Home Flippers are 'Flipping' Over New FHA Rules
Friday, January 22, 2010 | Ethan RobertsRating:
Attention short-term real estate investors:I have great news for you today!!!
They say that time heals all wounds. And in matters of the heart, it is often said that absence makes the heart grow fonder.
Nowhere is this more true than in the Federal Housing Authority's (FHA) decision last week to relax the "90-day rule" for real estate property flippers.
The 90-day rule states that a borrower taking an FHA loan cannot sign a contract on a home that another individual has only owned for 90 days or less.
I guess that the FHA was missing the flippers -- those "red-headed stepchildren" of the real estate market -- who have been quietly laying low, perhaps even underground, since the FHA imposed strict rules against them in 2003.
Of course, a declining housing market had a lot to do with their disappearance as well.
What's in it for the Government?
By modifying the existing 90-day rule, the FHA is also hoping to be able to unload more of its own foreclosures more quickly. It hopes the relaxing of the rule will motivate more investors to help whittle down the large inventory of HUD homes on the market.
But like former lovers who haven't seen each other in a while, each side has forgotten the bad about the other and remembers only the beautiful romantic moments that they shared together. ...
FHA rep and a real-estate flipper share a moment together...
A little history is in order. (Sorry folks -- no time machine this week. It's in the repair shop.)
At one time an investor could buy a foreclosure, either from the bank or at an auction, and then re-sell it to someone else for a much-higher price.
Sometimes the investor might spruce the home up a little, adding fresh paint or new carpet or perhaps a few ceiling fans, and try to double or triple their money.
In theory, there is really nothing wrong with this practice. People do it all the time with cars, boats or antiques they buy cheaply at garage sales.
A dab of Gorilla Glue here, and a little spit and polish there, and you can make yourself a fast buck.
Hey, this is still a capitalist country, isn't it?
(At least, it is this week!)
How the 'Flip' Turned to 'Flop'
The problem with home-flipping was that some of the flippers were not content with their quick profit -- they decided to get greedy and commit a little fraud as well.
Some of them hooked up with other unscrupulous types in the mortgage and appraisal industries, and they really went to town.
Homes that were purchased for as little as $30,000 in my area, were resold for three or four times the price, with nothing more done than cosmetic enhancements.
Naive first-time buyers were fraudulently assured they did not need home inspections, and so they often ended up buying homes with beautiful new paint ... along with a leaky roof and subpar plumbing system.
Appraisers on these deals stretched the values as far as they could, and the mortgage lenders (often recommended to the unsuspecting buyer by the seller) gave the buyer whatever kind of dumb and dopey loan they could to keep the monthly payment low.
Yes, these buyers should have done their homework to be more-astute, but they didn't.
And, well, you know the rest of that story.
FHA to the Rescue
In 2003, the FHA -- in an effort to protect the naive consumers -- decided to put a big damper on the flipping party by enacting new rules, such as:
At one time an investor could buy a foreclosure, either from the bank or at an auction, and then re-sell it to someone else for a much-higher price.
Sometimes the investor might spruce the home up a little, adding fresh paint or new carpet or perhaps a few ceiling fans, and try to double or triple their money.
In theory, there is really nothing wrong with this practice. People do it all the time with cars, boats or antiques they buy cheaply at garage sales.
A dab of Gorilla Glue here, and a little spit and polish there, and you can make yourself a fast buck.
Hey, this is still a capitalist country, isn't it?
(At least, it is this week!)
How the 'Flip' Turned to 'Flop'
The problem with home-flipping was that some of the flippers were not content with their quick profit -- they decided to get greedy and commit a little fraud as well.
Some of them hooked up with other unscrupulous types in the mortgage and appraisal industries, and they really went to town.
Homes that were purchased for as little as $30,000 in my area, were resold for three or four times the price, with nothing more done than cosmetic enhancements.
Naive first-time buyers were fraudulently assured they did not need home inspections, and so they often ended up buying homes with beautiful new paint ... along with a leaky roof and subpar plumbing system.
Appraisers on these deals stretched the values as far as they could, and the mortgage lenders (often recommended to the unsuspecting buyer by the seller) gave the buyer whatever kind of dumb and dopey loan they could to keep the monthly payment low.
Yes, these buyers should have done their homework to be more-astute, but they didn't.
And, well, you know the rest of that story.
FHA to the Rescue
In 2003, the FHA -- in an effort to protect the naive consumers -- decided to put a big damper on the flipping party by enacting new rules, such as:
1) Sellers must wait three months from the day they close on a property until the day they write a contract with buyers who are taking FHA loans.
