When you're selling a home or investment property, it's possible to have different types of buyers: all-cash buyers, buyers who will get a conventional mortgage, and buyers who will use a Federal Housing Administration, or FHA, mortgage loan, which is insured by the federal government.
Cash buyers often don't get the property appraised at all; they typically have a good idea of the investment's worth. But mortgage lenders require appraisals. The Department of Housing and Urban Development (HUD), which sets standards for FHA loans, also requires appraisals, which are more rigorous than what a conventional mortgage lender requires.
What are the requirements for an FHA appraisal?
HUD sets the appraisal requirements for approval for an FHA loan. All homes that are approved must meet "minimum property requirements," as determined by HUD. New construction, which is defined by HUD as homes less than a year old, must also be appraised and must meet HUD's "minimum property standards."
An FHA appraisal differs from an appraisal with a conventional loan. With conventional loans, the appraiser is determining the value of the property only, whereas with an FHA appraisal, the home must meet health and safety standards as well.
As with most appraisals, the appraiser determines whether the home is in livable condition, structurally sound, and worth the price the buyer has offered to pay. And as with any appraisal, the appraiser looks at comparable properties (comps) to determine value and should visit the property to evaluate the home's condition.
How an FHA appraisal differs from a regular appraisal
If an FHA appraisal reveals problems with a home the FHA appraiser determines are safety concerns, these need to be fixed before the loan can be granted.
An FHA appraisal requirement might include something like "loose stair railings need to be fixed," for instance. So the loan process is put on hold until the seller addresses the issues in the appraisal report. This doesn't happen with a conventional loan.
Additional requirements for FHA loans
The list below contains the most common FHA appraisal requirements, but there are more, which you can find by visiting HUD.gov and reading the FHA Single Family Housing Policy Handbook, also called Handbook 4000.1. If anything is amiss with the home or the appraiser deems something a health or safety hazard, the appraiser will mark the home "subject to repair."
The following are issues an FHA appraiser looks for:
- There should be no potential hazards for residents of the house.
- The lot should be graded so water does not run toward the home's foundation or basement.
- To be called a bedroom, the room must have an egress window (which a person can fit through to get outside) in case of fire.
- There can be no peeling or chipped paint. This is particularly important for homes built prior to 1978 because of potential lead-based paint, in which case a remediation company should probably be used.
- There must be handrails on all stairways.
- There must be heat.
- There can be no cracked windows.
- The floors and countertops must be in good shape.
- The roof needs to be in good enough shape to last for at least the next two years. It specifically needs to keep water out, and there can be no more than three roofing layers; otherwise, a new roof must be put on.
- The foundation needs to be sound.
- Walkways cannot be cracked or likely to cause someone to fall.
- There can be no major plumbing issues.
- There can be no exposed wiring.
- There can be no rotting wood.
- The exterior doors must lock.
- The basement or crawl space cannot be wet.
What type of appraisers can do FHA appraisals?
Appraisers must be qualified to conduct FHA appraisals. The FHA maintains a list of approved appraisers on the HUD website. The appraiser must be on this list for the appraisal to be valid for an FHA loan.
The appraiser must be state-certified, with credentials based on licensing or certification criteria. Appraisers also must be knowledgeable about the Uniform Standards of Professional Appraisal Practice (USPAP) and FHA appraisal requirements, as well as understand the local market.
What it means when your buyer has an FHA loan
If your buyer has an FHA loan, they must use an FHA-approved appraiser to assess the property. If the appraiser determines repairs are needed, there needs to be a discussion about how they will be handled. For example, the seller can make the repairs, the seller can lower the sales price so the buyer can make the repairs after closing, there can be a compromise where the seller makes some repairs and the buyer will make some, or the buyer can walk away.
If you decide on seller concessions (effectively lowering the home's purchase price), you'll place the amount of money needed for the repairs (not much more than $1,000) in an escrow account, called an "escrow holdback." In this case, the escrow officer pays the contractors from the money in the escrow account.
If the cost of repairs is extensive, maxing out at $35,000, the buyer might be interested in an FHA 203(k) loan, which can finance the purchase and repairs. There are two types of 203k loans: the Limited and the Standard.
“The Limited 203k has a max of $35,000 for renovation loan costs, but the Standard, which has been around since the early 1970s, allows for renovation loan costs to go as high as the maximum FHA loan limit for the county where the property is located. In some areas, that is up to $1.4 million,” says Paul Welden, director of the 203k Contractor Certification Program.
How to prepare your home
To prepare for buyers who will purchase your home using an FHA loan, focus on the following home issues to make sure your property passes inspection:
- HVAC system
- Lot grading
- Crawl space
What this means for you
If you're selling a property, you want the potential pool of buyers to be as big as possible, and many potential buyers might be using an FHA loan. In 2018, 12.1% of mortgage loans were FHA-insured. Therefore, it would be wise for you to get your property in condition to pass an FHA appraisal. Otherwise, the deal might fall through, and that can be frustrating for everyone involved.
The bottom line
You might think the FHA appraisal guidelines are too strict, but an FHA-insured loan makes it possible for more people to qualify for a mortgage. The requirements for an FHA borrower help ensure the loan is a sound investment. It's true you may need to fix up your property more than you planned, but in the end, that's a good thing. Your property will be more marketable and likely to sell for top dollar.