The U.S. Department of Housing and Urban Development (HUD), Office of Inspector General (OIG), conducted a limited review of HUD’s oversight of loans underwritten by HUD-approved Federal Housing Administration (FHA) lenders.  We conducted the internal review as part of OIG’s annual audit plan, prompted by four recent OIG external lender audits reporting that the lenders allowed prohibited restrictive covenant agreements.  The objective of the internal review was to summarize the recently completed OIG external audits and determine the extent to which HUD had identified and discouraged such agreements.

Our seven audit reviews of six different FHA lenders demonstrated that HUD needs to strengthen its oversight of prohibited restrictive covenants in connection with FHA-insured properties, prohibited under 24 CFR 203.41(b).  HUD has regulations in place to prevent prohibited restrictions on conveyance of FHA-insured properties; however, in the four most recent OIG audits, we found an estimated 2,479 loans with prohibited restrictive covenants.  HUD should enhance its efforts to reiterate to the mortgage industry that prohibited restrictive covenants are unacceptable and HUD regulations will be enforced with appropriate penalties.  These prohibited agreements persist due to builders, with associated lenders, wanting to protect their economic self-interests in their single family housing developments.  We also attribute this condition to HUD’s lack of recent public regulatory reinforcement and discouragement of these material violations that impact the insurability of the loans.  As a result, FHA insured ineligible loans and incurred unnecessary losses.  With the six lenders reviewed, we identified more than $67 million in potential losses that would not have otherwise occurred, putting the FHA fund at unnecessary risk.

We recommend that HUD’s Deputy Assistant Secretary for Single Family Housing (1) reinforce HUD regulatory requirements concerning restrictive covenant agreements to the industry, including lenders and builders; (2) develop and implement specific review procedures to identify prohibited restrictive covenants during Homeownership Center loan reviews and provide education to Homeownership Center personnel to reiterate the importance of identifying the various types of prohibited restrictive covenant agreements; (3) develop and implement specific procedures detailing penalties and corrective actions that can be applied consistently to each violating lender and builder; and (4) develop and implement procedures for tracking loans identified with prohibited restrictive covenants, including the type of restriction.