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In the United States, there are many different paths to homeownership. One of the most common ways to buy a home – especially if you can’t make a huge down payment – is with help from the Federal Housing Administration (FHA).
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. However, there will be a lot of things to keep in mind, such as whether the condition of the foreclosed home can pass the FHA’s pre-purchase inspection.
In this guide, we’ll answer some of the most common questions you might have about buying a foreclosed home with an FHA loan. By taking some time to learn about how this process works, as well as the various pros and cons that come with it, you can decide if buying a foreclosed home with an FHA loan is right for you.
Can You Buy a Foreclosure With an FHA Loan?
Yes, in many cases, you can buy a foreclosed home using an FHA loan. The FHA doesn’t have a policy forbidding you from buying a foreclosed property. In fact, thousands of people use FHA loans to buy foreclosed properties every year.
However, as we’ll further explain in this guide, there are some limitations regarding the type of property you can buy. To start, you have to meet the FHA’s basic borrowing standards. After that, you’ll have to make sure you choose a property that meets the FHA’s minimum property standards, such as passing an FHA appraisal and inspection. But as long as you can work within the pre-established framework, buying a foreclosed home with an FHA loan is very possible.
FHA Loan Standards for Borrowers
The FHA loan is very transparent about the standards it has for borrowers. This means that whether you’re hoping to buy a foreclosed property – or any other type of property – with an FHA loan, you shouldn’t run into any big surprises.
Generally, these standards fall into one of two categories: standards for borrowers and standards for the property itself.
Borrower requirements
To secure an FHA loan, most borrowers will need to meet each of the standards listed below:
- Credit score: With some exceptions, FHA loans will require all borrowers to have a credit score of at least 580. Having an even higher credit score may help you secure better terms.
- DTI ratio: Your debt-to-income (DTI) ratio represents the portion of your income that’s used to service debt, including mortgages, credit cards and other types of debt. The maximum DTI ratio you can have with an FHA loan is 57%, though a lower ratio will be better.
- Down payment: The FHA requires most borrowers to make a minimum down payment of 3.5% to secure a home. However, there are a few programs available that might allow you to purchase a home without a down payment.
Home requirements
Not every foreclosed property will be eligible for an FHA loan. Here are some of the home requirements you’ll want to keep in mind:
- Primary residence: The FHA will only issue loans for homes that will be used as your primary residence, meaning these loans can’t be used for vacation homes or investment properties.
- FHA approved appraiser: If you want to get a loan from the FHA, you’ll need to get an appraisal from a pre-approved FHA appraiser – be sure to check your appraiser’s qualifications.
- U.S. Department of Housing and Urban Development (HUD) habitability: The FHA will only issue loans for homes that a person could reasonably live in without significant changes. So if the foreclosed property you’re considering is in pretty bad shape, you might not be able to use an FHA loan.
Pros and Cons of Buying a Foreclosure With an FHA Loan
As with any home loan, you should carefully consider both the pros and cons of buying a foreclosed property with an FHA loan before making your final decision.
PROS of Buying a Foreclosure With an FHA Loan👍
When compared to traditional (conforming) mortgages, FHA loans often require a considerably lower down payment. For most people, the minimum down payment requirement is 3.5% [1], with some exceptions. Considering most traditional loans require a down payment of 5% – or more – you might be able to secure a foreclosed property for several thousand dollars less. This could help you save money to put toward any repairs that may need to be made.
Generally, the credit score requirements for FHA loans are pretty lenient. In fact, according to recent FHA guidelines, you might be able to qualify for a loan with a credit score as low as 580, if you put the required 3.5% down. [2] That’s 40 points lower than the 620 cutoff imposed by most traditional lenders.
All things considered, an FHA loan is often the easiest path to homeownership. The combination of low down payment requirements, low credit requirements and other benefits make these loans especially appealing to first-time homebuyers and people with a limited credit history.
CONS of Buying a Foreclosure With an FHA Loan👎
Not all foreclosed properties can be purchased with an FHA loan. For a property to qualify for this type of loan, it’ll need to meet the HUD’s minimum property standards, which can be strict.
In most cases, the bank or mortgage lender who owns the foreclosed property won’t make any repairs to it. In other words, you’ll buy it as-is, inheriting any existing problems with the home, which can be very expensive if the home hasn’t been cared for or regularly lived in.
Most mortgage lenders will be motivated to get foreclosed properties off their hands, which is why they’ll usually sell them for a considerable discount. While this can be great news for buyers in certain situations, it also creates a lot of immediate competition. This means you might end up paying more than the original sticker price.
How To Buy a Foreclosed Home With an FHA Loan
Once a home has been foreclosed on, the mortgage lender will become the outright owner of the property – and then usually look to sell it. If you’re considering buying a foreclosed property, be sure to work with a real estate agent who’s familiar with this unique market.
There are several different points in the foreclosure process where you can buy a property. This includes pre-foreclosure, short sales, property auctions and more. In some cases, you might be able to buy the property directly from a federal agency. Generally, the process is fairly similar to buying any other property.
Use an FHA 203(k) loan
A 203(k) loan is a special type of FHA loan that can be used to purchase a house in need of repair. 203(k) loans are often used to buy older homes that haven’t been lived in for a while. However, one important thing to keep in mind is that the property will still need to meet the HUD’s livability standards.
How To Find Foreclosures for Sale
Foreclosed homes are often listed alongside other homes for sale, though you might need to set your search to include the qualifier “foreclosed homes.” You can also work with a real estate agent who specializes in these sorts of properties – they’ll often have knowledge of a foreclosure before the rest of the market.
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HUD. “LET FHA LOANS HELP YOU.” Retrieved November 2022 from https://www.hud.gov/buying/loans
HUD. “Special Attention of: Transmittal: Handbook 4000.1.” Retrieved November 2022 from https://www.hud.gov/sites/dfiles/OCHCO/documents/4000.1hsgh-112021.pdf
