What Buyers (and Sellers!) Need to Know about FHA Financing

I took a class on FHA & VA Financing from Bruce King last week and thought I’d share a few of the notes I made in class.  They may be a bit cryptic, so if you have any questions, please feel free to contact me or Bruce.

The lending environment has changed dramatically! Bruce shared that in 2002, his company offered 70 kinds of loans, and this year they offer just four:

• Government (FHA & VA)
• Conventional
• Jumbo (privately funded)

I learned that the FHA loan program was created by the National Housing Act of 1934 to help lower income families to purchase homes.  It virtually disappeared in the white hot market several years ago, but it appears to me that it is now the most commonly seen loan for properties priced under the Maricopa County loan limit of $346,250. (effective 1/1/2010).

Correction: The Maricopa County loan limit remains at $346,250 for 2010.

Bruce shared some of FHA Myths (and then proceeded to debunk them):

1. Too complicated
2. Too much paperwork
3. Too expensive for seller
4. Higher rates
5. Mortgage insurance cannot be removed
6. Takes too long to close
7. Doesn’t benefit the buyer
8. Doesn’t benefit the seller
9. Conventional is a better loan
10. You have to have more money to close
11. Conventional is a better loan
12. Buyer can’t understand the loan

And then, he explained many of the benefits of FHA financing:

• No reserves are required, versus 2 months for conventional.
• 3.5% minimum down payment, versus 10% for conventional.
• Gift funds are allowed
• Non-occupant co-borrowers allowed (kiddie condo)
• Pricing same regardless of FICO score
• Up to $5,000 medical collections can be unpaid
• No credit history required — alternate credit such as car insurance, utility bills, or cell phones can be used.
• Minimum time after Chapter 7 is 2 years.
• Can be approved after one year of on-time payments after Chapter 13
• Minimum time period after a foreclosure is 3 years, unless there are extenuating circumstances, such death or serious illness

Gift funds are allowed for down payment and closing costs, and can be used can come from:

• Relative (some fairly specific requirements here)
• Borrower’s employer or labor union
• Charitable or non-profit organization
• Government agency
• Public entity with home ownership assistance
• First-time buyer program

First-time home owners can also use money from their 401K/ IRA’s as down payment.  I’ve been told that in this situation, the buyer does not have to pay the 10% early withdrawal in this case.

Bruce said that qualifying for an FHA loan is based on the four C’s:

• Character (credit)
• Capacity (income)
• Capital (reserves)
• Collateral (value)

And, the buyer will need to have documentable income:

• Two years of employment / self-employment history
• Income must be stable
• Must continue for at least 3 years

Once the buyer has a loan approval and an accepted offer on a property, the FHA appraisal will be ordered.  In addition to valuing the property, the appraiser will be evaluating the property looking for health and safety issues that must be addressed before the loan is approved.

Some of the the home repairs that typically must be completed prior to FHA loan approval are:

• Peeling paint
• Broken windows
• Plumbing leaks
• Exposed wiring
• Pool & pool equipment
• Termite damage
• Exposed exterior surfaces
• Roof issues

For home sellers who are considering accepting FHA financing, it’s really best to have these type of issues corrected prior to the FHA appraisal to streamline the process.

From my perspective, FHA loans have become the loan of choice for most, if not all, of the first-time home buyers I work with.  However, I thought it was worth looking at the Scottsdale real estate market a little bit more closely to see if FHA is as predominant as I believe.

I reviewed single family home sales in Scottsdale for the month of December 2009 (via the Arizona Regional MLS), and found 35 single family homes had sold between $100,000 and $200, 000.

• 16 homes  used FHA financing (45%)

• 8 chose conventional (23%)

• The remainder paid cash (31%)

In the price range between $201,000 and 300,000, the proportions changed somewhat.  (The FHA limit was $346,250 through 12/31/2009.)  A total of 69 homes sold in December.

• 16 homes (23%) used FHA financing

• 29 used conventional (43%)

• 1 utilized VA

• The remainder paid cash (33%)

So, FHA is really funding a significant portion of the entry-level range of the Scottsdale home market, but does taper off as home prices rise. Buyers who are hoping to take advantage of the Home Buyer Tax Credit Extension will definitely increase their possibility of home ownership by taking a more serious look at FHA financing and discussing it with their lender.

I bought my first house, a couple years out of college, with FHA financing.  It’s the only way I could have done it, during a period of double digit interest rates.  I’m glad to know the program is still around, helping home buyers reach their goals.