The CHAIRMAN. Now, Mr. Rothchild, you argue in your statement that even with 100-percent insurance the lender has sufficient incentive to assure the quality of the loan because it would take a loss on foreclosure costs if it goes bad. How much of a loss would that be on the average and has it increased through any revised FHA procedure since the height of the scandal period when so many unsound loans were made?

Mr. ROTHCHILD I didn't hear the last part of that, Senator.

The CHAIRMAN. I wonder whether the loss has increased since the height of the scandal period when so many unsound loans were made. Mr. ROTHCHILD. I think the losses for mortgagees on 221 (d) (2) loans and some of the 235 loans have increased. I go back to the 203 (b) program. HUD has not had any losses in the general program under that program. The mortgagees suffer this kind of loss in foreclosure.

In the first place, the figures from the industry clearly document that the mortgagee makes an investment in the long-term servicing of the mortgage. In other words, origination fees do not cover the cost of originating loans. That shortfall is approximately 1 percent of the principal balance. We can point out that if the loan which is foreclosed carries with it an interest loss, FHA pays no interest back for the first 60 days of a foreclosed loan, so there's approximately onesixth of an annual interest bill that is lost. The FHA reimburses the mortgagee for only two-thirds of the foreclosure and conveyance cost. The mortgagee assumes the responsibility of delivering the foreclosed loan according to regulations of the FHA and that costs a considerable amount of money in most mortgagee offices to maintain the proper system of meeting the FHA regulation.

The Federal insurance contract that serves as one of the financial linchpins for all single-family home mortgage programs administered by the Federal Housing Administration is widely misunderstood. One of the more popular misconceptions is that an FÍA-insured loan provides 100-percent Federal insurance for the mortgagee and, because of this Federal backstop, does away with normal market incentives that would be practiced by a prudent lender. In short, an FHA loan is supposed to be risk free with nothing but upside potential for the lender. In practice, however, the mortgagee stands to lose money, considerable sums of money, if the loan sours and eventually goes to foreclosure. When an FHA loan is foreclosed, the lender suffers both, first, an interest loss and second, a loss in foreclosure and conveyance costs. FHA pays no interest for the first 2 months of the delinquency and from that point on-once the loan is in default-interest is paid only at the debenture rate, set by HUD regulations, not the rate set forth in the mortgage. This rate differential is maintained from the time of default until settlement of the claim. Because foreclosure and redemption periods vary, and sometimes widely, from State to State, no statistics are available to determine the average length of time between default and settlement, but a conservative estimate would place this at 6 months.

The current FHA-administered mortgage rate stands at 82 percent. The debenture rate is 714 percent. Assuming an 81/2-percent, $20,000, 30-year FHA loan, with no discounts, the monthly interest on such a loan will be $140.80 at the end of the first year. Most FHA loans that go into default and subsequent foreclosure do so during the first year

of the loan. Because the first 2 months' interest under a defaulted loan is not recaptured by the mortgagee, this means an immediate loss of $281.60 is sustained. If the debenture rate of 74 percent is then applied to the principal outstanding at the end of the first year, this yields interest income of $120 per month versus the $140.80 being returned under the mortgage note. And if 6 months elapse between date of default and date of settlement, this means a further interest loss of $20.80 per month, or $124.80. So in interest income alone, the lender suffers a loss of $406.40, not an inconsiderable sum.

FHA reimburses the mortgagee for only two-thirds of foreclosure and conveyance costs, Depending on the size of the loan and the length of time needed to complete foreclosure and conveyance, this loss could easily amount to hundreds of dollars per loan. MBA has never attempted a statistical study on this particular aspect of foreclosure proceedings and HUD similarly does not maintain statistics on foreclosure and acquisition costs. Therefore, an average or representative dollar amount relating to the cost of foreclosure and conveyance is not available.

However, HUD does monitor attorneys' foreclosure fees on a Stateby-State basis to make sure they fall within an acceptable range of costs established for each State. Although HUD declines to identify the range for each State, we do know that nationwide, according to HUD figures, such fees go from a low of $150 to a high of $600. Since the mortgagee is absorbing one-third of this cost, it follows that the mortgagee's loss on attorneys' foreclosure fees alone runs anywhere from $50 to $200.

In addition to this direct loss on a per loan basis, there is the cost of maintaining a forbearance monitoring section, which is a nonreimbursable expense. Each mortgagee must carefully monitor the foreclosure process to make sure that all procedural and time requirements, set by law or HUD regulations, are met, or even larger losses will be sustained.

