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Shaken Standards

By Marty Whitford
April 1, 2001

Charles Andrews, owner of Atlantic Pest Control in Buzzards Bay, Mass., feels like The Grinch paid him a visit last December when — the week before Christmas — the U.S. Department of Housing and Urban Development (HUD) issued Mortgagee Letter 2005-ML-48, dropping its more than 40-year-old mandate for termite inspections for FHA-insured home sales, refinances and reverse mortgages in most states.

(Reverse mortgages, for the uninitiated, represent a growing number of mortgages filed in the United States. They allow homeowners who are at least 62 years old to borrow against the equity in their homes without having to sell them by giving up the titles or taking on new monthly mortgage payments. While FHA's share of existing home sales is shrinking, HUD insured 43,131 reverse mortgages in fiscal 2005 — 90 percent of all reverse mortgages in the United States — and this number is expected to steadily climb as more baby boomers retire.)

HUD says 2005-ML-48 is part of an overall strategy to reduce red tape, streamline FHA applications and, perhaps, recapture marketshare, which declined to nearly 2 percent in 2005 (just more than 606,000 homes) from an estimated 11 percent in 1997 and nearly 33 percent (when coupled with Veterans Affairs-insured loans) in the 1980s. 


None of that government mumbo-jumbo matters to Andrews. He doesn't really care about FHA's declining marketshare. All Andrews saw when he peered closely at 2005-ML-48 was money — significant money — disappearing from his bottom-line.

"I do a lot of FHA business — or at least I used to do a lot before ML-48 came out," Andrews says. "Since HUD issued the Mortgagee Letter, I've lost 80 percent of my FHA-related termite inspections. It looks like I will take a direct hit to the tune of $50,000 annually — that's 40-percent of my business gone with the stroke of a pen." 


HUD's relaxed termite inspection standards have created confusion in the market and prompted the National Pest Management Association (NPMA) to re-educate HUD, lenders, real-estate agents, appraisers, and home buyers and sellers on the importance of termite inspections. The new rules also apply to HUD-backed reverse mortgages. 


"Reverse mortgages were my golden egg-laying goose," Andrews says. "Now they're basically a lame duck."

Pest management professionals (PMPs) who, like Andrews, depend on steady termite business from HUD/FHA may have reason to worry, though the jury's still out on just how deeply the relaxed home-sale standards could affect their businesses.

Many PMPs, real-estate agents, appraisers and lawyers say the policy changes could force appraisers and home inspectors into the uncomfortable and untenable position of providing the first line of inspection for — and defense against — termite infestations and damage. On the other hand, some hope HUD's policy changes could strengthen consumer awareness of the value of termite inspections.

Whatever the eventual outcome, HUD's shaking up of its termite inspection standards could have profound effects on the industry for years to come.

SHAKING THE SYSTEM

Greg Baumann, vice president of the NPMA, says HUD intended to scale down government involvement in mortgage lending with 2005-ML-48, especially since FHA's share of the market has significantly diminished. HUD hoped to allow the standards of the conventional mortgage lending market to prevail, but the letter has caused some confusion. 


"HUD didn't realize many conventional lending markets still look to HUD as the standard setter, even though FHA accounts for just about 2 percent of existing home sales," Baumann says. "This complex issue could have been kept simple if HUD had just kept its policy intact."

Baumann says NPMA moved quickly in conjunction with HUD and PMPs to clarify exactly what the new rules mean. 2005-ML-48 states PMPs and lenders should continue to conduct termite inspections if they've been "customary" in their areas, and Baumann says it's important for PMPs to reach out to their real-estate agents, lenders and loan originator clients to explain the provision.

If everyone understood and followed the "if customary to the area" part of the Mortgagee Letter, the industry wouldn't lose any termite inspection business, Baumann says. In addition, some lenders who were not requiring inspections before HUD's action would better understand the probability of termite infestations in their areas and the value of inspections, and the industry could gain termite business.

