Selling a House to an FHA Buyer

Introduction:

In our recent Q&A Saturday video we discussed some qualifications needed for a property to be eligible for an FHA insured loan.  This is such a broad topic and with so many other issues involved we decided to write a more complete post discussing all the aspects involved with selling to a buyer that wants to use FHA financing.

FHA Logo - Real Estate Financing

What is FHA Financing?

First a quick discussion on what FHA financing is.  There is not actually an actual FHA loan per se.  What the FHA (Federal Housing Administration) does is insure loans made to buyers through this program and that meet the FHA’s lending guidelines.  One of the reasons for this is that the typical FHA borrower has some risk factors that would either keep them from getting a conventional mortgage or would make such a loan much more expensive.  Most lenders following Fannie Mae and Freddie Mac guidelines will start to impose “Risk Based Pricing” for lower down payments, credit scores under 740 and other things like if the property is a condo or a multifamily like a duplex or the around here the quintessential Boston Triple-decker.  For FHA no penalties for those types of properties (though condo complexes need to be FHA approved to qualify) and borrowers can put as little as a 3.5% down payment and minimum credit score of just 580.  That can even go as low as 500, but that does require 10% down.

So in a nut shell the FHA makes it possible for many people to finance a property that otherwise might have little to no chance of getting a mortgage loan.  In fact without some of these risk based penalties an FHA backed loan is often a lower rate than what is available from a conventional lender.

Why sell to an FHA borrower?

The simple answer is that it greatly expands your buyer pool.  You do not seek out an FHA buyer but by being accepting of people using an FHA loan you will be exposed to far more buyers than if you do not want to deal with those loans.

Now there are drawbacks to dealing with an FHA buyer.  First off since it is a government sponsored program there is a lot of extra paperwork and red tape and it typically takes longer for an FHA loan to close than a conventional one, it is a minor miracle if one ever closes in less than 45 days and don’t hold your breath for it to come in much less than 60.  There is also one particular situation that can really drag it out.  As mentioned above a condo complex must be FHA approved for a loan to be made on units in the complex.  The qualifications for that are not anything amazing, and honestly it would be almost impossible to get a conventional loan on a unit in a complex that doesn’t meet the FHA standards.  However for a conventional loan they just look at that data and say if they will do the loan or not while there is the formal FHA approval.  If the complex isn’t already approved it can be during the underwriting process.  A good loan officer with experience can sometimes turn these over in less than a month (Still expect that will basically add on to the time to do the loan) but we have personally had a sale hung up for over 6 months because of delays in getting this FHA approval.

In addition to being slow there can be additional costs associated with them.  On occasion they will require a 2nd appraisal and the seller has to pay for this.  This issue will come up much more often for an investor selling a property.  Also while it is common for buyers to ask for closing cost concessions from sellers it is almost a given for FHA.  If you have someone that can just barely get the minimum down payment if you don’t agree to pay their closing costs they likely just can’t buy the place for lack of funds, so it is less likely to be a negotiation point as it might be a necessity to have the purchase move forward.  Also one of the additional forms you have to fill out is an addendum that basically says that the buyer can back out of the deal and you cannot keep the deposit even if they have gotten to the point of waiving all the contingencies.

Finally the biggest issue is the mandated repairs required by the underwriters to meet the FHA property condition standards.  These size and scope of the repairs can be all over the place but if they are cited by the appraiser or requested by the underwriter they need to be done or the loan will not close.   The impetus falls on the seller to make these repairs or their sale will fall though.  If you are low on funds and had intended to sell you house “As Is” this can be a big issue if the work is of any size.

What Repairs does FHA Require?

We went over a lot of this in our video last weekend on “Does My House Qualify For FHA Financing?” but here is a recap and slightly expanded list of things that you should expect will always be required to be fixed prior to closing an FHA loan.

