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!