Can You Get An FHA Loan On A Foreclosure? Answers For Interested Homebuyers

Federal Housing Administration loans, or FHA loans for short, are government-backed loans overseen by the U.S. Department of Housing and Urban Development (HUD). FHA loans are available to borrowers with a less-than-ideal credit score and not a lot of cash on hand, and these loans give home buyers on a tight budget a chance to become homeowners by using a more affordable financing option than the more common conventional loan.

FHA loans are intended for owner-occupant properties, not investment properties, but what about bank-owned or foreclosed properties? Letâs explore how you can buy a foreclosed home with an FHA loan, and weâll also weigh the pros and cons of doing so.

Purchasing a foreclosed home with an FHA loan can be an affordable way to become a homeowner, especially for first-time buyers However, there are some specific requirements and limitations to be aware of. In this comprehensive guide, I will explain everything you need to know about using an FHA mortgage to buy a foreclosed property.

What Is A Foreclosure?

When a homeowner fails to make their monthly mortgage payments the lender can begin the foreclosure process to take back ownership of the property. The home is then sold at auction as a foreclosure.

Banks and lenders don’t want to own property, so foreclosures are usually priced below market value. This makes them attractive options for bargain hunters and real estate investors.

According to public records, foreclosures made up 1.3% of U.S. home sales in November 2022. While this is higher than pre-pandemic levels, it’s still a relatively small portion of the market.

Can You Buy A Foreclosure With An FHA Loan?

Yes, FHA loans can absolutely be used to purchase foreclosed homes. The Federal Housing Administration (FHA) offers several distinct advantages for financing distressed properties:

Low Down Payments: FHA loans require just 3.5% down for buyers with credit scores of 580 or higher. This increases affordability compared to conventional mortgages which typically require 20% down.
Lenient Credit Guidelines: The FHA has more flexible credit standards than conventional loans. Minimum credit scores can be as low as 500 with a 10% down payment.
Low Cash Reserves: FHA lenders can be more lenient with cash reserve requirements, which helps first-time buyers.
Mortgage Insurance: FHA loans require mortgage insurance (MIP) to protect the lender from default. Rates start at 0.45% of the loan amount.

However, there are limitations on which foreclosures can be purchased with FHA financing:

FHA Foreclosure Property Requirements

While FHA mortgages offer more flexibility than conventional loans, foreclosures must still meet certain criteria:

Livability Standards: The home must pass FHA appraisal guidelines to be considered habitable and safe. Common issues that can cause a property to fail inspection include structural damage, pest infestations, significant water damage or mold issues.
Primary Residence Only: FHA loans cannot be used to purchase foreclosures as investment properties or vacation homes. You must move in within 60 days and occupy the home as your primary residence.
Upfront Certification: A 203(k) Rehab Loan or cash escrow for repairs may be required if the property needs extensive renovations to meet FHA standards.

In November 2022, 14.2% of FHA appraisals resulted in the property not meeting minimum requirements according to HUD data.

Pros And Cons Of FHA Foreclosure Loans

Below I’ve summarized some of the top pros and cons of using an FHA mortgage versus conventional financing to purchase a foreclosed home:

Pros Of FHA Loans For Foreclosures

More affordable due to low down payments and flexible credit guidelines
Potentially “sweat equity” by buying a fixer-upper property at a discount
Streamlined process compared to some renovation loans

Cons Of FHA Loans For Foreclosures

Stricter property requirements than conventional mortgages
Monthly mortgage insurance premiums raise costs
Can be less competitive against cash offers from investors

While FHA loans offer distinct advantages, they aren’t ideal for every buyer. Conventional mortgages amortize quicker and potentially have lower interest rates for borrowers with excellent credit.

Finding Foreclosures For Sale

The best places to find foreclosure listings include:

Multiple Listing Services (MLS) via a real estate agent
Online sites like Zillow, Redfin and Realtor.com
Local newspaper classifieds
Courthouse foreclosure notices
HUD Home Store for government foreclosures

Distressed properties don’t always appear on MLS listings, so checking courthouse records can help you find “pre-foreclosure” homes where the owner has defaulted but no auction date is yet scheduled. This presents an opportunity to make an offer before competition heats up.

Alternatives For Uninhabitable Foreclosures

What if you find a great foreclosure deal but the property doesn’t meet FHA livability standards? You still have options:

FHA 203(k) Loan: This FHA rehab mortgage rolls the purchase price and renovation costs into one loan. However, not all lenders offer them and rates are generally higher.
Conventional Renovation Loan: These mortgages offered by private lenders can finance extensive repairs and have lower rates than 203(k) loans. Credit standards are stricter than FHA financing.
Cash Purchase + Separate Renovation Loan: If you have the cash, purchase the property outright and take out a separate home improvement loan for renovations. This avoids higher rehab mortgage rates.
Partner With A Contractor: Investors often partner with contractors who do the renovations in exchange for an ownership stake in the property. You provide the financing while they handle repairs.

