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  • FHA loans, what they mean for both buyers AND sellers

    Friday, January 19, 2024   /   by Amy Brown

    FHA loans, what they mean for both buyers AND sellers

    FHA loans can be a great loan program but they also come with stipulations that need to be considered before signing up for this program or accepting a contract from a buyer who is using this program, so I wanted to go over some of the nuances to clarify what this means for both sides.

    Let's start with buyers:

    What is an FHA loan?

    An FHA loan is a mortgage insured by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development. With a minimum 3.5% down payment for borrowers with a credit score of 580 or higher, FHA loans are often a good fit for first-time home buyers or people with little savings or credit challenges.

    The federal government doesn’t issue FHA loans, but it does insure them. FHA loans are issued by private, FHA-approved lenders, including many banks, credit unions and nonbanks (a type of lender).

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    FHA vs. Conventional Loans

    Here are some key differences between FHA and conventional loans:

    • Credit score and history: FHA loans allow for lower credit scores than conventional loans. If you’ve had credit problems (including bankruptcy), you might find it easier to qualify for an FHA loan.

    • Mortgage insurance: Unlike conventional loans, all FHA loans require mortgage insurance. (However, the amount you pay varies based on the size of your down payment.) With a conventional loan, mortgage insurance generally isn't required if you make a 20% down payment or once you reach 20% equity in your home.

    • Gift funds for down payments: FHA rules are more flexible regarding monetary gifts from family, employers or charitable organizations you can apply to your down payment.

    • FHA appraisal: To qualify for an FHA loan, the property must undergo an appraisal to make sure it meets government standards for health and safety. An FHA appraisal is different and separate from a home inspection. Conventional loans don’t require this.

    FHA Loan Requirements

    The FHA sets minimum requirements for borrowers seeking an FHA loan. However, each FHA-approved lender can determine its own underwriting standards, so long as those requirements are in line with the minimums set by the FHA.

    For example, a lender can specify the minimum credit score that they are willing to accept and they set their own interest rates and fees. Bottom line...shop around.

    Credit Score Requirements for FHA Loans

    According to the FHA, the minimum credit score for an FHA loan is 500. If your score falls between 500 and 579, you can qualify for an FHA loan, but you'll need to make a down payment of at least 10%.

    If your credit score is 580 or higher, you can qualify for a down payment as low as 3.5%.

    Again, these are FHA guidelines; individual lenders can and often do opt to require a higher minimum credit score.

    Debt-to-Income Ratio

    Your debt-to-income ratio, or DTI, is a measure of your monthly debt payments in relation to your pretax income. That includes your rent or mortgage costs in addition to things like auto or student loans and credit card balances. In general, lenders view a lower DTI as more favorable when issuing loans.

    DTI requirements for FHA loans differ based on your credit score and other compensating factors, such as how much cash you have in the bank. If you have a credit score from 500 to 579, the FHA generally requires a DTI of less than 43%.

    Down Payments

    The minimum down payment required for an FHA loan is 3.5% if you have a credit score of 580 or higher. If you have a credit score from 500 to 579, you'll have to put down at least 10% of the purchase price.

    Mortgage Insurance

    FHA mortgage insurance is built into every loan. When you first get an FHA mortgage, you'll make an upfront mortgage insurance payment, which can be rolled into the total amount of the loan. Then, you make monthly mortgage insurance payments thereafter. The length of your monthly payments varies based on the size of your down payment.

    • If your down payment is less than 10%: You will pay FHA mortgage insurance for the life of the loan.

    • If your down payment is 10% or more: You will pay FHA mortgage insurance for 11 years.

    With a conventional loan, you can cancel private mortgage insurance once you reach 20% equity in your home. FHA mortgage insurance can’t be canceled in the same way.

    FHA Loan Limits

    No matter what type of FHA loan you're seeking, there will be limits on the mortgage amount. The loan limit in Buncombe county is $498,257.

    What does this mean for sellers?

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    Any property that is being financed under FHA will have to undergo an FHA Appraisal but this is not merely an appraisal of value. An FHA appraisal also comes with an inspection by an FHA-approved professional to ensure that the property meets FHA minimum property requirements.

    The FHA appraisal is separate and different from a home inspection. The goal is to be sure the home is a good investment for both the borrower and the government and that it meets basic safety and livability standards.