Not all home lenders are eager to continue using termite inspections, however. Maggie O'Connell, a loan originator and manager of Seattle Mortgage Co's Livermore, Calif., branch, says she and many of her colleagues have wondered for some time whether termite inspections are worth the cost.

"The legitimacy of termite inspections and their findings has long been in question," O'Connell says. "Some so-called termite inspectors actually inspect little, while others always seem to find subterranean termite problems that often don't exist but coincidentally do pad their pocketbooks.

"I'm not saying all termite inspectors are bad," O'Connell concludes. "It's just that we need to be more selective in when we use them, who should conduct the inspections and how they're monitored."

THE ENEMY WITHIN

Though PMPs might bristle at O'Connell's strong words, she may have a point in some cases. Take a recent case that Scott Dier, general manager of Strand Termite & Pest Control Co. in North Myrtle Beach, S.C., encountered.

Dier recently inspected a home that supposedly had been declared termite free by another company three years ago when the current homeowner purchased the house and in the two successive years. When Dier inspected the house late last year, he found more than 150 visible termite mud tubes.

"This was your typical FHA-type home — a single-family, three-bedroom house with a crawlspace," Dier says. "If this home was inspected anytime in the past several years and somehow declared termite free, it surely had to be after a 'drive-by' inspection. All you had to do was shine a flashlight in the crawlspace and you could see clear evidence of severe, active termite infestation — probably at least three colonies. It was one of those homes where you shook your head and asked yourself, 'How is this one still standing?'"


Dan Collins, owner of Collins Pest Management in Evansville, Ind., and a Pest Control editorial advisory board member, says some PMPs are cutting corners on termite inspections, claiming prices dictated for these services don't come close to covering their investments in training, inspection tools and time.

"HUD's only added to the problem because now a lot more homes won't receive termite inspections by qualified, certified PMPs," Collins says. "Expecting appraisers to identify active infestations is crazy. HUD's opened up a Pandora's Box with this one."

Kevin Kordek, president and owner of A-Active Termite & Pest Control in Virginia Beach, Va., says his company has been brought in on a number of cases in which PMPs working for other firms certified homes as termite free on behalf of home sellers and then the buyers' home inspectors found clear evidence of infestations.

Kordek says he was brought in to deliver a "third expert opinion" in a case in which one local pest control company sent a recent high school graduate in to check a home for termite damage and infestation. Of course, the untrained, uncertified individual found nothing. The home was later found to have more than $100,000 worth of structural damage due to termites, Kordek says.

"Some companies are charging $25 for termite inspections, while others are literally giving them away for free as a way of generating leads for treatments," Kordek says. "Some people are finding out the hard way that you get what you pay for."

BATTLING BACK

Byron Reid, product development manager for Bayer Environmental Science, says the industry is battling perceptions like O'Connell's among some home buyers, home sellers, real-estate agents and lenders.

"Termite inspections are an underappreciated benefit to any real-estate transactions no matter the location," Reid says. "We've depended on mandated termite inspections as a major lead generator for decades, but that is changing due partly to HUD's policy changes."

Reid says the industry should launch an intensive re-education campaign for real-estate agents, mortgage companies, lenders and consumers about the prevalence of termites, the value of inspections and of the risks associated with not having termite inspections.

"As far as the business side of pest management goes, this is the biggest story of the year," Reid adds. "It has some rather ponderous ramifications that are rather hard to predict right now."

Sal Santamarie, vice president of operations for Bug Doctor Termite & Pest Control in Paramus, N.J., says despite the horror stories some people tell about some PMPs not conducting adequate termite inspections, the people who should be most worried about HUD's relaxed standards are the appraisers, who he says now bear the burden of spotting termite infestations — something most appraisers are not trained to do on a regular basis.

"I can't believe HUD's actually relaxing FHA's termite inspection standards," Santamarie adds. "We're going in the opposite direction we should be."

