This is part of an ongoing series where we answer frequently asked questions about FHA loans. Today’s question comes from Tammy in Tennessee, who had concerns about using this type of mortgage when buying a home.
She asks: “Why would a seller not want or accept an FHA loan when an offer is made on the house? Are there legitimate disadvantages to the seller with this mortgage program?”
The short answer: It is true that some sellers are wary of accepting offers from home buyers using FHA loans. Sometimes these reservations are passed along from the real estate listing agent. In some cases, there might be legitimate reasons why a seller would not want to work with an FHA borrower. But more often than not, these concerns are unfounded and unnecessary.
Why a Seller Might Not Want Offers with FHA Loans
The truth is, many of these seller fears and concerns are overblown. FHA loans are widely used these days, particularly among first-time home buyers who can’t afford a large down payment. It would be foolish for a seller to disregard all offers from borrowers who use this program.
Whether they are justified or not, there are two primary reasons why a seller might not want to accept an FHA loan offer from a buyer:
- Underwriting concerns. Some sellers believe that FHA loans are more likely to fall through during the underwriting stage, since the program attracts borrowers with lower credit scores and other issues. But the data don’t support this notion.
- Appraisal and inspection concerns. An FHA home appraisal is different from one where a conventional loan is being used, because it includes a property evaluation. FHA-approved home appraisers will determine the value of the property, but they also must ensure that it meets HUD requirements for health and safety. Some sellers fear that their homes will not pass this review process, so they see an FHA loan as a disadvantage to them.
Concerns That the Loan Will ‘Fall Through’ in Underwriting
It’s true that the average credit score used for an FHA loan is lower than the average among borrowers who use conventional mortgage loans. In fact, this program is often used as a fallback for people who cannot qualify for conventional mortgage loans.
But that doesn’t necessarily mean these loans have a higher rate of denial or rejection during the underwriting stage. Actually, once an FHA borrower clears the first hurdle of mortgage pre-approval, there is a very good chance that the loan will close.
Don’t take my word for it, let’s look at some data on the subject.
According to the latest “Origination Insight Report” from Ellie Mae (a mortgage software company), FHA and conventional purchase loans have a similar rate of success.
- According to the company’s data, around 73% of FHA purchase loans successfully closed within 90 days.
- By comparison, around 76% of conventional purchase loans successfully closed during that same timeframe.
These figures were for the month of June 2017. There were some months where the closing rate between FHA and conventional purchase loans was nearly identical.
This shows that FHA loans have an undeserved and unwarranted reputation for “falling through” during the underwriting stage. Issues can arise during underwriting with both of these mortgage options. But it’s not a very common scenario. In most cases (more than 70% of the time) loans that were originated went on to close successfully within 90 days.
Underwriting concerns are one reason why a seller might not want to accept offers from an FHA borrower. But this is often a perceived disadvantage of FHA loans that doesn’t reflect reality. There are other concerns among sellers as well, and the home appraisal is one of them.
Seller Concerns Over Home Appraisals and Inspections
As we’ve written before, the FHA home appraisal process is slightly different from the process used for a conventional mortgage.
With a conventional loan, the home appraiser is entirely focused on determining the value of the property.
When an FHA home loan is being used, the appraiser must determine the market value of the home being purchased. But he will also review the property to make sure it meets the minimum requirements set forth by the Department of Housing and Urban Development. This is not a full-blown home inspection. But it does go a step further than regular appraisals for a conventional loan.
This is another perceived disadvantage of FHA loans for sellers. Some sellers try to avoid borrowers who use this mortgage program because they feel their homes will not pass the appraisal process.
There is actually some merit to this particular concern. Depending on the type of property being used — and its overall condition — an FHA home appraisal could potentially uncover issues that present an obstacle for both the buyer and seller. This is especially true for properties that are in a state of disrepair, or have significant safety issues.
When it comes to home appraisals, FHA guidelines and requirements are primarily focused on the health and safety of the occupant. For example, all bedrooms must have a window that allows egress in the event of a fire or other emergency. Most homes today meet this requirement, so it’s usually not an issue.
But there are some houses out there that have no bedroom windows, or windows that are too small to serve as an egress. So that would become an issue if the home buyer was using an FHA loan.
That’s just one example of an appraisal issue that could prevent the loan from closing.
FHA Loans Have Government Involvement (Red Tape)
With a conventional mortgage loan, the government is not directly involved in the appraisal, underwriting or loan approval process. Even if the loan is insured, it is done through a private-sector company (hence the term “private mortgage insurance”).
But with an FHA loan, the government is more involved because they insure the lender against default-related financial losses. So it’s the government — and specifically HUD — that establishes all guidelines for home appraisals, property requirements, and mortgage underwriting.
And let’s be honest. The federal government does not have a reputation for efficiency. There tends to be more “red tape” involved with an FHA loan. This is why some sellers do not want FHA loan offers from home buyers. They sometimes view the government’s involvement as a disadvantage to them.
As we have discussed, these fears and concerns are often overblown and unwarranted. FHA loans have a similar closing success rate as their conventional counterparts. And the property evaluation part of the home appraisal is mostly focused on health and safety issues. If a home is in generally good repair and presents no safety hazard to the homeowner, it should be able to clear the FHA appraisal process.
But there are situations where an FHA loan could actually be a disadvantage to the seller. This is especially true if a person is selling a house that has a lot of issues, such as peeling paint, damaged stairs, or other items in disrepair. In such cases, the Department of Housing and Urban Development might not allow the loan to close or be funded.
Read: 7 things sellers ask about this program
Bottom Line: Use the Program That Works for You
This article is not meant to discourage future home buyers from using FHA loans. On the contrary, our purpose is to debunk some common myths and misconceptions regarding this program.
Our advice is to choose the kind of mortgage loan that works best for your particular situation. If one seller does not accept your offer because you’re using an FHA loan, you can be reasonably sure that another seller will. A qualified borrower is a qualified borrower – regardless of what kind of mortgage loan they are using.