If you have less-than-stellar credit or youâre a first-time home buyer, FHA loans can offer a number of benefits to help you overcome some of the most common obstacles to homeownership. These benefits include relatively lenient income and credit score qualifications, as well as a down payment requirement as low as 3.5%.
FHA loans are also insured by the Federal Housing Administration (FHA), making them a dependable form of mortgage financing.
Letâs take a look at some of the reasons sellers are reluctant to accept FHA-backed offers and what options you have if a seller refuses your FHA loan.
As a home seller in today’s market, you’ll likely receive offers from buyers using FHA financing. While these government-backed loans help buyers, they can present some drawbacks for sellers.
In my 15 years as a real estate agent, I’ve helped countless clients navigate offers with FHA loans. From that experience, I’ve seen the key disadvantages FHA loans pose for sellers.
In this complete guide we’ll cover
- What FHA loans are
- Top 3 disadvantages for sellers
- How to evaluate FHA offers
- FAQs on FHA issues
Let’s dive in!
What Are FHA Loans?
First, a quick primer on FHA loans. FHA stands for Federal Housing Administration – this government agency insures these mortgages.
Key features:
- Only 3.5% down payment required
- More flexible credit guidelines
- Loans insured by the FHA
With low down payments and credit requirements, FHA loans help more buyers afford a home. That’s why they are popular, especially with first-time buyers.
Now let’s look at why some sellers don’t like FHA offers.
Top 3 FHA Disadvantages for Sellers
While FHA loans help buyers, they can create headaches for sellers. Here are the top 3 drawbacks:
1. Stricter Home Inspection Requirements
The FHA requires an appraisal on the property. FHA appraisers thoroughly inspect the home to ensure it meets guidelines.
As a seller, it’s important to understand the rigor of FHA appraisals:
- Completed by a licensed, FHA-approved appraiser
- Must meet HUD minimum property standards
- Appraiser can test appliances, utilities
- Can kill deals if major issues found
If your home has lots of problems, an FHA loan may fall through due to appraisal issues.
2. Lower Down Payments
FHA buyers only need 3.5% down, compared to 5-20% on conventional loans. Low down payments mean:
- Less cash invested by the buyer
- Potentially weaker offers
With small down payments, FHA buyers have less skin in the game. This could make their offer less attractive in a competing bid scenario.
3. Longer Timelines
FHA loans can take longer to close than conventional mortgages. Reasons include:
- More paperwork for government-backed loans
- Potential FHA appraisal delays
- New FHA buyers less familiar with process
Closing delays can cause headaches for sellers. You may have to extend rate locks or temporary housing.
How to Evaluate FHA Loan Offers
While FHA loans have downsides, don’t automatically dismiss these offers. Here are tips for evaluating them:
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Compare total down payment dollars, not percentages. An FHA buyer offering 3.5% on a $300K home is putting down more than a conventional buyer offering 5% on a $200K property.
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Look at other factors like close date, contingencies waived, etc. A strong FHA offer can be better than a weak conventional one.
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Consider your area. In a hot market, you may prefer conventional loans to avoid delays. In a slower market, an FHA offer may be your best bet.
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Work with a real estate agent experienced with FHA transactions. They can provide guidance on how to negotiate these offers.
The bottom line is to weigh the overall strength of any offer, regardless of loan type. With some savvy negotiation, an FHA offer could end up being your strongest option.
Frequently Asked Questions About FHA Loans and Sellers
Still have questions about how FHA loans impact you as a seller? Here are answers to some common queries:
Can I refuse an FHA offer?
Yes, sellers can turn down any offer for any reason. However, evaluate FHA offers closely, as they could be your best option. Automatically rejecting them could cost you a good deal.
Do low down payments mean the buyer can’t afford the home?
Not necessarily. FHA loans allow responsible buyers to purchase with lower down payments. Pre-approvals help ensure buyers can afford the monthly payments. As a seller, focus less on down payment size and more on the strength of the offer overall.
Is the appraisal really a home inspection?
No, FHA loans do not require a separate home inspection. The appraisal verifies the home meets minimum property standards. Cosmetic flaws are OK, major issues are not. A property in good shape shouldn’t have problems passing.
How can I avoid problems with the FHA appraisal?
Get a pre-listing inspection done upfront to identify any deficiencies. Make necessary repairs before putting your home on the market. This prevents major issues from arising later in the FHA appraisal.
Do FHA loans fall through more often?
When done right, FHA loans have about the same closing rates as conventional mortgages. Work with an experienced real estate agent to ensure a smooth FHA transaction. Get your home in great shape before listing. This sets up FHA buyers for appraisal success.
The Bottom Line
While FHA loans present some disadvantages for sellers, they shouldn’t automatically be dismissed. Offer strength matters more than loan type.
As a seller, know the potential drawbacks to expect with FHA buyers. But also recognize when an FHA offer could be your best option in a given scenario.
FHA Underwriting Worries Some Sellers
One reason a seller might refuse your FHA-backed offer is that they believe the home sale may be more likely to fall through due to the FHA loan programâs more lenient underwriting requirements. Because FHA loans help low- to moderate-income borrowers with less-than-stellar credit become homeowners, sellers may feel that FHA buyers are less likely to be approved for a loan than conventional borrowers.
What sellers may forget to consider is that, as long as you have preapproval from a credible mortgage lender, that lender has already checked your credit score, verified your income, calculated your debt-to-income ratio (DTI) and approved you for a certain loan amount.
While initial approval doesnât guarantee final loan approval, FHA borrowers historically have a closing rate thatâs comparable to the closing rate for conventional borrowers. For example, according to an Ellie Mae Origination Insight Report from May 2019, 76% of all FHA purchase loans made it to closing within 90 days, compared to 77% of all conventional purchase loans.
In March 2021, another Ellie Mae Origination Insight Report revealed that FHA purchase loans had a closing rate of 77.2% compared to 78.6% for conventional purchase loans within a 90-day cycle.
FHA Appraisals Concern Sellers
Another concern sellers have with FHA mortgage loans is the FHA appraisal. Letâs take a look at how FHA appraisals compare to conventional appraisals:
- Conventional loans: Because the home serves as collateral for a conventional mortgage, the primary purpose of an appraisal is to determine that the fair market value of the home is not lower than the purchase price. This way, if a borrower defaults on their mortgage, the lender can sell the property, recoup their losses and not lose any money.
- FHA loans: In addition to determining the homeâs appraised value versus its market value, the FHA wants to ensure that the property is safe, secure and structurally sound. As such, an FHA appraiser inspects the home to make sure it meets a strict set of standards established by the United States Department of Housing and Urban Development (HUD). Weâll discuss these standards in more detail in the next section. There are health and safety standards for properties backed by conventional mortgages as well, but they arenât as thorough.