Who is responsible for the safety of drinking water?

The U.S. Department of Housing and Urban Development (HUD) Office of Inspector General (OIG) has suggested – for the second time – that lenders making Federal Housing Administration (FHA) insured loans should be held to a higher level of accountability in ensuring that FHA borrowers have a safe and potable water supply. In a report dated September 29, 2017, the OIG’s stated concerns are two-fold: first, HUD may be endorsing loans for properties with water contaminants that affect their occupants’ health; and second, property values may decrease due to water quality issues, thereby posing an increased risk of loss to both HUD and homeowners. The OIG’s solution is for HUD to improve its guidance on safe water requirements as well as to sanction lenders that fail to identify water safety issues for properties known to be affected by water contaminants.

FHA guidelines currently require lenders to ensure properties meet certain minimum eligibility criteria, which include, among other things: a safe and potable water supply under adequate pressure and of appropriate quality for all household uses, including domestic hot water; connection to public or community water systems meeting local health department standards; satisfaction of health authority requirements for water quality standards, or Environmental Protection Agency (EPA) standards if there are none; and requirements for individual water supply systems, water wells, and water purification systems. Under some circumstances, local health authority approval for individual water systems or well water analysis is required. Existing FHA guidelines also require appraisers to notify lenders of deficiencies in any of these areas. Appraisers must note any readily observable deficiencies in individual water supply systems and require test or inspection if any of various conditions are present, including if: the water supply relies on a water purification system due to the presence of contaminants; pipes are corroding; there is an usually objectionable taste, smell, or appearance of well water; or there are areas of intensive agriculture, coal mining, or gas drilling, or there is a dump, junkyard, landfill, factory, gas station, or dry cleaning operation, within ¼ mile of the property.

Based on a water crisis in Flint, Michigan last year and more recent reports of water contaminants on thousands of properties across the country, the OIG does not believe these FHA rules go far enough to protect either homebuyers or HUD.

After receiving reports of lead contamination in public water systems across the country, the OIG audited HUD’s oversight of FHA loans for safe water requirements nationwide. The audit was on the heels of a prior audit of HUD’s oversight of water safety in FHA-insured loans in Flint conducted in July 2016, which was in response to a public health emergency after the city had begun using the Flint River as its water source. The OIG’s review of 17 of 144 potentially affected FHA-insured loans in Flint served as the basis of its 2016 report. The OIG more recently reviewed 49 loans of 1,432 that have experienced lead problems through public water supply systems nationwide. In its report last month, the OIG noted that none of the files for those 49 cases contain any information regarding the public notices that were issued, evidence of water testing, or related information from the appraisers. Just as it did in 2016 in connection with the Michigan properties, the OIG concluded that HUD’s safeguards are insufficient nationwide because they fail to clarify when water testing is required or to ensure appraisers notify lenders when properties are serviced by public water systems with unacceptable levels of contaminants. The OIG recommended not only that HUD improve its guidelines, but that HUD require the lenders prove that the remaining 1,383 loans of the 1,432 affected nationwide have safe and potable water sources, or that the appraisers in those cases failed to notify the lenders of the water quality issues in their appraisal reports. The OIG suggested that, if the lenders cannot provide such evidence, HUD should require them to do water testing and any necessary remediation, or indemnify HUD for the loans.

In its response to the OIG, HUD agreed that it needs to improve its guidance on safe water requirements and expressed intent to work with the EPA and HUD’s Office of Lead Hazard Control and Healthy Homes to determine whether and how to improve its published guidelines. However, HUD disagreed that administrative action against lenders is warranted. HUD acknowledged that there is no evidence that any lender or appraiser knew that water was not potable at any given property and that, in the absence of such knowledge or any specific testing requirement, administrative action against a lender would not withstand legal scrutiny.

All that being said, lenders should monitor HUD/FHA requirements for changes to the minimum property standards and related water safety guidelines. Given the fact that individuals’ health and safety are at issue, the number of affected properties across the country, and the fact that the OIG is raising this issue for the second time in just one year, change should not come as a surprise.