FHA Financing and HUD Foreclosures

First off, HUD is the U.S. Department of Housing and UrbanDevelopment. FHA is the Federal Housing Administration, an agency administered by HUD. For our purposes, they are one and the same.

An FHA mortgage is a mortgage made by any lender for which FHA is the mortgage insurance company (for more info on mortgage insurance, see this article). There are three types of FHA mortgages. All are available only to owner occupants, not investors.

203(b): This is the standard FHA loan. Borrowers may qualify with credit scores as low as 580, debt ratios as high as 56%, and down payments as low as 3.5%. The property can be any house, townhouse, 1-4 unit multifamily building, or FHA-approved condominium (more on this later). The property must also be in 100% livable condition with all systems functioning properly, no safety hazards, no mold, etc. It can be ugly as sin, as long as it works.

203(k): This is the "rehab mortgage" version of FHA financing. It allows the buyer to finance the purchase and rehab costs of a home. Rehab costs must exceed $5,000. Example: A house is currently worth $50,000 and is in need of extensive repairs. After those repairs it will be worth $150,000. The buyer makes a down payment and purchases the house for $50,000. The buyer's mortgage is $125,000, with the difference being held in an escrow account. As the repairs are made by licensed contractors who bid the project out before the closing, the contractors are paid out of the escrow account. Work is completed, the borrower moves in with a mortgage of $125,000, and the house is worth $150,000. The 203(k) loan is good because it allows for a great deal of flexibility, but it is a long and complicated process relative to a 203(b) and many lenders don't offer it. More info here and here.

203(k) Streamline: This is what it sounds like - a quicker, easier version of the 203(k) rehab loan. The buyer can finance rehab costs up to $35,000 into the loan, but money cannot be used for structural work. For more info, click here, then click on the "HUD Mortgagee Letter" link.

FHA-approved condominiums: Aside from any restrictions mentioned above, any type of FHA financing can only be used on a condo if the condo project (development, building, complex, whatever you want to call it) has been approved for FHA financing. The condo association needs to gather all of their legal and financial documents and submit an application to FHA, who will then review the file and determine if the association meets their criteria. These criteria include a minimum amount of cash held in reserve, maximum concentration of FHA loans in the complex, maximum number of rented units, and maximum number of units delinquent on assessments, among others. Once the project is FHA approved, buyers can use FHA financing to purchase there. Beware - many homes that appear to be townhomes are legally condos, which must be approved. Most people don't know there's a very easy way to verify whether an association is FHA-approved: the HUD database.

HUD REO: You already know what HUD is. REO stands for "real estate owned," and that's how banks refer to their foreclosed inventory. HUD REO refers to property that was mortgaged with an FHA loan that foreclosed; the property is now owned by HUD. HUD allows some extra leeway in financing their REO, and they provide more information than any other bank or seller pertaining to the property's value and condition.

Run a search in your state and ZIP code on HUD's REO website. Click on the property case number for one of the listings to pull up the details. Photos are shown at the far left; basic property attributes are shown in the middle; and on the right you will see some listing dates and deadlines and then the "As-is Value." HUD already had the property appraised in its current condition, and this number is the appraised value as of the "Appraisal Date" shown in the middle column.

Below the as-is value, you'll see "FHA Financing:" followed by one of three codes.

> IN (Insured): Property condition meets FHA 203(b) standards.

> IE (Insured Escrow): Property condition ALMOST meets 203(b) standards. Repairs of $5,000 or less are needed. Buyer can use 203(b) by posting a repair escrow (see below).

> UI (Uninsured): Property needs more than $5,000 of repairs to comply with 203(b) standards and is therefore not eligible for 203(b). Buyer must use 203(k) or Streamline if eligible (see below).

The next line down shows if the property is eligible for 203(k) loans. This almost always says "Yes," but it will say "No" if the property is a condo in a complex that is not currently FHA approved.

Keep moving down and you'll see the line "Repair Escrow" followed by an amount (if the status was IE). If the buyer wishes to use a 203(b) loan, they must post this amount into an escrow account at the closing, have the necessary repairs done to bring the property into compliance, and complete a compliance review before the escrowed funds are released back to them.

Below the repair escrow amount, you will see "Review PCR for Repair Escrow Items." Click on the "Addendums" tab. You will see a few links; the one you want is the PCR or Property Condition Report. Click the link and download the PDF. A HUD contractor tested various components in the property, including all the major mechanicals, and this report shows the results. Another file on this same page, usually titled Escrow report or PCR summary, shows the contractor's estimate of the repair costs and the total amount that must be escrowed.

