Should I worry about an FHA appraisal?

I often find when working with a seller there is a fear of accepting an offer with FHA financing.

Let’s look at what the differences in financing are to the seller and why this fear exists today.

First, why would a buyer choose FHA over a conventional loan?

 

Conventional

FHA

Credit Score

Requires Higher Credit Scores

Allows Lower Credit Scores

Downpayment

As low as 3% with upper 600 credit score

As low as 3.5%

Mortgage Insurance

Required if borrowing more than 80% to value

Always required, but slightly ess expensive usually

 

Varies depending on credit score and downpayment

Same regardless of credit score, varies on downpayment

 

Is removed after payoff reaches 78% of purchase price

Never is removed

Debt to Income

Generally 43%

50% or less

Property Standards

No set property standards, appraisal inspection

FHA Handbook Guidelines and increased appraisal inspection scope

Generally, buyers that have credit scores below 700 and with lighter downpayment will see benefits to FHA financing while heavier downpayment buyers with higher credit scores will see lower payment costs with conventional financing. 

As a seller, it’s important to know who your target buyer is. Typically marketing to the “typical buyer” in your market will fetch the highest amount. Is your typical buyer a first time home buyer with limited downpayment funds? An investor buying for rental purposes? Or is your buyer likely a move-up buyer moving the equity from their sale to the next home?

If your typical buyer needs FHA financing to qualify, eliminating a large pool of buyers may be detrimental if you are wanting top dollar from your home. If your typical buyer is well qualified or an investor it may only be advantageous if an FHA buyer is willing to pay more than a well-qualified buyer. 

The real fear for most sellers is dreaded FHA inspections. This is an inspection performed by the appraiser and is used to ensure that the property is safe, sound, secure and adheres to certain local code restrictions. In short, it’s to ensure that a borrower who often has limited financial resources does not enter into owning a home that is uninhabitable or may need significant and often costly repairs. 

In the old days (before the mortgage boom of the 2000s) FHA was much more stringent. When I first became an appraiser many appraiser’s refused to even offer FHA inspections because of the added headache. During the 2000s 80/20 loans (a 0% down financing technique that used two loans; an 80% first position loan and a 20% second position loan) with often very limited income and asset verifications became the norm. FHA At the time if you were an FHA buyer you were at a disadvantage as seller’s would refuse FHA more often as the largest buyer pool was a simple conventional financed buyer. FHA saw a significant decline in loans. This decline moved FHA to reexamine its property standards and qualification guidelines. There have been many revisions since this era each seeming to reduce the minimum standards. 

So what does an appraiser inspect? 

The FHA inspector is the eyes and ears for the lender and the Federal Housing Authority 

The inspection performed by the FHA appraiser consists of mostly visual inspections, meaning only was can be readily examined by the eye. The appraiser is trained only on very general knowledge and techniques. Appraisers are required to test each system and ensure that they seem to be in working order. 

A shortlist of common inspection items (not a complete list)

  • Windows must open if they were designed to open
  •  The furnace must produce warm air
  • Air Conditioner is not required but if installed then must operate
  • Roof has to have at least 2 years of economic life remaining (estimated)
  • Gutters not required
  • Insulation not required
  • Smoke detectors not required (must work if installed though)
  • Water heater must heat water and not leak. 
  • Water heater TMP valve cannot leak and downpipe has to be 4-6” from the floor (scalding water hazard)
  • Broken windows are ok as long as you cannot be cut by the glass (taped passes)
  • Peeling paint on a home built before 1978 must be scraped and repainted. The flakes must be disposed of and not left on the ground (Lead-Based Paint Hazard).
  • Handrails must be installed on stairs and deck at appraiser’s discretion (must be safe)
  • Appraiser must flush a toilets
  • Appraiser must test some plumbing fixtures
  • Water pressure must be adequate
  • The electrical system must be safe (knob and tube wiring and certain electric panels can be safety hazards)
  • Wiring that has been spliced must be mounted in a junction box (electrical shock hazard, fire risk)
  • Shifting of foundation walls must be noted
  • Perform a head and shoulders inspection of attics (looking for fire damage, lack of ventilation, leaks)
  • Perform a head and shoulders inspection of crawl space (look for standing water, settlement issues and any damages to plumbing, electrical, etc. as can be seen from the entry point)

As you can see the list is comprised of items that pose safety and soundness risks and is generally straight forward and reasonable. This inspection is not as in-depth as that of a home inspection completed by a home inspector.

Appraiser’s refer to the 4000.1 HUD Handbook. The handbook is not very specific and leaves much of the determination up to the appraiser relying on the “3 S’s” (Safety, Soundness, Security). 

Now that FHA appraisals have relaxed some of the fear associated is still as strong as ever. 

So what are the similarities between FHA appraisals and conventional appraisals?

An appraiser in a conventional loan is the eyes and ears of the lender only. Not the borrower, just the lender is the client. 

There are no specific property standard guidelines for properties but there still exists a standard per se. Most lenders who are selling loans backed by Fannie Mae and selling the loans to the secondary market must have loans and properties that are conforming. This means they set the standard for properties that are at least C4 conditions (C1 new to C6 falling over scale). This means the appraiser is still looking for items that would drag the condition below C4 condition (which is average condition, may need some repairs but all the systems work, is safe and habitable). The appraiser also must note any deficiencies that are value influencing. An example may be peeling paint, just like FHA. Depending on the lender and in my experience, most lenders, the underwriter would require many of the same items noted in an FHA appraisal be corrected. As appraisers run into this more and more it is now becoming more common that the appraisers will preemptively call these items out and will make the report “subject to” these repairs being completed before close. The lender and appraiser do not want to take on the liability of allowing someone to move into an unsafe home. We, appraisers and agents, are taught it’s always better to over disclose than to under disclose and in a sue-happy world, we want to take every precaution we can. 

It should also be noted other government programs such as USDA and VA also follow the same HUD handbook. 

To summarize there are differences between the two loan programs. The fear of FHA should be reconsidered as a useful marketing strategy. There is not hard and fast, one size fits all advice. It’s best to have an experienced agent who knows these nuances which can earn and/or save you thousands of dollars. Experienced agents have relationships with appraisers, have seen lots of transactions and can help you prepare, hedge and take advantage of opportunities in markets using the tools in their tool bag.