FHA Loans for Real Estate Investors?

Look no further than the FHA mortgage program if you want to see the benefit of soaring home values. The FHA’s 2021 results are nothing short of remarkable, a situation that raises a question: Isn’t it time to open the FHA program to real estate investors?

Founded in 1934 under Franklin Roosevelt as part of the effort to fight the Depression, the Federal Housing Administration has insured nearly 44 million individual mortgages as well as 50,000 multifamily loans. Today, the program allows borrowers with credit scores of 580 and higher to finance with as little as 3.5% down.

In exchange for that low-down payment, borrowers pay two forms of insurance. There’s a 1.75% upfront mortgage insurance premium (the upfront MIP) and a .85% annual premium (the annual MIP).

While the FHA down payment is attractive, premium costs add up. Buy a $350,000 home with FHA financing and the upfront premium is $6,125, a cost that can be added to the loan amount. The annual MIP is $239 per month or $2,868 a year.

Like any insurance program, the FHA has a reserve fund to pay off claims, the Mutual Mortgage Insurance Fund (MMI or MMIF). If a borrower doesn’t make payments, the FHA steps in and pays the lender with MMI cash. The MMI reserves provide 100% loss coverage for lenders, a huge incentive to make FHA loans.

A banner year

At the end of September, the FHA was insuring more than 7.8 million single-family mortgages. The unpaid principal balance amounted to more than $1.2 trillion.

Those outstanding FHA mortgages represent a certain amount of risk. To offset potential claims, Congress requires the FHA to have a reserve equal to at least 2% of the mortgage balances it insures, or about $24 billion.

The FHA reserve levels have increased substantially in recent years, reaching 8.03% in fiscal 2021 — that’s four times the congressional requirement and roughly $96 billion.

Why have FHA reserves ballooned?

“Soaring home values during the past two years mean that most mortgage borrowers have additional equity,” said Rick Sharga.

Sharga, the Executive Vice President with RealtyTrac, explained that “if a property owner gets in trouble, they can likely avoid foreclosure by simply selling the home on the open market for enough to repay the mortgage, if not more. Just as importantly, a quick sale is likely. In September, according to the National Association of Realtors, the typical existing home took just 17 days to sell.”

The FHA’s reserve ratio compares well with other government insurance plans. The FDIC, as one example, has a 1.27% reserve ratio to protect the nation’s bank depositors. And then, of course, there’s the National Flood Insurance Program (NFIP). In 2017, Congress forgave $16 billion in NFIP debt owed to the Treasury. At the start of this year, the NFIP owed more than $20 billion to the Treasury, and so it may need another bailout.

What about real estate investors?

You won’t find the term “investors” in the FHA’s 2021 annual report. While the FHA program is great for first-time buyers — HUD estimates that almost 85% of all first-time purchasers buy with FHA-backed loans — it’s barely open to real estate investors. At this point, the FHA options for investors look like this:

• Since 1989, investors have been unable to buy a single-family home for use as a rental. However, you can buy a two-, three-, or four-unit property with FHA financing and 3.5% down, but only if you occupy at least one unit. You can then rent the rest.
• Investors can purchase HUD Real Estate Owned (REO) properties in certain instances.
• “Streamline refinancing without an appraisal is permitted on investment properties,” according to HUD.

203(k) buy & rehab mortgages

What about the 203(k) program? That’s the FHA option that allows borrowers to acquire and then rehabilitate a prime residence with a single, long-term loan and just 3.5% down. That’s a huge advantage because with one loan there’s only one closing, a big money-saver, instead of separate loans to first acquire the property and then fix it up.

The catch is that real estate investors are barred from the 203(k) program.

HUD used to allow 203(k) financing for investors but then ended their access. As HUD explained, “this moratorium will allow the Department to consult with the industry and affected communities to explore legislative and policy reforms that will result in a program which will provide the neighborhood rehabilitation benefits of the investor program without the abuse and risk to the insurance fund.”

This is not a recent ruling. HUD has been consulting and exploring since 1996 when it announced the investor ban.

Why real estate investors deserve FHA 203(k) mortgage access

After a quarter of a century, isn’t it time to re-open the 203(k) program for investors?

It may seem as though getting more buyers into the marketplace is hardly a priority. The real estate market is hot right now with quick sales, rising prices, and multiple bids.

However, real estate investors take properties often shunned by others, rehabilitate them at their risk, and then sell or rent the revitalized properties. The net result is that local neighborhoods have more and better housing options when investors are active.

Also, HUD already insures investment mortgages but only for those financing big properties — think of the FHA’s 50,000 multifamily loans that finance 4.8 million rental units. Why not help smaller real estate investors as well?

HUD could, if it elected, again allow investor access to the 203(k) program, perhaps with some special requirements to reduce marketplace risk.

• How about FHA-backed financing for investors with 10% down — that’s more than the 3.5% most owner-occupants pay but a good deal for investors.
• Why not a minimum credit score of at least 750 instead of the 580 needed to borrow with 3.5% down?
• How about a cash-reserve for 203(k) investor borrowers equal to at least four monthly mortgage payments?
• And — to assure that the program is not taken over by large investors and corporations — why not restrict 203(k) borrowing to those with a financial interest in not more than four residential rental units at the time of application?

Twenty-five years have passed since the start of the investor 203(k) moratorium. Times have changed. With almost $100 billion in reserves, surely the moment is right for the FHA to re-open the 203(k) program to investors.