I do not see FHA giving approval for the financing on the home with an un-permitted addition. While the construction may look sound and the work completed by a licensed Contractor, it was not permitted. I recommend that you speak with your Lender on this matter right away prior to submitting an offer. Should you be in your designated inspection perid of escrow (typically within 17 days after offer acceptance, unless otherwise agreed to in writing), then you will need to speak with your Lender quickly. Should your Lender come back with a no on loan approval, you will have time to cancel escrow and get your good faith deposit back. Good luck!
If you are set on it you may need to try and get approval for a conventional loan.
FHA has pretty strict funding conditions, unpermitted additions are a No No.
Best Of Luck To You.
Kawain Payne, Realtor
However, the appraiser will be unable to give it any value.
As long as the appraiser does not call for any health or safety issues for this property, then you should be okay.
Appraiser may deduct for 'cost to cure' in regard to converting back to garage.
Typically an FHA appraiser will call this out and you will have two options; 1) Tear out the walls and convert the garage back into a garage while you're in escrow (you may be able to request this of the seller depending on how motivated the seller is to sell the home and how long it's been on the market) or 2) Speak with your lender about possibly going with conventional financing. Typically while a conventional appraiser will make note of the conversion, they will not make it a condition as being needed to be addressed in order to fund the loan. The underwriter on the conventional loan, however, may or may not take issue with the conversion depending on a number of factors; i.e. amount of down payment, FICO scores, if there is plumbing (bathroom), etc. Typically the more risk involved in issuing a loan (low down payment, lower FICOs, etc.) will give the conventional underwriter more cause to deny the loan.
Also on a flip going with an FHA loan, if the home has not been "seasoned" - that is, the seller has not owned it for more than 90 days, your lender will require two appraisals on it; one from your lender and one on the seller's side. And should one of the appraisals come in for less value than the other, your lender will lean on the lower appraisal to base your loan approval on. Some flip sellers are agreeable to this, while others aren't - which is why a lot of times on flips you'll notice that sellers will only accept cash or conventional financing only.
Typically when we see garage conversions they have not been permitted and thus can cause problems when it comes time to qualify for an FHA loan.
Hope this helps,