You can buy a foreclosed home using an FHA loan. First-time homebuyers may find this option attractive since FHA loans require a low down payment and foreclosure properties tend to have a lower listing price. However, despite the better deals, there are some drawbacks to using FHA financing for a foreclosed home.
Many homeowners have used an FHA loan to help them buy a foreclosed home. If you also want to take advantage of homes available at discounted prices but don’t have enough cash on hand, an FHA loan could be a great financing option. These loans allow borrowers with less than stellar credit scores and little savings to purchase properties.
However, as with other major decisions in life, there are things to keep in mind when considering this financing option. Read on to learn more about the pros and cons of buying a foreclosed home with an FHA and discover whether it’s the right decision for you.
What is an FHA loan?
An FHA loan is a mortgage that is insured by the Federal Housing Administration and is typically issued by qualified lenders. Because FHA loans are backed by the government, they generally have a much lower interest rate than other types of conventional loans.
Apart from its low interest, an FHA loan is a popular choice for first-time homebuyers as they offer low down payment requirements and flexible credit standards. However, they’re not available to anybody. Borrowers must still meet certain eligibility criteria as well as property requirements in order to qualify. And for those who do, FHA loans can be a great way to finance a new home.
Can you buy a foreclosed home with an FHA loan?
What are the FHA loan requirements?
Before you make an offer on a foreclosed home, you must meet the necessary requirements to obtain an FHA loan. This includes both your ability to repay the loan as well as the property’s condition and price.
To qualify for an FHA loan, you’ll need to prove that you can reasonably afford to repay the loan. To do this, the U.S. Department of Housing and Urban Development (HUD) requires the following:
- Substantial funding. Borrowers must prove that they can afford the additional mortgage debt of an FHA loan. To do this, you’ll need to show that your debt-to-income ratio is around 50% or less, though this may change depending on your individual case. You’ll also need to provide a consistent employment history to prove your funding source
- Credit score and report. Fortunately, you don’t need a stellar credit score to obtain an FHA loan. Provided you and your potential property meet the other requirements, you can qualify for the loan with a credit score of 580. If you’re able to make a 10% down payment, your credit score can be in the 500 to 579 range.
- Down payment. Depending on your credit score, you must be able to afford a minimum 3.5% down payment (or 10%, as mentioned above). You’ll need to have the funding ready by the time you apply for the loan or be approved for a down-payment assistance program.
- Mortgage insurance. You must be able to cover the upfront mortgage insurance premium (UFMIP), which is usually 1.75% of the base loan amount. After the initial cost, you must be able to afford future monthly PMI payments. Depending on your down payment or how much equity you build in your home, you may not have to make these payments the entire time you own the house.
- Occupy the property. Make sure you use the FHA loan to purchase a home you like. The HUD requires borrowers to make their new property their primary residence.
In addition to the borrower’s qualifications, the property must meet the FHA’s minimum property standards to finance a foreclosed home with an FHA loan.
- Appraisal required. Before approving the loan, the HUD will assign an FHA-approved appraiser to review the property. Not only will the appraiser assess the home’s value, but they’ll also point out any significant damage that could be a concern.
- Appropriate condition. If the appraiser finds conditions in the house that could pose a threat to the safety of the occupant or jeopardize the soundness and structure integrity of the house, additional inspections or repairs may be necessary.
If you’ve met every other requirement listed above, then there’s only one step remaining: the size of your loan. Each year, the HUD releases the FHA loan “floor” and “ceiling” loan limits.
- Floor limit. This is the minimum loan amount you can apply for. As of this year (2022), the minimum loan you can apply for is $420,680 for a one-unit property.
- Ceiling limit. As you may have guessed, the ceiling limit is the maximum loan amount you can apply for. In 2022, the ceiling for a one-unit property is $970,800.
How to get pre-approved for an FHA loan
The process of applying for an FHA loan is quite similar to the way you apply for other types of mortgages.
- Find an FHA-approved lender. The good news is that the majority of banks, credit unions, and online lenders provide FHA loans, so this shouldn’t be too difficult. Because mortgage terms can vary quite a bit depending on the lender, make sure to contact multiple FHA mortgage lenders and request a quote from each of them.
- Start your mortgage application. To complete your application, lenders will typically need some essential information about your finances. This might require you to provide documents showing you have sufficient, stable, and sustainable income. These documents can include your recent pay stubs, W-2 forms, investment earnings, bank statements, etc.
- Compare loan estimates. Once you’re done with the application, you should then receive a loan estimate from the mortgage lender. Loan estimates provide important information about your monthly mortgage payments, your estimated interest rate, as well as the total closing costs for the loan. Be sure to compare loan estimates from various lenders before making the final decision.
The closing costs of your FHA loan are similar to those of a conventional loan. You should expect to pay around 2% to 6% of the total loan amount.
