If you are in the market to buy a home, you might consider the opportunity to look at foreclosures. After all, they are generally sold at a fraction of the cost of the home’s value. If you plan to use FHA financing for the purchase, though, you might run into a little trouble. If the home is not in perfect condition or at least acceptable to the FHA, they won’t guarantee financing on the home. Don’t worry though, this doesn’t mean all hope is lost. There is one way you can buy a foreclosure and use FHA financing to do so.
What are the FHA Property Requirements?
You can use FHA financing on most properties including:
- Single-family homes
- 1-4 unit properties
The key, however, is that the home is worth the price you agreed to pay. That’s pretty standard for any home loan, though. No lender will give you funds for a home that they cannot back up with the collateral (the value of the home).
An FHA exclusive requirement, however, is that the home must be ‘safe’ and ‘sanitary.’ In other words, you must be able to live in the home as it is and right away. This could make it difficult to purchase any foreclosures because they are often left in poor condition.
The FHA appraiser can determine if a foreclosure would qualify for FHA financing as it stands. The appraiser conducts an appraisal/inspection that lets the FHA-approved bank know if the home meets the FHA standards. If the home doesn’t meet the FHA standards including being ‘safe and sanitary’, the FHA won’t allow you to secure an FHA loan for it.
Don’t despair, though; if you find a foreclosed home that you want that is not in FHA-approved condition, you might consider the FHA 203K loan.
The FHA 203K Loan
The FHA 203K loan is a combination of a standard FHA loan with a rehab loan. In other words, you get the money to purchase the foreclosed home plus the necessary funds to rehab the home. The FHA 203K loan has the same guidelines as a standard FHA loan including:
- 5% down payment
- 580 credit score
- 31% front-end debt ratio
- 43% back-end ratio
The difference with this loan is the lender uses the after-repaired value of the home. While this sounds strange because who knows how much a home will be worth down the road, it’s possible. Here’s how.
Before you choose a contractor to do the work, you will have to run the company past your lender. The lender will have a say in who you choose based on the lender’s experience, credentials, and ability to complete the work on time (all FHA 203K work must be done in 6 months). Once you choose a contractor, he will work with your lender on a contract. This contract will include the work that he will do and the amount it will cost to do so. The lender will then pass this information onto the appraiser who will use it in his current valuation and approximation of the future value.
You are able to borrow up to 115% of the future value of the home based on the appraiser’s report. Keep in mind, though, that you must complete the required renovations that will bring the home up to the FHA code. The FHA and the FHA approved lender will not approve the loan if the home will not meet the FHA code once the work is complete. Any money you have left over after you make the necessary changes can be used as you see fit – the FHA 203K loan doesn’t have any restrictions regarding what you can do with the home as long as the repairs/renovations are modest and not considered luxurious.
The FHA 203K loan makes it easier to purchase foreclosures when looking at homes. While it’s not your only option if the home is in good condition, it’s an option to remember should you come across the ‘perfect home for you that is in less than perfect condition. Either way, you get flexible guidelines and low down payment requirements, helping you make the most of your purchase dollar.