Lennie J. Carter Sr., president of Carter Termite & Pest Management in Sicklerville, N.J., says 2005-ML-48 will lock a lot of homeowners and lenders, including HUD/FHA, into bad deals.

"These policy changes are going to hurt everyone," Carter says. "The bar is clearly being lowered, and we will all pay the price."

Carter says 2005-ML-48 and the lack of termite swarms the past several years are a double whammy to the industry from a revenue standpoint.

"What we need with these weak swarms is more termite inspections, more steady business that also generates more leads for treatments — not less business," he says.

HUD's relaxed home-sale standards, combined with the lack of swarms, is an absolute nightmare for everyone involved, says Robert Dixon, owner and president of Dixon's Termite & Pest Management, in Washington.

"In a hurry to push through more deals, HUD, other lenders and real-estate agents are cutting key people — qualified termite inspectors — out of deals," Dixon says. "We need to get the word out on what we're up against and how it's a really bad move for all involved, and see if collectively we can't do something to change this."

PROVE THE VALUE

Lloyd Smigel, president of Oceanside, Calif.-based Care Management Consultants, says the industry needs a louder consumer awareness campaign educating homeowners, lenders and real-estate agents to the various needs and bottom-line benefits of termite inspections. "If I were buying a home, I'd pay $250 for a good termite inspection in a heartbeat, but that's because I know the true value of the service when it's conducted correctly," Smigel says.

Kordek says he'd rather not see government mandates for termite inspections. Instead, he believes consumer demand should drive the business — just like other aspects of the pest management industry.

"I know this change won't be easy, and that this might not be an entirely popular view within our industry, but when demand is driven by regulation, all too often the price isn't commensurate with the value of the services provided — and we've suffered from that with termite inspections for decades," Kordek says. "We have to build value with home buyers instead of home builders and real-estate agents, who often are more interested in getting a slip of paper to close faster on a deal than in obtaining thorough, professional termite inspections."

Greg Crosslin, an attorney with Crosslin & Associates in Destin, Fla., adds that home buyers — not sellers — should hire and pay for qualified termite inspections. Currently, home sellers usually pay for the service, and he says that's a built-in conflict of interest.

HUD's policy changes are equally concerning to home buyers.

"We've seen several cases of termite infestations, some with $15,000 or more worth of structural damage. The one that really stands out, though, is a house that was so bad they had to fix it with a bulldozer," says Joe Silvestrini, president of Norristown, Pa.-based Pest Control Technicians.

"Unfortunately, HUD and other lenders might not see the true value of a thorough termite inspection conducted by an experienced, certified PMP until they are directly hit by more termite infestations, which I suspect will happen as we let our guard down," Silvestrini says. "Sometimes, you don't realize what you have until you lose it."

Austin M. Frishman, president of AMF Pest Management Services in Boca Raton, Fla., says the industry needs to ask itself why HUD changed its requirement for termite inspections in FHA-insured home sales in most states.

"We haven't done a good enough job making a case for ourselves with HUD, other lenders, real-estate agents and consumers that we're actually in the insurance business — insuring the largest investment most consumers will ever make against serious damage from wood destroying insects and organisms," Frishman says. "We also have to ask ourselves how the communication lines broke down, and we were left in the dark on this one."

Frishman warns the newly empowered home inspectors might eat even more holes in PMPs' remaining termite business because they have done a good job of self-policing and have more widely embraced leading-edge inspection technologies such as infrared cameras.

"I know this HUD decision seems really bad to the industry right now," Frishman says. "Like the loss of chlordane, however, it just might be just the wake-up call we've long needed to improve our process for doing termite inspections."

Right now, PMPs like Andrews aren't worried about providing a wake-up call for the industry. Andrews is far more worried about how he's going to replace the $50,000 per year he stands to lose from HUD's policy changes.

"I conducted termite inspections for 265 FHA-insured reverse mortgages in 2005, and at least 10 percent of those resulted in treatments and annual monitoring," Andrews says. "Most of the lenders I deal with are ignoring the 'if customary to the area' part of the Mortgagee Letter. What am I going to do now?"

