Federal Housing Authority loans (FHA loans) have even higher loan limits for 2018 in many counties, which should make them an attractive option for a larger range of buyers. But, there are risks that sellers’ agents should be aware of when dealing with FHA buyers. It’s critical that you inform your clients of potential issues and reduce your own risk of being sued by a client if a deal goes bad.
Know Who You’re Working With and Why
An FHA loan is insured by the Federal government and pays the lender if the loan goes into default. These loans require just a 3.5% down payment. They can make home ownership more accessible for first-time homebuyers, those with a lower household income, and individuals with credit challenges or lower FICO scores.
Millennials were the largest group of homebuyers in 2017, accounting for 34 percent of the market. Of those buyers, 35% chose an FHA mortgage in January of 2017. Many first-time homebuyers choose FHA financing, with the FHA reporting that 82% of their loans went to first-time buyers. These first-time buyers enter the workforce with student debt and few assets. They simply don’t have the cash for the down payment (typically 20-30%), closing costs, and other fees necessary to qualify for a conventional loan.
Contracts with a FHA Buyer
The FHA Amendatory Clause may appear in sales contracts with FHA buyers. This clause expressly states that the buyer shall not be obligated to complete the purchase of the property or incur any penalty if the appraisal comes in lower than anticipated. This is a risk to your sellers. If the FHA appraisal is lower than expected, there is a chance that a FHA buyer may withdraw from the deal even if the seller has already incurred expenses related to the sale negotiation.
FHA buyers do have the option of going ahead with the purchase despite a low appraisal. Because many FHA borrowers are facing credit challenges, this may not be likely. In highly desirable neighborhoods or other markets where the seller receives multiple offers, this risk may affect your seller’s decision to accept an offer from a FHA buyer in the first place.
The Appraisal Process
The appraisal process when an FHA loan is involved is quite different to the appraisal process in the traditional sense. The FHA appraiser does still assess the market value of the property, but they also look at the condition of the property both inside and out. Anything deemed of concern in regards to health and safety, or issues that the FHA believes make the property uninhabitable, will be noted in the appraisal. This has the potential to cause issues for the seller if the property is in need of major repairs.
This stringent appraisal process protects the FHA because it ensures the home meets minimum standards. It’s also worth noting that an FHA appraisal is valid for 120 days. If sellers make repairs on items noted by the FHA, they may even have to pay for a second appraisal themselves in order to achieve a higher valuation and appraisal.
If the property is a HUD REO, there are additional requirements of the appraisal.
There is a long list of requirements for the appraiser to check off when inspecting a property for an FHA-insured loan. Issues an FHA appraiser may highlight include:
- Peeling paint
- Unsafe wiring
- Fences requiring repair
- Wood rot
- Unserviceable heating system
So, who is responsible for the repairs? This issue is complex and a number of scenarios may arise:
- Your sellers may decide to carry out the repairs, so they can proceed with the sale.
- Your sellers may choose to drop the sales price, taking into consideration the repairs.
- The buyer may decide to withdraw from the purchase because of the defects identified and repairs needed.
- Your seller may refuse to do the repairs and look for another buyer.
If your seller wants to sell their property “as-is”, an FHA buyer may not be an attractive option. As a seller’s agent, it’s best to keep your client informed of the unique risks of dealing with an FHA buyer, so there are no misunderstandings.
This is not to say that all FHA buyers will withdraw from a sale if the property needs repairs. It’s simply something you and your sellers need to be aware of. Sellers on a shorter timeline to sell (i.e., to buy another property or on a moving deadline) that inadvertently get held up by this experience will likely blame you, their agent, for not informing them of the risks in advance.
The sale of condos to FHA buyers can present some difficulties that you should discuss with your seller. Not only does your sellers’ condo need to be FHA approved, but their entire building needs to be approved in order for a buyer to obtain FHA approval.
You can check if your client’s condo is already approved here. If it isn’t, this is something your seller should consider before putting the condo on the market. FHA buyers are strictly not able to purchase condos which haven’t been vetted by the US government.
Document All Communication in Writing
If something goes wrong with an FHA buyer, and your seller can prove you were negligent in educating them about the risks, you may find yourself at the receiving end of a lawsuit. Protect yourself by sharing this knowledge with clients in writing and recording it in their transaction file. Inform your sellers about how things work with FHA buyers and maintain proactive communications throughout the selling process. Importantly, never assume your seller understands — get it in writing that you gave them the information. Due diligence is your best defense against a real estate lawsuit.
With CRES Real Estate E&O + ClaimPrevent®, you’ll get access to the CRES legal hotline 7 days a week. You can ask one of our local real estate legal experts any questions you have about FHA buyers, home appraisals or the negotiation process. Get the answers you need before a claim situation occurs.
Have you had an FHA loan cause misunderstandings and confusion during or after the selling process? What did you do to educate your sellers in order to avoid a real estate lawsuit?