oversight

Homeownership: Information on Changes in FHA's New Single-Family Appraisal Process

Published by the Government Accountability Office on 1997-07-25.

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

                  United States General Accounting Office

GAO               Report to the Chairman, Subcommittee
                  on Housing and Community Opportunity,
                  Committee on Banking and Financial
                  Services, House of Representatives

July 1997
                  HOMEOWNERSHIP
                  Information on
                  Changes in FHA’s New
                  Single-Family
                  Appraisal Process




GAO/RCED-97-176
      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      Resources, Community, and
      Economic Development Division

      B-277088

      July 25, 1997

      The Honorable Rick A. Lazio
      Chairman, Subcommittee on Housing
        and Community Opportunity
      Committee on Banking
        and Financial Services
      House of Representatives

      Dear Mr. Chairman:

      Since December 1994, private mortgage lenders making single-family
      mortgage loans insured through the Department of Housing and Urban
      Development’s (HUD) Federal Housing Administration (FHA) have been able
      to select any licensed or certified appraiser listed on FHA’s roster to
      determine the value of homes. Before December 1994, appraisers (referred
      to as FHA fee panel appraisers) were assigned to lenders by FHA to appraise
      such properties.1 Appraisals have an influence on the amount of the
      mortgage loan, and if a borrower defaults and the loan is subsequently
      foreclosed, lenders can recover losses from FHA, including the unpaid
      principal balance of the loan. According to some former FHA fee panel
      appraisers, allowing lenders to select appraisers has resulted in exposing
      FHA to greater financial risks because some of the appraisals now being
      performed are incomplete, inaccurate, and favorable to the lender.

      Because of these concerns, you requested that we obtain information on
      FHA’s appraisal process. Specifically, you asked us to provide information
      on (1) how appraisals of FHA-insured single-family homes were assigned
      before December 1994, who assigned appraisal work, and why the
      appraisal assignment process changed; (2) what the reactions to this
      change have been from the affected parties—former FHA fee panel
      appraisers, FHA, and FHA lenders; and (3) what problems have been
      identified by HUD since the implementation of the new appraisal
      assignment process. As requested by your office, we spoke with 12 former
      FHA fee panel appraisers to discuss their concerns about the new process.
      However, as agreed with your office, we did not attempt to verify any
      allegations of the former fee panel appraisers.




      1
       After December 1994, the number of appraisers selected by lenders began increasing, and by
      January 1996, most FHA appraisals were being performed by lender-selected appraisers.



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                   Prior to December 1994, houses that were being appraised for FHA-insured
Results in Brief   home loans were appraised by FHA fee panel appraisers who were assigned
                   on a rotational basis to lenders, and, in turn, lenders paid the fee panel
                   appraisers for their services.2 HUD’s field offices had approximately 6,000
                   FHA fee panel appraisers to conduct the appraisals. Legislation was
                   enacted in 1990 that allowed FHA’s single-family lenders rather than FHA to
                   choose the appraisers of properties whose loans were to be insured by
                   FHA.3 HUD implemented the legislation in December 1994. According to its
                   history, this legislation was enacted to (1) improve the efficiency of FHA
                   lenders who would no longer have to rely on HUD’s field office staff to
                   assign appraisers and (2) improve the quality and reliability of appraisal
                   services for HUD’s mortgage assistance and other housing programs by
                   promoting uniform eligibility standards for those performing federal
                   appraisals. In January 1996, FHA informed its lenders that effective
                   March 1, 1996, they had to select appraisers from FHA’s roster of about
                   31,000 state-licensed or -certified appraisers. HUD also allowed lenders to
                   use their in-house appraisers if they were on the roster and assigned by the
                   lender.

