If you’re getting a home loan from the Federal Housing Administration (FHA), you’ll typically need to obtain an appraisal on the home. This appraisal is designed to ensure that the property is worth as much as it’s selling for; it’s also designed to determine whether the home is fit for occupancy, or whether repairs are required before a mortgage can be approved.
But how exactly does it work, and what does it mean for you, the homebuyer? We’ll go over the ins and outs of the FHA appraisal process. By the time you’re done, you’ll know everything you need to know, and you’ll be prepared to take the next step.
What Is An FHA Mortgage?
An FHA mortgage is a mortgage loan that’s insured by the Federal Housing Administration. By guaranteeing these loans, the FHA can improve homeownership opportunities for borrowers who don’t meet the financial requirements for a traditional mortgage.
Specifically, FHA-backed mortgages are available to individuals or couples with a FICO credit rating of at least 500. Borrowers also need to be able to come up with a down payment of at least 3.5%. The mortgage is provided by a traditional bank, but the FHA guarantees that they will reimburse the bank if the borrower defaults on their loan. As a result, banks are willing to provide mortgages to people who wouldn’t otherwise qualify. This isn’t just good for the new homeowners. Having more homeowners in the market is good for the entire economy.
One thing to keep in mind is that FHA loans have special requirements for borrowers who put down less than 10% as a down payment. For those individuals, you’ll be required to purchase mortgage insurance. This only makes sense; with a very small down payment, you represent a higher risk to the lender. On the plus side, you only need to keep paying for mortgage insurance until you’ve purchased 10% equity in the home. At that point, you’re free to drop the insurance.
This is actually more lenient than the rules for traditional mortgages. Private lenders will require mortgage insurance for anyone who puts down less than 20% in most cases.
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What Is An FHA Appraisal?
To ensure they’re providing a good return for tax dollars, the FHA wants to make sure they’re only guaranteeing homes worth the investment. This is not all that different from the requirements traditional lenders use for their loans.
To understand why, imagine this scenario. A homebuyer purchases a home for $200,000 without an appraisal. After six months, they lose their job and cannot continue making payments. Eventually, the bank repossesses the home, and tries to sell it to recoup their losses. Unfortunately, the original homebuyer had significantly overpaid, and the house will only sell for $150,000. All of a sudden, the bank is taking a loss.
Along the same lines, an appraisal is designed to ensure that the home is suitable for habitation. If the home is unsuitable, the homeowner may be forced to move out and default on their loan. This is even worse for the bank, because now they’re repossessing a home that requires repair before it can be resold.
An FHA appraisal must be performed by an FHA-approved appraiser, but other than that, it’s not all that different from an ordinary appraisal. The appraiser will evaluate the home’s features, square footage, condition, neighborhood, and other factors. After the appraisal is finished, they’ll provide you and the FHA with their estimate of the home’s fair market value. This isn’t just good for the bank and the FHA, by the way. It also helps you to ensure that you’re not overpaying for your new home.
FHA Appraisal Vs. Home Inspection
If you’re not intimately familiar with the home buying process, it can be easy to confuse an appraisal and a home inspection. The two terms sound similar, but they’re actually very different procedures.
FHA and conventional appraisals have two goals: determining the home’s fair market value and identifying any major safety defects. The primary purpose, though, is to help lenders ensure that they’re not taking on excessive risk. They’ll look at the home’s appraised value and the requested loan amount. They’ll calculate the borrower’s monthly payments, as well as the loan-to-value ratio. With all of that information, along with the borrower’s credit rating, the lender can easily determine how risky the loan is.
A home inspection is entirely different. An inspector will check for many of the safety issues an appraiser will, but they’ll look much deeper. They’ll try to identify any defects whatsoever. For example, if the roof is liable to need re-shingling in the next couple of years, they’ll point that out. Their job is not to determine the value of the property, nor to report to the lender. Their job is to ensure that prospective homebuyers are fully informed on the home’s condition.