Imagine the (Possible) Liabilities

As PMPs around the country scramble to figure out what HUD's recently relaxed home-sale standards mean for them, some wonder out loud, "What's the big deal?" After all, the industry has dealt with government rule changes before. What makes the shifting HUD regulations so different?

Greg Crosslin, an attorney with Crosslin & Associates in Destin, Fla., says that no matter what some PMPs may think, HUD's Mortgagee Letter 2005-ML-48, issued Dec. 19, 2005, is a big deal — especially from a liability standpoint. FHA currently insures more than 4.1 million single-family home mortgages worth a combined $351 billion. That's a lot of money and homes, going forward, that are being placed at additional risk by 2005-ML-48. Moreover, much of the conventional market follows FHA's lead, he adds.

Lemar C. Wooley, HUD spokesman, says FHA and the NPMA have been collaborating on ways to better inform FHA-approved lenders and other industry partners on the importance of prudent underwriting regarding determining when an inspection for wood-destroying insects/organisms is necessary.

Wooley adamantly denies claims made by some PMPs, attorneys, appraisers, real-estate agents and industry consultants that 2005-ML-48 leaves the appraiser as the lead inspector for termite infestation and damage.

"2005-ML-48 does not state that appraisers are responsible for identifying damage and signs of infestation," Wooley maintains. "Rather, the Mortgagee Letter states: 'Wood Destroying Insects/Organisms (WDI/WDO): Inspection required only if evidence of active infestation, mandated by the state or local jurisdiction, if customary to area or at lender's discretion.'

"FHA requires the appraiser to report only what is readily observable," he adds. "FHA strongly recommends a home inspection by a qualified inspector to potential borrowers." 
Crosslin disagrees.

"HUD's stance that Mortgagee Letter-48 does not make appraisers responsible for identifying damage and signs of infestation is pure government double-speak," Crosslin argues. "How do you know if there is an active infestation unless an appraiser spots damage and/or signs of infestation?

"And this whole business about 'if customary to the area' saving the day ... I have talked to at least eight mortgage brokers and not one can define what that means, nevermind follow it," Crosslin adds. "This set of policy changes really slipped through the cracks and is sure to harm homeowners, PMPs and our industry as a whole. The change could shatter some consumers' perception of the value we provide with termite inspections and other services."

Crosslin says the industry has "woefully undercharged" for WDI/WDO inspections for years which, in turn, also has hampered perceived value and has given some termite inspectors an excuse (albeit unjustified) to take shortcuts.

"More than one-third of the cases I'm handling involve WDI/WDO inspections," Crosslin adds. "There was more than enough finger pointing going on before HUD issued Mortgagee Letter-48."

Realtors, lenders debate changes

When the U.S Department of Housing and Urban Development (HUD) relaxed its home-sale standards in December 2005, the policy changes had a ripple effect well beyond pest management professionals (PMPs).

Prior to issuing Mortgagee Letter 2005-ML-48, HUD for decades had required termite inspections for Federal Housing Administration (FHA)-insured home sales, refinances and reverse mortgages in most states, but now the need for wood-destroying insect/organism (WDI/WDO) inspections in these transactions is left largely up to lenders' discretion and state and local jurisdictions.

"We're happy as peaches, of course, that we don't have to have termite inspections on everything anymore," says Maggie O'Connell, a loan originator and manager of Seattle Mortgage Co.'s Livermore, Calif., branch. "This is something I have been pushing for for years."

Tom Wayne, president and owner of Medina (Ohio) Appraisal Co., questions HUD's move but understands some of the business drivers behind it.

An appraiser and real-estate agent, Wayne realizes FHA's marketshare has dropped to nearly one-quarter what it was 10 years ago as other lenders have gotten more creative and competitive, offering deals with seller-financed down payments and buyer-financed down payments as little as 2 to 3 percent (mirroring typical FHA-insured loans).