                   We found opinions in both opposition and support of allowing FHA lenders
                   to select appraisers. Those most directly affected by the change, such as
                   the 12 former FHA fee panel appraisers, were particularly opposed to the
                   change, charging that the appraisals now being performed were
                   inaccurate, incomplete, or favorable to lenders. HUD’s Office of the
                   Inspector General is reviewing the information provided by the former FHA
                   fee panel appraisers to determine if an investigation is warranted. FHA’s
                   appraisal manager and four FHA lenders cited, among other things,
                   improved timeliness and quality of appraisals and a decrease in the
                   number of HUD field office staff needed to administer the appraisal process
                   as the reasons they support allowing lenders to select appraisers.4 The
                   appraisal manager also said that factors such as unprofessional conduct by
                   some prior fee panel appraisers, fewer FHA properties needing appraisals,
                   and an increase in the number of appraisers on FHA’s roster as the reasons
                   for the decrease in lenders’ hiring of former fee panel appraisers.



                   2
                   FHA’s policy at that time also allowed in-house appraisers employed by lenders to conduct appraisals.
                   However, most appraisals made before December 1994 were conducted by fee panel appraisers.
                   3
                    Section 322 of the Cranston-Gonzalez National Affordable Housing Act, 1990, amended section 202(e)
                   of the National Housing Act, allowing lenders to choose the appraisers of property to be insured by
                   FHA.
                   4
                   The four FHA lenders we contacted are among the largest FHA loan originators in California,
                   Colorado, Virginia, and Maryland.



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             HUD has identified two problems—the lack of reviews for completed
             appraisals by staff in some HUD field offices and the decline in the number
             of women and minority appraisers selected by lenders—since the
             implementation of the new appraiser selection process. The lack of
             appraisal review surfaced when a private accounting firm hired by HUD to
             conduct a financial audit of the agency reviewed HUD’s Los Angeles field
             office’s appraisal process as part of that audit. We also reported on similar
             problems with reviews of completed appraisals by HUD’s Los Angeles field
             office in February 1991.5 The accounting firm found that the Los Angeles
             field office had not performed any required field reviews of completed
             appraisals in fiscal year 1996. The purpose of appraisal reviews is to,
             among other things, verify the accuracy and reasonableness of the
             appraisers’ property valuations; rate appraisers; and ensure that appraisals
             comply with administrative, statutory, and regulatory requirements. FHA’s
             appraisal manager agreed with the finding and cited a lack of staff to
             perform the reviews as the cause of the problem. In December 1996, the
             manager indicated to the accounting firm that FHA was looking into the
             possibility of contracting out the review function. In addition, FHA’s
             records show that 6 other HUD field offices among its 81 offices had
             conducted few or no field reviews of completed appraisals from October
             1, 1996, to June 20, 1997. In June 1997, FHA officials told us that while
             agency instructions require field offices to conduct some field and desk
             reviews of completed appraisals, the agency no longer requires that a
             specific percentage of the appraisals be reviewed by field offices.

             The other problem identified by HUD since the implementation of the new
             appraisal process is that women and minority appraisers are not being
             selected to perform a proportionate number of FHA appraisals. In response
             to this problem, HUD’s Assistant Secretary for Housing-Federal Housing
             Commissioner in a July 1996 letter to FHA lenders requested that they
             review their appraiser assignment process to ensure that women and
             minority appraisers receive a fair share of the appraisal assignments
             commensurate with their representation on the appraisers’ roster. HUD is
             currently reviewing various strategies aimed at resolving this problem.


             The National Housing Act (12 U.S.C. 1709) authorizes FHA to insure
Background   mortgage loans made by private lending institutions to buyers of
             single-family homes. The amount that FHA can insure is based, in part, on
             the appraised value of the home. The maximum loan amount permitted

             5
              Federal Housing Administration: Monitoring of Single-Family Mortgages Need Improvement
             (GAO/RCED-91-11, Feb. 7, 1991).



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under FHA’s program for single-family homes in the highest-cost areas of
the continental United States is currently set at $160,950. If a borrower
with an FHA-insured mortgage loan defaults, the lender may foreclose on
the loan and collect nearly all of the losses from FHA.6 Losses generally
include the unpaid principal balance of the loan, delinquent interest due
on the loan, and legal expenses incurred during foreclosure.

In 1983, FHA implemented the Direct Endorsement Program, which
authorized FHA-approved lenders to underwrite loans without FHA’s prior
approval. HUD authorizes a direct endorsement lender to execute all phases
of an FHA mortgage. Almost all of FHA’s single-family mortgages today are
provided by direct endorsement lenders. Underwriting usually includes
determining the borrower’s ability to repay the loan and performing
appraisals, which establish the value of the property to be mortgaged.

