Numerous articles have been published over the last year noting the recent hyper-appreciation of homes in the Albuquerque, N.M., vicinity. This media coverage has spawned an influx of out-of-state investors bidding on U.S. Department of Housing and Urban Development repossessions and other affordably priced single-family dwellings.
In the course of my personal business, I've actually had run-ins with savvy investors who roll into town ready to wheel and deal. They aim to lock in 97 percent FHA backing by presenting themselves as owner occupants, but their real mission is to turn around and sell for a quick profit. When the property changes hands, the new purchaser effectively pays off the FHA acquisition loan, replacing it with their own financing.
Not only does the lender lose their investment due to the rapid pre-pay in this type of transaction, but also the Government National Mortgage Association-backed security loses value!
This practice is called "flipping," and it's not good for FHA, Ginnie Mae or the affected lenders. Moreover, the negative effect dominoes to those earnest purchasers who end up bearing a harsh increase in interest rates as lenders seek to recoup their losses.
In response to an increase in flipping, HUD recently issued an interim rule that broadens and clarifies certain exceptions to the timing restrictions for properties acquired and subsequently sold that involve FHA financing.
In 24 CFR Part 203, Part IV, published on Dec. 23, 2004, HUD defines flipping as, " ... a predatory lending practice whereby a property that was acquired is quickly resold for a considerable profit with an artificially inflated value, often abetted by a mortgagee's collusion with the property appraiser and others involved in the mortgage loan transaction." 1This interim rule became effective on Jan. 24. This amends the final rule published by HUD on May 1, 2003, which established new eligibility requirements for properties being purchased with FHA financing, in an attempt to crack down and prohibit the use of FHA loans to support the practice of property flipping. 2
Among other requirements, that ruling prohibits FHA financing for any property being sold within three months after acquisition by the seller. Properties that are sold to FHA borrowers between 91 and 180 days after the acquisition by the seller are subject to additional documentation requirements to ensure that any increases in the value of the property are supportable.
The interim rule broadens the exception on time restrictions to include all federal agencies that acquire properties (i.e., HUD's real estate-owned properties) as a result of a function of their programs, allowing them to quickly market and sell these acquired properties. However, the exception does not apply to government-sponsored entities, namely Fannie Mae and Freddie Mac.
The interim rule also provides that time restrictions on sales do not apply to properties that have been acquired by inheritance. HUD clearly explains that the purpose of time restrictions is to curb fraudulent property flips, whereby a property is deliberately acquired for the purposes of reselling quickly at an inflated value. While an heir may turn a property quickly and at a profit, HUD now acknowledges that the sale of an inherited property falls outside the intended scope of the regulation.
Additionally, the interim rule establishes that time restrictions do not apply to the sale of properties acquired by an employer or relocation agency in connection with the relocation of an employee.
HUD noted that it has received inquiries as to whether or not the exception to time restrictions could be extended to situations involving bank foreclosures, and situations in which a builder offers to purchase a property on the condition that the seller purchases one of the builder's new homes.
HUD declined to extend the exception to these situations, safeguarding that, "There is more risk ... that in some of these sales, predatory lending activities could occur."
In summary, with the exception of an heir selling a home or a person who is forced to relocate due to a job transfer, the HUD definition of "flipping" applies to all transactions by individuals (non-agencies) who purchase or refinance using FHA funds. This rule forbids a sale within 90 days of purchase and requires increased documentation by the lender if an FHA-financed home is flipped within 180 days.
My advice to mortgage originators is that if you determine that a potential buyer is really an investor looking for a quick turnaround, steer away from FHA financing entirely and seek to place the buyer in a conventional loan. If the prospect balks, give them a copy of this article!
Greg Frost is the owner of Frost Mortgage in Albuquerque, N.M., and vice president of new product development for LoanToolbox.com. He may be reached at (505) 292-7200 or e-mail [email protected]
1--24 CFR Part 203, Part IV, Prohibition of Property Flipping in HUD's Single-Family Mortgage Insurance Programs; Additional Exceptions to Time Restriction on Sales; Interim Rule
2--24 CFR Part 203, Part II, Prohibition of Property Flipping in HUD's Single-Family Mortgage Insurance Programs; Final Rule