FHA loans hit speed bumps

Frances Katzen, an executive vice president at Prudential Douglas Elliman, was elated when she found a buyer for the one-bedroom she was representing in a Lower East Side condo conversion.

The transaction went awry, however, when the buyer learned at the closing table that the financing she had been counting on had fallen through, thanks to an obscure loophole in guidelines by the Federal Housing Administration: Loans insured by the FHA currently cannot be issued in a condo conversion until at least one year after the condo has been declared effective.

The buyer “got all the way to the closing and was told that the mortgage was not issued,” recalled Katzen, who now refuses to work with FHA-insured loans, despite the fact that the government-backed mortgages are exploding in popularity.

“We’re reading about FHA loans, but we’re finding it very difficult [for buyers to get them,]” she said. “It’s been a very trying time, and disappointing.”

The obstacle Katzen encountered is only one of many obscure and ever-changing regulations that make FHA-insured mortgages nearly impossible for many New Yorkers to obtain, brokers said.

With conventional financing elusive, many developers are undertaking the lengthy and expensive process of having their projects FHA-approved, believing it will give them a leg up on sales amid the credit crunch.

But even as the once-rare program becomes more widespread, brokers and developers are discovering that FHA-insured loans are not all they’re cracked up to be. What’s more, changes to the agency’s guidelines slated to become effective October 1 will drastically reduce the number of eligible buyers for the program by capping the number of FHA loans in a given project at 30 percent, even in FHA-approved developments.

“It’s horrible what they’re proposing,” said Philip Sutcliffe, a Pennsylvania-based consultant who specializes in submitting new condo projects around the country for FHA approval. “It’s bad public policy at a point when the condo market can least afford to have restrictions placed on it.”

Loans insured by the FHA, an arm of the U.S. Department of Housing and Urban Development (HUD), provide lenders with protection in the event that the homeowner defaults. Because the lenders bear less risk, FHA-insured loans require smaller down payments — sometimes as low as 3.5 percent — and allow buyers more flexibility on income, credit scores and payment ratios. In exchange, buyers pay an insurance premium on the loan, which in some cases makes their monthly payments higher than conventional loans.

Until recently, FHA loans were rare in New York City because most homes here cost more than the agency’s maximum loan limit. For the same reason, New York developers here generally avoided the expensive and time-consuming process of seeking FHA approval for their new condos, especially since the easy credit markets of recent years made it easy for buyers to get financing from other sources.

But the FHA this winter raised its maximum loan limit here to $729,750 as part of the national stimulus package, making FHA loans more accessible for New Yorkers.

“Six months ago, nobody knew about FHA,” said Richard Bouchner, managing director of Commodore Property Group, a mortgage company and real estate brokerage. He said that’s changing now that conventional financing requires higher down payments than in the past, adding that he’s gotten several inquiries from buyers looking for FHA programs.

“Most people see FHA as a kind of shining light, something they didn’t think they would be able to get,” he said.

Meanwhile, many developers recently have rushed to get FHA approval for new developments. Projects that have already been approved include 111 Monroe in Bedford-Stuyvesant, 105 Lexington Avenue in Clinton Hill, NV in Williamsburg, Hamilton Lofts in Harlem and 10-50 Jackson Avenue in Long Island City.

The program is seen as the savior of many of these projects, real estate insiders said.

At 111 Monroe, “I don’t think we would have any deals or any potential deals if we did not have FHA,” said David Behin, an executive vice president at the Developers Group, a marketing and sales firm that is in the process of merging with another company, the Real Estate Group New York. It has encouraged its developers to get FHA approval. “It’s been an enormous help for us.”

FHA loans are also gaining in popularity nationwide, according to Adam Glantz, a spokesman for the New York bureau of HUD, who said they are being tapped more frequently by homebuyers across the country, filling the void left by subprime lending.

In 2006, Glantz said, FHA backed only about 3 percent of home loans in the country. Now, that number has swelled to at least 30 percent.

In New York City, the number of FHA-backed loans issued between January and March of 2009 leaped to 2,315, up from 995 in the same period of 2008, said Glantz.

But many New Yorkers are now discovering that securing an FHA-insured mortgage is more difficult than it may first appear.

The program has a raft of often-inscrutable guidelines, many of which disproportionately impact New Yorkers. For example, the FHA does not currently insure loans for purchases of co-ops, Glantz said.

Another obstacle for New Yorkers is that the FHA does not back loans in buildings where the board of managers may exercise a right of first refusal on units being sold. While the practice is rare in other parts of the country, it’s very common here, removing FHA loans as an option for many buyers.

New York is “one of the only states that have right of first refusal language in the documents,” Sutcliffe said. “We have thousands of projects all over the city that have a right of first refusal.”

In response, Sutcliffe said, developers of many new condos are rushing to remove the option from their offering plans.

“I’m working on about 100 projects in New York City, and in every one of them, the offering plan has to be amended to remove the right of first refusal,” he said. But it’s too late for purchasers of older apartments in buildings where the board of managers already has the right of first refusal. For them, getting an FHA-backed loan isn’t an option.

Then there’s the one-year delay for condo conversions, which stipulates that if a developer is converting a building from a prior residential use to condos, FHA will not back loans in the building for one year after the condo declaration has been recorded, Sutcliffe explained.

On top of these complications, buyers often don’t know until the last minute whether they are eligible for FHA financing because the loans are manually underwritten, Bouchner said.

With Fannie Mae and Freddie Mac, buyers can input their information into a computer and get a formal preapproval. With FHA loans, buyers “don’t know if they’ve been approved until their file gets in front of an underwriter,” Bouchner said. “It’s a bit frustrating.”

He added, “FHA is this really weird, opaque part of the mortgage world.” Starting on October 1, FHA is changing some of its guidelines, Sutcliffe said. The one-year minimum for conversions and the right-of-first-refusal requirements will be removed, but they will be replaced by a far larger obstacle: Under the new guidelines FHA will no longer insure more than 30 percent of loans in a given building, even if that project has been FHA-approved.

The change could hurt the condo market because for buyers unable to afford large down payments, “FHA is the only game in town,” Sutcliffe said.

It’s particularly problematic because FHA-insured loans require 51 percent of the units in a project to be in contract. If only the first 30 percent can get FHA loans, “how are [developers] going to sell the other 20 percent of the units if [they] don’t have the financing they need?” Sutcliffe said. “It’s almost a self-fulfilling prophecy.”

Manny Alvarado, an FHA specialist at HUD, said the agency put the limitation in place to limit its risk in case a project fails. “We’re looking at reducing our exposure,” he said.

The rule change presents a roadblock for developers who have spent time and money to get their projects FHA-approved and are now depending on FHA-insured loans to help their buyers get financing.

“It’s a death blow,” said Moshik Regev, the vice president of Absolute Development and the developer of the Prospect & Homes Condominiums at 1236 Prospect Avenue in the Bronx. “They’re taking the last market niche that’s still out there, and they’re going to kill it.”

The 18-unit development, where the average purchase price is $250,000, was pre-
approved for FHA loans last year, and all but one of the buyers in contract plan to use FHA financing, Regev said.

“It wouldn’t be possible for [buyers] to do it without FHA,” he said. “To cap the units at 30 percent, it’s ridiculous. To me, in this day and age, to do something like that is just terrible.”

He said he has an option to buy and develop two lots, one in Brooklyn and one in the Bronx, but he and his partners have put the plans on ice for the time being as a result of the rule change.

“At this point, we put them on hold,” he said. “We don’t know what’s going to happen.”