Can you buy a foreclosure with an FHA loan?
Photo by RDNE Stock project.
If you’ve repeatedly asked the internet ‘Can I buy a foreclosure with an FHA loan?’ and gotten answers on both sides of the aisle, there’s a reason for that: the answer is both a yes and a no. The reason is that there are various stages in the foreclosure process, and the stage a house is in can affect how easy it is to use an FHA loan. For some stages, it’s simply too risky for most people.
So, the answer is technically yes for every stage of the foreclosure process, but you’re likely to run up against a lot of red tape if you try to use an FHA loan at an auction.
Below, we talk about why, and we delve into which foreclosure stages are the most suitable for an FHA loan.
What is a foreclosure?
You likely already know what a foreclosure is— a house that has been reclaimed by a lender because the homeowner failed to make monthly mortgage payments— but do you know the multiple stages of the foreclosure process?
So that we’re all on the same page, let’s review the overall foreclosure process::
Pre-foreclosure: Homeowner falls behind on mortgage payments, triggering the foreclosure process.
Notice of default: Lender notifies homeowner of missed payments and impending foreclosure.
Foreclosure auction: Property is sold at public auction to the highest bidder.
Bank-owned property: If property doesn't sell at auction, ownership officially reverts to the lender. When a property’s title is transferred to a lender, it becomes an REO property, or a real estate owned property.
REO sale: Lender sells the property on the open market to recoup losses. Property is often listed below market value to encourage a fast sale.
What about short sales?
Short sales are not technically a part of the foreclosure process. With a short sale, the homeowner is not behind on payments and the lender has not seized the home. Nevertheless, the current owner wants to move and is willing to sell the home at a loss.
Selling a home at a loss may seem illogical, but there are multiple reasons why a homeowner may choose to do this— for example, they may be financially struggling, they may suddenly need to relocate, or they may be worried about a possible foreclosure in their future (fyi, a short sale hurts a person’s credit score, but a foreclosure hurts it more).
Lastly, you can use an FHA loan to buy a short sale property. The only issue you may have is that the current homeowner may need to sell fast, and FHA loans can take a little longer to process than conventional loans.
Which types of foreclosure properties are easier to buy with an FHA loan?
Can you buy a foreclosure with an FHA loan? Yes, but it's much easier to buy a foreclosure with an FHA loan when the home is either in pre-foreclosure or is an REO property.
As discussed above, an REO property is one that was put up for sale at a public auction and failed to sell. The lender put the home up for sale on the open market.
A pre-foreclosure is one that is about to be put up for sale at an auction but hasn’t officially gone into foreclosure—so time is of the essence.
What to consider with pre-foreclosures:
You can get a great deal with a pre-foreclosure, but here are some things that may throw a wrench in your plans.
You’ll likely have to negotiate directly with the homeowner instead of an agent or lender: The homeowner didn’t choose for their house to be in pre-foreclosure, which means there will likely be more emotions involved than usual. Plus, they may have unrealistic expectations about their home’s value and you as their ‘white knight’. Real estate agents usually prevent both of these issues from going too far, so we strongly suggest finding an agent as soon as possible.
There’s a timeline: With a normal home purchase, both the seller and the buyer can usually take their time negotiating numerous variables. With a pre-foreclosure, the homeowner only has a set amount of time before the lender will put the home up for sale at an auction. You have to move fast to avoid this.
Your lender may not be willing to finance a pre-foreclosure purchase: Some lenders may be hesitant to finance pre-foreclosure properties due to the uncertainty surrounding the foreclosure process. This may be because of:
Title issues: It’s not uncommon for pre-foreclosure properties to have title issues or other liens that need to be addressed before the sale can proceed. This means property records will need to be researched and you’ll need to get title insurance.
The property condition: FHA loans require homes to meet certain standards. For pre-foreclosures, it’s not uncommon for homes to need a lot of work. This is normally OK, but the current homeowner may not have the finances to address any necessary repairs.
Using an FHA loan at a foreclosure auction:
As you now know, yes, you can use an FHA loan to purchase a foreclosure at an auction, but it will be difficult. Here’s what to keep in mind:
The foreclosed property must meet FHA standards:
Therefore, get pre-approved and start talking with a loan officer asap;
If a house comes up that you’re interested in, send it to them. Your loan officer is not the same as an underwriter, but he or she will be able to communicate with the person in charge of underwriting your loan. Depending on the auction house, you may be able to get it inspected before the balance is due.
The terms of the auction may prevent you from using an FHA loan:
Foreclosed properties must meet FHA standards, which means many auctions limit acceptable mortgages to conventional only.
Home may not have a clear title, which is needed for an FHA loan.
The auction may have strict time limits between the auction and when you need to pay:
Many auctions only give buyers a few days to provide them with the full purchase price.
