Ok, ok, I know, flipping has never been illegal, but with recent changes in the mortgage industry, the lenders are coming back around and asking for our help again. Wells Fargo was actually the first major lender to change its stance on seasoning, but because FHA is a government program, this is huge. First, let me give you a little back ground so you understand what the hoopla is all about over FHA temporarily suspending its 90 day title seasoning rule.
Several years ago, when all was right with the world, some investors were taking advantage of a unique situation in the mortgage industry. The federal government wanted everyone to be able to take advantage of the America dream. So they lowered interest rates and loosened up the required mortgage qualification guidelines for Fannie Mae and Freddie Mac backed mortgages, including down payments. This actually made it cheaper and easier for people who normally would never have been able to qualify for a mortgage, get one with little or no money down.
These changes actually made it cheaper for a tenant to get a mortgage than it was to rent a property, because they could finance the entire purchase price, including their closing costs. If they were to rent a property, they would at least need the first month’s rent and a security deposit. But if they bought a house, they didn’t need any of their own money up front and their first payment wasn’t due until after they had lived in the property for one month. Plus, with a mortgage, the lender only pulled their credit report, and since most of these tenants never established credit, they didn’t have bad credit. Note that a credit report doesn’t show eviction notices or criminal history, which is where many of these tenants had records.
Because of this unique situation, some unscrupulous investors would buy bank REO’s at a huge discount that needed major updates and rehab work. Rather than updating and renovating the properties, they would just put paint and lipstick on the houses, leaving all the major renovation items to be handled by the new unsuspecting homeowners to deal with later. It worked because even though the property needed major items updated, the new buyer, who had been a tenant their whole life got a chance to buy a house and these properties “Looked” better than any of the other properties that they had ever rented before, so they were happy.
All this activity started to increase real estate values so everyone was happy, especially the mortgage industry because of all the new mortgages they were able to write and the mortgage industry exploded in size and volume. The government was happy because their agenda of all Americans owning a home was moving closer to a reality. Homeowners were happy because their properties now had a lot of equity and they could refinance their properties again and again to pay off their credit card debt. And so the cycle kept repeating itself for several years.
But then the problems started to happen, for all those properties that were sold to people who were used to being tenants, the furnaces started to fail, the roofs started to leak, and the electrical systems couldn’t handle all the modern appliances, computers, hi-def televisions and so on. When these problems started happening only a month or two after they had moved in, these people reverted back to what there were accustomed to. If something didn’t work, they didn’t make the rent payment until someone came and fixed the problem. The problem with this is that they were no longer making a rent payment, they were making a mortgage payment and a lot of these previous tenants didn’t understand the responsibilities of being a homeowner, only the responsibilities of being a renter.
That’s when the foreclosures began and a new term was coined, “First Payment Default”. The new homeowners simply weren’t making their payments and they couldn’t afford the cost of repairs. So they were foreclosed on. Since this was happening so frequently, the banks began looking into the cause of it and found that the previous sellers had bought and sold the properties the same day and didn’t do the major rehab work and stuck these new homeowners with repairs that were going to be required and costly in the near future. Even the attorney generals of most states investigated these cases. Some investors even went to jail because of it. Not because they were flipping, but because they were defrauding the lenders in order to get their tenants a new loan and quickly sell the property for a huge profit.
Most of the flipping in the market was legitimate and most investors were doing the full renovations and putting out a good quality product, but those few investors who were not screwed it up for the rest of us. Because of all the losses the banks had suffered, they decided to impose a title seasoning requirement. In FHA ’s case they made it 90 days. Their theory was that if the buyers couldn’t get a loan for 90 days or so after the investor purchased the property, that only the true rehab investors would be able to buy the properties in the first place.
This theory was flawed because it pushed a lot of good investors out of the market, wholesalers and short sale investors primarily. It got to the point where a lot of investors became good at finding deals, even deals that didn’t need any structural work, but rather needed financial restructuring. Situations like pre-foreclosure and short sales. Investors would get good at fixing these problems, but they needed to resell the properties quickly in order to complete the transaction and get paid. Because of the Title Seasoning, the back end buyers couldn’t get mortgages to buy these properties so all those deals fell apart. The homes went to foreclosure, the buyers couldn’t buy and the investors went broke.
That is why the announcement of FHA suspending their 90 day title seasoning requirement is such a huge deal for everyone. There are a lot of potential short sales out there and now the investors have a way to get their back end buyers financed after they have successfully negotiated a short sale which is a win-win-win-win for everyone. The seller can avoid a foreclosure, the banks can avoid having to take back a property and lose even more money, the buyer can now get financing on these deals and the investor now has a financial motivation to become more skilled at short sales without having to risk some cockamamie scheme to accomplish the same thing.
Even though this is only temporary, I have a feeling it will last a lot longer than one year. Wells Fargo, who is one of the largest conventional lenders out there, was actually the first one to relax their title seasoning rules for short sales. Once they see the benefits of this, they will have no other choice but to extend it, hopefully they will even waive it entirely someday. Everyone has realized that the government cannot get us out of this mess that they have created, so they are now asking us to do it for them, and in return, they have taken away the biggest obstacle that was holding us back.