With median selling prices of homes still going for a lofty $420,800 in Q1 2024, home buying can be difficult for many buyers. A foreclosure home may be a viable option for homeownership at a lower purchase price. Government-backed loans like VA loans, USDA loans, and FHA loans are often a good option for borrowers who don’t ordinarily qualify for conventional mortgages.

Can you buy a foreclosed home with an FHA loan? While possible, you must comply with the Federal Housing Administration’s (FHA) livability and credit requirements to qualify. Read on to learn more about these loan requirements, helpful tips, and alternatives to consider.

Can You Buy a Foreclosed Home with an FHA Loan?

You can buy a foreclosed home with an FHA mortgage, but the property must be habitable and meet the minimum requirements for you to qualify.

A foreclosed home is any property that the lender has seized from a previous owner due to mortgage payment default or violating the terms of the mortgage loan. Since these homes usually sell for less than market value, they can be a good option for home buyers.

FHA loans allow first-time home buyers and others to purchase a home even if they don’t have a strong borrower profile. However, these loans come with a few stringent guidelines that may make it more difficult to purchase foreclosed homes.

Understanding FHA Loan Requirements for Purchasing a Foreclosed Home

You must meet certain criteria to buy a foreclosed home with an FHA loan, including credit and property requirements. Here’s what you should know.

Borrower Requirements

  • Down Payment: You’ll need at least a 3.5% down payment for an FHA loan. However, you may have to pay a 10% down payment in some cases, depending on your credit score.
  • Credit Score: You must have a credit score of 580 or higher if you plan to put down 3.5%. You may still qualify for an FHA loan with a credit score as low as 500, but you’ll need a 10% down payment.
  • Debt-to-Income Ratio: Usually, you’ll need a debt-to-income ratio (DTI) of 43% or lower to qualify for the loan.
  • Mortgage Insurance Payments: You’ll need to pay monthly insurance premium payments (MIP) for at least a minimum portion of the term of an FHA loan.

Property Requirements

  • Primary Residence: You can only use an FHA loan for a home you will use as your primary residence. You can’t use the loan to purchase a second home, such as a vacation home or an investment property.
  • Safety Standards: The property you’re purchasing should be able to meet the minimum property standards set by the U.S. Department of Housing and Urban Development (HUD).
  • FHA-Approved Appraiser: The property you plan to purchase should be appraised by an FHA-approved appraiser to ensure you meet the lender’s requirements.

The Pros and Cons of Buying a Foreclosed Home with an FHA Loan

Buying a foreclosed home with an FHA loan has several advantages and disadvantages. Carefully consider these to make an informed decision about whether this is a good option for you.

Pros

  • You’ll have the opportunity to buy a home at a lower price (because the home has been in foreclosure and is now being put up for sale by the previous owner’s lender/bank for whatever they can sell it for).
  • FHA loans have low down payment requirements.
  • You can qualify for an FHA mortgage loan even with a credit score as low as 500.
  • FHA loans have less stringent mortgage requirements, so they’re easier to qualify for.  

Cons

  • The property must meet the livability and minimum property standards set by the Department of Housing and Urban Development (HUD).
  • It may be difficult to find and have your offer to buy a foreclosed home accepted due to higher competition from other buyers looking for the same kind of home purchase bargain.
  • The sales process for foreclosed homes is lengthy and complicated.
  • You’ll have to purchase the property “as-is” and may have to spend money to fix any issues.

What Is an FHA 203(k) Rehab Loan, and Can You Use It for a Foreclosed Home?

You may qualify for an FHA 203(k) rehab loan if the foreclosed home is a fixer-upper or doesn’t meet the livability standards. With a rehab loan, you can roll the cost of home repairs into the cost of purchase. You’ll then have a single payment each month for the home loan and repairs.

The eligibility requirements for a 203(k) loan are different from those for FHA loans, and the interest rates can be slightly higher. You’ll also need an appraiser to assess the cost of renovations and the value of the home once repairs are completed.

Tips for Buying a Foreclosed Home with an FHA Loan

The exact home purchase process will vary by state, but there are a few things to keep in mind when buying a home that will help you be better prepared:

  • Research foreclosure types and decide which one may work for you. In some states, you’ll need to pay a cash deposit, while in others, you may have to pay for the home in cash immediately.
  • Take a closer look at your budget to decide how much you can afford to pay each month. Ideally, your mortgage payments shouldn’t be over 28% of your gross (pre-tax) income. Keep in mind that there will be other expenses, such as property taxes and insurance.
  • Work with a real estate agent who is familiar with foreclosed properties to help you navigate the entire foreclosure process.
  • Use online resources like Redfin or Zillow to find foreclosed homes for sale. You can use filters to find listings that are already foreclosed or are in the pre-foreclosure stage.
  • Look for lenders that are willing to offer FHA loans for foreclosures. Compare multiple quotes to find the best mortgage rates.
  • Get a pre-approval letter before you start viewing properties so you’ll have more negotiating power when you find a home you like.
  • Make sure you have all the documents you’ll need for the lender before you start the application process.
  • Make sure you have enough money set aside for any necessary repairs since foreclosed homes are sold as-is.
  • Find an FHA-approved appraiser.

Alternatives To an FHA Loan for Buying a Foreclosed Home 

Purchasing a foreclosed property with an FHA loan can be a lengthy and complicated process. If you don’t think it’s the right option for you, there are other options to consider:

  • Conventional Mortgage: You can use a conventional loan from an online mortgage lender, bank, or credit union to buy a foreclosed home. However, it may be difficult to qualify if the property isn’t livable.
  • HomePath ReadyBuyer: The HomePath ReadyBuyer program by Fannie Mae can provide up to 3% in closing cost assistance when you buy a foreclosed home owned by Fannie Mae.
  • Home Equity Loan or HELOC: If you have equity in your existing home, you can use a home equity loan or HELOC to help finance the purchase of a foreclosed property.
  • Private Mortgages: You can borrow money from a private lender to buy a house when you have bad credit. Keep in mind that these loans come with higher mortgage rates than conventional loans.

Carefully Consider the Risks Involved Before Buying a Foreclosed Home With an FHA Loan

An FHA loan can be a solid choice for financing the purchase of a foreclosure property. However, you’ll need to meet several requirements as a borrower and must buy a property that is livable and safe to qualify for the loan.

Another thing to keep in mind is that there are several risks in buying an as-is foreclosed property. You’ll likely need to have a substantial budget for repairs and get a home inspection done to ensure habitability. Carefully consider these downsides before you decide to purchase a foreclosed home.