For example, if the property you plan to buy costs $500,000, you’ll have to shell out anywhere from $10,000 to $30,000 in closing costs. So be sure to take this into account before purchasing a foreclosed home with an FHA loan.
Should you buy a foreclosed home?
If you’re looking for a housing option that won’t break your bank, a foreclosed home may be a great option. However, be prepared for some serious legwork.
Since a foreclosed home is reclaimed by the bank or government lender, most of these properties need considerable repairs. For home flippers, this isn’t a problem, but new homeowners may want to stay away.
Where can you find foreclosures for sale?
If you’re looking to find a foreclosed home, you can search for great bargains on real estate listing sites such as Zillow.
You can also find foreclosures on HUD Home Store. The homes listed here are properties that have been acquired by the government due to foreclosure on an FHA mortgage. You can also check the Freddie Mac’s HomeSteps and Fannie Mae’s HomePath for additional listings.
In addition to online listings, search for a real estate agent who specializes in foreclosed homes. This is especially important for first-time foreclosed buyers, as you may not know a good deal when you see one, but your agent will.
Pros and cons of buying a foreclosure with an FHA Loan
Just like financing a home with any other type of loan, buying a foreclosure with an FHA loan also has its upsides and downsides.
Here is a list of the benefits and drawbacks to consider.
- Low down payment. If you have a credit score of at least 580, an FHA loan only requires a 3.5% down — which is much lower than the traditional 20% down required by many lenders. This makes it much easier for those who want to purchase a foreclosed home without a lot of money saved up.
- Less stringent qualifications. As mentioned above, FHA loans have a more lenient credit score and down payment criteria compared to conventional mortgages. This makes it a great option for borrowers who might not otherwise qualify.
- Better deals. Another benefit of purchasing a foreclosure with an FHA loan is that foreclosures are usually priced lower than similar homes for sale in the same area. Combined with the low-interest rate and low down payment requirements for FHA loans, this can allow you to secure a good deal on a home that may otherwise be outside your budget.
- Need to meet FHA property requirements. When you buy a foreclosure with an FHA loan, you still need to meet FHA property requirements. This can be difficult if the house is in poor condition or needs repairs, especially if the property has defects and damages that would affect the safety, security, or soundness of the home.
- Competition with other investors. Because foreclosed homes are usually sold at a lower price, many are looking to make a return on their investment by flipping these properties for a future sale. If these potential buyers are looking to purchase the foreclosed home in cash, financing it with an FHA loan might put you at a disadvantage. Mainly because a cash offer comes with fewer contingencies and lower risk, and sellers tend to prefer it over a financed offer.
- Foreclosed properties are sold as-is. Foreclosed properties are sold as-is, which means that any repairs are your responsibility and there’s usually no room for negotiation. So if something major goes wrong with your house after closing, you’ll have to pay for the repairs yourself. Make sure to take this into consideration beforehand. Repair costs can add up quickly if the property isn’t in great condition.
Can you buy a bank-owned home with an FHA loan?
Yes, you can buy a bank-owned home with an FHA loan.
A bank-owned home is essentially property that has been foreclosed on by a financial institution. And if the foreclosed property goes unsold at auction, the lender becomes the owner of the property instead of an individual. This house will then sit on the bank’s books until it’s sold.
Can you buy a short sale with an FHA loan?
Yes, you can also buy a short sale with an FHA loan as well.
The term “short sale,” also known as a pre-foreclosure sale, happens when a home is sold for less than the remaining balance on a mortgage. It’s an alternative to foreclosure that allows the borrower to sell their home and pay off their debt while avoiding the damage to their credit score that comes with foreclosure.
Because short sale properties are already at a discounted price, you can save potentially save even more money in the long term with the FHA loan’s low interest and low down payment.
- You can buy a foreclosure with FHA loans, but you need to meet certain requirements first. Also, the foreclosed home will need to meet minimum property standards.
- An FHA loan is a government-backed mortgage that provides a relatively low interest rate, down payment requirements, and flexible credit standards compared to conventional mortgage loans.
- The advantages of buying a foreclosure with an FHA loan include the less stringent qualification process, minimal down payment required, as well as the opportunity to secure a good deal on a home that you might otherwise not afford.
- The downside of financing a foreclosed home with an FHA loan is that there might be more competition. Also, the property will be sold as-is, and it’ll still need to meet FHA’s property criteria.
View Article Sources
- Federal Housing Administration — U.S. Department of Housing and Urban Development
- HUD Homes for Sale — Benefits.gov
- The Definitive Guide to FHA Loans — SuperMoney
- How To Buy Foreclosed Homes With No Money — SuperMoney
- What is an FHA Amendatory Clause and Are You Obligated to Sign It? — SuperMoney
- What is a Partial Claim Mortgage? — SuperMoney
- How to Finance a House — SuperMoney
- Best Mortgage Lenders | April 2022 — SuperMoney