Top Five Silliest Real Estate Laws: No. 3: The FHA’s “Seasoning” Rule
One of the things that I’ve learned as a real estate attorney from the housing market downturn is the effect that seemingly minor laws can have on the free flow of transactions in residential real estate. Almost daily I field questions from clients and prospective clients about possible deal structures that make economic sense but cannot proceed due to a legal issue. The issue could be licensing (which rears its head when a real estate investor wants to buy and sell a large number of properties), but more often than not it is a federal regulation promulgated by the U.S. Department of Housing and Urban Development (“HUD”) and administered through the Federal Housing Administration (“FHA”) known as the “Seasoning Rule”, No. 3 on our list of the Top Five Silliest Real Estate Laws.
On May 1, 2003, HUD imposed a 90 day title “seasoning requirement for all new FHA insured mortgage loans. This rule can be found at 24 C.F.R. § 203.37a. “Seasoning” refers to the length of time that the seller has owned the property. Home buyers cannot obtain a conforming mortgage if they are putting less than 20% down and the seller hasn’t owned the property for at least 90 days. The rule was originally put in place to prevent certain “flipping” transactions where a party would purchase a property and immediately sell the same property at a marked-up price.
Like many real estate laws, the objectives behind the Seasoning Rule might have been laudable. When the real estate market was booming in the late 1990s and early 2000s, a market developed for investors to buy properties and quickly turn them for a profit.
Unfortunately, a few bad actors ruined it for everyone else. A practice known as “equity stripping”, where homeowners in foreclosure were induced to sell their home to someone who was offering to help them avoid foreclosure and then lease it with an option to buy it back or buy it back on a contract for deed, only to have the terms of the repurchase be such that default was inevitable, led to government intervention into the market. Minnesota went so far as to pass a foreclosure reconveyance law and, around the same time, the Seasoning Rule came about.
In the current market, however, the name of the game when it comes to housing prices making a recovery is to clear out the inventory of distressed properties so as to normalize the supply and demand curve in the residential real estate market. The Seasoning Rule, however, frustrates those efforts as it forces investors to hold properties for at least 90 days before reselling it if the end buyer(s) are obtaining an FHA-insured mortgage. Many investors, however, can close on, rehab and resell their properties in substantially less time, and the seasoning requirement – since it applies to so many of the mortgage products currently on the market – is a deterrent to their business model.
Perhaps in recognition of this fact, HUD recently announced the temporary suspension of the Seasoning Rule for sales to first time home buyers. In my opinion, HUD should go further and suspend the rule in full (as it did for a period of time in 2008) or, even better, repeal the rule in its entirety, as this regulation is a classic example of how government interference in the real estate market adversely affects the market.