It feels like nearly every deal we do today in my market involves an FHA buyer buying a bank-owned property. Although buying activity is great, this is a buyer/seller combination with its complexities.
Spurred on by government-backing, during the credit crunch, and one of the only low-down payment options today, the FHA loan has experienced explosive growth in recent months.
At the local branch of the retail bank, where I work, nearly 40% of all of the loans today are FHA. Company-wide they are predicting 50% FHA loans very soon.
However, like all loans, there are potential land mines in the FHA loan that threaten your purchase deals. You may have deals current in escrow where your buyer is going FHA that are currently in jeopardy and you don't even realize it.
Here are the top five challenges you face with FHA loans:
CHALLENGE #1: The Property Flip
For those that haven't run into this yet, you probably will very soon.
When processing an FHA loan, we have to perform a title search to see how long the owner of the subject property has owned the house.
If the owner has owned the house for less than 90 days, it's considered a "flip."
The 90-day window ends from the day the seller signs a new contract. If your contract is signed before the seller has owned the property 90 days, the file has to go to HUD for an exception. FHA will only make an exception if the property is a Bank-owned REO.
To make matters even more challenges, if it's a Bank-owned REO property, and you seek the exception, the bank has to either be State or Federally chartered for the exception to be granted. Not all banks are.
REO properties owned by Fannie Mae and Freddie Mac are exempt as well. If the bank-owned property is not State or Federally chartered the home cannot be sold to an FHA buyer before 90 days.
We are seeing a ton of buying activity in foreclosed homes. Some tell me its 80% of all resale purchases today in our market. In many of these transactions today, FHA buyers are purchasing an REO.
The bank foreclosed on the previous owner, has taken possession of the property and is the new owner.
The bank then turns around and puts it on the market with a real estate agent, and, fortunately for them, gets an accepted offer within 90 days of taking possession.
This then requires the buyer's lender to send the file for FHA for a flipped-property exception.
FHA is taking as many as 10-15 business days to approve the exceptions in our market. You can imagine what those 10-15 business days can do to your close of escrow date.
The Solution
When making the offer, have your trusted home loan consultant look up the subject property on the County website, or get with your title rep, and identify which bank owns it, how long, and if they are State or Federally chartered.
If they owned it for less than 90 days, prepare the buyer to get their conditions into the lender as soon as possible so your lender can submit the loan to FHA as soon as possible.
Also, you may want to ask for a 45-day escrow from the bank, on FHA loans, so you don't have to stress about getting an extension at a later date.
If the bank is not State or Federally chartered or has some other exemption, and they haven't owned it at least 90 days, you may want to consider financing other than FHA.
CHALLENGE #2: The Appraisal
With prices in decline and values dropping all over, its hard to comprehend you could have appraisal challenges today. However, it can happen on FHA loans where the buyer is requesting the seller to participate in Nehemiah's down payment assistance program.
It is FHA's pet peeve, and one of the reasons for the costly law suit they eventually lost, but buyers are making offers over list price to cover their down payment for the down payment assistance programs like Nehemiah.
This can mean an inflated offer that the home's value does not support. The listing agent and the seller certainly did a fair amount of research before listing the home and now your offer may be above appraised value. Banks will only loan on the lesser of purchase price or appraised value.
We are seeing appraisals coming in under purchase price because of this and sellers and buyers then having to renegotiate or cancel their deal.
The Solution
Be very careful. Know your property's true value before making your offer. There is a lot of sales activity lately. Pull comparable sales, preferably in the neighborhood, to make sure the sales price of your offer will be supported by the appraisal.
CHALLENGE #3: The Repairs
In most cases, FHA will not allow withholds for repairs (they do have a special program that sometimes allows for this but that's a newsletter for another time). They will also not allow a buyer to get cash-back at closing for repairs.
Often, we will see an addendum that states the seller will pay up to $2000 for a "flooring allowance" or an "appliance allowance."
It is very challenging to credit this to the buyer on an FHA loan.
If the property is in poor condition, repairs have to be done prior to closing. Examples are broken windows, broken doors, "green" pools, missing air conditioners, exposed electrical wires, power not turned on, holes in walls, etc. Essentially anything that affects health, safety and habitability of the home.
The Solution
Don't request a credit for repairs. You can request the seller pay for more in closing costs, provided it doesn't exceed 6%. The seller can participate in the Nehemiah down payment assistance program (3%) and they can still pay up to another 6% towards closing costs on FHA loans.
You can also consider asking for the sales price to be reduced in place of the credit.
If you want the repairs made prior to closing or they are required to be made before closing and you aren't sure what exactly needs to be repaired, simply wait for the appraiser to be finished with the appraisal and then get with the seller. The appraiser will detail these repairs for you in his report.
If you are aware of some of the obvious items that need to be repaired, before the appraisal, you can request the seller take care of it.
If the seller is unwilling to make obvious repairs that are required to be made for an FHA loan, then you may want to reconsider your interest in this home or make the repairs yourself, prior to close, assuming the seller gives you permission.
Making the repairs yourself, prior to close, is often a challenge. Sellers, especially banks, don't usually like the liability of letting you or your workers into the home while they are responsible from an insurance perspective.
CHALLENGE #4: The Broker Transaction Fee
Many real estate companies today charge a Broker Fee or Broker Doc Prep fee. This is usually a $200 - $500 fee that helps the real estate company cover some of their hard expenses.
Usually, the buyer pays this at closing. However, on an FHA loan, this is not commonly permitted.
The Solution
FHA will allow the buyer to pay this on an FHA loan, provided that it is disclosed on the signed Buyer/Broker Agreement prior to going to contract. Yet another reason to get a signed Buyer/Broker Agreement.
CHALLENGE #5: The Non-Titled Spouse
It happens all of the time. For one reason or another, we do a loan for a married couple and one of them decides not to be on the loan. On an FHA loan, the lender is still required to pull a credit report for the spouse that is not going to be on the loan.
Even though the non-titled spouse's credit cannot be considered in the credit-decision process, nearly all debt incurred after marriage, will have to be included with the borrower's debt. This can certainly affect debt-to-income ratios.
Installment debt incurred prior to the marriage by the non-titling spouse doesn't necessarily have to be included in the borrower's debt. However all revolving debt, regardless of when the non-titling spouse incurred the debt, has to be included.
The Solution
Your trusted home loan consultant needs to address this prior to issuing the approval letter. You don't want to spend hours driving your clients around looking at homes to ultimately discover that the loan can't be done because of the non-titled spouse's debts.
Also, you will want to structure the contract correctly. You want to know who will be on the contract and who will not, so your lender is not scrambling around at the end of the transaction getting addendums signed adding or removing a spouse.
The FHA loan is back and more popular than ever and is the first choice for many borrowers today. But like all loans, they have their own unique sets of guidelines. Knowing these five challenges will save you and your clients and lot of time and "11th hour" aggravation.
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