Memorandum Report on the Office of Inspector General's Internal Audit of HUD's Single Family Seven-Loan Limit

Published by the Department of Housing and Urban Development, Office of Inspector General on 2014-09-30.

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

                                                U.S. DEPARTMENT OF
                               HOUSING AND URBAN DEVELOPMENT
                                         OFFICE OF INSPECTOR GENERAL


                                           September 30, 2014

                                                                                              MEMORANDUM NO:

TO:           Carol Galante
              FHA Commissioner-Assistant Secretary, Office of Housing, H

FROM:         Ronald J. Hosking
              Regional Inspector General for Audit, Denver Region, 8AGA

SUBJECT:      Memorandum Report on the Office of Inspector General’s Internal Audit of
              HUD’s Single Family Seven-Loan Limit


The Office of Inspector General (OIG) conducted an audit of HUD’s Single Family seven-loan
limit. We initiated this review based on issues identified in an audit of the Wyoming Housing
Opportunities Association in memorandum 2013-DE-1801. Our objective was to determine the
impact of investor loan properties on the FHA fund.

                                METHODOLOGY AND SCOPE

We used FHA’s Single Family Housing Enterprise Data Warehouse to identify borrowers who
had greater than seven active single-family FHA mortgage loans. The system query generated
37 individual investors that held 622 active FHA loans. We analyzed the data to determine
whether the loans closed prior to Mortgagee Letter 96-59; dated October 29, 1996, which put a
moratorium on investor 203k (rehabilitation) loans. We determined the loans in our review
closed prior to the moratorium and therefore, are eligible under HUD’s current rules and
Next, we narrowed our review by selecting 8 of the 37 investors who had greater than 20 active
FHA loans. For these 8 investors, we reviewed the data to determine whether their loan
eligibility and housing standards were putting a negative impact on the FHA fund. We selected
the two investors where the properties were in closest geographic proximity to each other and
conducted on-site reviews to evaluate the condition of the properties.
                                                Office of Audit Region 8
                                   1670 Broadway, 24th Floor, Denver, CO 80202
                                      Phone (303) 672-5452, Fax (303) 672-5006
                          Visit the Office of Inspector General Web site at www.hudoig.gov.

We then analyzed 4 investors that had more than 20 FHA single family mortgages where the
properties were located in the same geographic area. The 4 investors in our sample held 177
active FHA mortgages. The table below shows the location of the 4 properties, total number of
loans, original mortgage amounts, and current unpaid principal balance.

    Borrower Location              Total      Original mortgage         Unpaid balance
    ID                             loans      amount
    9095         Humacao, PR       91         $ 2,665,445               $          962,758
    5798         Baltimore, MD     33         $ 1,370,852               $        1,144,905
    8342         Columbus, OH      27         $   986,327               $          446,020
    4481         Memphis, TN       26         $ 1,103,140               $          389,503
                 Total:            177        $ 6,125,764               $        2,943,186


The Federal Housing Administration (FHA) provides mortgage insurance for loans made by
FHA-approved lenders throughout the United States and its territories. FHA insures mortgages
on single family and multifamily homes including manufactured homes and hospitals. It is the
largest insurer of mortgages in the world, insuring over 34 million properties since its inception
in 1934.

The seven-unit limitation prohibits any borrower, including non-profit organizations, State and
local government agencies, and private investors, from obtaining FHA-insured financing for a
property that may be rented if the borrower has, or will have, a financial interest in more than
seven rental units (regardless of financing type) in a contiguous area. This is generally defined
as within a two-block radius. FHA designed the regulation to limit its insurance exposure on
multiple mortgages to any one borrower in any one area. The seven-unit limitation appears in 24
CFR 203.42(a), paragraph 3-9 of HUD Handbook 4155.1 Rev-4, Change 1 and, specifically for
the Section 203(k) program, in paragraph 4-6 of HUD Handbook 4240.2 Rev-2.