The Federal insurance backstopping FHA's single-family home mortgage programs is obviously excellent and has played a highly visible role in the operation of those programs. However, as just illustrated, it is not a 100-percent guarantee that allows the lender to step neatly away from a loan that has been foreclosed. The mortgagee is very much involved and concerned. No mortgage lender makes a profit, or even breaks even, on foreclosure. In economic terms, a foreclosure brings about the worst possible situation for a mortgagee. It means spending money-the cost of processing the foreclosure-to get rid of an income stream-the servicing income.

The CHAIRMAN. Can you give us any specific proportion of the loan that these losses would amount to?

Mr. ROTHCHILD. I think it probably ranges in the range of 3 to 5 percent in losses on foreclosure and in a State like Illinois where a foreclosure period is long and very costly it would be in the 5-percent range. In a State like Texas where there's a very short redemption period it's probably 3 percent.

The CHAIRMAN. Let me ask Mr. Maier and Mr. Zinsmeyer to respond as to whether they think the lenders' losses on foreclosure costs are an adequate incentive for quality underwriting and services.

Mr. MAIER. Well, the 3- to 5-percent loss on foreclosure does not come anywhere near the loss that HUD experiences if a loan goes to foreclosure, which is now, as I said earlier, about $10,000 for each home loan. Therefore, the lender does not have nearly the kind of market incentive that HUD would have for proper underwriting and processing.

I might also mention that in some cases the up-front fees, such as prepaid interest and origination related fees, can cover the foreclosure costs. It depends on the particular circumstances of the loan.

Mr. ZINSMEYER. When we talk about loss on foreclosure, we absolutely have to look at the total income that a mortgage banker receives on one single loan. The points that it receives, the seller points that are paid and the origination point that is paid at the initiation of the loan quite often can cover the cost of foreclosure. What the points do is they raise the effective interest rate on the loan and, if the loan is foreclosed on in the first or second year, then the effective interest rate on the loan is considerably higher for the mortgagee.

Second, there are marketing costs and the mortgagee actually markets the loan and someone purchases it on-say FNMA or an institutional investor-there usually are gains that are achieved on that. I think it was in 1972 or 1973 HUD did a study of whether or not the origination fees should be increased. They found that the returns on marketing, on origination, and the like, more than covered origination costs.

We don't have good data on mortgage banking operations. The industry supplies data which HUD has attacked as "guesstimates," as not being effective or accurate, and HUD has also not collected reliable data. But it appears that HUD is telling us in a number of studies that the total return on origination and marketing of a mortgage will cover the cost of foreclosure in most cases. So we can't just look at foreclosure costs, just on interest rate foregone, or just on the actual legal cost of the foreclosure.

The CHAIRMAN. Mr. Rothchild, you have the floor again. How about it? Are the unfront costs likely to cover the risk anyway so there's no real loss to the mortgage banker?

Mr. ROTHCHILD. Well, clearly, it's our view that they are not sufficient. I do not like the notion that there are people who make a profit on foreclosures and I cannot say that there's never been an exception to the rule, but that should not happen. Perhaps it does. The best way to satisfy that the upfront charges that have been referred to as feesI think discounts are not there, is to see that there's a free market rate so there are not discounts in the market. That is the easiest and quickest answer to preventing large discounts that could provide an incentive to early foreclosure.

Our industry and the mortgage lenders are people who invest monev and spend a good deal of monev getting their money at work. They lose money when it stops working by foreclosures.

The CHAIRMAN. But if Congress can you take a prohibition on points? Didn't the mortgage bankers oppose that?

Mr. ROTHCHILD. Yes, we have. What we have proposed is a market

rate.

The CHAIRMAN. You opposed it?

Mr. ROTHCHILD. We have opposed the elimination of discounts. The CHAIRMAN. Right.

Mr. ROTHCHILD. What we propose is that there be a free market rate which would include discounts just as the Federal Government discounts some of its obligations in the marketplace. But when you have a free rate you have a very, very narrow margin of very little incentive for deep discounts. We have always proposed that the rates be free or change rapidly at least so the discounts disappear from the markets. They are a disincentive to invest. They are a disincentive to the borrower. They raise front-end costs and we don't like them. We think they do provide the possibility for that kind of abuse.

The CHAIRMAN. I want to get to Ms. Cincotta in just a minute. I have been trying to work that in, but we've gotten involved in this. Ms. Cincotta, I'm sure you can understand. I just want to finish this thought if I can.

