FHA loans provide people a financing option to buy homes, even if they have less than stellar credit and don’t have a 20% down payment. There are many requirements you need to meet in order to get your FHA loan approved. As such, a massive pool of potential FHA buyers exists in the United States. This leads many investors who want to sell to this population to ask, what are the FHA requirements on house’s condition?
For FHA loans, an FHA appraiser conducts an inspection of the property. This inspection does not go to the level of detail as a professional home inspection. Instead, the FHA appraiser needs to confirm that the general condition of the home meets basic standards of habitability and functionality.
In the following article, I’ll go into some more detail on FHA house condition requirements and associated investor considerations. Specifically, I’ll cover each of the following topics:
- What are FHA Loans
- What are the FHA Requirements on House Condition
- What are the Differences Between FHA Appraisal and Home Inspection
- Investment Strategies to Meet FHA Condition Requirements
- Final Thoughts
What are FHA Loans?
The FHA, or Federal Housing Administration, is a government agency that provides mortgage insurance throughout the United States. As a mortgage insurer, the FHA doesn’t actually lend to home buyers. Rather, the organization insurers a large number of FHA-approved lenders.
Backed by this insurance, these lenders face significantly less risk. If a borrower defaults, the FHA will protect the lender up to a certain guaranteed amount. Due to this reduced risk, FHA-insured lenders provide loans to borrowers with both lower credit scores and down payments less than 20%. In this capacity, the FHA enables mortgages for millions of home buyers who wouldn’t otherwise qualify for financing.
Why’s this important to investors?
As fix & flip investors, profit depends on actually selling a renovated property. As such, you want to make sure that your property meets FHA lending qualifications. If not, you’ll massively limit your pool of potential buyers—hardly a good idea when trying to sell a property.
What are the FHA Requirements on House Condition
While the FHA imposes a variety of conditions on approved transactions, one of the most relevant to investors involves the actual condition of the property. More precisely, the FHA mandates baseline levels of habitability and functionality in homes before actually approving a loan.
For investors looking to buy properties, this means that you likely cannot use FHA-backed financing to purchase a distressed property to rehab, as it won’t meet these baseline standards. For investors looking to sell properties, it means that you’ll want to make sure your property meets FHA requirements prior to listing it, otherwise you’ll prevent the whole population of FHA-backed buyers from qualifying for financing on your property.
Okay, so what condition does a property actually need to be in to meet FHA requirements?
As stated, the FHA wants a baseline level of habitability and functionality in homes. The organization exists to promote home ownership, not investing. As such, it wants to support buyers looking for a primary residence—not an investment property to fix & flip.
From a practical perspective, the FHA confirms house conditions by sending an FHA-approved appraiser to a property prior to approving a loan. Typically, an appraiser solely focuses on property valuations. While this means getting a baseline understanding of property condition, it really focuses on assessing the subject property relative to market comps to confirm an accurate valuation.
FHA appraisers, on the other hand, conduct more of an “inspection, light.” Yes, they fulfill the valuation responsibilities of an appraiser. But, they also inspect the general condition of the home to make sure it meets FHA standards. While not an all-inclusive list, here are some of the major items these appraisers look for:
- Roof: Is it in decent condition with at least five years of remaining life?
- Wood/earth contact: Do any wooden portions of the house have direct contact with the earth? This can lead to significant water and termite damage, meaning appraisers may deem the property below standard.
- Grade: If the surrounding grade slopes towards the house, the potential for flooding exists.
- Cover plates: Do electric outlets all have cover plates? If not, significant electrical hazards exist, suggesting a house is unsafe.
- Appliances: Are they functioning and in generally good condition? Of note, appliances do not need to be brand new, but they do need to be in good condition.
- Kitchen: As with appliances, in general, the kitchen doesn’t need to be brand new, but it does need to be functional. A house cannot very well be occupied if the residents can’t actually cook there.
While the FHA appraiser will review all of the above, he or she will just do quick, visual inspections—not deep dives.
What are the Differences Between FHA Appraisal and Home Inspection
As outlined above, the FHA appraiser does not do a comprehensive inspection of a property. For this, you still need to rely on a professional home inspector.
Consequently, if you’re an investor looking to buy a property with FHA financing (which you certainly can; it just can’t be a distressed property), you should also hire a professional home inspector for due diligence purposes. While FHA appraisers complete surface-level inspections, they often won’t uncover potentially major items an inspector will.
For example, an FHA appraiser will likely look at the roof from ground level to get a general feel for its current condition. An inspector, on the other hand, will often get onto the roof to do a deep-dive inspection of its current condition.
Investors need to understand this distinction. For due diligence purposes, if you’re using FHA-backed financing to purchase a property, make sure you hire a professional home inspector. And for new investors, I highly recommend asking this inspector if you can follow him or her around during the inspection. This serves as an outstanding opportunity to A) learn about the specific property, and B) learn about home maintenance items, in general.
With experienced investors, you can often bypass the expense of hiring a home inspector by just having your general contractor do a walkthrough of a property you’re considering. But, this depends upon an established relationship and a significant amount of trust.
Investment Strategies to Meet FHA Condition Requirements
Okay, if I want to fix & flip properties, how should I approach FHA requirements on house condition?
As outlined above, investors need to understand that they will not qualify for FHA-backed financing for most distressed rehab properties that support a profitable fix & flip budget. Having said that, here’s the approach I use:
Step 1: If you don’t have enough cash on hand, use a hard money loan to purchase a distressed property to rehab. Hard money lenders don’t care about how a property looks now, they only care about what the value will be following the renovation. In other words, hard money lenders view a property for its potential, not its current condition.
Step 2: Renovate the property to a standard that will meet FHA house condition requirements.
Step 3: List the property with the confidence that home buyers using FHA-backed loans will qualify for the property, as FHA appraisers will approve the post-rehab home condition.
Investors shouldn’t view FHA house condition requirements as an insurmountable obstacle. Rather, by understanding how this appraisal/inspection process works, you can craft an investment strategy that allows you to A) buy distressed homes, B) rehab them to FHA condition requirements, and C) sell them to the entire pool of FHA-approved buyers.