BROKER RISK MANAGEMENT
WEEKLY PRACTICE TIP
FHA Loans
Q: I am a listing agent on a single-family property. I received an offer from a buyer and I noticed that buyer indicated that buyer was applying for an FHA loan but, not knowing much about FHA loans, we did not counter that provision and now, in contract, we find out that buyer and the lender are expecting my seller to pay certain closing costs that would normally be buyer costs. The contract is not clear on this issue. What is going on here?
A: If a buyer is specifying that they are obtaining an FHA loan, sellers must be aware that seller may very well be obligated to pay some closing costs that normally would be paid by buyer. This is because of caps placed by FHA on the amount of closing costs that buyer can be responsible for if an FHA loan is made.
1. BACKGROUND: An FHA loan is a federal assistance mortgage loan insured by the Federal Housing Administration (“FHA”), and which is issued by federally-qualified lenders. So, the FHA does not make loans; it insures loans made by private lenders which meet the FHA guidelines.
There were not many FHA loans in California in the past because of the low loan limits on FHA loans and the high California home prices. But the loan limits on FHA loans have been raised considerably, to as high as $729,750 in more expensive areas (as of March, 2008, an increase to a minimum of $417,000, or 125% of median sales price, whichever is greater, with a cap of $729,750)
2. CRITERIA: Some of the FHA criteria are:
A. Mortgage insurance is funded into the loan
B. Allowable debt ratios are higher than for conventional loans
C. FHA repair requirements are more reasonable now than in the past
These loans allow down payments of as little as 3 percent on the first $25,000; 5 percent on the next $100,000; and 10 percent thereafter
Also, before a property can be approved for an FHA guarantee, an FHA-approved appraiser must make a comprehensive survey of the property’s physical condition.
3. BUYER ALLOWABLE CLOSING COSTS: FHA defines allowable closing costs that may be charged to the buyer. All other costs in the transaction are considered to be non-allowable and generally paid by the seller. Allowable costs which can be paid by buyer include:
A. Appraisal and inspection fees
B. Home inspection fees up to $200
C. Cost of credit reports
D. Lender origination fee (but not more than 1%)
E. Deposit verification fees
F. Cost of title insurance
G. Document preparation by a third party
H. Property survey
I.. Transfer stamps, recording fees and taxes
J. Test and certification fees
However, the specific costs and amounts that are deemed reasonable and customary are determined by each local FHA office.
4. SELLER CLOSING COSTS: According to the FHA, the seller (or other interested third parties such as real estate agents, builders, developers, etc., or a combination of parties) may contribute up to six percent of the sales price toward the buyer's actual closing costs, prepaid expenses, discount points, and other financing concessions. Some rules include:
A. Contributions exceeding six percent of the sales price (or exceeding the actual cost of prepaid expenses, discounts points, and other financing concessions) will be treated as inducements to purchase, thereby reducing the amount of the mortgage. Closing costs normally paid by the borrower are considered contributions if paid by the seller.
B. The six percent limitation also includes items such as seller payment for permanent and temporary interest rate buy-downs and other payment supplements; payments of mortgage interest (but not principal) for fixed rate mortgages and Graduated Payment Mortgages only; and mortgage payment protection insurance.
C. Fees typically paid by the seller under local or state law, or local custom, such as real estate commissions, charges for pest inspections, fees paid for trustees to release a deed of trust, etc., are not considered contributions
For more information on FHA rules for these loans visit:
http://www.hud.gov/offices/hsg/sfh/fharesourcectr.cfm
PRACTICE TIPS:
BUYER AGENTS:
1. If your buyer is planning to obtain an FHA loan, get the buyer approved for the loan and determine the amount that buyer will be allowed to contribute to the closing costs.
2. Use a purchase agreement or addendum that specifies which party will pay for which closing costs, and make sure that the allocation of costs in the purchase agreement reflects the allowable costs for your buyer under the FHA loan program, and also the costs for which seller will be responsible. Be as detailed as possible to avoid confusion later.
(See e.g., California Association of REALTORS® RPA Purchase Agreement paragraph 2.C (2) which allocates these costs.)
LISTING AGENTS:
1. Review each offer, on properties that are priced within the FHA guidelines for your area, to determine if buyer has specified that buyer will be obtaining an FHA loan. If so, your seller may likely be obligated to pay some closing costs not normally paid by sellers.
2. If not clear in the purchase agreement, contact the buyer agent to ascertain in writing the costs for which seller will be responsible.
3. Discuss with your seller whether seller is willing to be obligated to pay those closing costs over and above the normal seller closing costs for this type of property in your area. This may affect your seller’s decision as to the selling price.
4. If seller does agree to ratify the purchase agreement under those circumstances, make sure that the purchase agreement allocation of closing costs accurately reflects the costs that seller will be obligated to pay.
5. You may wish to state in the contract (counter-offer, e.g.) that this will be the limit of seller’s obligation so as to avoid a misunderstanding later.
Note that the CAR purchase agreement paragraph 2.C (2) contains blanks for caps on the amount that seller may be obligated to pay.
This Weekly Practice Tip is attorney-client privileged and for the exclusive use of clients of Broker Risk Management and their agents. It may not be reproduced or distributed without the express written consent of Broker Risk Management. The advice and recommendations contained herein are not necessarily indicative of standards of care in the industry, but rather are intended to suggest good risk management practices.
© Copyright Broker Risk Management 2008 09-19-08