    Here are what the FHA appraisers are looking for:

    1. Operational Appliances

    HUD requires that all appliances that “remain and that contribute to the market value opinion are operational.” Make sure these major appliances are in good working order:

    • Dishwashers
    • Garbage disposals
    • Microwave ovens
    • Ovens/ranges
    • Refrigerators
    • Washers and dryers
    2. Adequately insulated and safe attic

    • Lack of insulation on the interior roofing
    • Deficient materials
    • Leaks or readily observable evidence of significant water damage
    • Previous fire damage
    • FRT sheathing
    • Exposed and frayed wiring
    • Inadequate ventilation by vent, fan, or window
    3. Dry and ventilated crawl spaces and basements

    Lenders can reject properties for “significant incurable ponding of water” in basements and crawl spaces.Every crawl space must be readily accessible for an appraiser to enter up to their head and shoulders at a minimum. Crawl spaces must be free of debris, with good airflow and no pooled water.In the basement, appraisers look for any moisture, dampness, and structural issues that might pose a health risk or compromise the home’s integrity. They also test sump pumps to ensure they are functioning correctly.

    4. Sufficient drainage and grading

    The appraiser checks for “readily observable evidence of grading and drainage problems.” This entails looking for effective drainage control measures like gutters, downspouts, and appropriate grading to deliver water away from the structure. The appraiser will note standing water if it seems related to a drainage issue.Proper grading directs rainwater on the roof and the ground away from the structure’s foundation. If existing grading does not allow for proper drainage, the FHA appraiser will require the seller to address the issue.

    5. Adequate and functioning electrical system

    The electrical system should adequately support the usage and functions that typically occur in the home. Frayed or exposed wires are not permitted. The appraiser tests switches, receptacles, and fixtures to ensure they work.

    6. Reasonably safe site conditions

    The appraiser looks at “externalities,” or off-property issues that affect the home’s value and marketability. Some environmental issues could make a property less safe.
    Externalities include:
    • Heavy traffic
    • Airport noise and hazards
    • High-pressure gas lines
    • Overhead power lines
    • Stationary storage tanks
    • Noxious fumes
    7. Solid foundation

    HUD requires repairs for safety problems and deficiencies that comprise the foundation’s integrity. Poor drainage and soft soil commonly cause cracks, leaks, and bowing in a structure’s foundation. The FHA appraiser records defects and structural issues that he or she observes during the inspection.
    As the seller, you may have to get an inspection from a licensed structural engineer. Repair costs for foundation problems range from a few hundred dollars for minor cracks up to several thousand dollars to install underpinning piers or steel reinforcements.

    8. Adequate heating and cooling

    HUD requires heating and cooling systems equipped to keep the living space comfortable and healthful.

    Every habitable room must have a heat source that uses fuel readily available in the local geographic area.

    While central air is not an FHA requirement, any existing central air system must be operational.

    9. No disturbed lead paint

    This applies to any home built before 1978.

    10. Well functioning plumbing

    The appraiser flushes toilets and turns on faucets to verify the property’s plumbing system provides adequate water pressure, flow, and waste removal. Faucets should supply hot and cold water with no unpleasant odors.

    The water heater should contain a temperature and pressure-relief valve diverting hot water and steam safely. Signs of leaks or structural damage near faucets and pipes are reportable issues.

    During the FHA appraisal, the appraiser checks septic systems, as well. The appraiser observes septic systems for “signs of failure or surface evidence of malfunction.” Required repairs depend in part on local guidelines, the extent of the damage, the lender’s discretion.

    11. Stable roof with two or more years of life left

    The roof covering should provide a barrier against moisture and provide “reasonable future utility, durability, and economy of maintenance;” basically, the roof must be in solid condition and not require major repairs that could be costly to the buyer.

    If the appraiser feels the roof has less than two years of remaining life, they will require an additional inspection from a professional roofer.

    12. No presence of termites

    What happens next?


    If you decide that you would like to accept FHA borrowers when you list your home for sale, make sure that the above criteria is up to shape BEFORE you list the house so that you aren't asked for any type of concessions during the due diligence period and you get as close to your contracted price as possible.

    If a discrepancy is found, it will have to remedied and reinspected before the loan can close. The burden of that responsibility usually falls on the seller, however, sellers can refuse. Just know, that unless the borrower has the money to pay for the repair out of their own pocket, more than likely the deal will not go through as this is a loan requirement for purchase.

    If a buyer really wants to go ahead with the purchase, the seller has declined any repair requests, but they don't have the money to pay out of pocket, the last option is to obtain an FHA 203(b) loan which gives the borrower up to $10,000 and 90 days to complete the repairs which they can finance into their total loan amount.

    I know that this was a bit of a long read but I appreciate you taking the time. I hope that this sheds some clarity on the responsibilities of both sides when encountering an FHA loan scenario.

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    FHA loans can be a great program to get someone into a home that just needs a little bit of a boost. Just know that as a seller your property will need to meet certain requirements to seal the deal. Knowing these ins and outs can save you a lot of time, money, and frustration.

    We are here to help and shed some light on buying real estate in the Asheville area!