Mr. Maier, Mr. Rothchild supports the use of FHA regulated interest rates which, of course, leads lenders to charge points in order to get a market yield as he just indicated. Do you have an opinion on whether consumers would be better served by a free market rate and what points?

Mr. MAIER. Yes. We believe that minimizing these points is worthy of consideration-by lifting the interest rate ceilings because, as we said earlier, prepaid interest can be an incentive for foreclosure. I want to point out this is by no means a whole solution to the problem, because it will restore only a portion of the incentive for proper lending and servicing. You still must have either effective coinsurance programs or an effective lender supervision system. The CHAIRMAN. Ms. Cincotta?

STATEMENT OF GALE CINCOTTA, CHAIRPERSON, NATIONAL PEOPLES ACTION COALITION, CHICAGO, ILL.

Ms. CINCOTTA. My name is Gale Cincotta and I am chairperson of the National People's Action. I am here today to submit my views on the future role of FHA in the inner city. Both Federal Housing Commissioner Simons and the representatives of the mortgage banking industry have testified before me. Given that a recent HUD-commissioned task force report on the future of FHA which included Mr. Simons and Mr. Jones of the Mortgage Banking Association have set a tone for the role of FHA, my views will contrast sharply. In the task force report entitled "Revitalizing the FHA," there is a great oversight. That oversight is the failure of the report to seriously discuss the question of regulation. Although the report acknowledges the "maladministration of FHA (under HUD's direction)" and the resulting scandals, it glosses over this finding as merely a factor of time and place. The report goes on to conclude that FHA should "aggressively participate in both the nonsubsidized and subsidized markets." The dominant concern expressed in the task force report is for efficient processing of large quantities of FHA paper with little regard for quality control.

This, Senators, is a fatal path. FHA foreclosure rates are still too big. HUD's mortgage assignment program still is being sabotaged by mortgage bankers and HUD, 518 (b) and 518 (d) payback claims for

FHA defects are still rejected being indiscriminately. Block-by-block property rehabilitation of FHA foreclosed homes has yet to take place. An effective counseling program for homeowners still is not implemented. Excessive FHA mortgage points still are being charged. Racial steering and mortgage discrimination still are a byproduct of FHA. As such, the revitalization of FHA cannot begin until adequate regulation and administration is provided to remedy these problems which are commonplace to the FHA insurance programs.

REGULATION OF MORTGAGE BANKERS

HUD has and continues to show itself incapable of regulating mortgage bankers, particularly in regard to FHA's single family insurance programs. For this reason, independent regulation of mortgage bankers is vital if FHA is to have a sound productive future in the inner city. In Illinois, community organizations who have experienced years of frustration in monitoring HUD have succeeded in the passage of legislation which will provide for independent licensing and regulation of mortgage bankers in regard to foreclosures rates on Government insured mortgages FHA/VA. Although this bill has been watered down in the legislative process, it has established a precedent for independent regulation of mortgage bankers which should be taken up nationally.

THE ASSIGNMENT PROGRAM

HUD's handling of the mortgage assignment again clearly demonstrates their inability and unwillingness to regulate mortgage bankers. The assignment program is a court approved settlement which HUD agreed to on May 26, 1976, in order to satisfy a "fast foreclosure" suit. against them. The program provides that homeowners who are in default for a legitimate reason, that is, sickness, layoff, can have their mortgage assigned to HUD for negotiation of a "work-out" agreement on missed payments over a 3-year period. Yet as of May 1977, less than 7 percent of all homeowners going into foreclosure have requested assignment to HUD. There is evidence that the mortgage bankers have not provided homeowners with sufficient information about the availability of the program. Furthermore, as of August 1977, HUD reports show that only 16 percent of the assignment requests are accepted. There is further evidence that HUD has established quotas which limit the acceptance of assignment requests. Thus, HUD has violated its agreement with the courts by not regulating mortgage bankers and by taking their own steps to sabotage the assignment program. This is clear evidence that independent regulation of mortgage bankers is extremely necessary.

THE FHA PAYBACK PROGRAM

The 518 (b) and (d) payback programs are another example of inept administration by HUD in regard to the FHA insurance programs. The payback programs which were legislated to reimburse homeowners for defects in their homes which were "overlooked" in FHA inspections cover homes purchased from August 1, 1968 to August 23, 1976. Since it began in 1974, homeowners have consistently appealed on the basis that they were rejected without cause. The recent