Government-backed Federal Housing Administration (FHA) loans are available to those with low or non-existent cash reserves or credit score limitations. Foreclosures, not only homes for sale by owner, should be considered when looking for a house to buy since FHA loans also allow homebuyers to purchase properties in this category. This may enable potential homebuyers to discover the perfect house for them while paying a low mortgage amount.
With the recent FHA loan changes, now may be the best time to consider an FHA loan. Take the time now to learn more about the ways FHA loans can help you more easily acquire a home with the guide below.
Buying a foreclosure can be an affordable way to become a homeowner, especially if you get financing through an FHA loan. FHA loans are popular among first-time homebuyers because they require lower credit scores and down payments than conventional loans. But can you actually use an FHA loan to purchase a foreclosed property?
The short answer is yes you can buy a foreclosure with an FHA loan under certain conditions. While FHA loans provide more flexible qualifying criteria foreclosures still must meet FHA property standards and appraisal requirements before purchase.
In this comprehensive guide we’ll explain everything you need to know about purchasing a foreclosure with FHA financing including
- What is an FHA loan?
- FHA loan requirements
- Can you buy a foreclosure with an FHA loan?
- Pros and cons of using an FHA loan for a foreclosure
- FHA 203(k) rehab loans
- How to find foreclosures for sale
- Tips for buying a foreclosure
What is an FHA Loan?
An FHA loan is a mortgage insured by the Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development (HUD). The government backing allows lenders to offer FHA loans to borrowers with lower credit scores and smaller down payments than conventional loans.
Key features of FHA loans include
- Down payments as low as 3.5%
- Minimum credit score requirements between 500-580
- More flexible debt-to-income ratio requirements
- Low closing costs
FHA loans can only be used to purchase or refinance a primary residence – investment properties do not qualify. And borrowers must occupy the home within 60 days of closing.
FHA Loan Requirements
To qualify for an FHA loan, borrowers must meet certain requirements:
Down Payment: At least 3.5% of the purchase price. Gifts and grants can be used for the down payment.
Credit Score: Minimum 500 credit score required, but each lender sets their own minimum score. Many lenders require a 580 score or higher.
Debt-to-Income Ratio: Typically, your total DTI must be below 43%. But some borrowers may qualify with DTIs up to 57%.
Cash Reserves: Varies by lender but often 1-2 months of mortgage payments.
Mortgage Insurance: You must pay an upfront mortgage insurance premium of 1.75% of the loan amount, plus ongoing monthly premiums.
Home Inspection: The property must pass an FHA appraisal and meet HUD’s minimum property standards.
As long as you meet these requirements, you can qualify for an FHA loan even with past credit problems or very little money saved up.
Can You Buy a Foreclosure With an FHA Loan?
Yes, you can purchase a foreclosed home with an FHA loan, provided the property is habitable and passes inspection.
When a homeowner defaults on their mortgage, the lender forecloses on the property and becomes the new owner. The lender then sells the home usually below market value just to recoup their losses quickly.
Foreclosures can sell for 20-30% less than comparable homes, making them attractive bargains, especially for first-time homebuyers.
However, foreclosed homes are sold “as-is.” The lender will not make any repairs or improvements to get the home ready for sale. And you typically cannot negotiate repairs orcredits with an FHA loan.
This means the property must meet FHA minimum property standards and be deemed habitable in order to purchase it with FHA financing.
Pros and Cons of Buying a Foreclosure With an FHA Loan
Using an FHA loan to purchase a foreclosure has several potential advantages:
Pros
- Lower home prices and down payments
- More flexible credit score and income requirements
- Ability to buy a home with imperfect credit or minimal savings
- Potential for equity and appreciation as the housing market improves
Cons
- Properties sold “as-is” with no seller-paid repairs
- Must meet FHA property standards and inspection requirements
- Competition from cash buyers and investors
- No negotiating room on repairs or credits
- Slower closing times than conventional mortgages
While FHA loans provide a great opportunity for financing, foreclosures require more scrutiny. Thoroughly inspect the property and consult with a real estate agent to get a realistic outlook on needed repairs and costs.
