FHA loans have a bad rap from home sellers and their listing agents. But is that negativity deserved? Maybe.
How FHA loans thwart home sellers
- When the sale blows up because the appraisal is lower than the agreed-upon price.
- When the buyer chooses FHA because of its looser credit requirements.
- When the seller has to make expensive repairs instead of selling as is.
- When the condo association isn’t on the FHA’s approved list.
When the appraisal is low
Federal Housing Administration-insured mortgages allow buyers to buy homes with less-than-perfect credit and small down payments. The minimum down payment is just 3.5% of the home’s purchase price.
A small down payment, by itself, shouldn’t be a concern for sellers, says Rob McAllister, owner and broker at West Seattle Mortgage in Seattle. But when you pair a small down payment with a low appraised value, the situation becomes more nuanced.
Selling a house and buying another? Compare mortgage offers in your area.
A tale of 2 borrowers
McAllister describes a situation where a buyer has enough cash for a 20% down payment, but the appraiser says the house is worth 10% less than the negotiated price. If the seller refuses to reduce the price, the buyer can still pay the agreed-upon amount. In that case, the mortgage’s loan-to-value ratio is close to 90%, which the lender is likely to approve.
But if the buyer makes the minimum 3.5% down payment required by the FHA “and the property appraises low, the buyer isn’t in a position to remedy that,” McAllister says. That’s because the buyer is asking to borrow more than the home’s appraised value. The lender won’t approve a loan for more than the house is worth. Unless the seller reduces the price, the deal falls through.
How to resolve it: More cash
The buyer might have more cash to bring to the deal to overcome the appraisal. But the seller probably wouldn’t know that and might reasonably conclude it would be unlikely for an FHA borrower, making the minimum down payment, to have extra cash available.
“Usually they don’t have anything left over,” McAllister says.
That leaves the seller with a hard choice: Accept a lower price that’s supported by the appraisal or find another buyer who seems better qualified.
A persistent appraisal
There’s no guarantee that a new buyer will improve the seller’s position, says Rebecca Marvel, a Realtor for Carrington Real Estate Services in Palmdale, California.
“With FHA, the appraisal sticks with the house for 90 days,” Marvel says, “so the seller has to either wait 3 months or take less (money) unless the buyer can come in with (more) to make up the difference.”
Sellers who want to move quickly might find the risk of such a quandary unacceptable. Saying “no” to FHA buyers from the outset could eliminate the risk.
When the buyer has credit issues
For borrowers with credit problems, FHA loans are easier to get. Low-down-payment FHA loans generally are available to borrowers with credit scores as low as 580. Conventional loans (those that aren’t insured by the FHA) generally are available to borrowers with credit scores as low as 620.
Buyers tend to choose the FHA loan because they’re strapped for cash, their credit is smudged or both. The credit piece can raise red flags for sellers.
“From a seller’s perspective (the question is), ‘Why is the buyer going with FHA and not a conventional loan?’ If it’s due to credit, there’s always a worry that that will create a problem in underwriting,” McAllister says.
That red flag might turn out to be a false warning, but again, it’s unlikely that the seller would be aware of the buyer’s true situation.
FHA buyers who are short of cash might want more concessions from sellers.
“Oftentimes they will be asking for closing costs as well as some cash toward possible renovations or repairs,” says Mark Fleysher, broker-manager at Sellstate Deluxe Realty in Las Vegas. All else being equal, that extra cash comes out of the seller’s pocket.
When repairs are required
A related concern for sellers is that FHA guidelines require appraisers to make note of property defects that could pose habitability concerns or health, safety or security risks if they notice them.
In a hot locale like, say, Las Vegas, that could mean an air-conditioning system in the home has to work, Fleysher says.
“If there is an A/C, that A/C has to work, so if the seller knows the A/C doesn’t work and doesn’t have the money to fix it, that seller had better not be accepting an FHA loan,” Fleysher says.
The appraiser rings twice
The seller might also have to pay for the appraiser to visit the home again after repairs have been completed.
“Essentially what happens is that the appraiser will put some condition on the appraisal … and then the appraiser goes back out and does a reinspection and charges the buyer or seller for it,” Fleysher says.
What’s more, repairs must be actual fixes, not credits to the buyer’s side of the ledger.
“FHA requires that the property be in pretty darn good condition,” Marvel says.
McAllister’s experience is different. He says he hasn’t seen repair issues come up with FHA loans and an FHA appraisal could be an advantage for the seller because it takes a stronger resume for an appraiser to be FHA-approved.
When it’s a condo for sale
Condominiums present other special issues because FHA approval is required not only for the individual unit, but for the entire project. If the project isn’t FHA-approved, sellers cannot close a sale to a buyer with an FHA loan.