Short sales became the preferred way of disposing of bad assets when they surpassed bank foreclosure sales and accounted for 25 percent of all home sales. A short sale transaction involves selling a home for less than the balance owed on its mortgage. Buyers seeking a bargain can get a short sale for about 25 percent less than a non-distressed sale. Buying the home with a loan insured by the Federal Housing Administration (FHA) can save you additional money up-front on the down payment.
Buying a short sale home using FHA loans can help you save a significant amount of money upfront.
Purchasing a short sale property can be a great way to get a discounted price on a home. If you plan to use FHA financing, there are some important guidelines and restrictions to keep in mind.
In this comprehensive guide we’ll cover everything you need to know about buying a short sale with an FHA loan. including
- What is a short sale?
- FHA short sale rules and timeframe
- Tips for getting your offer accepted
- Pros and cons of using FHA financing
- Alternatives like conventional loans
- FAQs on short sale purchases
Let’s dive in!
What Exactly is a Short Sale?
Before we get into the nitty-gritty details let’s quickly recap what a short sale is.
A short sale takes place when the seller’s mortgage debt exceeds the home’s current market value. Basically, they owe more than what the house is worth.
With lender approval, the homeowner is allowed to sell the property for less than what they owe on the mortgage. This avoids foreclosure and helps the owner avoid further damage to their finances and credit.
For buyers, short sales present opportunities to purchase homes below market value. However, securing financing and getting offers accepted on short sales involves extra legwork.
FHA Rules and Timeframe for Short Sale Purchases
The Federal Housing Administration (FHA) does allow borrowers to purchase short sale properties using its loan programs. However, there are some specific guidelines and waiting periods to be aware of.
Waiting Period
For a borrower with a previous short sale, FHA requires a waiting period of 3 years from the date of the short sale to the case number assignment date for a new FHA mortgage.
However, borrowers whose short sale was due to verified extenuating circumstances like job loss or illness may be eligible for a reduced waiting period of just 1 year.
Additional Restrictions
On top of the waiting period, the FHA has additional restrictions when purchasing a short sale property:
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The buyer must be an owner-occupant – no investors allowed.
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Flipping rules apply, meaning the seller must have owned the home for at least 90 days prior to contract.
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Full FHA appraisals and inspections are required.
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Any needed repairs must be completed prior to closing.
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The buyer must qualify based on traditional FHA income, credit, and debt-to-income requirements.
Essentially, the FHA treats short sales similar to foreclosures when it comes to financing guidelines and property eligibility requirements.
Tips for Getting Your Short Sale Offer Accepted
Beyond meeting FHA requirements, buyers will want to make their short sale offer as appealing as possible to boost chances of seller and lender acceptance. Here are some tips that can help:
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Submit a complete offer package – Include pre-approval letter, proof of funds, earnest money deposit, and price justification. Don’t give the lender any reason to dismiss your offer.
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Offer a competitive price – Research recent comps so your offer reflects current fair market value. Avoid lowball offers.
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Keep contingencies minimal – Limit contingencies that give you an “out” if you get cold feet. For example, don’t make the sale contingent on selling your existing house.
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Act quickly – FHA short sale approvals can take several months. The sooner you submit a solid offer, the better.
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Be patient and persistent – It often takes follow-up letters and calls to lender loss mitigation departments to get offers approved. Don’t let delays deter you.
Hiring a knowledgeable real estate agent experienced in short sales can help steer you through the process successfully.
Pros of Using an FHA Loan to Buy a Short Sale
The main appeals of using an FHA loan to purchase short sales include:
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Low down payments – FHA requires just 3.5% down, making short sales more accessible. Conventional mortgages often require 20% down.
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Less cash needed – FHA also offers flexible gift funds and down payment assistance options that can reduce out-of-pocket costs.
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Looser credit requirements – FHA approves borrowers with credit scores as low as 580 and higher debt-to-income ratios. They also look at overall credit profiles.
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Streamlined appraisal – FHA appraisers are familiar with evaluating short sales. No need to explain details like you might with other lenders.
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Buyer protections – Mandatory home inspections uncover issues. Repairs must be made before closing, unlike with as-is foreclosure sales.
For buyers who don’t have a lot of cash saved up or want some credit leniency, FHA can make financing a short sale attainable.
Potential Cons to Weigh
However, there are also some drawbacks potential buyers should keep in mind:
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Strict occupancy rules – No investors allowed. Must be owner-occupied primary residence only.
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Longer timeframes – FHA short sale approval often takes several months due to overloaded processors.
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Limit on seller contribution – FHA limits seller closing cost contributions to just 3%, so you may pay more out-of-pocket.
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Upfront MIP – FHA loans require upfront mortgage insurance payments that raise your closing costs.
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Ongoing MIP – You’ll also pay annual mortgage insurance premiums for the life of the loan unless you put down 10% or more.
While still an option, an FHA loan may not be the most efficient financing method for all short sale buyers.
Alternatives to Consider Beyond FHA Loans
Some buyers may be better served using conventional financing to purchase short sales:
Conventional 97 – Allows just 3% down like FHA, but no ongoing MIP.
HomeReady or Home Possible – Down payments as low as 3% with discounted MIP from Fannie Mae and Freddie Mac.
Portfolio loans – Local banks may offer better terms for borrowers they know, regardless of credit scores.
203(k) rehab loan – Finance purchase and renovations in one loan if home needs significant repairs.
Cash-out refinance – Use proceeds from another property to buy a short sale in cash, then cash-out refinance.
Shopping around is wise to make sure you select the most fitting loan program for your short sale home purchase.
FAQs About FHA Short Sale Purchases
Can you negotiate repairs or credits on FHA short sales?
Yes, repairs and seller credits for closing costs can be negotiated like with any sale. However, FHA does limit seller contributions to just 3% of the purchase price.
How can I improve my chances of FHA short sale approval?
Make a solid offer at fair market value, get fully underwritten pre-approval, provide earnest money deposit and proof of funds, and be responsive to loss mitigation requests. Hire a knowledgeable real estate agent with short sale expertise.
What happens if my FHA short sale falls through?
Unfortunately short sale deals can fall apart at any point given their complexity. Have a backup plan ready in case it does so you don’t miss other purchase opportunities. Don’t hand over notice at your current rental until you close.
Can I use gift funds for an FHA short sale down payment?
Yes, FHA allows gift funds from relatives for the entire down payment as long as it is properly sourced and documented. No repayment or interest on gifts is required.
The Bottom Line
While requiring some patience and effort, buying short sales for under market value can be rewarding for savvy FHA borrowers. Just be sure to follow all the guidelines, know it may take months, and work with experienced real estate pros. Shop loan options too – FHA may not always be the best fit if you have other financing available.
Pre-qualifying for Short Sales
It is best to get pre-qualified for the loan before searching for a home so that you know exactly how much you have to spend. Short sale brokers and sellers typically want to know that you have your financing in place before they will consider moving forward with your offer. Pre-qualify with an FHA-approved lender by completing a loan application and providing the lender with your financial documentation, including most recent W-2s, tax returns, pay stubs and bank statements.
For Homeowners, Not Investors
FHA-insured loans are intended for owner occupants, not investors. Its low down payment requirement of 3.5 percent is intended to help borrowers of modest means, but the increased FHA limits in certain high-cost areas of the country mean borrowers with higher incomes can also benefit from the program. To circumvent the use of its insurance to build an investment portfolio, FHA only gives one loan to a borrower at a time. It requires that the borrower establish occupancy within 60 days of getting the loan and live in the home for the majority of the year.