Prior to December 1994, FHA did not require fee panel appraisers to be
licensed by states. However, to perform FHA appraisals, fee panel
appraisers had to meet certain requirements established by FHA concerning
their general and specialized experience and attend FHA training courses.
In 1989, the Financial Institutions Reform, Recovery, and Enforcement Act
(FIRREA) was enacted, which, among other things, required appraisals
performed for federally related real estate transactions to be done by
individuals licensed or certified by the state in which they work. This law
was in response to a concern in the Congress that poorly conducted or
fraudulent appraisals by unlicensed appraisers played a major role in the
weakening and collapse of some financial institutions in the 1980s. In
addition, the Department of Housing and Urban Development Reform Act
of 1989 required that the appraisal of all properties securing an FHA-insured
mortgage be performed in accordance with generally accepted appraisal
standards and be prepared by a licensed or certified appraiser. Since the
states implementation of licensing and certification procedures took until
1994 to complete, FHA did not mandate that appraisers be licensed or
certified until December 1994.




6
 FHA does not allow lenders to recover one-third of their administrative costs and 2 months’
delinquent interest.



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                        Before December 1994, appraisals for FHA-insured homes were conducted
Recent Change to        almost exclusively by approximately 6,000 fee panel appraisers. Each of a
FHA’s Appraiser         lender’s loans was assigned on a rotational basis to an appraiser from the
Selection Process and   fee panel maintained by HUD’s field office staff. Collectively, the fee panel
                        appraisers conducted about 500,000 to 750,000 FHA appraisals each year,
the Reasons for the     usually at a cost commensurate with the market rate for private appraisals
Change                  in the area. FHA did not pay the fee panel appraisers; rather, lenders paid
                        the appraisers and charged the cost to the borrowers.

                        After completing an appraisal, the fee panel appraiser then submitted the
                        results to the lender and the appropriate HUD field office. HUD’s field offices
                        were required to review 10 percent of all completed appraisals, including
                        5 percent of each appraiser’s work for mathematical accuracy,
                        reasonableness, logical conclusions, and the adequacy of any adjustments
                        made in determining the appraised value. The results of those reviews
                        were to be used to rate the appraiser’s work and identify appraisers who
                        were not adhering to FHA’s appraisal guidelines. If an appraiser received at
                        least three “poor” ratings in a 12-month period from the field office for
                        poor-quality work, FHA could remove the appraiser from the panel.
                        According to an FHA official, the cumbersome and time-consuming
                        administrative requirements needed to remove appraisers from performing
                        FHA appraisals resulted in few being removed .


                        In 1990, legislation was enacted allowing FHA single-family direct
                        endorsement lenders rather than FHA to choose state-licensed or -certified
                        appraisers of properties secured by FHA-insured mortgages. HUD drafted
                        regulations calling for lenders’ selection of appraisers while waiting for all
                        50 states to complete licensing and certification standards for appraisers,
                        as required by FIRREA. In its draft regulations issued on September 16, 1993,
                        HUD specifically requested opinions from the public on this issue. In the
                        final regulations published on October 3, 1994, HUD noted that the law
                        precluded the agency from denying FHA lenders the right to choose
                        appraisers and that responses to the lenders’ selection of appraisers were
                        fairly well balanced between support and opposition to the practice. In
                        addition, the regulations continued to allow direct endorsement lenders
                        the right to use in-house appraisers for FHA appraisals. HUD’s final
                        regulations were effective December 2, 1994.

                        FHA established a roster of appraisers from which FHA lenders could select.
                        Between December 1994 and January 1996, FHA approved about 37,000
                        state-licensed or -certified appraisers nationwide for the roster, including
                        many former FHA fee panel appraisers. During that time, FHA lenders used



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fee panel appraisers and appraisers selected or employed by lenders to
perform FHA appraisals. In January 1996, the FHA Commissioner, noting
that the vast majority of appraisals were being performed by
lender-selected appraisers, directed all FHA lenders that effective March 1,
1996, FHA appraisals had to be performed by appraisers selected from the
new roster. In addition, FHA allowed lenders to continue to use appraisers
who worked exclusively for them if they were listed on the roster and
chosen by the lenders for each case.

