Chances are, you’ve had a relocating employee in the U.S. whose home sale or purchase involved a Federal Housing Administration (FHA) loan. If not, the potential for it is great. You may not know what makes that type of loan different from a conventional loan, which could lead to some headaches for you and your employee. Being aware and prepared for those differences could save both of you time and energy.
FHA loans have risen in popularity over the last few years as a direct result of the housing crisis that erupted in 2007-2008. During the housing boom of the early to mid-2000s, FHA market share was less than 5% of total mortgage generation. But in the wake of the housing crisis, the agency’s market share shot up to nearly 40%. This trend affects home buyers as well as sellers, and as a result, it’s important to understand how this government-backed mortgage program works.
The FHA loan program is managed by the Department of Housing and Urban Development (HUD), who issues the guidelines and requirements for FHA appraisals and the appraisers who perform them. In order to issue a final approval on the loan, the lender must have the property appraised to determine its value. A licensed home appraiser evaluates the property to determine its current market value and then produces a written report that details the findings, including the estimated value of the home.
How is the FHA Process Different from a Conventional Loan Transaction?
Home buyers and homeowners are often surprised to find that FHA appraisal guidelines include detailed instructions for inspecting the property. This is different from a standard appraisal, where the appraiser mainly wants to know what the house is worth. Following are the primary differences between an appraisal for a conventional loan and an appraisal for an FHA loan:
- Conventional: In a typical real estate transaction, where a conventional (non-government-insured) home loan is used, the appraiser is mostly concerned with the current market value of the property in question. That is his primary objective when visiting the house. He is only concerned with the condition of the property as it relates to the value.
- FHA: When an FHA loan is used, the appraiser has two objectives:
- HUD requires the appraiser to determine the current market value, as with any appraisal.
- HUD also requires a property inspection, which is built into the appraisal, to make sure the home meets HUD's minimum standards for health and safety. This inspection is what makes the FHA appraisal process unique. It is important to note that this inspection is not the same as a regular home inspection.
As you can see, the primary difference between FHA and regular appraisals is the level of inspection that is required by HUD.
If the HUD-approved appraiser flags certain safety issues, those issues must be corrected before the loan will be funded. In other words, the transaction will be put on hold until the discrepancies are resolved. That is not the case with a regular appraisal used for a conventional home loan, and if you or your employee isn’t prepared for this possibility, it could negatively impact their move timeline or throw off the sale or purchase entirely.
Home buyers would still be wise to have a complete "regular" home inspection separate from the "health-and-safety" inspection conducted by the FHA appraiser. HUD actually encourages this. All borrowers who use this program have to sign a disclosure that says, "I understand the importance of getting an independent home inspection. I have thought about this before I signed a contract with the seller for a home."
What are the General FHA Appraisal Requirements?
In chapter 3 of HUD handbook 4150.2, they’ve outlined the six key requirements for an FHA home appraisal. The following information has been adapted from the handbook:
- FHA home appraisers are required to make a “complete visual inspection” of the home that is considered for purchase. They must examine the home inside and out. As a result, the appraiser will need to be granted access to the property. This can be done by the homeowner, a real estate agent, or via lockbox.
- The appraiser is required to take photos of the entire exterior of the property. This includes the sides of the house, the front and rear of the property, and any improvements made to the property that might add value. Examples of value-adding improvements include patios, decks and swimming pools.
- During an FHA appraisal, the home appraiser must also take photos of similar homes that have sold in the area recently. These are referred to as comparable sales, or “comps.” These photographs must be submitted with the final evaluation report.
- If the home is located in an area that is currently under development (such as a new neighborhood), the appraiser must also include a map showing the proposed construction area, including roadways
- The FHA appraisal report must include a copy of a street map showing the area where the home is located. The subject property must be clearly marked on the map, and so must all of the comparable sales that were used to support the home appraisal.
- If the property is a new construction that has not yet been built, the appraiser is required to take photos that show the grade of the vacant lot.
What Minimum Property Standards Have to be Met for FHA Loans?
Requiring that the property meet minimum standards protects the lender. It means that the property should be easier to sell and command a higher price if the lender has to foreclose. At the same time, a borrower is more likely to stay in a home that meets minimum standards because he or she will not be burdened with expensive home repair bills from the start. Also, borrowers will try harder to make payments during difficult financial times if the home is a pleasant place to live.
According HUD, the FHA requires that the properties financed with its loan product meet the following minimum standards:
- Safety: The home should protect the health and safety of the occupants
- Security: The home should protect the security of the property
- Soundness: The property should not have physical deficiencies or conditions affecting its structural integrity
The FHA does not require the repair of cosmetic or minor defects, deferred maintenance and normal wear if they do not affect the safety, security or soundness. However, there are many areas where the FHA does require problems to be remedied in order for the sale to close. This article has a helpful list of those issues that do and don’t require repair if you’re interested in the nitty-gritty.
As stated above, these requirements are significant to both home sellers and buyers. A transferring employee who is selling a home and considering an offer that includes an FHA loan may need to meet additional requirements to satisfy the lender prior to closing (which may be very costly), and the buyer needs to know what lies ahead as he considers which home to purchase. While FHA loans make it easier for borrowers to qualify for a mortgage, they don't necessarily make it easier to buy a property. FHA borrowers who know what to expect when home shopping can restrict their search to properties that are likely to meet FHA guidelines, or at least avoid getting their hearts set on a fixer-upper property before having it appraised.
http://www.homebuyinginstitute.com: 6 Basic Guidelines for FHA Home Appraisals
http://www.investopedia.com: The FHA's Minimum Property Standards
http://www.fhahandbook.com: FHA Appraisal Guidelines for 2015 - What the Appraiser Looks for