In the Addendums tab you may also see a link for HUD's "$100 down payment" program. This means a buyer purchasing this property with any type of FHA financing can qualify for a $100 down payment instead of the usual 3.5%, during special promotional periods.

How cool is that? They tell you the appraised value, what's wrong with the property, and how much it will cost to fix. Find me another institutional seller (or any seller, for that matter) who will do that!

Bidding on HUD property is a different conversation, but unlike some bidding sites an offer can only be input by a HUD-registered broker. If you’re reading this article then you know a HUD registered broker, so check the website out, then talk to me!

How to use the MLS mortgage calculator

When considering buying or refinancing a home, affordability is often the most important factor - not the amount financed, but the amount of the payment. The concept of $300,000 isn't something we can easily grasp in everyday terms, but the payment we make every month is immediately applicable to our lives. I often quote estimated payments to home buyers to help them evaluate their decisions, because figuring a mortgage payment isn't exactly simple math. But better than giving you a fish is teaching you to fish, so here's a step-by-step guide on how to calculate estimated mortgage payments using the MLS mortgage calculator.

Depending on whether you're talking about a house or a condo/townhouse, and depending on what type of financing you're using, there are going to be three to five different parts of the payment. The first part is the principal and interest, which is the mortgage itself and is calculated just like a big, long, car note. You'll also be escrowing your property taxes and homeowners insurance, which means you pay your mortgage company 1/12 of the annual cost of each of those expenses every month, they hold it in a separate account (escrow), and when the bills come due the mortgage company pays them. If you're putting less than 20% down, you'll also be paying mortgage insurance. And if the property is part of an association with a monthly fee, such as a condo or townhouse association, you'll also have to figure in the monthly association fee. Although this fee is paid directly to the association, not to your mortgage company, mortgage companies include it as a part of the payment for qualification purposes and you should include it when determining how much you can afford.

Check out the screenshot below; this is the blank slate. We'll start with the simplest calculation and then add the other moving parts.

Example #1: $200,000 purchase, 20% down payment. Property taxes of $5,000/yr, and homeowners insurance of $720/yr. Here we will only have principal & interest, property tax escrow, and homeowners insurance escrow. Enter the purchase price, $200,000. Enter the down payment as a percent (20%), and the $ field will auto-populate. Enter the interest rate: As of today I'm entering 4.25%, but the day will come when that will seem utterly outrageous. Leave the Number of Years at 30 unless you're pursuing a 15yr mortgage or other term. Enter the annual property taxes of $5,000. Enter the ANNUAL mortgage insurance of $720 and click the ANNUAL radio button, or if you're premium was quoted as a MONTHLY amount, enter that number and leave the MONTHLY radio button selected. Click Calculate, and voila:

The calculator separates out the principal & interest amount, then provides the total estimated payment including taxes and insurance. Toy around with the interest rate and the price to see how the payment changes - for instance, how much will a .25% increase in the interest rate change the payment? How much will the payment change if you get the house for $195,000 or $190,000 instead of $200,000?

Example #2: Same as Example #1, except now let's say you're getting a 5% down conventional mortgage. So you'll change the down payment to 5%, and you'll have to add mortgage insurance. (For more info on what mortgage insurance is and how it's figured out, read this article.) Today I'm using .85% for mortgage insurance, but this rate will vary depending on the borrower's credit score, amount of down payment, and market conditions. Enter .85% into the PMI / MIP field, which stands for "private mortgage insurance / mortgage insurance premium."

The calculator has also separated out the monthly mortgage insurance amount here. What a nice mortgage calculator.

Example #3: Now imagine the property in Example #2 is a condo with a monthly association fee of $150. Just enter $150 into the Association Fees field, make sure the MONTHLY radio button is selected, and the calculator will include this amount in the total estimated payment. I won't bore you with a screenshot of this one, you get the point.

Example #4: And for the grand finale, we will use an FHA loan. (For more information on what an FHA loan is and why it's different for this purpose, read this article.) Use the same information from Example #2, except change the down payment to 1.75%, and change the PMI rate to 1.25%. The minimum FHA down payment is actually 3.5%, however there is an upfront mortgage insurance premium for FHA loans (separate from what is paid monthly) that can be rolled into the loan as opposed to being paid at the closing. With interest rates so low, it's extremely common in today's market to roll the upfront MIP into the loan. The upfront MIP rate is currently 1.75% of the loan amount, so in order to account for adding that amount to the loan balance, we're taking it off the 3.5% down payment. Here's the result:

So you can see, when comparing Examples #1, #2, and #3, the difference in the affordability of the payment depending on the amount of your down payment and the type of financing you're using.

