 How-
ever, we do not believe that it is germane to this report.
10. We believe that the term “income eligibility limits” clearly identifies
eligibility for QMBloans or MCCS.
11. We do not believe that the analysis is as straightforward as Treasury
suggests.The starting income, the recapture formula’s $6,000 constant,
and the number of years before the home is sold all contribute to the
different shapesand levels of the curves. This very point is illustrated
by the charts in chapter 2 and appendix II.

‘We reported in 1988 that the Service had no ongoing compliance review program for QMBs. See pp.
92-93 of Home Ownership: Mortgage Bonds Are Costly and Provide Little Assistance to Those in Need

Page97                    GAO/RCED-9@117
                                     Recapturingthe QualifiedMortgageBondSubsidy
Appendix IX
Major Contributors to This Report

                       Dennis W. Fricke, Assistant Director
Resources,             JamesC. Ratzenberger,Evaluator-in-Charge
Community, and         Patrick B. Doerning, Operations ResearchAnalyst
Economic               Alice G. Feldesman,Social ScienceAnalyst
                       Carol Herrnstadt Shulman, Reports Analyst
Development Division
Washington, DC.

                       Page98            GAO/RCED-BO-117
                                                     Recapturingthe QualifiedMortgageBondSubsidy

    Page BB   GAO/RCED-90417
                          Recapturingthe QualUledMortmge BondSubaId~
Related GAO Products

              Home Ownership: Targeting Assistance to Buyers Through Qualified
              Mortgage Bonds (GAO/RCED8%~~OBR, June 27,lSSS).
              “Role of Qualified Mortgage Bonds in Providing Home Ownership
              Opportunities,” Testimony Before the Subcommitteeon Taxation and
              Debt Management,SenateCommittee on Finance (GAO/T-~~~~88-31, Mar.
              Home Ownership: Mortgage Bonds Are Costly and Provide Little Assis-
              tance to Those in Need (GAO/RCED-%iii, Mar. 28,lSSS).
              “S-1698, The First Time Homebuyer Assistance Act of 1983,” Testimony
              Before the SenateCommittee on Finance, Sept. 13,1983.
              “The Costs and Benefits of, Single-Family Mortgage RevenueBonds,”
              Testimony Before the House Committee on Ways and Means,June 16,
              “The Costs and Benefits of Single-Family Mortgage RevenueBonds,”
              Testimony Before the Subcommittee on Taxation and Debt Management,
              SenateCommittee on Finance, May 13,1983.
              The Costs and Benefits of Single-Family Mortgage RevenueBonds: Pre-
              liminary Report (GAO/RCEP~~-146,Apr. 18,1983).

(385177)      Page100           GAO/WED-ml17 Recapturingthe QuellfledMortgageBondSubsidy
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