HUD Chief Halts Fix-Up Loan Program

A nationwide moratorium on investor participation in the fast-growing 203(k) home fix-up loan program has been announced by Henry Cisneros, secretary of Housing and Urban Development, after federal auditors found widespread “waste, fraud and abuse” by investors.

Cisneros said HUD will examine ways to improve administration of the program, including possible proposals for Congress in 1997.

The program offers down payments as low as 3% to 5% and maximum loan amounts based on the estimated market value of the home after renovation is completed.

Virtually moribund on the books of the Federal Housing Administration during the 1980s, the program has been promoted aggressively under the Clinton administration. After a streamlining of program rules in 1993--opening participation to investors and nonprofit groups--the program jumped to 8,500 loans in 1995 and a projected 15,000 nationwide in fiscal 1996.

But according to a yearlong investigation by the Department of Housing and Urban Development inspector general’s office, the 203(k) program as administered now is “highly vulnerable” to “risky property deals, land sale schemes, overstated property appraisals and phony or excessive fees” as well as shoddy or nonexistent rehab work.

The program “seems to be viewed by some [lenders, investors and nonprofits] as merely a means to turn a quick profit,” according to Kathryn Kuhl-Inclan, a district HUD inspector general whose staff examined 203(k) files and rehab work in eight states covering mid-1993 through mid-1996. The states were California, Virginia, Florida, Massachusetts, Illinois, Georgia, Texas and North Carolina.

“Our results show that extensive program abuse is occurring around the country by lenders, investors and nonprofits,” Kuhl-Inclan said. She has asked the FHA to undertake immediate reforms to prevent “substantial losses” to the government and consumers.

Auditors documented cases in which investors fraudulently inflated land prices through sham sales and deed-flips to boost the amount of the FHA 203(k) mortgage money they could pocket at closing. In one case, according to a summary report to the FHA by Kuhl-Inclan, an investor falsified loan settlement statements to indicate a cost of $123,000 apiece for 27 properties purchased in Georgia. But investigators found that the investor had paid only $80,893 per property and had walked away with an illegal $1.14-million profit “with minimal investment or risk.” That fraud, in turn, increased the risk of loss to FHA’s insurance fund by $35,800 per property, according to Kuhl-Inclan’s computations, or about $966,000.

In a similar case in Florida, a nonprofit group bought 52 homes for fix-up for $1.25 million from a seller who had purchased the same homes the same day for just $715,000. The seller netted a one-day profit of $533,000. Key to the abuse here, said the inspector general’s report, was inside dealing. The president of the nonprofit group borrowing the money “also served as the closing agent for the . . . loans.”

When investigators visited properties supposedly rehabilitated with federally backed loan money, they sometimes found little if any actual work performed. In one case in Illinois, a lender certified to the FHA that all renovation work was completed on 43 houses, thereby triggering release of all funds held in escrow. Site visits revealed, however, that on 12 homes, virtually no rehab had been done, while on the rest, “substantial portions of the scheduled work had not been performed.”

Other problems with the booming 203(k) program turned up by auditors:

* Over-valuations of properties, allowing excess rehabilitation funds to be pocketed for work that was not performed. In one sample of 61 203(k) loans in Illinois, according to the report, 50 of the properties carried “substantially” inflated appraisals.

* “Excess profits by nonprofit borrowers.” Although by law nonprofits are supposed to be just that, investigators found nonprofit groups taking 21% to 42% of loan money placed in escrow for the rehab as their profits for the work.

The report attributed a major part of these problems to basic design flaws in the program, including the FHA permitting private lenders to handle most of the application, underwriting and approval decision-making--all fee-generating activities--on their own.

“In many cases,” the report read, “lenders performed the work write-up and cost estimate, appraisal and rehab inspections with in-house staff.” The government relies on lenders to be honest, “yet the prospect of earning the large fees allowed by this program . . . has enticed lenders to break the rules.”

Kuhl-Inclan asked FHA to bar private investors from the 203(k) program altogether, as well as to increase its oversight of lenders and nonprofit groups. In a written response to Kuhl-Inclan, FHA Commissioner Nicolas P. Retsinas said that his agency had already tightened its administration of the program.

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Distributed by the Washington Post Writers Group.