Hopefully this article allows you to figure out what you can afford when looking at a purchase or refinance. Of course, you'll still need me to set you up with an MLS account and a good loan officer to fill you in on the latest changes in interest rates, mortgage insurance rates, and financing programs available - but this is a start!

Pricing in a Declining Market

That's the title I give to a discussion I have with sellers before listing their home for sale. I long for the day when I can skip that discussion, but for the time being it is a crucial part of selling a home. Sellers commonly take the approach of, "Let's see how much I can get first, then we can drop the price." I can absolutely relate to the thought process that produces that statement as I have sold property myself and thought the same thing. As a real estate professional, however, I can tell you that statement is downright dangerous. There are three reasons sellers are hurting themselves by taking that approach, backed up by mountains of data.

Reason #1: The first three weeks on the market are the most precious. That's a known fact in the real estate community, and although it's founded in buyer psychology it's statistically proven. This is when all the buyers who have been searching for a home see your listing come on the market. If they look at the listing or perhaps schedule a showing and determine the home is overpriced, you've most likely lost that buyer for good. Because no matter how many times they see your listing pop up, such as with every price drop, they will always see it as that overpriced house they looked at awhile back. You remember that old adage about first impressions, right? If you lose the buyers who are already looking at the time you list, then you have to wait for new buyers to enter the market and hope one of them notices your listing. Would you guess there is a greater number of buyers currently searching for homes in your area than the number of new buyers who will enter the market in your area in the next month? If you guessed yes, you guessed right. Best to capitalize on that opportunity as a well-priced new listing.

Reason #2: As your market time ticks up and you repeatedly drop your price, your home becomes less appealing to buyers and you lose negotiating leverage. What do you think are two of the most common questions asked by buyers during a showing? How long has it been on the market, and how much have they dropped their price. In fact, buyers don't even need to ask anymore because that information is now visible to buyers on the MLS listing. Which of these two identical houses do you think generates more interest and urgency in a buyer:

• House A, which has been on the market 125 days and has dropped their price from $199,900 to $164,900, or... 
• House B, which just came on the market 8 days ago and is asking $164,900? 

The houses are identical and listed for exactly the same price, but House A looks like a desperate seller and House B looks like a listing that might get snatched up if the buyer doesn't make a move immediately. That also means House B is more likely to get a higher offer whereas House A will attract low-ball offers and have a difficult time negotiating them up. Ironically, the seller of House A has actually diminished the amount they can get for their home by trying to get more for it.

Reason #3: If you're not priced right when you list and the median value of homes in your area is still declining, you are faced with the challenge of dropping your price at a faster rate than the rate of market decline. The primary problem with that is that we don't know at any given point how quickly the market is declining. Contract prices are private until the sale closes, at which point 30 to 90 days have passed since the buyer made their buying decision. Since then, your toughest competition has lowered their asking prices. That means in a declining market, even if you price your home for exactly the amount the identical home next door just sold for, you are priced too high because you're at a "three months ago" price.

Consider the graph below. This shows a [hypothetical] listing that comes on the market for $149,900 at a time when it was actually worth $125,000. They drop their price $5,000 here, $10,000 here, wincing each time at the money they're losing. Meanwhile, the market has continued to decline. At the end of 12 months, there will be a very frustrated seller and an unsold house. They have dropped their asking price by 20% since they listed, but to no avail because the market value of the house has fallen by the same rate over the same time period and they started above the curve. Even with slightly more aggressive price drops they may not have caught up - they would have had to drop from $149,900 to $129,900 within 60 days of listing in order to have a shot at being "priced right," and I don't know too many people who are ready to stomach a perceived loss of that size, that quickly.

By contrast, consider the next graph as an example of how it SHOULD look:

Here, the seller actually gets more for their house than they would have in the first example - they sell for about $125,000 now, instead of being stuck with the house for a year until it's worth only $100,000. Just like with Reason #2, pricing too high will result in selling your home for less.

As I mentioned before, the primary problem with this whole scenario is that nobody knows exactly where that green curve is until three months later, at which point value has already been lost. We do have information about how declining markets work, though, so if we (seller + broker) take that information seriously and adopt an aggressive approach to pricing, you can beat your competition and sell your home for the highest possible price.