In 1996, HUD issued Mortgagee Letter 96-59 that placed a moratorium on all investor loans.
That moratorium is still in effect.

The seven-loan limit and the investor loan moratorium do not apply to FHA Streamline
Refinance loans. Specifically, HUD Handbook 4155.1 6.C.3.e, states an eligible investor that
has a financial interest in more than seven rental units, as described in 24 CFR 203.42, may only
refinance without appraisals. We reviewed the loans in our analysis and determined that of the
177 loans above, 16 loans were not Streamline Refinance loans. The 16 loans closed prior to the
1996 investor loan moratorium; therefore, those loans were eligible under the previous criteria.

                                    RESULTS OF REVIEW

We found multiple instances of investors deferring maintenance on their investment property.
Since there is no policy for periodic evaluation of property conditions or appraisals in the case of
refinancing, this might put undue risk on the FHA insurance fund.


We conducted onsite visits of the Baltimore, MD, and Columbus, OH, properties to determine
whether the borrowers maintained the properties similar to HUD’s Housing Quality Standards.
Additionally, we wanted to ensure the properties were not in such disrepair they would decrease
the property’s value and place the FHA insurance fund at risk. We determined that multiple
homes had deferred maintenance, including cracked or boarded up windows, exposed wiring,
loose or missing railing, leaking plumbing, missing entry stairs, etc.

We believe the deferred maintenance issues existed because there is no policy for FHA or its
approved lenders to conduct periodic evaluations of property conditions for properties with
single-family mortgage insurance, as there would be if these properties had mortgages with
multi-family mortgage insurance. We also believe the issues also exist because the investors can
refinance their mortgages without obtaining an appraisal, which could disclose significant
deferred maintenance.

The properties we inspected contained multiple deficiencies that might decrease their property
value, putting risk on the FHA insurance fund. If the above-mentioned properties were insured
under multifamily mortgage insurance programs, some would not meet HUD’s Housing Quality
Standards. Furthermore, some of the homes we inspected had deferred maintenance that may
have decreased the insured value of the home. See appendix A for various pictures of our onsite

The 33 active mortgages for the Baltimore, MD investment properties have all been refinanced
without appraisals. The amounts of the original mortgages were more than $1.3 million and the
current mortgages still have outstanding principal balances of more than $1.1 million. The
original mortgage closing dates ranges are 1991 – 1996 with refinance loan dates of 1997 –
2004. This investor has had conveyance claims filed against two additional properties totaling
more than $96,000. The remaining properties are in deteriorated condition but the mortgage
balances are only about 16% less than they were around 20 years ago.

These properties function much like multifamily properties, but FHA does not have the
protections for single family properties that are in its multifamily insurance programs. These
loans pose a greater risk to the insurance fund than ordinary single family loans because they are
greater in number, are all on properties being rented out, and are managed and maintained
similarly. If the borrower stops making payments on one loan, they could stop making payments
on all their loans, possibly at a significant cost to the insurance fund. This happened recently
with an investor who held 51 mortgages in Cheyenne, WY as identified in our audit
memorandum 2013-DE-1801. Therefore, FHA should consider developing additional
protections, like requiring appraisals on refinanced investor loans and, if FHA reinstates the
investor loan program, consider other changes to the insurance requirements for investor loans
that will better protect the insurance fund.



We recommend that the FHA Commissioner-Assistant Secretary, Office of Housing

1A.   Perform a study of the risks involved with deteriorating property conditions related to
      investor loans and evaluate whether changes are needed, such as requiring appraisals on
      refinanced investor loans and making changes to the insurance requirements for investor


                                        Appendix A
The pictures below are from various Baltimore, MD properties.

             Broken window                                        Boarded up egress window

      Broken exposed external wirings                          Damaged stairs with no railing

The pictures below are from various Columbus, OH properties.

            Missing window                                   Leaking plumbing and no cabinet doors


                                      Appendix B

                              AUDITEE COMMENTS

HUD chose not to provide comments to this report.