There really was no particular logic to this rule, other than the FHA seeking to discourage flippers who were looking to flip homes they bought within a few weeks.
2) If the sales price is greater than double what the flipper paid for the home, a second appraisal is necessary, and must be done by a different appraiser than the one who performed the first one.
There really was no particular logic to this rule, other than the FHA seeking to discourage flippers who were looking to flip homes they bought within a few weeks.
2) If the sales price is greater than double what the flipper paid for the home, a second appraisal is necessary, and must be done by a different appraiser than the one who performed the first one.
FHA employee wearing his favorite T-shirt in 2003...
But now we are in 2010, and these are different times.
Flippers are not as abundant in numbers, tougher lending and appraisal standards rule the day and, oh yeah, the FHA is painfully aware that the real estate market can't get out of its own way.
So, it's time for investors and the FHA to kiss and make up!
Therefore, the FHA announced that, on Feb. 1, it will place a one-year moratorium on the anti-flipping rule, which will allow buyers with FHA-backed loans to purchase homes that have been held for less than 90 days.
This is a great benefit for real estate investors and should spur a renewed interest in flipping homes.
But is there really an advantage for buyers with FHA loans, who currently make up the largest percentage of new purchasers?
Well, it does give the homebuyer more homes to choose from, and perhaps an ability to snare a decently priced home.
That's because, along with the new relaxed rule, there is also this cute little string attached:
"The seller's profit is limited to 20 percent above the purchase cost, unless an independent appraiser confirms that renovations and repairs justify the higher price."
In addition, the buyer is now REQUIRED to get a home inspection on any home purchased that is more than 20 percent higher than the investor's purchase price.
As Ronald Reagan quipped to Jimmy Carter in their 1980 debate, "There you go again."
Reagan and Carter shake hands after their debate...
Now, this is where it starts to gets nutsy.
If you buy a house for $30,000, a 20 percent profit limit means you can only re-sell it for $36,000. By the time the seller pays closing costs and Uncle Sam takes his cut, it's almost not worth doing.
But buy a house for $300,000, and the 20 percent profit on a flip is $60,000.
Remember that Congress raised the limits on FHA loans last year, and while some places like Alabama have loan limits of just $271,000, in parts of California those limits exceed $700,000!
OK, but what if the flipper does some renovations? Just how much is a fresh coat of paint and new carpet worth?
One appraiser may say $4,000, while another appraiser gives the seller $7,000, regardless of the actual cost. Does adding a few cosmetic enhancements justify a 30 percent profit margin?
Then how about 40 percent or 50 percent?
Remember that appraisals are more art than science, and that appraisers always have a range of values that they can ascribe to any particular improvement on a home.
So, this new rule is apt to make things quite confusing for both buyers and sellers. One thing we do not need is inconsistency from the FHA at this point.
FHA Giveth and FHA Taketh Away
Given the news about relaxing standards with flipping, it was kind of surprising this week to see that FHA is getting set to raise its fees on Mortgage Insurance Premium (MIP) from 1.75 percent of the loan amount, to 2.25 percent.
The FHA is also planning to ask Congress to increase the maximum annual premium that it is allowed to charge.
So, for example, on a $100,000 loan, the borrower will now have to pay a fee of $2,250, instead of $1,750.
Considering that the FHA raised the minimum down-payment from 3 percent to 3.5 percent last year, this will further burden the very population that FHA is designed to help: the lower-income homebuyer.
True, the MIP can be rolled into the loan amount. But increasing the total monthly payment for borrowers with the smallest incomes and the lowest credit scores will not help cure the default rate.
The FHA is taking this action because of rising default numbers, which right now is above 18 percent, so it is understandable that it needs to do something to pump up its revenue to continue insuring loans. (Remember, the FHA insures, but does not make loans.)
But it's just curious to me that -- at the same time they relax the standards against property flippers -- they turn around and penalize first-time homebuyers by tightening their standards.
So if you have been thinking about buying a property to flip, now is the time to take action, as the FHA has just given you a present!
But if you are planning on buying that flipped home, or any other home, with an FHA loan, then you'd better dig down deeper to pay more in down-payment and MIP fees.
Tycoon readers, thank you for some really outstanding comments last week. So, what do you think of these new FHA measures? Let's hear what you are thinking!
See you next week!
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Ethan Roberts
Contributing Editor
The Tycoon Report