2005-ML-48 followed on the heels of 2005-ML-034, issued Sept. 23, 2005. 2005-ML-34 details FHA's revised appraiser reporting form, which includes an area titled "Evidence of Infestation" in which the appraiser is supposed to:

  • Mark this box if there is evidence of infestation, including the house and/or other structures within the legal boundaries of the property — otherwise leave blank. 

  • Examine the subject property for readily observable evidence of wood-boring insects. 

  • Do not require a pest inspection based solely on the age of a property. Inspections are necessary whenever there is evidence of decay, pest infestation, suspicious damage or when it is customary to the area or required by state law.

"I question these policy changes because essentially they make appraisers the first line of defense against wood-destroying insects — in identifying damage and infestation and then calling on a professional termite inspector if we happen to see something," Wayne says. "I'm simply not trained, experienced or certified to do this."

Wayne says he will have to look at 2005-ML-34 and 2005-ML-48 more closely with a lawyer and probably will add a WDI inspection-related disclaimer to his appraisal reports.

Dennis J. Rath, a professional Realtor with ERA RATH Realtors in Rocky River, Ohio, says, "Termite inspections should be a requirement for all home sales — FHA-insured or otherwise — everywhere in the United States.

"Most termite infestations are deep in the structures, unseen to most untrained eyes," Rath says. "That's why we have trained, experienced, certified termite inspectors. It's ridiculous to make appraisers responsible for first identifying termite infestations before calling in the experts."

Rath says termite inspections in Northeast Ohio typically cost $50 to $75.

"Who wouldn't want to spend $50 to $75 — or whatever it costs (up to $250 or more in some areas of the country) — to verify the structural integrity of a home before investing hundreds of thousands of dollars to buy it?" Rath asks. "If lenders want to save money on closing costs, why don't they eliminate the $300 worth of 'junk fees' — like the $35 a title company charges just to keep a homeowner's signature on file?

"These HUD policy changes should definitely help sell more FHA-insured homes, but they also will help sell more bad, termite damaged and infested homes, which will come back to bite lenders, home buyers and sellers, appraisers and real-estate agents," Rath says. "The only people who win out in the long run with policy changes like these are the lawyers."

Termite Infestation Map

The National Pest Management Association (NPMA) added a button on its home page titled "Mortgagees & HUD" to combat confusion stemming from the U.S. Department of Housing and Urban Development's (HUD's) Mortgagee Letter 2005-ML-48, issued Dec. 19, 2005.

The Mortgagees & HUD link (http:// www.npmapestworld.org/HUD.asp) features a map of the United States detailing areas of termite infestations. By clicking on "Important Information About Inspections," visitors to the new Web page automatically download a one-page Microsoft Word document explaining 2005-ML-48 and the NPMA's position, including the following:

"Conventional mortgage companies and HUD require WDI (wood destroying insect) inspections if 'customary to the area,' which means that no policy should change as to areas that were previously inspected as 'customary.' Some lenders may misinterpret this to mean that no inspections are required in any case beyond what an appraiser may note.

"In order to help members clarify and justify areas where WDI inspections should be conducted, NPMA has posted a copy of the International Residential Code (IRC) map (pictured above) showing areas of termite infestations, prepared by the U.S. Forest Service. This may be used by WDI inspectors to show areas where WDI inspections should be conducted, which is most of the United States. WDI inspectors who are notified that inspections are no longer required should refer the underwriter to this site."

The new Web page explains how 2005-ML-48 leaves the policy for WDI inspections for Federal Housing Administration (FHA)-insured home sales, mortgage refinances and reverse mortgages up to the underwriters of such loans, consistent with conventional loan practices. Prior to that, for more than 40 years, HUD has required WDI inspections for FHA-insured loans in most states (typically at least those areas identified as "Very Heavy" or "Heavy to Moderate" on the IRC map).