What San Diego Real Estate Investors Should Know About FHA Loan Rules

Legal News GavelAuthor: Staff

House flipping,” which is the process of purchasing a residential property, making improvements to it, and selling it, has been particularly popular in recent years among real estate investors in California and around the country. It often involves purchasing distressed properties, such as those that are already in, or at imminent risk of, foreclosure. Investors can therefore purchase a property well below its market value, and with a bit of work—new coats of paint, new appliances, and such—sell it for a considerably greater amount. House flipping can be subject to legal restrictions, however, including local land use ordinances and lending regulations. The Federal Housing Administration (FHA), among other functions, insures many home mortgage loans. It also sets restrictions on residential properties when its mortgages are involved. These restrictions can affect house flippers who intend to sell to a buyer who needs an FHA-insured loan.

What Is the FHA?

Congress created the FHA when it enacted the National Housing Act of 1934, which was part of the New Deal during the Great Depression. The economic conditions of the time limited lending and kept home ownership out of reach for most Americans. By providing insurance for home mortgages, the FHA encouraged lenders to offer better terms for home buyers. This eventually helped spur massive increases in home construction after World War II, continuing through the 1970s. The FHA further states that its programs helped stabilize home prices during the recession of the early 1980s.

FHA-insured loans benefit people who might not qualify for other mortgage loans because of factors like income or credit. These loans, which can only be issued by lenders that meet FHA qualifications, can be available at substantial loan-to-value ratios, and with comparatively low interest rates.

FHA Resale Rules

The FHA’s Single Family Housing Policy Handbook 4000.1, commonly known as the “SF Handbook,” contains its restrictions regarding sales of homes by house flippers in § II(A)(1)(b)(3). It describes the practice of house flipping in unflattering terms, stating that it “is indicative of a practice whereby recently acquired Property is resold for a considerable profit with an artificially inflated value.” It is unfortunate that the government seems to view this practice–which improves neighborhoods–as something less than admirable.

The rule focuses on two aspects of house flipping:  the short period of time that often passes between the house flipper’s purchase and sale of a property, and the difference between the amount paid by the house flipper and the amount paid by the subsequent buyer. It restricts the ability of a real estate buyer to obtain an FHA-insured loan, therefore affecting the house flipper’s ability to sell the property. The two main restrictions are:

– A property is ineligible for an FHA loan if fewer than 90 days will have passed between (1) the date that the seller—i.e., the house flipper—obtained title to the property, and (2) the date that the buyer and seller close on the sale.
– If closing occurs between 91 and 180 days after the house flipper purchased the property, and the purchase price is equal to or greater than the amount paid by the house flipper, the buyer/borrower must obtain a second appraisal. This is in addition to the appraisal required for all FHA loans. If the value shown in the second appraisal is over five percent lower than that of the first appraisal, the lower value takes precedence.

Exceptions to this rule may apply, and the FHA has relaxed or even waived these restrictions in the past.

More Blog Posts:

House Flipping for California Real Estate Investors: A Legal Checklist, Titles and Deeds, May 12, 2018

Trends in San Diego Residential Real Estate Present Opportunities for Investors, Titles and Deeds, November 21, 2017

What San Diego Real Estate Investors Should Know About House Flipping, Titles and Deeds, November 13, 2017