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 foreclosed home can be an excellent way for first-time homebuyers or budget-conscious buyers to purchase a home at a discount. With home prices high across much of the country, finding ways to save on your home purchase is more important than ever. This is where an FHA loan can come in handy.
FHA loans are government-backed mortgages insured by the Federal Housing Administration (FHA). They offer more flexible credit and down payment requirements than conventional mortgages, making them ideal for buyers with less-than-perfect credit or limited funds for a down payment.
But can you use an FHA loan to purchase a foreclosed home? Let’s take a deep dive into everything you need to know about buying a foreclosure with FHA financing.
Can You Buy a Foreclosure With an FHA Loan?
The short answer is yes, you can use an FHA loan to purchase a foreclosed home in most cases. However there are some specific requirements the property must meet for FHA financing eligibility.
The FHA has minimum property standards that aim to ensure the home is safe, sanitary and structurally sound. This means a foreclosed home must be in livable condition in order to qualify for FHA financing.
If the property doesn’t meet FHA property standards, you may still be able to buy it with FHA financing through the FHA 203(k) rehab loan program. This program allows you to roll renovation costs into your mortgage. But more on that later.
Beyond being in livable shape, there are a few other requirements to be eligible to buy a foreclosure with FHA:
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The home must be for your primary residence. FHA loans can only be used to purchase a primary home, not an investment property.
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You must occupy the home within 60 days. FHA requires borrowers occupy the home as their primary residence within 60 days of closing.
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The home must be appraised. An FHA appraisal is required to ensure the property meets FHA minimum property standards and to determine market value.
As long as you plan to live in the home as your primary residence and the property meets FHA criteria, you can use an FHA loan to buy a foreclosed home.
FHA Loan Requirements for Borrowers
In addition to meeting property requirements, you’ll also need to meet general FHA borrower eligibility guidelines to qualify for an FHA mortgage. Here are the key requirements:
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Credit score. FHA requires a minimum credit score of 500 to qualify. But each lender sets their own minimum, often around 580. The lower your score, the larger down payment you’ll need.
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Down payment. FHA requires at least 3.5% down for buyers with credit scores of 580 or higher. Lower scores require 10% down.
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Debt-to-income ratio. Your total debt payments, including the future mortgage payment, usually cannot exceed 43% of your gross income.
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Mortgage insurance. You’ll need to pay an upfront mortgage insurance premium and ongoing monthly premiums.
Meeting FHA’s credit, income and down payment requirements is essential for approval. Be sure you meet the guidelines before applying.
Pros and Cons of Buying a Foreclosure With FHA
Purchasing a foreclosure with FHA financing has several notable pros and cons you should weigh before moving forward.
Pros
- Lower down payment requirement
- More flexible credit requirements
- Potentially purchase a home for less than market value
Cons
- Home must meet FHA property standards
- Ineligible if you won’t live there as your primary home
- Higher competition from cash buyers
- Slower closing process than conventional loans
For buyers who don’t have a large down payment saved up or have credit challenges, an FHA loan can make buying a foreclosed home possible where a conventional loan may not. Just keep in mind the property must be in good shape, reducing your selection.
How to Find FHA-Eligible Foreclosures
Not all foreclosures will meet FHA criteria, so focus your search on properties more likely to qualify:
- Check MLS listings through a real estate agent
- Search bank websites like Wells Fargo and Chase
- Look for HUD foreclosures on HUDHomeStore.com
- Check out Fannie Mae HomePath.com and Freddie Mac HomeSteps.com
Once you find a property, be sure to have it inspected to identify any deficiencies that may disqualify it from FHA financing. Act fast, as competition is high for eligible foreclosures.
Using FHA 203(k) Financing for Fixer-Uppers
If you find a foreclosure you love but it needs repairs to meet FHA standards, the FHA 203(k) program may be an option. The 203(k) loan allows you to finance purchase and renovation costs in a single mortgage.
With a 203(k) loan:
- An appraiser will estimate renovation costs upfront
- Loan funds are held in escrow and released as work is completed
- You can move in either before or after repairs are done
Because administered properly, 203(k) loans come with more complexity. Not all lenders offer them. Rates may be higher as well. But the program provides financing flexibility if the home you want needs repairs.
The Bottom Line
Buying a foreclosure can help you find an affordable home. While FHA financing is available, the property must meet minimum standards. With some extra legwork, you can likely find a foreclosed home that will qualify. But act fast in the competitive market and be ready to move quickly.
An FHA loan can make buying a foreclosure possible even with a lower credit score or down payment. But the home must pass FHA criteria. Do your homework to find a foreclosed property in livable condition and you can land a great deal on your dream home.
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?