Can You Buy A Foreclosed Home With An FHA Loan?

Federal Housing Administration (FHA) loans are government-backed loans, overseen by the U.S. Department of Housing and Urban Development (HUD). They are available to borrowers with less than perfect credit scores and less cash on hand.

FHA loans allow the chance for homeowners on a tight budget to finance their home with a more affordable option than conventional loans. FHA loans are intended for owner-occupant properties, not investment properties. But what about bank-owned or even foreclosed properties?

We’ll guide you through how you can buy a foreclosed home with an FHA loan and how to weigh your pros and cons.

Can I Buy A Foreclosure With An FHA Loan?

Yes, you can buy a foreclosed home with an FHA loan. A foreclosed home is a property that was seized from its previous owner due to the borrower defaulting on payments or otherwise breaking the terms of the loan. 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 give more house hunters the chance to find their forever home with an affordable finance option, there are certain standards and steps that make purchasing bank-owned and foreclosed homes more difficult.

How To Buy A Foreclosed Home With An FHA Loan

To buy a foreclosed home with an FHA loan, you have to meet certain criteria. A borrower who purchases a foreclosed property with an FHA loan must move into the home within 60 days of signing their loan and live in it as their primary residence.

The FHA also has several standards and inspection procedures before you can close on the house. Here are the requirements a borrower and the property must meet.

Requirements For An FHA Loan

Borrower requirements:

• FICO^Ⓡ Score of 580 or higher
• Have the ability to repay the loan, with a debt-to-income ratio (DTI) of typically less than 45%, though DTI requirements may differ based on every individual’s financial situation
• Make a down payment of at least 3.5%
• Pay the upfront and monthly mortgage insurance premium (MIP) 

Home requirements:

• Property must be used as a primary residence
• Property must be appraised by an FHA-approved appraiser
• Property must meet the minimum HUD home inspection standards for safety and habitability

FHA 203(k) Rehab Loan

In some cases, if the foreclosure home doesn’t meet the livability standards and is more of a fixer-upper, the FHA also offers FHA 203(k) rehab loans.

These rehab loans roll the cost of renovations or upgrades into the overall price and allows borrowers to repay lenders for both repairs and the home loan in one monthly mortgage payment. Borrowers also do not have to live in the house until the renovations are completed. The program involves an appraisal to determine the cost of repairs and value of the home once completed.

203(k) loans have different standards and often a higher interest rate than traditional FHA loans. 

Pros And Cons Of Buying A Foreclosure With An FHA Loan

There are both advantages and disadvantages to using an FHA loan to buy foreclosed homes. Let’s take a look at some of the most common pros and cons.

Pros

FHA loans allow lower minimum credit scores and a lower down payment requirement to buy a home. Since foreclosed homes are typically priced lower than comparable homes for sale in the area, an FHA foreclosure purchase allows some house hunters the chance to buy a home that may otherwise be out of budget.

Cons

The downside to buying a foreclosed home with an FHA loan is that the property must meet strict criteria. One of the most important factors is that the home is safe. 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.

There is also more competition with buying foreclosures since investors may be able to pay with cash, which is less risky for banks when compared to an FHA borrower, who will need a mortgage.

Even though FHA home loans are an affordable finance option, it’s important to budget for closing costs and general home maintenance.

How To Find Foreclosed Homes For Sale

Foreclosed properties for sale can be found online at multiple listing service (MLS) websites, in your local newspaper, at bank offices and on most real estate listing websites. The HUD Home Store, Fannie Mae’s HomePath and Freddie Mac’s HomeSteps are other websites with foreclosure properties for sale.

The Bottom Line

An FHA loan can be used to help finance the purchase of a foreclosed home. When considering a foreclosed house, remember the home must be safe, livable, and free of health and safety hazards. The downside is that FHA loans may also put home buyers at a competitive disadvantage for foreclosures if they are up against investors and their cash offers.

Many home buyers finance foreclosure properties with an FHA loan. Are you ready to get started on your FHA loan approval?