And remember, you’ll likely compete with cash buyers who can close more quickly. So you’ll need a solid offer to stand out.
FHA 203(k) Rehab Loans
If the foreclosure needs significant repairs to meet FHA standards, you may qualify for an FHA 203(k) loan. This program combines a mortgage with funds for renovating a fixer-upper property.
With a 203(k) loan, the home doesn’t need to meet FHA minimum property requirements before closing. You can buy the property, make repairs, and have just one mortgage payment including funds for repairs.
Two types of 203(k) loans exist:
Standard 203(k): Repairs limited to $35,000. At least $5,000 in repairs required.
Limited 203(k): Repairs between $5,000 and $35,000 only. No structural or major additions.
An FHA-approved consultant will inspect the property, estimate repair costs, and oversee the renovation process. The total loan amount covers purchase price plus improvements, subject to FHA limits.
Where to Find Foreclosures for Sale
Foreclosed properties are usually sold at a courthouse auction or by the mortgage lender. Here are some places to find foreclosure listings:
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MLS listings – Ask your real estate agent
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Auction sites like Hubzu.com and Auction.com
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Bank websites – Bank of America, Wells Fargo, etc.
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Government sites – HUD, Fannie Mae, Freddie Mac
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Local newspaper classifieds
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Foreclosure listing services like RealtyTrac
Drive by any property you’re interested in to view the exterior condition. Thoroughly research property records to understand its history. Hire an inspector to identify any hidden issues.
And remember – foreclosures are sold as-is, so assume repairs will be needed, especially if the home has been vacant.
Tips for Buying a Foreclosure With FHA Financing
If you plan to purchase a foreclosure using FHA financing, keep these tips in mind:
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Get pre-approved for an FHA loan to make your offer more competitive and put you ahead of buyers without financing in place.
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Hire a knowledgeable real estate agent who can guide you through the foreclosure process and represent your interests.
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Thoroughly evaluate the property condition and anticipate repairs that may be required. Consider a 203(k) renovation loan if major repairs are needed.
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Research the title history to identify any liens, judgements or other issues that may affect your ability to buy the home.
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Inspect the property carefully for structural, electrical, plumbing, and HVAC issues that may not be visible on the surface. Hire a licensed home inspector to identify problems.
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Submit the strongest offer you can afford with the least contingencies. Expect competition from investors paying cash. Escalation clauses and higher earnest money deposits also make your offer more attractive to sellers.
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Get an independent appraisal of the property’s value, and do not overpay simply because it is a foreclosure.
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Understand that closing may take longer with an FHA loan, so be prepared to wait 30-45 days for closing. Ask your lender for an accurate estimate based on their workload.
With proper preparation and persistence, you can successfully purchase a foreclosure property with an FHA loan. The ability to buy a home with a low down payment and flexible qualifying guidelines makes FHA financing a great option. Just be sure to weigh the pros and cons carefully when buying a foreclosed home.
The Bottom Line
Yes, you can purchase a foreclosed property using an FHA loan provided the home meets FHA minimum property standards and passes inspection. FHA financing allows buyers with lower credit scores and down payments to buy a home, including foreclosures sold below market value. However, you’ll likely compete with cash buyers who can close faster. Thoroughly evaluate the home’s condition and prepare a strong offer to boost your chances of success when buying a foreclosure.
What are the Requirements for an FHA loan?
There are a handful of FHA requirements that borrowers will need to meet before the purchase of a foreclosed home can proceed. These requirements include:
Borrower Requirements:
- Credit Score/Status: Your credit score must be 580 or higher to qualify for an FHA loan. If the borrower has this score, they will be eligible for an FHA loan with a 3.5% down payment if all the FHA loan criteria are met. However, borrowers with credit scores as low as 500 can still receive FHA loans, but they may be required to pay an additional 10% down payment depending on the lender if the credit score does not improve.
