Private mortgage insurers, such as United Guaranty and Mortgage  Guaranty Insurance Corporation (MGIC), were among the first to develop  mortgage scorecards in the early 1990s. But TOTAL’s  effectiveness could be limited by some of the choices that were made  during the development process, including the fact that (1) the data FHA  and its contractor used were 12 years old by the time TOTAL was  implemented, (2) FHA has not developed policies and procedures for  updating TOTAL, and (3) the benchmark analysis for determining TOTAL’s  predictive capability may have been inadequate. Some Development and Implementation Choices Could Limit TOTAL’s Effectiveness

Although FHA and its contractor used a reasonable and generally accepted  practice for developing TOTAL, some of the choices made during that  process could affect FHA’s ability to maximize its use of the scorecard. However, since 1992,  significant changes have occurred in the mortgage industry that have  affected the characteristics of those applying for FHA-insured loans. As a result, HUD did not update TOTAL  either before it was deployed or subsequently. As described in table 1, FHA’s current use of TOTAL has provided  additional benefits over previous scorecards, such as less paperwork for  lenders and more consistent underwriting decisions. In addition, private sector organizations use their  scorecards to help inform general management decision making, set prices  based on risk, and launch new products. As a result of these uses, private lenders have been able to broaden their  customer base and improve their financial performance. FHA could better anticipate, understand, and react to changes in the  marketplace if, like the private sector, it routinely updated TOTAL. FHA followed an accepted process in developing TOTAL and has already  seen significant benefits from the scorecard. Finally, FHA has  not taken steps to share credit scores utilized by TOTAL with Ginnie Mae,  which could use the information to help improve the transparency of the  secondary mortgage market. Recommendations for Executive Action

To improve how HUD uses and benefits from TOTAL, we recommend that  the Secretary of HUD take the following two actions:  develop policies and procedures for updating TOTAL on a regular basis,  including using updated data, testing additional variables, exploring  hazard model benefits, and testing other cut points; and  explore additional uses of TOTAL and the credit data it utilizes,  including to help adjust cut points, implement risk-based pricing,  develop new products, and enable Ginnie Mae to disclose more  information about securities backed by FHA-insured loans. Scope and Methodology

To assess the reasonableness of the Federal Housing Administration’s  (FHA) approach to developing Technology Open to Approved Lenders  (TOTAL), we reviewed agency documents and interviewed the Department  of Housing and Urban Development (HUD) and contractor officials to  determine (1) the process and data used to develop TOTAL, including how  FHA identified and evaluated scorecard variables; (2) the reliability of the  analysis used to evaluate TOTAL’s effectiveness in predicting defaults; and  (3) how FHA established policies on cut points and overrides.
Why GAO Did This Study

Along with private mortgage providers, the Department of Housing and Urban Development's (HUD) Federal Housing Administration (FHA) has been impacted by technological advances that began in the mid-1990s and that have significantly affected the way the mortgage industry works. As a result, in 2004, FHA implemented Technology Open to Approved Lenders (TOTAL) Scorecard--an automated tool that evaluates the majority of new loans insured by FHA. However, questions have emerged about the effectiveness of TOTAL. Given these concerns, you asked GAO to evaluate the way the agency developed and uses this new tool. This report looks at (1) the reasonableness of FHA's approach to developing TOTAL and (2) the potential benefits to HUD of expanding its use of TOTAL.

What GAO Found

Some of the choices that FHA made during the development process could limit TOTAL's effectiveness, although overall the process was reasonable. Like the private sector, FHA and its contractor used many of the same variables, as well as an accepted modeling process, to develop TOTAL. However, the data that FHA and its contractors used to develop TOTAL were 12 years old by the time FHA implemented the scorecard, and the market has changed significantly since then. Also, FHA, among other things, (1) did not develop a formal plan for updating TOTAL on a regular basis; (2) did not include all the important variables that could help explain expected loan performance; and (3) selected a type of model that limits how the scorecard can be used. Despite potential problems with TOTAL, HUD could still see added benefits from it. As a result of TOTAL, FHA lenders and borrowers have seen two new benefits--less paperwork and more consistent underwriting decisions. However, FHA could gain additional benefits if, like private lenders and mortgage insurers, it put TOTAL to other uses. These uses include relying on TOTAL to help inform general management decision making, price products based on risk, and launch new products. Adopting these scorecard uses from the private sector could potentially generate three other benefits for FHA, including the ability to react to changes in the market, more control over its financial condition, and a broader customer base. Additionally, HUD's Government National Mortgage Association, a government corporation that guarantees securities of federally insured or guaranteed mortgage loans, could use credit scores that are used by TOTAL to help improve the transparency of the secondary mortgage market.