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!

Common Questions Answered: Buying Short Sales & Foreclosures

Distressed property is all the rage these days. And it's a good thing: If it weren't for investors and bargain hunters snapping up low-priced inventory, we'd be in a whole different place (a much worse one).

When we speak of distressed property, we're primarily talking about short sales and foreclosures. In almost every initial conversation I have with any potential buyer, they inevitably ask me what the difference is between short sales and foreclosures. So I'll start there and pose a few of the most common questions I get, along with my answers. If you have a question I don't answer here, post it below and I'll get right on it.

Q: So what is the difference between a short sale and a foreclosure?
A: A foreclosure, also known as a bank-owned property or REO (real estate owned, which is how it shows up on the bank's books), is property the bank has repossessed from the owner due to nonpayment of the mortgage. The bank owns the property outright and hopes to sell it for as much as possible to recoup some of their losses on the deal.

A short sale is a situation in which, most likely, the owner has fallen behind on mortgage payments, the bank is moving to foreclose, and the amount owed on the mortgage is greater than the property's value (some call this condition "underwater"). The owner is trying to sell the property for whatever it's worth, hoping their lender would rather take a discounted or "short" payoff right now instead of seeing the rest of the lengthy foreclosure process through. So in this situation, the seller still owns the property, but their lender calls the shots.

Q: How long do these transactions take to close?
A: An offer on a foreclosure will usually get a response within five business days. After that, you can close within a normal time frame (30-45 days).

An offer on a short sale must be signed by the seller, then submitted to the seller's lender for review along with a litany of other documents. Depending on which lender holds the mortgage, how many mortgages and other liens there are, and the skill and experience level of the person handling the short sale (typically the seller's agent or attorney), buyers can expect a response to their offer within three to six months. That time frame is rarely shorter and occasionally longer.

Q: What additional risk is involved in buying distressed property?
A: Both short sales and foreclosures are sold "AS-IS." That means the seller is not going to do anything to the property and the buyer accepts it with whatever physical or legal defects it may have. Buyers CAN and always SHOULD have a home inspection done, and they can still back out of the deal if the inspection turns up anything unacceptable. The buyer is also responsible for passing any municipal inspections, purchasing all transfer stamps (even those customarily purchased by the seller), and ordering a survey if their lender requires one.

In the case of a short sale, the seller will provide the customary disclosures regarding the property's condition and any known material defects, as required by state law. A bank selling REO has likely never even seen the property; therefore it is exempt from those disclosures and buyers are truly on their own.

One thing that is NOT different about buying distressed property is that the seller (if it's REO) or the seller's lender (if it's a short sale) WILL provide the buyer with clean title and a title insurance policy, just like a traditional sale. That means they clear up any known liens on the property and pay or credit the buyer for any unpaid real estate taxes. You may open a can of worms fixing the place up, but at least you know it's yours!

Q: Should you include foreclosures and short sales in your home search?
A: It depends.

I almost always advise buyers to include foreclosures. They are frequently priced below-market and present great opportunities for instant equity. The only time we have to be careful with foreclosures is when a buyer only qualifies for FHA financing. When FHA appraises the property they expect everything to be intact and fully functional; they won't lend on it if anything is broken or missing (e.g. windows, a bath vanity or kitchen cabinets, a furnace). An ordinary seller might offer to get the property into "FHA condition," but if it's owned by a bank you can pretty much forget it. There are exceptions, but that's a whole other discussion.

I advise buyers to include short sales when their circumstances allow it. Due to the time frame they take to close, short sales are often a consideration for people who are not on a timeline: Those who don't have to sell and buy at the same time, investors purchasing multiple properties - in general, buyers who aren't in any sort of hurry. For buyers who need to close before their lease is up, live in a certain school district or area by a set date for school or work, or in general have to be moved by particular date, short sales are not recommended. Same goes for anyone who lacks patience!

Q: Which is a better deal, short sales or foreclosures?
A: Ah, the million dollar question. Where can you get the best deal? There are two schools of thought on this, but I believe foreclosures most frequently present the best opportunities. Why? Primarily because of the way the bank determines what price they'll take for a house when they already own it, which is different from how they evaluate it when the borrower still owns it.

With short sales, once an offer is received and submitted to the seller's lender, they hire an appraiser to give them the current, as-is market value of the property. They will usually accept a certain percentage of that value, commonly about 90%. If there are other liens on the property, such as a second mortgage or delinquent property taxes, those liens need to be satisfied too - after the lender who holds the first mortgage gets their 90%. So the best deal you're going to get is 90% of the property's current as-is value, as determined by an appraiser, but you might have to cough up a little more depending on secondary liens.

With foreclosures, the price is determined by an asset manager who bases his/her decision on a BPO - that's a broker opinion of value, a report completed by a real estate agent who is often going to be the one listing the property for sale. It's in the agent's best interests to get the bank to list the property for an attractive price. In fact, many banks request the BPO agent to recommend a "30-day sale price." So when these listings come on, they're often at hot prices.

A few years ago when short sales were just coming on the radar, banks used desktop valuations or BPOs for short sales instead of appraisals, and they didn't have the procedures and rules they have in place now. It's those appraisals, procedures and rules that have changed the game with short sales and made foreclosures more attractive in my experience.

I did a little research to back up my belief, for those who might disagree. I looked at the median sale prices of all foreclosed and short sale residential property that has sold in the past 12 months in Oak Lawn, Matteson, Tinley Park, and the Loop (as of October 2011). In every case, the median sale price of foreclosures was lower than the median sale price of short sales - by anywhere from 3% (in Matteson) to almost 30% (in Tinley Park). Further, in all three suburban areas, foreclosures sold for a larger discount off their asking prices than did short sales. That didn't hold up in the Loop where foreclosures sold for a median of almost 107% of their asking prices - but that was still 19% lower than the median short sale price.

So if you have any general or specific questions I didn't touch on here... Fire away!