There were various reasons why the change to lenders’ selection of
appraisers was made. The conference report on the legislation proposing
FHA lenders’ selection of appraisers states that the conferees believed the
legislation would improve the efficiency of FHA lenders because they
would no longer have to rely on HUD’s field office staff to assign appraisers.
The conferees believe it would also improve the quality and reliability of
appraisal services for HUD mortgage assistance and other housing
programs by promoting uniform eligibility standards for those performing
federal appraisals.

In addition, according to FHA’s appraisal manager, other reasons
contributed to the change in the method used to select FHA appraisers.
First, the number of staff in HUD’s field offices had been reduced and the
remaining staff had difficulty assigning, maintaining, and monitoring the
fee panel appraisers. FHA believed that devolving this responsibility to
lenders freed its field office staff to perform other duties. Second, FHA
wanted to privatize some of its functions, and since lenders were already
adept at selecting appraisers for their conventional home loans,
transferring the responsibility of selecting FHA appraisers to them seemed
reasonable. Third, according to FHA’s appraisal manager, some lenders
complained to HUD and Members of Congress about the personal and
professional conduct of some fee panel appraisers assigned by FHA’s field
offices. The appraisal manager told us that FHA and its lenders believed
that some fee panel appraisers acted unprofessionally because once
approved as FHA appraisers, they were guaranteed work from FHA and did
not have to market themselves to lenders or compete with other fee panel
appraisers for work.




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                            The 12 former FHA fee panel appraisers that we spoke with were strongly
Views of Former Fee         opposed to allowing FHA lenders to select appraisers because they believe
Panel Appraisers on         that some of the appraisals now being performed are incomplete,
Lenders’ Selection          inaccurate, and favorable to lenders. However, FHA and the four lending
                            officials we contacted believe that lenders’ selection has been beneficial to
Differs From Those of       them by improving the timeliness and overall quality of FHA appraisals and
FHA and Its Lenders         by eliminating a burdensome administrative task from HUD’s field office
                            staff.


Former FHA Fee Panel        The 12 former FHA fee panel appraisers from Ohio, New Jersey, Michigan,
Appraisers Allege That      Texas, and the District of Columbia that we spoke with allege that some
                            FHA lenders are selecting appraisers who are not accurately reporting the
FHA Lenders Are Selecting
                            value and physical condition of the homes they assess. According to the
Appraisers Who Provide      former fee panel appraisers, they and their colleagues were told by FHA
Inaccurate or Incorrect     lenders that as a condition of employment, they will have to provide
Valuations                  property valuations specified by the lenders or ignore defective conditions
                            in the properties. The former fee panel appraisers believe that if left
                            uncorrected this situation will result in increased financial risk to FHA if
                            borrowers default on their mortgage loans. They also believe that with
                            inaccurate reporting on the physical condition of homes, borrowers will
                            not know the extent and cost of needed home repairs. The former fee
                            panel appraisers wrote to HUD and Members of Congress with their
                            concerns in 1996 and 1997, and, in response, HUD requested that they
                            provide the information on wrongdoing between FHA lenders and
                            appraisers to the agency. HUD’s Office of the Inspector General is
                            reviewing the information provided by the former FHA fee panel appraisers
                            to determine if an investigation is warranted.

                            The former fee panel appraisers also noted that some of the new
                            appraisers on FHA’s roster are providing incorrect or inaccurate property
                            valuations because they are not familiar with FHA’s minimum standards for
                            appraising properties. The former fee panel appraisers told us that prior to
                            the lenders’ selection of appraisers, fee panel appraisers were required to
                            attend at least four FHA-sponsored training sessions a year. However, new
                            applicants for the roster are required only to read FHA’s procedures on
                            appraisals and sign a document stipulating they have read the information
                            before being listed on the roster. The former FHA fee panel appraisers told
                            us they want the Congress to repeal the 1990 law, which allows FHA
                            lenders to select appraisers and return to a system in which FHA would
                            rotationally select a limited number of appraisers.




