Federal Housing Administration loans are one of the most popular methods of financing a home purchase. Whether it is an FHA loan or a conventional loan, though, an appraisal of the property will have to be performed. Out of all the events in the purchase transaction that can go wrong, more often than not it is the appraisal that sends the buyer and seller back to the bargaining table.
The Federal Housing Administration, part of the U.S Department of Housing and Urban Development, has been around since 1934. FHA does not lend money; instead, it insures mortgages from approved lending institutions.
FHA-backed mortgages are attractive to homebuyers because of the ease of qualification. Because the lender is assured of receiving its money should the buyer default, the qualification process is a bit more relaxed than that of a conventional mortgage. Other benefits include an opportunity to pay a lower down payment; FHA offers a 3 percent down payment program, and the money for the down payment can come from a number of sources not allowed with a conventional loan.
The Purpose of an Appraisal
Once your new home has been chosen and it's under contract, the lender will order an appraisal. An appraisal is a method of determining the value of a house. FHA will not insure a loan on a house that isn't worth what the buyer is borrowing. This is to ensure that if the borrower were to stop making payments on the home and the lender were forced to foreclose, there would be enough equity in the home to repay the lender.
FHA also specifies certain property requirements that must be met prior to the home's passing its appraisal process.
FHA Property Requirements
Although HUD urges borrowers to obtain an independent home inspection prior to purchasing the house, there are specific FHA minimum standards for the property. First, the home must not have anything wrong with it that would "threaten the safety and well-being of the occupants," according to HUD. Each bedroom is required to have a closet, and all stairs must have handrails.
Only appraisals performed by FHA-approved appraisers are accepted. First, the appraiser will look at the home to determine whether there are any health or safety problems and any items that will need to be repaired. Items that FHA will order repaired include inadequate "access/egress" from the bedrooms to the exterior of the home. Leaking roofs will need to be repaired. If there is any evidence of a structural problem, such as foundation damage, that will need to be repaired before FHA will insure the loan on the house.
Next, the appraiser will determine the value of the property. To do this he will compare it to between three and five comparable properties, within a one-mile radius, that have recently sold. Based on differences in age, size, condition, etc., the appraiser will make adjustments to the sales prices, finally determining the value of the home.
What If the Home Doesn't Appraise?
If the appraised value of the home turns out to be less than the buyer has agreed to pay, the parties to the sale will have to renegotiate the contract. This usually results in the seller reducing the price of the home to meet the appraised value.
- Daniel Wildman/sxc.hu, Sufi Nawaz/sxc.hu, Mark Sigurd Decroos/sxc.hu, Aleš Čerin/sxc.hu