Auction-bought homes do not come with appraisal contingencies:
If the home does not appraise for the purchase price, you are responsible for the difference.
If you want to pursue buying a foreclosure at an auction, then you need to do four things:
Understand the terms and conditions of the auction house— your best bet is to call and speak with the front desk. If they don’t accept anything but cash or conventional loans, you may need to try a different auction house. However, doing so may take you away from your desired purchase area.
Speak with your lender about your intentions— if they are willing, and the auction house is willing to take an FHA loan, you need to know your maximum purchase price before bidding. Should you go over that amount, you’ll need to cover the difference yourself.
Ask the auction how long you have to get the bid amount to them in full— unfortunately, many auction houses require payment between one and seven days.
Ask the auction house if they need a pre-approval letter from your lender— the auction house may not even allow you to bid without a pre-approval letter.
Other considerations to keep in mind:
Foreclosures are sometimes complicated. Here are a few more nuggets to keep in mind.
Deposits on auction houses:
Some auction houses that are open to FHA loans require a large deposit. The amount of the deposit is often between 20-30% of the purchase price. If you are able to put this amount down, the auction house will cover the difference while your lender is processing the loan.
HOWEVER, if you are unable to complete the purchase for whatever reason, it’s not uncommon for auction houses to require you to forfeit your deposit. For this reason, buying a foreclosure at a public auction is considered an unnecessary gamble for many buyers. You could lose a LOT of money and have zero legal recourse to get any of it back.
Fees for auctions:
Many auction houses also require a fee to be placed on top of the winning bid. The fee is non-refundable, and cannot be added on top of your loan amount.
If you are not the highest bidder:
Assuming the highest bidder is an investor, one strategy is to contact him or her and ask if they would be willing to sell to you. Sounds unlikely, but they may be willing to sell to you for just a few thousand more than they bought it if they know they won’t have to do any work to it.
For foreclosures that need work:
There is an FHA loan called a 203(k), which is a combination of a renovation loan and a regular mortgage.
An FHA 203(k) loan allows homebuyers to finance both the purchase of a home and the cost of renovations or repairs into a single loan. This loan program is designed for buyers purchasing homes that need significant work.
With an FHA 203(k) loan, borrowers can borrow up to a certain percentage of the home's projected value after improvements, making it possible to finance repairs or renovations that might otherwise be out of budget.
The loan proceeds are typically held in an escrow account and disbursed as needed to cover the costs of approved renovation work, which must be completed by licensed contractors. Overall, an FHA 203(k) loan provides a convenient financing option for purchasing and rehabilitating homes in need of repairs or upgrades.
HUD Foreclosures:
If you don’t want to compete for auctions or REO properties, another option is to go to HUD’s ‘Homes for Sale’ page. Closing costs are a bit more, but to secure a home prior to closing with an FHA loan often only requires $100 down.
Conclusion
You can use an FHA loan to purchase a foreclosure, but your best bet is using an FHA loan to purchase an REO foreclosure. REOs are homes that failed to sell at an auction and are now for sale on the open market. Yes, you’ll have more competition buying an REO than you would at an auction, but you won’t have to worry about time, nor will you have to understand an auction company’s specific rules and requirements.
To find foreclosures in your area, we suggest foreclosure.com. They list out every foreclosure in your area, and you can even filter homes by the stage of foreclosure they’re in, as well establish room, bathroom, and square foot requirements.
If you need more guidance on buying a home, we have the Homebuyer’s Workbook, which discusses mortgage types and their true costs, bidding strategies for both buyer’s and seller’s markets, how to find down payment assistance programs in your area, and much more. It’s 86 pages in total, and packed with everything we think first-time buyers should know.
FAQ
Can you buy a foreclosure with a USDA loan?
Yes, you can, but there will be difficulties if you want to use a USDA loan to purchase a pre-foreclosure or an auctioned-property, your biggest issue will likely be the amount of time it takes to process a USDA loan. Your best bet is to buy an REO foreclosure with a USDA loan.
Can you buy a foreclosure with a VA loan?
A VA loan will likely give you the same issues as an FHA loan. Like FHA loans, VA loans require the house or property to meet certain standards. Therefore, while the answer is yes, you can use a VA loan to purchase a foreclosure, your best chance is to use a VA loan to purchase an REO property. At an auction, the risk of losing your deposit is too high.
Should I buy a foreclosure for my first home?
Generally, there are no absolute statements when it comes to real estate. Your unique financial situation and living needs may warrant another type of property. That said, we like foreclosures because of the potential for immediate equity. That equity can be used to take out a low interest home equity loan and prevent you from paying for mortgage insurance. Plus, should you decide to sell, you’ll take home more cash after you pay off your remaining mortgage.