1)      Some major repairs that FHA will almost always require fixing

  1. Non functioning HVAC
  2. Leaking Roof
  3. Peeling Paint in Pre 1978 Houses (Lead issue)
  4. Non-Functional kitchen (Usually missing/damaged Stove)
  5. Bad Drainage (Water in basement, standing water around foundation, bad grading of yard, inadequate drainage from gutters…)
  6. In MA you will need a passing Title V report – See our recent video on “Can I Sell a House with a Failed Septic System
  7. Active pest infestations
  8. Bedrooms with insufficient egress
  9. Evident structural problems
  10. Dilapidated out-buildings (Think the rotted out shed that is about to fall over)
  11. Empty swimming pools

 

Now most of these things are not crazy requests and many will be issues with conventional financed buyers as well.  However many of these would not be issues or at least not to the extent that they are for FHA backed loans.

Some things such as the HVAC needs to be on during the appraisal and needs to function at that time and appear to not be past the end of its useful life.  If it works you are probably okay, but if has issues and looks something like this:

 Bad HVAC - FHA Financing Issues

Then you are going to have issues with FHA or conventional.

In contrast to that peeling paint is unlikely to ever come up as an issue for funding a conventional loan but will be a big issue for FHA.  Take a look at this ceiling:

Peeling Paint - FHA Financing Issues

This is actually the ceiling in the hallway right outside the bathroom in my own home.  We buy, sell and lease properties for a living and usually do extensive renovations on places often to the tune of $40K or more, yet my own home would not qualify for FHA financing without doing some of these minor repairs.

What other Repairs Might FHA Require?

Again this was discussed in the video last weekend.  There are many items that MAY be cited and need to be repaired, but are not always an issue.  Any of these items could be cited on the report and if they are they will need to be taken care of as well.

2)      Some minor repairs that might get cited

  1. Missing/damaged handrails
  2. Cracked glass in a window (Not a broken or boarded up window)
  3. Damaged or soiled floors (Not to extensive and not a safety/trip hazard)
  4. Damaged walls, like small random holes
  5. Ripped screens
  6. Peeling paint in post 1978 built houses
  7. Minor plumbing issues (Think leaky faucets, busted pipes will be an issue)
  8. Evidence of previous (non active) pest infestation
  9. Rotted/damaged counters and cabinets
  10. ANYTHING else they decide to put on there…

 

These are all items that could be cited but often do not come up as issues.  However it is often a matter of degree.  For example even though they do not often cite damage and extensive wear and tear in a kitchen if yours looks something like this:

Crappy Old Kitchen

You might have an issue.  This one could be borderline for being cited as an issue for a conventional loan as well.

Bullet point #10 above is the biggest issue with FHA repairs.  It is that you just do not know what other things they might say are an issue and will need to be fixed.  You can try to talk with them and try to get them to change the requirements but if they are not open minded they do not have to listen to you and there is no particular recourse for you.  The choice generally will come down to do all the repairs listed or lose the sale.

Conclusion:

If you feel the best way to sell your property is to a retail buyer then you should be willing to work with FHA buyers.  This group is a very sizable portion of buyers and if your goal is to maximize your sale price having the largest pool of potential buyers possible will be needed for that.

If you want to sell the place fast and with as few hassles as possible that is not going to be the experience with an FHA buyer.  While selling to any retail buyer that needs financing can be slow and lots of issues come up someone getting a conventional loan will likely close a bit faster and with far less issues. 

Another important point to consider is that when selling to an FHA buyer the repairs will be required and you must do them or the sale will fall through.  When selling to a conventional buyer they can request repairs but you do not have to do them, it is part of the negotiations.  If you want to sell your house “As Is” that is unlikely to happen with an FHA buyer and can be an issue for many conventional buyers as well, but it is possible.  Of course when selling to an investor that is the normal way.

In summary working with FHA borrowers is necessary to maximize exposure of your property but that exposure comes with a price.

 

 

Do you want the opposite of the FHA experience?  Do you need to sell your Massachusetts or New Hampshire house fast?  If you would like to sell your home fast and hassle free schedule a consultation with us today.

Please share your questions and comments below.

 

 

Comments

  1. Very good article. Easy to read with pertinent details.

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