We audited the Federal Housing Administration (FHA) Preforeclosure Sales Program claim process in accordance with our goal to contribute to improving the integrity of FHA single-family insurance programs.  Our audit objective was to determine whether the U.S. Department of Housing and Urban Development (HUD) paid ineligible preforeclosure sale claims that did not meet the net sales proceeds requirements.

FHA paid preforeclosure sale claims that did not meet the sales proceeds criteria and were, therefore, not eligible in accordance with the program requirements.  Of 95 statistically selected claims paid from September 1, 2011, through November 30, 2012, 47 did not meet the minimum net sales proceeds criteria or were approved based upon variances without a documented justification.  HUD paid ineligible preforeclosure sale claims because it did not design adequate controls to ensure that lenders complied with the minimum net sales proceeds requirements.  HUD’s controls were inadequate to (1) correctly determine the required minimum proceeds amount, (2) ensure that variance approvals were consistent with the program’s objectives, (3) ensure the quality of appraisals used to establish minimum net sales proceeds amounts, and (4) ensure the reliability of lender-provided claim data.

By projecting our sample results, we estimate that HUD paid more than $404 million in claims for 4,457 preforeclosure claims that did not meet the program requirements.  Sales proceeds were deficient in these cases by an estimated amount of $8.62 million.  The ultimate cost to the FHA insurance fund associated with the $404 million in ineligible claims is not known because loss amounts (if any) for each loan would have varied depending on how the loan default was otherwise resolved if the program rules were followed.

We recommend that HUD (1) design and implement controls to ensure that lenders comply with the preforeclosure program minimum sales proceeds requirements to put $6,898,518 to better use; (2) evaluate the risk associated with HUD’s claim system controls over data reasonableness and consider additional measures to address this risk; (3) immediately discontinue the practice of approving variance requests without a valid documented justification; and (4) design and implement controls to evaluate the quality of preforeclosure sale claim property valuations and detect or prevent possible program abuse involving undervaluation.