What Types Of Homes Can Be Approved?
FHA loans are typically only available for people who are purchasing owner-occupied properties. They can’t be used to finance most investment properties since the FHA won’t guarantee a mortgage on a house that has been previously sold within the last 90 days.
Acceptable property types include:
Standalone single-family homes
Manufactured homes (trailers)
Assigning Value On A Home
An FHA appraiser’s primary job is to evaluate the fair market value of a particular home. This involves several different factors, and all of them need to be considered.
An appraiser will look at the home’s square footage and amenities, as well as the size of the lot. Then, they’ll choose a set of comparable properties in the area that have sold recently. The appraiser will account for any differences. For example, they may add value for a house with an extra bathroom and subtract value for a house with a smaller garage. After they’ve made their adjustments, they average out the value of the comps, and arrive at the appraised property’s fair market value.
The FHA appraiser’s secondary job is to perform a safety evaluation on the property. This serves two purposes. First, it alerts the bank and the prospective homeowner of conditions that may render the house unlivable. Secondly, it alerts them to issues that could cause problems in the future, should the homeowner need to sell or should the bank need to repossess.
During a normal safety evaluation, the FHA-approved appraiser will look for the following hazards:
Nearby power lines
Potential natural disasters
Other toxic substances
FHA Appraisal Guidelines
An FHA appraiser will be looking at many aspects of the property during the appraisal. Some things are related to the home’s value, while others are more related to its condition and safety. Let’s talk about some of the things they’re going to consider:
The building’s physical structure and condition:
The building’s livability:
The condition of the lot:
There must be no damage to the siding, foundation, or roof.
The house must be free of insect or rodent infestations.
There must be no loose or exposed wiring.
The utilities must be connected and in good working order, as must the heat.
There must be a connection to a sewer line or a sanitary well.
There must be no exposed lead paint.
The house must meet all fire codes and other applicable local safety codes.
There must be no contaminants in the soil.
There must be sufficient drainage to keep water away from the foundation.
The property itself must be safe to access.
After the appraisal, they’ll need to determine some comps, as well as cite other data. At minimum, they need to include:
Two comparable properties that have closed within the past 90 days
Three recent closures on the appraisal grid
Two currently-active listings on the appraisal grid
What Happens After An FHA Appraisal?
What happens next depends entirely on the results of the appraisal. If there are no safety hazards and the loan amount is reasonable for the appraised value, the lender will approve the loan, and the FHA will agree to back it. But what happens if there are issues? Let’s take a look.
If An Appraisal Comes Back Low
A low appraisal is one where the appraised value is less than the proposed sales price. In that case, the bank normally won’t approve the loan. However, there are a few things you can do about this:
The seller can challenge the appraisal, and provide reasons why they think their home is worth the asking price.
The buyer can challenge the appraisal.
Both parties can renegotiate for a sale at the appraised price.
The seller may offer to provide outside financing.
The buyer may purchase the house with cash.
If The Appraiser Requests Repairs
If the home requires repairs to meet health and safety standards, the lender may conditionally approve the loan. They will provide a list of required repairs to the seller, and if the seller makes those repairs, the loan will go through. If the seller opts not to make repairs, the loan will not be approved.
However, it’s usually in the seller’s best interest to make any repairs; more than likely, any future potential buyers will want those issues addressed before they buy!
How To Find FHA-Approved Homes
FHA loans are provided through the US Department of Housing and Urban Development (HUD). If you go to the HUD website, you’ll easily be able to find a list of homes in your area that are already FHA-approved. Of course, you can purchase just about any property with an FHA loan, but the website makes them easier to find.
As you can see, the FHA appraisal isn’t all that different from an ordinary appraisal. The main difference is that your new home is being appraised by an FHA-approved inspector, rather than one approved by a private bank. As long as you’re prepared for the results, you’ll be well on your way to owning your new home.
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