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                          In addition, the former fee panel appraisers, many of whom also perform
                          appraisals for home loans guaranteed by the Department of Veterans
                          Affairs (VA), expressed concern that legislation will be changed to allow VA
                          lenders the right to choose appraisers and that this change will lead to the
                          same abuses and problems they claim to have observed in FHA’s appraiser
                          selection process. Currently, legislation requires VA’s appraisers to be
                          rotationally assigned to lenders by VA’s field office staff. (See app. I for a
                          discussion of VA’s appraisal process.)


FHA Supports Lenders’     FHA’s appraisal manager stated that FHA supports allowing lenders to select
Selection of Appraisers   appraisers for homes purchased with FHA-insured loans, reiterating the
                          reasons he provided on why the legislative change was made. Namely, he
                          believes that lenders’ selection has simplified and quickened FHA
                          appraisals because lenders no longer have to contact a HUD field office to
                          obtain an appraiser each time an appraisal is needed. According to the
                          appraisal manager, consumers benefit from the new appraiser selection
                          process by having appraisals performed faster, which will allow closing to
                          occur sooner. Also, lenders’ selection has eliminated the need for
                          understaffed field offices to manage the fee panel appraisers, allowed FHA
                          to privatize one of its processes, and resolved the problem of some fee
                          appraisers’ behavior.

                          The appraisal manager said that he is not surprised that some former FHA
                          fee panel appraisers are not receiving the volume of appraisals they once
                          did, but he doubted the reason was wrongdoing by lenders and appraisers,
                          as claimed by the former fee appraisers. Rather, the manager attributed
                          the decrease in appraisal work to a general decline in lenders’ need for
                          their services and the large group of appraisers from which lenders can
                          now select. For instance, the official said that the number of home loans
                          being insured by FHA that required appraisals decreased from about
                          765,000 in 1994 to approximately 577,000 in 1995, while the number of
                          appraisers eligible to perform FHA appraisals increased from about 6,000 to
                          about 31,000. In addition, the appraiser manager said that FHA always
                          informs buyers that the appraisal is not an inspection. In fact, FHA
                          mandates that borrowers be given notice of “Importance of Home
                          Inspections,” which must be signed by borrowers on or before the date of
                          the sales contract.

                          In commenting on this report, the FHA Commissioner stated that although
                          some former fee panel appraisers have alleged that some appraisers have
                          performed poorly, either by design or due to a lack of skills and



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                            understanding of HUD’s procedures, no statistical or other basis exists for
                            concluding that the appraisal system is flawed.


FHA Lenders Like Being      The officials we contacted at four of the largest (in terms of lending
Able to Select Appraisers   activity) FHA lenders in California, Colorado, Virginia, and Maryland
                            indicated that being able to select appraisers reduces the amount of time it
                            takes to obtain an appraisal because they no longer have to wait until an
                            appraiser is assigned to them by HUD’s field offices. In addition, the lenders
                            told us that the quality of the appraisal work performed by the former fee
                            panel appraisers varied and that being able to select appraisers for FHA
                            cases generally ensures more professional results than if appraisers are
                            assigned to them.


                            HUD has identified two problems since the implementation of the new
Problems Identified         appraiser selection process. A review of FHA’s appraisal operations by a
by HUD Since the            private firm hired by HUD found that a HUD field office was not
Implementation of the       implementing required internal control procedures over the quality of
                            appraisals made in its jurisdiction. In addition, FHA’s internal review of
New Appraiser               information received from FHA lenders showed that women and minority
Selection Process           appraisers are not obtaining work assignments from lenders under the
                            new selection process in the same proportion they did when FHA assigned
                            appraisers.


