We see tons of offers on our listings with buyers approved for FHA financing, especially in the $100,000-$300,000 price range. There are a lot of misconceptions about these loans and sorting through the facts and fiction can be difficult. So here is what you need to know if you are a seller thinking about accepting an FHA backed offer.
If you are flipping the house, check the timing:
There is a “90 day rule” with FHA. This means an FHA loan cannot be originated if the prior owner has owned the property less than 90 days. And this applies to the date in which you previously closed on the property and the date in which you execute the new contract (not when you plan to close). So if you are an investor, understand your timing so you can be sure you are even able to accept an FHA buyer.
Potential work around:
If you are close to the 90 day mark and all parties are on board, you can find a work around. You can go ahead and execute the contract, let the buyer complete all inspections and due diligence as normal. Once the the 90 day mark hits, the buyer terminates the contract and then immediately re-executes the contract with a new execution date that is beyond the 90 day mark. A seller should make sure the second contract does not give the buyer extended outs in the way of their option period or a reset financing contingency periods. Once the new contract is executed, the lender can push the appraisal through on a rush, get the file through underwriting and close within 2 weeks of the new execution date if everyone is hustling.
Why a buyer would choose an FHA loan over a conventional loan:
There are several reasons a buyer would choose an FHA loan over a conventional loan. Here is a list of several of reasons:
- Only a 3.5% minimum down payment on an FHA loan as compared to 5% on conventional
- Lower minimum credit score required. FHA loans with 3.5% down can go as low as 580 on the credit score and in some cases can even push as low as 500 with 10% down. So borrowers struggling with their credit can still qualify to buy a home.
- Higher DTI (debt to income ratio) is accepted with FHA loans creating a larger pool of buyers with debt problems that can’t qualify with conventional.
- With an FHA loan the buyer can ask the seller to cover up to 6% of the sales price towards the buyers closing costs. What does this mean and why is this important?
- If a buyer has enough money for the down payment but can’t cover the closing costs, a seller can make the deal work by providing a credit towards the buyer’s closing costs in order to lessen the cash to close required of the buyer. Often times an FHA buyer is willing to pay a higher sales price with a seller credit towards their closing costs to make the deal work. The seller just needs to understand, the credit should be subtracted from the sales price to properly calculate the net offer to them. i.e an offer for $200,000 with a $5,000 seller credit towards their closing costs, should be viewed as a net offer of $195,000.
So what is the trend here? Most buyers buyers going FHA are less qualified than conventional buyers. They need less money, can have a lower credit score with higher debts and still get a loan. That’s important to know when analyzing an offer, especially if you have multiple offers.
House Appraisals are tougher for FHA loans
With an FHA loan in place there are several things a seller needs to understand before they accept the offer to prepare for the appraisal.
- FHA loans are meant to be “owner occupying” loans and not any kind of investment loans. Which means the property must be safe and liveable right after closing. Any glaring signs of significant problems such as foundation, plumbing, electrical, roof, wood rot on siding, etc could get flagged by the appraiser and then they become a lender required repair. Then the issue MUST be fixed prior to closing or the deal could be dead.
- Be wary of going over asking price in order to give the buyer a credit towards their closing costs. Appraisers hate seeing this because it can be an indication of a false inflation of the value in order to give the buyer the credit to cover closing costs. Remember, the house HAS to appraise at the contract price or the buyer has a potential “out” in the third party financing addendum to terminate the contract and get their earnest money back. So make sure if you pump up the price to give that credit, you better feel confident it will appraise.
- If you have flipped the home and have owned it for more than 90 days but less than 180 days, a second appraisal will be required under FHA guidelines and as the seller you could get stuck paying for this.
- Be prepared to show what you bought the property for. Lenders will require investors to turn over their closing statement from when they purchased the home. They are looking to see if the value of the property has increased significantly in a short period of time. They may also ask for a scope of work to validate the stark increase in value.
- FHA appraisals stick to the property for 120 days. Meaning, if the appraisal comes in low and kills the deal, you won’t be able to move forward with another FHA buyer until that appraisal falls out of FHA’s system 120 days later.
Things to note when selling your home and get an FHA offer
Here are a few more important things to understand and look for when considering an FHA buyer:
- You want a solid pre-approval letter that shows the items below have been completed. It is VERY easy to get a generic pre-approval. Because FHA buyers can be less qualified than conventional buyers, it is extremely important to vet the buyer and lender.
- The buyer has completed a full loan app in writing (note verbally).
- They have pulled credit
- Reviewed assets and verified there are enough funds to close
- Understand that if the property does not appraise, you are likely to either have a dead deal or you will have to come down on your price to make it work. Many FHA buyers have just enough money to get to the closing table. In the event of an appraisal shortage, they won’t have the funds to make up the difference to close that the lender will require. If you are ok with that risk and feel strongly about the value, then you should be good to proceed. If you are feeling dicey about where the appraisal might land, then you may want to think twice if you are not willing to budge on your price.
- If you give a seller credit up front, there may not be anything left over to help you negotiate repairs. What I mean by this is, a buyer can only accept a credit towards their closing costs from the seller up to the total amount of their closing costs. So if that is negotiated in to the agreement up front, you won’t be able to offer an additional credit en lieu of making repairs after the inspections. If the buyer has deal breaker items they find on the inspection, you will likely be stuck doing those repairs prior to closing since you can’t give them any more money within the transaction for them to complete the repairs after closing.
- This is likely a first time home buyer you are dealing with. Buyers purchasing a second or third home typically have the benefit of rolling their equity into a conventional loan with a bigger down payment. Most FHA buyers have less cash so they opt for the loan with the lowest cash to close. Why is this important? First time home buyers are riskier. They are less versed in the process and get spooked easier by inspections or hiccups in the closing. It can be a more emotional and jumpy transaction. So be prepared for that.
All in all, FHA loans are extremely popular and you shouldn’t be scared of them as a seller. But, you do need to be prepared and informed for what may lie ahead if you accept a contract from an FHA buyer. As always, if you have any questions, don’t hesitate to reach out to us and we are always happy to help.
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