Norma Eason always wanted to buy a home and believed that, now, she was ready.
The 31-year-old bolstered her savings and researched home buying. Eason, a custodian at the University of Pennsylvania, and her husband, who works in construction, got preapproved for a loan backed by the Federal Housing Administration. They started their search in March for a place for them and their four young children.
Their first bid on a house got rejected. So did their second and third.
“It’s depressing, but you gotta keep going,” Eason said. “It’s very challenging. Because you have so many people out there looking for a home right now.”
Her real estate agent suggested she pay down some credit card debt to raise her credit score and improve her financial position as a buyer. Eason already was close to qualifying for a conventional loan, so to raise her chances at getting a house, she has decided to try for that kind of loan and a mortgage larger than the $150,000 she’s approved for now.
In the current ultra-competitive housing market, where some buyers are offering cash, paying above asking price, and waiving contingencies, some buyers’ agents are suggesting clients switch away from FHA loans to improve their odds with sellers. FHA appraisals are more strict about inspecting homes for health and safety concerns, and FHA borrowers historically have less cash on hand.
FHA mortgages are meant to make home ownership accessible to people who otherwise would face barriers to getting loans, focusing on first-time home buyers, racial groups traditionally underserved in the conventional market, and those with low to moderate incomes. They require lower credit scores than conventional loans.
The FHA loan is “an instrument of equity,” said Adrian Garcia, director of fair housing and commercial property at the Pennsylvania Human Relations Commission.
Sellers lately have been expressing preferences for conventional mortgages, especially in “more hotly competitive housing markets in regions across the country under the COVID crisis,” said Morgan Williams, general counsel at the National Fair Housing Alliance. Hearing those reports has prompted the organization to start looking into the prevalence of the practice, he said.
“It is of great concern,” he said. “If on a case-by-case basis sellers are setting policies that ultimately exclude an important avenue of access to credit for buyers of color, they’re ultimately setting policies that have the effect of excluding borrowers of color.”
Why some sellers prefer conventional loans
In general, home sellers don’t care what loan a buyer uses to purchase a property. But they do care about the price they can get and the likelihood of closing the sale. The current housing market strongly favors sellers, thanks to high buyer demand and low housing supply, so sellers hold much of the power. Some buyers are waiving the home inspection as a contingency for sale to make their bids more attractive — a move most real estate agents strongly discourage. FHA appraisals, however, include inspections for health and safety and require repairs before sale.
“It’s a seller’s market. They don’t want to fix what they don’t need to fix,” said Jaene Bindom, an agent with RE/MAX Access who is working with Eason. “And they don’t have to.”
Also, if a sale with an FHA appraisal doesn’t close, that appraisal still applies to future FHA buyers interested in that property for the next four months. So sellers could be disadvantaged by a lower appraised value in an environment of bidding wars and skyrocketing prices. If the sale price agreed upon is higher than the appraised value, sellers can ask buyers to pay the difference, which can knock those with FHA loans — who often don’t have extra cash — out of the running.
Because sellers have more leverage, “they have the ability to look for the cleanest, easiest offer as well as the best price,” said Tom Toole III, team lead at Tom Toole Sales Group with RE/MAX Main Line. “Cash offers are a really effective strategy right now,” he said, because they eliminate the need for appraisal contingencies, the condition that an appraiser must value the home at the sale price or higher to satisfy a lender and for a contract to be binding.
An analysis of Philadelphia deeds that the Pew Charitable Trusts released last year found that, in 2018, nearly two out of three homes that sold below the median sales price were purchased with cash. Many are investors. So FHA borrowers in the lower-priced end of the market are competing against buyers offering cash, as well as those with conventional mortgages.
In some cases, “FHA offers that are being presented are not even considered,” said Abraham Reyes Pardo, director of housing at the Urban League of Philadelphia. “As a seller, you have more certainty — quote, unquote — that the transaction will go through if it’s backed by a conventional loan” supported by more liquid assets.
The National Association of Realtors said it has heard the concern that FHA borrowers are being kept out of the market and is monitoring the issue. The association is reviewing FHA loan requirements and rules to come up with suggestions for how the government can improve FHA programs, which the association strongly supports.
Rejecting FHA loans can toe the discrimination line
Most of the aspiring home buyers counseled by the Urban League of Philadelphia can barely meet the credit score and other requirements to qualify for FHA loans, Reyes Pardo said, so conventional loans are out of reach. Some are working to break cycles of generational poverty.
Nationally, FHA loans account for about 15% of residential mortgages. In Philadelphia, roughly 32% of originated mortgages for one-unit, single-family primary residences were FHA insured in 2019, according to an analysis of the most recently available federal mortgage data.
A seller’s decision to go with one type of loan product over another “looks neutral on its face, but when you look at its impact,” it may be discriminatory if it disadvantages groups of people who are protected under the Fair Housing Act, including people of color and women who are single parents, said Garcia at the Pennsylvania Human Relations Commission.
The Fair Housing Act protects various populations from housing discrimination, but it “doesn’t prohibit sellers from accepting the most financially beneficial offer for their own self-interest,” said Rachel Wentworth, executive director of the Housing Equality Center of Pennsylvania. The group has fielded calls from people about potential discrimination because of record-low housing supply.
The Philadelphia-based financial counseling nonprofit Clarifi has seen clients with FHA loans passed over during bidding wars, said Chelsea Barrish, vice president of program impact.
“So a lot of our buyers are looking to pivot to conventional mortgages to be more competitive in their bids for homes,” she said. “What they’re hearing from their Realtors when they’re making offers is they’re going to be more likely to get their offers accepted if they have a conventional loan.”
Garcia has heard this, too, and said “no one should actively steer someone away from” FHA loans. Over the next year, the Pennsylvania Human Relations Commission plans to analyze home sales data and monitor the number of buyers who are using FHA loans to see whether this is a widespread trend, Garcia said.
What buyers can do
Market pressures show no signs of letting up. According to Berkshire Hathaway HomeServices Fox & Roach, the Greater Philadelphia region had one month worth of housing supply in April, which means the number of homes on the market would sell in a month at the current sales pace. In April 2020, the region had five months of housing supply.
Williams at the National Fair Housing Alliance said real estate trade organizations could issue guidance for agents to help discourage blanket loan preferences that could result in discrimination.
Buyers with any type of loan should educate themselves about the process and get as prepared as possible, said Reyes Pardo at the Urban League of Philadelphia. Buyers should look to improve their financial profile, so they can get whatever type of loan they want.
In this competitive market, sellers tend to prefer buyers with liquid assets, he said, so grants can help sweeten any offer. Many lenders offer assistance, particularly to first-time home buyers. One grant program Philadelphians relied on for help with closing and down payment costs, Philly First Home, ran out of funds in September. In March, the Pennsylvania Housing Finance Agency launched a program called K-FIT to give loans for these costs. Ten percent of the loan is forgiven each year for 10 years, and homeowners pay back what’s left if they move earlier.
“Some clients using FHA loans have been able to close because they have this additional resource,” Reyes Pardo said. “In this type of market, it makes a huge difference.”
This story was updated to reflect the FHA’s new rules on how long appraisals apply to specific properties.