Problems With Field         A 1996 audit of HUD’s Los Angeles field office by the firm of KMPG Peat
Reviews of Appraisals in    Marwick under a contract with HUD found that the office had not
Some HUD Field Offices      conducted any field reviews of completed appraisals during fiscal year
                            1996. HUD usually requires an on-site review of its processes and
                            procedures at least at 1 of its 81 field offices as part of the annual financial
                            audit of the agency. Field office reviews of completed appraisals are
                            essential to ensure that appraisals comply with statutory, regulatory, and
                            administrative requirements. The results of such reviews are used by FHA
                            to rate appraisers and identify FHA lenders with deficient appraisal
                            practices that warrant close monitoring. In response to the audit finding,
                            field office management cited insufficient staff to perform the reviews and
                            monitor lenders. FHA’s appraisal manager indicated in December 1996 that
                            the FHA field office might contract out for the appraisal review function. In
                            addition, FHA’s records showed that six other HUD field offices conducted
                            few or no field reviews of completed appraisals during the period October




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                           1, 1996, to June 20, 1997 (four offices reviewed 1 percent or fewer of the
                           completed appraisals, and two offices performed no reviews).

                           However, in June 1997, FHA officials told us that while agency instructions
                           require field offices to conduct some field and desk reviews of completed
                           appraisals, the agency no longer requires that a fixed percentage of the
                           appraisals made be reviewed by field offices. In addition, according to the
                           appraisal manager, few HUD field offices require a percentage of completed
                           appraisals to be reviewed, but the majority of field offices do review some
                           percentage of the appraisals made. Although field reviews of completed
                           appraisals were not conducted by all HUD’s field offices, FHA’s records
                           showed that all of the field offices conducted desk reviews of some
                           completed appraisals.7 It should be noted that this problem is not a result
                           of lenders’ selection of appraisers.

                           In the past, we reported a similar problem involving HUD’s review of
                           completed appraisals in its Los Angeles field office. In our February 1991
                           report on the agency’s monitoring of single-family mortgages, we reported
                           that HUD’s Los Angeles field office lacked documentation of supervisory
                           desk reviews of appraisals for either FHA-processed loans or direct
                           endorsement loans. In response to our audit findings, HUD acknowledged
                           that the failure of field offices to document their actions limits the
                           agency’s ability to track performance or evaluate program monitoring, and
                           indicated that it was committed to more effective documentation of
                           monitoring compliance. HUD indicated that the Los Angeles field office
                           would develop logs to document and track the results of future reviews,
                           and the office has done so.


Women and Minority         Comments received by HUD on its draft regulations on FHA lender selection
Appraisers Are Not Being   of appraisers included concerns that women and minority appraisers
Proportionately Selected   would obtain significantly fewer appraisal assignments from FHA lenders
                           than they did when FHA selected appraisers. HUD responded to this concern
by FHA Lenders             in a November 1994 letter to all FHA lenders, which stated that the agency
                           expected that lenders would affirmatively select appraisers from these two
                           groups for a fair share of appraisals.

                           HUD uses a specially designed computer system called Computer Homes
                           Underwriting Mortgage System (CHUMS) to collect descriptive data of
                           FHA-approved appraisers, such as their state license or certification


                           7
                            Desk reviews are performed by HUD staff who check that appraisals submitted to the field office are
                           properly performed and accurately reflect the value of the house.



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              number, sex, and racial background to monitor lenders’ selections. In
              mid-1996, HUD conducted an analysis of the lender and appraiser
              information in CHUMS after receiving complaints that women and minority
              appraisers were not being selected by some lenders. HUD’s analysis showed
              that the shares of FHA’s appraisal work going to women and minorities
              were not in proportion with their representation on FHA’s roster of
              appraisers since lenders’ selection was mandated by HUD. In response, the
              FHA Commissioner, in a July 1996 letter to all FHA lenders, requested that
              they review their appraiser assignment process to ensure that women and
              minority appraisers be given a fair share of appraisal assignments
              commensurate with their representation on FHA’s roster. The
              Commissioner also offered to assist FHA lenders in identifying women and
              minority appraisers on the roster who can be selected for appraisal work
              and indicated that HUD will continue to use CHUMS to monitor lenders’
              choice of appraisers and the sex and race of appraisers who are chosen.

              In commenting on a draft of this report, the FHA Commissioner stated that
              in addition to the actions already taken to eliminate this problem, FHA is
              working to develop additional means by which to remedy the problem. In
              addition to increasing lenders’ awareness and sensitivity to the matter, HUD
              plans to refine its computer tracking system to provide data on a local
              rather than national basis. This action will allow HUD to focus its attention
              on specific problem areas, even if the problem is not apparent on the
              national level.