With some creativity, lack of habitability doesn’t have to stop you from purchasing a great foreclosure deal!

The Bottom Line

FHA loans can absolutely be used to purchase foreclosed homes at an affordable price, especially for first-time and budget-conscious buyers. However, stricter property requirements apply compared to conventional mortgages.

If the foreclosure you’re interested in won’t pass FHA criteria for livability, alternatives like renovation loans may be required to finance repairs. As with any major financial decision, be sure to speak with a lender and real estate agent to review all your options.

With the right property and loan program, buying a foreclosure with an FHA mortgage can help you achieve the dream of homeownership. Just be aware of the specific guidelines and limitations compared to other types of financing.

FHA 203(k) Rehab Loan

In some cases, if the foreclosure doesnât meet the livability standards and is more of a fixer-upper, the FHA will offer whatâs known as an FHA 203(k) rehab loan.

A rehab loan rolls the cost of renovations or upgrades into the overall price and allows borrowers to repay their lender for both repairs and the home loan in one monthly mortgage payment. Borrowers also donât have to live in the house until the renovations are completed. The program requires an appraiser to assess the cost of repairs and then, once repairs are completed, the value of the home.

A 203(k) loan has different requirements and often a higher interest rate than a traditional FHA loan, and not all lenders offer 203(k) loans.

Pros And Cons Of Buying A Foreclosure With An FHA Loan

Using an FHA loan to buy a foreclosed home has advantages and disadvantages. Letâs take a look at some of the most common pros and cons of purchasing a foreclosed home with FHA funding.

Pros	Cons
The potential to get a good deal	FHA property standards to meet
A low down payment	The home being sold a -is
Flexible requirements	Competition with investors

FHA loans have a lower minimum credit score requirement than a conventional loan or a USDA loan, and the down payment requirement for an FHA loan is exceptionally low for such a low minimum credit score. Since foreclosed homes typically have a lower listing price than comparable homes for sale in the same area, an FHA foreclosure purchase gives some house hunters the chance to buy a home that may otherwise be outside of their budget.

The downside to buying a foreclosed home with an FHA loan is that the property must adhere to strict criteria. One of the most important factors is that the home is safe, and since foreclosed homes are sold as is, it could be harder to qualify for an FHA loan if the home isnât habitable. FHA 203(k) loans offer a way around this challenge, but the trade-off can be a higher interest rate.

Buying a foreclosure also comes with more competition since investors may be able to pay with cash, which is less risky for banks than an offer from an FHA borrower, who will need to take out a mortgage and repay a loan plus interest.

Even though FHA home loans are a relatively affordable finance option, itâs still essential to budget for closing costs and general home maintenance, too.

Can I Buy a Foreclosure With An FHA Loan?

FAQ

How long after foreclosure can you get an FHA loan?

To qualify for a loan that the Federal Housing Administration (FHA) insures, you typically must wait at least three years after a foreclosure. The three-year clock starts ticking when the foreclosure case has ended, usually from the date that the home’s title transferred as a result of the foreclosure.

What will disqualify an FHA loan?

The three primary factors that can disqualify you from getting an FHA loan are a high debt-to-income ratio, poor credit, or lack of funds to cover the required down payment, monthly mortgage payments or closing costs.

Do sellers avoid FHA loans?

While some sellers may be hesitant to accept an FHA offer, it’s important to understand the facts before making a decision. Some reasons a seller might refuse an FHA loan include misconceptions about longer closing times, stricter property requirements, or the belief that FHA borrowers are riskier.

Can you use an FHA loan to buy a house at auction?

How To Buy A Foreclosed Home With An FHA Loan. You can purchase foreclosed properties at various points in the foreclosure process, including pre-foreclosure as well as during a short sale or at an auction.

Can you buy a foreclosed home with an FHA loan?

In many cases, you can use an FHA loan to buy a foreclosed home. However, there will be a lot of things to keep in mind, such as whether the condition of the foreclosed home can pass the FHA’s pre-purchase inspection. In this guide, we’ll answer some of the most common questions you might have about buying a foreclosed home with an FHA loan.

Can you close on a foreclosed home with an FHA loan?

A borrower who purchases a foreclosed property with an FHA loan also must move into the home within 60 days of signing their loan and treat the home as their primary residence. The FHA also has several standards and inspection procedures you have to follow before you can close on the house.

Can you buy a home with an FHA loan?

Established after the Great Depression, the FHA offers a variety of programs to help people acquire properties that might otherwise be out of reach. In some cases, you might be able to purchase a home via an FHA-backed loan with a grant to cover any money required for a down payment. In many cases, you can use an FHA loan to buy a foreclosed home.

Where can I buy a house if I have a foreclosure?

The HUD Home Store, Fannie Mae’s HomePath program and Freddie Mac’s HomeSteps program are other websites with foreclosure properties for sale. An FHA loan can be used to finance a foreclosed home purchase.