Want to buy an REO in San Jose with a FHA loan?

The San Jose real estate market is changing.  Even though the media hasn’t quite got it yet, there are changes that are making it very difficult for first time buyers to take advantage of the market.   The first challenge is that there exist a small number of homes for sale.  Don’t believe anyone that tells you there are a “bunch of” foreclosures to purchase.  That may be true in the Central Valley of California but it is not true in San Jose.   Inventory (number of homes for sale) has not been this low since June 2006.   Summer inventories are typically lower but this is a significant occurrence in light of the expectation that there should be a flood of foreclosure sales. Since May 2009, the number of homes listed for sale has dropped 18%.

Secondly, since May 2009, the average sales price for a home in San Jose has increased 20%.  Many claim that this is simply part of the “W” recovery. (Nope, that isn’t literally George W. Bush type of “dub-ya” recovery but an actual economic term.)  It is also referred to as a “false bottom” of the market.  Why false?  Because jobs are still being lost (sorta, numbers reported Friday stated even job loss was less).  Because the number of “notice of defaults” (known as NODs)  are still rising.  Yes, filings of NODs have increased but actual foreclosures are down.  The California government has a moratorium on foreclosures for 90-days that began on June 15, 2009.  Even after the federal moratorium was lifted in May 2009 there was a decline in new REO listings in the San Jose market.

fhacontractThird, buyers utilizing the FHA loan program have more hoops to jump through. FHA loans require as low as 3.5% down payment.  It is very attractive.  In the beginning of the foreclosure release market, many foreclosures were purchased with FHA loans.  But challenges came to light with this practice.

1.) Many FHA loans take longer than 30 days to close. A buyer can be charged a per diem fee, around $150 per day for every day past close date stated in the contract. The average time to close an FHA loan with underwriting and processing in house (within the lenders building walls) is 45 days.   REO sellers want their money ASAP.  They hate waiting on delayed loan approval.

2.) Many FHA loans require two appraisals. If the loan amount is greater than $417,000 and the buyer is placing less than 5% down, two appraisals are required.  With the new HVCC appraisal process the time line for obtaining an appraisal and the success of accurately valuing the home is another potential time delay.   HVCC is not specific to FHA loans but certainly adds to the challenges of managing an FHA loan time line.

3.) Many FHA loans will come with conditions for repairs. Most commonly, section 1 work called out by a pest inspector.  Section 1 work is any “active infestation” of the wood in the home.  FHA can make repairing all section 1 work called out in the inspection a “condition” of funding the loan.

In response to these challenges, many REO sellers would prefer non- FHA offers.  Not that they will not accept and FHA offer but they will certainly take a conventional loan or all cash above an FHA offer if offer price is equal or close to equal.  Which can push the FHA buyer to write higher priced offers.  Which almost always leads to appraisal issues. 

Each REO listing agent offers instructions for the buyer’s agent on how to write an offer on a foreclosure/REO.  These instructions have continued to evolve with the market.  REO sellers prefer “direct lenders” like Bank of America, Wells Fargo, and the like over brokered loans.  Recently, I am coming across more and more challenging requirements related to the FHA loan on REO listings.  Here is an example of a listing agent’s instruction for any buyer considering writing an offer on their REO listings.

*If your buyer is using FHA financing, this MUST reflect in the purchase contract and be sent with the following:
1) Lender Approval
2) Underwriters Approval – must show loan conditions.
3) Proof of Funds

To obtain loan conditions, an accepted offer is forwarded to the lender, the file reviewed by the underwriter, the appraisal complete, and the conditions to funding the loan identified by the underwriter.  That is loan approval.  Once all conditions are met, the underwriter approves the loan for funding.  A “condition” could be something like “verification of employment on day of funding” or “work completion for all section 1 items called on pest inspection report”.  Although it is not impossible to have the underwriter’s conditions for the loan prior to having a ratified contract it is certainly more challenging.  A “conditional approval”  typically takes lower priority on the underwriter’s desk. This presents a timing challenge as many REO homes have multiple offers within days.  It would be best if  a buyer utilizing and FHA loan obtained the pre-conditional approval before shopping for a foreclosure home.  This would definitely make their offer stronger.

If you are going to write an offer using an FHA loan be aware of the requirements from the seller, learn about the FHA 203K loan program to help with repairs, and work with only an experienced direct lender for FHA loans.  It is more difficult with the changing rules but being informed regarding these changes might help you loosen the contraints of buying your first home.