              While current procedures that require state licensing and certification of
Conclusions   appraisers and lender quality assurance programs may help reduce
              financial risks to FHA, verification of appraisers’ valuations of properties
              would help to protect against fraud, waste, and mismanagement. Although
              FHA requires field offices to perform field and desk reviews, a key control
              over the quality of appraisals made on properties it insures—requiring a
              stated percentage of field and desk reviews of some completed
              appraisals—was eliminated because of staffing reductions. As a result,
              while most HUD field offices have conducted some field reviews of
              completed appraisals, others have conducted few or no reviews. In the
              absence of an agency mandate to review a specific percentage of
              completed appraisals, there is no assurance that appraisals comply with
              statutory, regulatory, and administrative requirements. Also, no assurance
              exists that FHA can monitor the quality of appraisers and identify FHA
              lenders with deficient appraisal practices.




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                       To reduce the financial risks assumed by FHA, we recommend that the
Recommendations to     Secretary of HUD reestablish a requirement that each HUD field office
the Secretary of HUD   responsible for overseeing appraisals randomly select a specific
                       percentage of completed FHA appraisals for field and desk review by either
                       HUD staff or a licensed or certified appraiser who is not a member of FHA’s
                       roster of appraisers for lenders’ selection. In addition, we recommend that
                       the Secretary of HUD establish a process to ensure that such field offices
                       meet this appraisal review requirement.


                       We provided HUD and VA with a draft of this report for their review and
Agency Comments        comment. We received written comments on the draft report from HUD.
                       (See app. II.) In addition, VA’s Assistant Director for Construction and
                       Valuation provided us with changes that clarified information contained in
                       the report, which we incorporated.

                       HUD concurred with our recommendation that each HUD field office
                       responsible for overseeing appraisals randomly select a specific
                       percentage of field appraisals for field and desk review. HUD stated that in
                       fiscal year 1998, its field offices will be required to perform field and desk
                       reviews on no less than 10 percent of the mortgage loans underwritten
                       within their jurisdictions. With regard to field reviews, HUD noted that they
                       may be conducted by HUD staff or by qualified appraisers working for FHA
                       on a contractual basis and that appraisers under contract with HUD are
                       ineligible to perform appraisals for FHA lenders. HUD did not comment on
                       our recommendation that it establish a process to ensure that each field
                       office meet the appraisal review requirement.

                       HUD pointed out that its latest report shows that during the period October
                       1, 1996, to June 20, 1997, 7.8 percent of all appraisals made were field
                       reviewed, and all such reviews were made within 45 days of the
                       completion of the appraisals. HUD also pointed out that during the same
                       period, all HUD field offices had performed some desk reviews of
                       completed appraisals. In total, 9.3 percent of all appraisals performed were
                       desk reviewed, and on a rating system of 1 to 5, appraisers received an
                       overall performance rating of 4.59.

                       On the basis of the scope and extent of the above field office activities and
                       the overall performance ratings achieved by lenders, to date, HUD stated it
                       was satisfied that no significant problems exist with the appraisal process.
                       Also, the experience of its Los Angeles field office is clearly the exception
                       and not the norm, according to HUD. HUD stated that nevertheless, FHA has



                       Page 12                                         GAO/RCED-97-176 Home Appraisals
              B-277088




              decided to enhance its current appraisal review process in fiscal year 1998
              in line with our recommendation that its field offices randomly select a
              specific percentage of field appraisals to be field and desk reviewed.

              Regarding HUD’s comment that the experience of its Los Angeles field
              office is clearly the exception and not the norm, it should be noted that
              other HUD field offices performed few or no field reviews of completed
              appraisals. As discussed in our report, two other HUD field offices in
              addition to the Los Angeles office had not performed any field reviews of
              completed appraisals in fiscal year 1997 as of June 20, 1997, and four other
              offices reviewed 1 percent or fewer of the completed appraisals.

              HUD also stated that under the current appraisal system, lenders, in making
              their own selections, have not selected women and minority appraisers in
              sufficient numbers. In addition to the corrective actions outlined in our
              report, HUD pointed out that it was developing additional means by which
              to remedy the problem. The additional actions being taken by HUD have
              been incorporated in the report.


