FHA, they are hard to get through, so much so that sellers and listing agents in the Roseville/Rocklin area are leery to accept an offer with FHA financing, even if it will net the seller the most $$$ at closing. The stigma is so strong right now sellers are often times ignoring the strongest offers.
In my experience a lot of things in real estate, especially finance, are unclear for a number of reasons. This FHA stigma issue is no different. It is one of the more complicated things about the current market, but the stigma IS NOT DESERVED.
In the past FHA had some pretty strict guidelines, guidelines that could easily make an escrow hard, if not impossible to close. At the time FHA loans were not en vogue as they were not needed, the private market had a myriad of loan products to fill in what FHA offered, and they were easy to close, so FHA was an afterthought.
After the mortgage meltdown of 07/08, FHA came back to the forefront as the choice of almost all buyers with less-than-perfect credit and low(er) down payments. FHA’s credit requirements are more lenient than conventional loans, and the minimum down payment is also lower.
Anytime you put down less than 20% down on a home using a conventional loan, private mortgage insurance (MI) must be acquired to insure the lender against the risk that you will default on your loan (there are a few exceptions and ways around this, which I will talk about in a future post).
Private MI usage fell dramatically during the period of 07-09 as the MI industry drastically revised their guidelines, leaving a lot of buyers no choice but to look at government loans. The guidelines have loosened up considerably since then, mostly over the last 12 months, but they are still somewhat strict, especially for those putting only 5-10% down.
Yep, what I am saying is these insurers have their own credit guidelines, often times more conservative minimum credit, income, and property (appraisal) requirements than the actual loan itself. And here is one of the reasons the old FHA stigma is not deserved, a conventional offer with less than 20% down actually has MORE hurdles to close than an FHA loan does in my opinion.
After that longer than usual ramble, I’ll put the rest into a nice little list…
Why a conventional offer isn’t always less likely to fall out of escrow and FHA offers should be considered:
1.) Conventional loans with MI are underwritten TWICE. Once by the lender and again by the MI company. This isn’t usually an issue but the most common issues one might find with an FHA loan (property issues, etc) are most likely to be issues with an MI company’s underwrite, regardless of if the lender themselves don’t care about the same issues.
2.) Conventional loans have more conservative income/asset/credit requirements. This one is simple, an FHA buyer can have a higher debt-to-income ratio, NO RESERVES in the bank after closing, and a lower credit score and still qualify (we might question if someone with a higher debt ratio, no money in the bank, and less-than-stellar credit should be a buying right now, but as a seller or listing agent that really isn’t your concern).
When you/your client is preapproved by a high quality lender this usually isn’t going to be an issue, but if something changes with the buyer’s credit, income, or assets while in escrow FHA’s more liberal guidelines make it less likely for the buyer’s approval to turn to dust and the deal to die.
3.) The “Credit Refresh”. Conventional loans require something called a “Credit Refresh” no more than 5 days from closing. A good lender will let their client know not to do ANYTHING with their credit other than pay their payments but if they don’t listen, an unexpected expense comes up they have to pay for with debt, or something is reported on their credit report by mistake while in escrow the Credit Refresh at closing will almost certainly catch it.
Best case if this happens, the new debt is added into the buyer’s debt ratio and the loan goes back to underwriting and re-approved with the new numbers. A worse case? The debt is added back in and the loan has to go back, and the purchase agreement or short sale approval needs to be extended, or possibly expires. Worst case? The deal can no longer be approved and the escrow dies.
4.) Appraisals. This is one of the bigger ones. In the past there were huge property issues with FHA loans. From mandatory pest inspections and clearances to appraisers being forced to nitpick all kinds of little things that would cause issues closing an escrow. These rules went out the window many years ago however, problem is not too many people got the memo.
Pest inspections are handled the same way they are on a conventional offer. If an inspection is requested in the offer the lender is going to need to see it, and Section 1 clearance, for both FHA and Conventional loans.
FHA loans require all mechanical systems to be fully functional, including a working heating and cooking source, under the guise of the home being “habitable” at the time of closing. And so do conventional loans! Even if Fannie/Freddie guidelines do not specifically state a property has to have a working cooking source, the lenders that actually fund these loans do (pretty much universally, 100% of the lenders I know do anyways).
There are a handful of health and safety issues that can come up on an FHA appraisal that probably won’t on a Conventional, such as requiring lead-based-paint to be handled if there is a lot of visible paint chipping off the house, but for the most part what is caught on an FHA appraisal will be caught on a Conventional appraisal.
Those 4 are my top reasons for now. There are more but for the sake of brevity (and your sanity, if you made it this far applause from me!) I’m cutting myself off here…
Please let me know if you have any questions…
Innerwork Mortgage – Roseville, CA