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FHA Loan Snags – Common Problems & How to Overcome Them

For the vast majority of those who want to own a home and need a mortgage to do so, the FHA has taken on an ever-growing presence.  When the problems that began in 2006 created a crisis that caused lenders to cut back on lending while increasing credit scrutiny, and raising down payments, the FHA was tasked by the government to help.  The FHA’s goal is to foster home ownership by keeping down payments low, and offering a more liberal credit policy.

While a great may people will be able to buy a home because of these FHA lending initiatives, there are requirements and limitations that are designed not only to protect the buyer, but the financial strength of the FHA as well.  Knowing where a snag can develop and threaten the mortgage and closing is important.  There can be ways to avoid or correct problems.

1.  Property Condition Problems

The FHA requires thorough home inspections, and that a home be in completely livable condition before a loan will be issued.  With a great many foreclosures and distressed properties, there can be homes in need of more than just minor or cosmetic repairs.  Some can even be stripped of everything from appliances to plumbing and flooring.  It’s a dilemma, as the buyer can’t get a loan without these items being fixed, but they can’t fix them because they don’t yet own the home.

This doesn’t have to be a deal-killer though.  An FHA 203k loan could be just the ticket.  This loan allows the financing of the needed repairs in the main loan at long term interest rates.  The home is appraised taking into account the value as if the repairs or rehab have already been done, and the repair dollars are placed in escrow to get the work done.  The lender interests are covered, so the loan can be completed, the work done, then the happy homeowner can move in.

  • Eligible Property – To be eligible, the property must be a one to four unit structure that has existed for at least a year.  Work that can be done even includes converting the property, reducing it from multiple living units down to one, or dividing the property into multiple living units.  A maximum of 25% of the floor area of a single floor property can even be used for commercial purposes.  There are differing percentages allowed for two or three story structures.
  • Condominiums May Qualify – If the condominium project qualifies for FHA financing, then an individual unit should qualify for the 203k loan.
  • Eligible Improvements – While luxury items do not qualify, repairs and improvements can include painting, room additions, and even decks.
  • Required Improvements – Energy efficiency improvements, such as caulking, weatherstripping, insulation and adequate ventilation are required as a part of the rehab work.  New heating and cooling systems must meet minimum efficiency standards as well.  Smoke detectors are required for occupant safety.

2.  When the Appraisal is Too Low

Especially when there are a large number of distressed properties, short sales and foreclosures, an appraiser may find it impossible to find comparable sold property prices, and the appraisal may be lower than the agreed-upon selling price.  This situation is actually more of a problem for the seller than the buyer.  The seller must realize that the same appraisal result is likely, even if the current deal dies.  They’re unlikely to be able to sell to any buyer needing a mortgage.

So, the buyer is in the position to renegotiate the purchase price with the seller.  By getting the price reduced to the appraised value, the seller gets the home sold, and the buyer gets a mortgage with lower payments.  If it’s the ideal home for the buyer, this is a good result, though the seller may be less happy.

3.  Too High of a Debt-to-Income Ratio

While the percentages change with current market conditions and different lenders and mortgage products, there is a number that the borrower must meet for a maximum ratio of debt to income.  If the home buyer has too much debt in relation to their income to qualify, it could be the death of the deal, but it need not be.  Even if it is, there are some actions that can help with the next purchase.

  • Pay off loans – While a loan isn’t allowed to make part of a down payment, a family loan to pay off debt on your credit report can clear enough to get the debt-to-income ratio to an acceptable level.  While a savings account is nice, it is likely not contributing to your loan qualification as much as using some or all of it to pay off debt.
  • Change debt type – Not always, but in some cases there is a difference in the calculation based on the type of debt.  If so, getting a consumer loan with a fixed payment to pay off several credit cards could change the result.
  • Count all income – Sometimes this ratio is so close that a percent or two can make the difference.  Be sure that all income has been listed, even part time work that seems like a small amount of money can tilt the scale.

The FHA will likely be the best resource for a home mortgage for millions of Americans.  Preparing for qualification, and knowing what to do when a snag develops can make the difference between renting and owning.

Jim Kimmons – HomeLoans.org Expert Jim is a New Mexico real estate broker who has held real estate brokerage licenses in Texas and Colorado during his 15 years of real estate practice. He is the Real Estate Business Guide writer for the New York Times website at About.com where he takes a pro-consumer stance in writing business articles for real estate agents, mortgage brokers, and real estate investors.

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