Flipped houses have a habit of catching buyers' attention. After all, they usually come along with the newest finishes. However, for buyers who are planning on using an FHA loan, purchasing one of these properties can be trickier than you might expect. With that in mind, we've laid out the FHA rules for flipped houses.
In this article we'll explore which regulations you need to keep in mind, why the FHA puts rules around house flipping in the first place, and what you can do to ensure that you're still able to buy the home of your dreams. Armed with the information in this article, you'll learn that it is possible to buy a flip with an FHA loan.
What is house flipping?
Above all, house flipping is a real estate investment strategy. In this case, instead of buying a property and renting it out long term, the investor buys the property, does renovations, and then puts it back on the market. The goal here is to invest in renovations that increase the value of the property so that it will sell for a profit.
It's also important to note that since owning a home costs money -- think mortgage payments, property taxes, and utilities -- flipped properties are generally only held by their investors for a short period of time. In fact, most investors try to do their renovations as quickly as possible to cut down on the total cost of carrying the property and increase their profit margins.
Why do buyers use FHA loans?
On the other end of the transaction, many buyers, especially first-time homebuyers, end up using FHA loans because they have easier qualifying standards. These loans are backed by the Federal Housing Administration (FHA), which means that they are guaranteed in the event that you default.
What surprises some buyers is that this insurance policy is there to protect the lender, not you, from taking a loss on the property. However, in exchange for the reassurance that the loan will be repaid, lenders are willing to soften their qualifying standards, which allows more people to become homeowners.
The FHA eligibility guidelines are as follows:
- Lower down payment options: FHA typically allows for down payments as low as 3.5%. On a conventional loan, the typical down payment falls between 5% and 20%.
- Relaxed credit score requirements: You can qualify for an FHA loan with a score as low as 500. Though, in order to make a 3.5% down payment, you need a score of 580. To qualify for a conventional loan, you would need a score of at least 620.
What are the FHA flipping rules?
Unfortunately, the FHA and its governing body, the Department of Housing and Urban Development (HUD), have put regulations in place to try and discourage its buyers from buying flipped properties with FHA loans. According to information on HUD's website, the organization believes that flipping "artificially inflates" the home's value.
In particular, HUD and FHA place limits on the amount of time that a seller must own the property before they can sell to a buyer using an FHA loan.
For properties owned for 90 days or less
This is what's known as the "FHA 90-day rule," and, unfortunately, it's pretty clear. A property that has been owned for 90 days or less cannot be sold to a buyer who is using an FHA loan. If the buyer needs to use an FHA loan to purchase the home, they must wait until the seller has owned the property for at least 91 days.
There also needs to be proof that this guideline is being followed. In particular, when working with an FHA loan, lenders need to hire an FHA appraiser. Part of what FHA appraisers look at when appraising the property is the last three years of the home's ownership. If the last recorded deed is fewer than 90 days away from the date of the purchase contract, the lender cannot fulfill the loan.
For properties owned between 91 and 180 days
That said, even if you wait for the 91 days to pass, there are still some added regulations you'll need to follow. In this case, it's important to look at how long the property has been owned and the price you've offered to pay for it.
According to FHA guidelines, if the property has only been owned for between 91 and 180 days, a second appraisal may be required. It will be deemed necessary if the resale price (the price you're paying) is 100% over the price that the seller paid when he or she first purchased the property.
For example, if the seller originally bought the home for $100,000 and sells it to you for $250,000 after doing some renovations, he or she will have sold the home for 150% over the price they paid for it. In that case, the FHA would require a second appraisal, which would include documentation to support the increased value of the home. If that appraisal comes back more than 5% lower than the first, it must be the one used for the home's fair market value.
Luckily, however, if a second appraisal is required, you won't have to pay for it. According to FHA regulations, the second appraisal must be paid for by the seller.
What do FHA appraisers look for when inspecting a flipped house?
If you're really concerned about the outcome of your appraisal, you can read the full list of FHA appraisal guidelines in HUD's single-family housing policy handbook. However, we should note that it's an incredibly dense document and not a very fun read. To make things easier, below is a selection of the top issues that FHA appraisers look for.
There cannot be any evidence of:
- Defective construction.
- A settling foundation.
- Leaks or unusual levels of dampness.
- Evidence of termites or other decay.
- Paint chipping or peeling.
- Obvious environmental hazards.
- Palpable odors or excessive noise.
Additionally, the following features must be present:
- The utilities -- including water, sewer, heat, and electricity -- must be turned on at the time of the inspection.
- Any and all appliances must be in working order.
- Both hot and cold water must be available, and the water pressure must be at acceptable levels.
- All electrical outlets and switches must be functioning properly.
- All windows must open, close, and lock.
- Any attic or crawl space must be undamaged and properly vented.
Exceptions to the FHA rules on flipped properties
Like with anything else, there are a few exceptions to the FHA rules regarding flipped houses. Before you worry about whether you'll be able to make your transaction work, check to make sure that your property does not fall under one of these categories:
- The property was found for you by your employer or through a relocation agency.
- The property is a resale by HUD under its real estate owned (REO) program.
- The property is being sold by another governmental agency.
- The property is being sold by a nonprofit approved to sell HUD-owned properties at a discount.
- The seller acquired the property through inheritance.
- The property is being sold by a state or federally chartered financial institution.
- The property is in a Presidentially Declared Major Disaster Areas (PDMDA) and an exception has been made by HUD.
The bottom line
Buying a flipped property with an FHA mortgage can be more difficult than it would be with a conventional loan, but it's not impossible. Ultimately, it's up to you and the seller if you want to tackle the extra regulations that must be met for these properties.
If you're concerned about how this loan and home combination might affect the strength of your offer, talk to your lender and real estate agent about what options are available to you. They may be able to come up with a solution that better serves your needs.