- Ability to Repay: Borrowers must have the ability to repay the FHA loans monthly payments. Lenders will ask that the borrower send in personal information like ID and proof that they have a stable job with a debt-to-income ratio typically less than 45%, although the exact percentage may differ based on each borrowers unique financial situation.
- Down Payment: The down payment that every borrower will need to make to qualify for an FHA loan is at least 3.5%, but this may rise to 10% at the most depending on the credit status. Different down payment options exist to more easily pay for this amount, including having the required cash on hand, qualifying for a down payment assistance program, or receiving a gift of a down payment.
- Mortgage Insurance Payments: Borrowers must pay the upfront and monthly mortgage insurance premiums (MIP), then they must continue paying the insurance payments for the life of the loan. Every borrower should use an FHA mortgage calculator to determine if applying for this loan type is right.
All lenders require their own qualifications for approval.
Property Requirements:
- Primary Residence/Owner-Occupied: The property in question must be used as the borrowers primary residence. If the borrower already owns a home that they use as their primary residence, an FHA loan cannot be used for the borrowers new property. An FHA loan cannot be used for investing in properties like rental properties.
- Minimum Home Inspection Standards: The borrower must ensure that the property theyre purchasing meets the minimum home inspection standards for both safety and habitability in order to qualify for the FHA loan. Fixer-upper homes will usually not be approved for standard FHA loans. However, ‘fixer-upper homes’ may be allowed under the FHA 203(k) program. Talk to your Loan Officer to see if this may be a viable option for you.
- Appraisal: An FHA-approved appraiser must appraise the property so the lender may know that the property successfully meets the minimum FHA loan requirements and local building codes while establishing the homes fair market value.
Pros and Cons of Buying Foreclosures With an FHA Loan
Before deciding to go ahead with buying a foreclosure with an FHA loan, potential homebuyers and borrowers should be aware of both the advantages and disadvantages of this process. The most important ones that every borrower should consider are outlined below.
Pros:
- Lower Down Payment: The smaller down payment needed to buy a foreclosure with an FHA loan can be as low as 3.5%, making it an incredibly attractive option for borrowers with poor credit.
- Easier Credit Requirements: The low credit score of 580 allows borrowers with a small or nonexistent credit score to qualify for an FHA mortgage that they may not have otherwise qualified for.
- Easier Qualifications: Borrowers looking to buy their first home or just starting out may find FHA loans provide a real pathway to becoming a homeowner.
Cons:
- Property is sold as is: Foreclosed properties are sold in the exact condition that borrowers first view them as. This means that the mortgage lender – the owner of the property – will not repair or otherwise fix the property in any way. The borrower will instead be the one responsible for performing any repairs, maintenance, or service the property in addition to planned home remodels.
- The livability standard: All foreclosures must pass the FHAs livability standard in the form of an appraisal, ensuring that the home meets the Department of Housing and Urban Developments (HUD) minimum property standards.
- High competition: The lower price attached to foreclosed properties means that many others will also be looking to buy the home the borrower may be interested in. Most of the competing offers will be in the form of cash, making them more appealing to the lender than deals involving large amounts of financing (such as the case with FHA loans).
- Slow sales process: The long qualification process paired with the list of eligibility requirements makes successfully processing FHA loans a drawn-out endeavor from the application phase to the final closing.
Can I Buy a Foreclosure With An FHA Loan?
FAQ
Can you use an FHA loan to buy a house at auction?
What is the waiting period for a foreclosure on a FHA loan?
Can a FHA loan be sold?
Can I buy a foreclosed home with an FHA loan?
To buy a foreclosed home with an FHA loan, you must meet certain criteria, including property and credit requirements. 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.
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.
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.
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.