              To describe FHA’s appraisal process and the reasons why it was changed,
Scope and     we reviewed legislation, including the National Housing Act; the Financial
Methodology   Institutions Reform, Recovery, and Enforcement Act of 1989; and the
              Cranston-Gonzalez National Affordable Housing Act. We also reviewed
              FHA’s appraisal-related policies, procedures, and memorandums on agency
              requirements; reviewed the goals and guidelines for FHA lenders,
              appraisers, and appraisals; and interviewed HUD and VA officials who are
              responsible for each agency’s appraisal policies.

              As requested by your office, we contacted 12 former FHA fee panel
              appraisers who raised complaints to obtain their reactions to FHA lenders’
              selection of appraisers. We also contacted FHA headquarters officials; four
              FHA lenders—three of whom are among the largest FHA lenders in their
              states and the other who is the largest FHA lender nationwide; and a
              headquarter’s official with the Department of Veterans Affairs. In addition,
              we examined trade association literature and other industry documents
              related to this issue. We did not attempt to verify the claims made by the
              former fee panel appraisers.

              Our information on the problems identified by HUD since the
              implementation of the new appraiser selection process was obtained
              through interviews with FHA officials in charge of the process and the



              Page 13                                        GAO/RCED-97-176 Home Appraisals
B-277088




manager of HUD’s financial audit and by reviewing KMPG Peat Marwick’s
report of audit findings for HUD’s Los Angeles field office and prior reports
of our office. We performed our work from December 1996 through
June 1997 in accordance with generally accepted government auditing
standards.


Please call me at (202) 512-7631, if you or your staff have any questions.
Major contributors to this report were Robert S. Procaccini and Phillis
Riley.

Sincerely yours,




Judy A. England-Joseph
Director, Housing and Community
  Development Issues




Page 14                                        GAO/RCED-97-176 Home Appraisals
Page 15   GAO/RCED-97-176 Home Appraisals
Appendix I

The Department of Veterans Affairs’
Appraisal Process

               The Department of Veterans Affairs (VA) provides assistance to qualified
               veterans, their families, and certain active duty military personnel by
               partially guaranteeing mortgage lenders against financial loss if a loan is
               foreclosed. VA is required by law (38 U.S.C. section 3731) to rotationally
               select and assign an appraiser from a list of VA-approved appraisers to
               perform an appraisal of a property for a lender whose borrower is seeking
               a VA loan. Prior to December 1994, both FHA and VA assigned fee appraisers
               to lenders and, under a reciprocity agreement, accepted each other’s
               valuation of the same property to reduce paperwork, simplify the appraisal
               process, and avoid duplication of effort. When FHA implemented
               regulations that terminated FHA’s assignment of fee appraisers, VA could no
               longer legally use appraisals prepared by FHA lender-selected appraisers.

               According to a VA official in charge of appraisals, some lenders and other
               program participants have complained to the agency and Members of the
               Congress about the loss in reciprocity of value determinations and the
               expense and time it takes to have both a VA and FHA appraisal performed
               on the same property. Also, VA lenders want the Congress to repeal VA’s
               legislation to remove the rotational assignment constraint, which would
               then allow VA to give lenders the same choice now permitted to FHA
               lenders. The official also said that some VA appraisers do not want the law
               changed to allow lenders’ selection because they believe the problems
               alleged by former FHA appraisers with FHA’s new appraisal process will
               occur for VA home loans. The VA official pointed out that legislation to
               change VA’s appraiser selection process has not been introduced and that
               VA did not have an official position on this issue as of June 1997.




               Page 16                                       GAO/RCED-97-176 Home Appraisals
Appendix II

Comments From the Department of Housing
and Urban Development




              Page 17         GAO/RCED-97-176 Home Appraisals
Appendix II
Comments From the Department of Housing
and Urban Development




Page 18                                   GAO/RCED-97-176 Home Appraisals
           Appendix II
           Comments From the Department of Housing
           and Urban Development




(385668)   Page 19                                   GAO/RCED-97-176 Home Appraisals
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