Can You Buy A Foreclosed Home With An FHA Loan?
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? Let’s explore how you can buy a foreclosed home with an FHA loan, and we’ll also weigh the pros and cons of doing so.
Can You Buy A Foreclosure With An FHA Loan?
Although you can buy a foreclosed home with an FHA mortgage, the home must be habitable and meet all FHA guidelines for you to make the purchase.
A foreclosed home is a property that a bank or mortgage lender seized from its previous owner because this person defaulted on mortgage payments or otherwise broke the terms of the loan agreement. These homes tend to sell for less than market value and can therefore be a potentially good deal for a home buyer.
While FHA loans can give first-time home buyers and others the chance to find a great home even if they lack a super-great financial profile, FHA loans have certain standards and steps that make them different from other types of home loans, and these guidelines can make purchasing bank-owned and foreclosed homes more difficult.
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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. Sometimes, you can even buy a foreclosed home directly from a federal agency.
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.
The FHA also has several standards and inspection procedures you have to follow before you can close on the house. Next up are the requirements a borrower and the property must meet.
Borrower Requirements For An FHA Loan
FHA loan requirements mandate that a borrower must:
- Have a FICO® Score of 500 or higher (Some FHA lenders require a 580 minimum).
- Be within the acceptable debt-to-income ratio (DTI) range (typically, less than 57%), although DTI requirements may differ based on one’s financial situation.
- Make a down payment of at least 3.5%.
- Pay the upfront and monthly mortgage insurance premium (MIP).
Home Requirements For An FHA Loan
Here are some of the minimum property standards for a house to be eligible for an FHA loan:
- The property must be used as a primary residence.
- The property must be appraised by an FHA-approved appraiser.
- The property must meet the minimum HUD home inspection standards for safety and habitability.
Individual mortgage lenders may impose additional requirements at their will.
FHA 203(k) Rehab Loan
In some cases, if the foreclosure doesn’t meet the livability standards and is more of a fixer-upper, the FHA will offer what’s 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 don’t 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. Let’s 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 |
Pros
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.
Cons
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 isn’t 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, it’s still essential to budget for closing costs and general home maintenance, too.
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How To Find Foreclosed Homes For Sale
Foreclosed properties for sale can be found on most real estate listing websites, in your local newspaper (or on the newspaper’s website) and at bank offices. Working with a real estate agent can also give you access to the multiple listing service (MLS) and a wider selection of foreclosed homes that are available.
The HUD Home Store, Fannie Mae’s HomePath program and Freddie Mac’s HomeSteps program are other websites with foreclosure properties for sale.
The Bottom Line
An FHA loan can be used to finance a foreclosed home purchase. When considering this loan program to buy a foreclosed house, however, remember that the home must be safe, livable, and free of health and safety hazards. Another potential challenge of using an FHA loan for a foreclosure purchase is that an FHA loan may put you at a competitive disadvantage if you’re up against an investor with a cash offer.
