Can I Buy a House at Auction with an FHA Loan?

You can buy a house at auction with an FHA loan, but there are some specific conditions to keep in mind. Federal Housing Administration (FHA) loans are a great financing option mainly because they offer low down payments and are easier to get even if you don’t have a great credit score. This makes it a popular choice for many first-time home buyers or those on a tight budget. However, buying a house at auction with an FHA loan requires following certain rules.

At RenoFi, we’re here to help you understand your borrowing options. In this guide, we’ll explain what you need to know about the process, the rules, and the benefits and challenges. We’ll also share some tips to help you successfully buy a house at auction with an FHA loan.

What Is an FHA Loan and How Does It Work?

An FHA loan is a type of mortgage that’s backed by the Federal Housing Administration, which is a government agency. The loan option is popular because it lets people buy a home with lower down payments and more flexible credit requirements. Thanks to FHA loans, more people can afford to own their homes.

But here’s the thing: if you want to buy a foreclosed home with an FHA loan, you need to make sure it meets all the FHA’s rules. This means the property has to be safe and livable, so it doesn’t become a financial burden for you.

Buying a Foreclosure vs Buying a Short Sell

When you’re looking to buy a property that’s listed below market value, it’s important to understand the difference between a foreclosure and a short sale.

A foreclosed home is a property that a bank or lender took back from its previous owner because they couldn’t pay their mortgage or broke the terms of their loan. These homes usually sell for less than their market value, making them a great option for buyers looking for a bargain. Generally, foreclosures have faster closing times and are sold “as-is”, so you, the buyer, know little about the property’s condition.

On the flip side, a short sale is when the original homeowner wants to sell their property at a loss, even though they are not behind on their mortgage payments and the bank or lender hasn’t taken the home from the owner. 

In most cases, the property is usually in better condition than foreclosures but buying it may involve a lengthy process and some back-and-forth negotiation.

Property Standards for FHA Loans

When you get an FHA loan, you’re taking out a mortgage backed by a property. If the property is in bad shape, you could end up facing costly repairs right from the start. Plus, it can be tough for the lender to sell it. To protect both you and the lender from unexpected financial challenges, the FHA sets minimum standards for properties it finances. These include:

Safety

The home needs to keep everyone safe and healthy. That means fixing things that may cause safety and health risks, such as:

• Electrical problems
• Poor heating source
• Broken shower, toilet, or sink
• Nuisances (nearness to things that cause excessive noise like heavy traffic)
• Health hazards (nearness to hazardous waste sites or high-voltage power lines)

Soundness

The house should have a strong foundation, solid walls, and a sturdy roof. It needs to be in good shape so it stays valuable and comfortable to live in. This includes:

• Making sure roofs and attics are in good condition
• Fixing excessive dampness and leakage problems
• Repairing any cracks in the foundation or damage to the structure

Security

The home should keep the occupants and their belongings safe. That means:

• Having good doors, windows, locks, and other security features in place
• Making sure the roofing prevents moisture and does not exceed three layers

Ensuring Properties Meet FHA Standards

To make sure homes insured by FHA meet the necessary standards, FHA enforces the following guidelines:

• Appraisal Process: An FHA-approved appraiser checks the home to see if it meets FHA’s rules.
• Lender’s Role: Lenders hire an appraiser to check if the home meets FHA standards. If they find problems, the lender may ask for repairs before approving the loan.
• Required Repairs: If there are issues, it’s up to the buyer to get them fixed before the loan goes through.

Property Requirements for FHA Loans

Before a house can qualify for an FHA loan, it must meet certain criteria:

• Primary Residence: FHA loans are for homes you plan to live in as your primary residence. You can’t use an FHA loan for a second home if you already have one as your primary residence. Consider getting a VA loan or home equity loan from RenoFi if you’re interested in financing a second home.
• FHA-Approved Appraiser: Only an appraiser approved by FHA should check the property. This makes sure the lender knows the home meets all the FHA loan rules.
• Safety Check: Make sure the home meets HUD’s safety and property standards. This keeps things safe and up to par with what FHA requires.

How to Qualify for FHA Loans

Now that we’ve answered the question “Can I buy a house at auction with an FHA loan?” and covered the property guidelines, let’s look at the requirements you need to meet to buy a foreclosed home with this loan.

Credit Score

Generally, you need a credit score of at least 580 to get an FHA loan with the minimum down payment. If your score is between 500 and 579, you might still qualify, but you’ll need to make a higher down payment.

Down Payment

With an FHA loan, you’ll need to put down at least 3.5% of the purchase price if your credit score is 580 or higher. If your score is lower, you might need to put down up to 10%.

Debt-to-Income Ratio

Your debt-to-income (DTI) ratio should ideally be 43% or lower. Some lenders might let you have a higher ratio if you have other good things going for you, like a big savings account or a high credit score.

Steady Income and Job

You need to show you have a steady income and a job. Lenders usually like to see you’ve been employed steadily for at least two years, preferably with the same employer.

Mortgage Insurance

You’ll need mortgage insurance to get FHA loans. This means paying an upfront mortgage insurance premium (UFMIP) of 1.75% of the loan amount, plus a monthly mortgage insurance premium (MIP).

Loan Limits

FHA loan limits vary depending on where you live, the type of home you want to finance, and the cost of living in your area. Make sure the price of the foreclosed home falls within the FHA loan limits for your area. You can use the Department of Housing and Urban Development (HUD)’s online search tool to check the loan limit in your state or county.

No Recent Bankruptcies or Foreclosed Property

You need a clean financial history for the past few years. Usually, you need to wait at least two years after a bankruptcy discharge and three years after a foreclosure to qualify for an FHA loan.

Advantages of FHA Loans

• Smaller Down Payment: You can qualify for an FHA loan with a down payment as low as 3.5%. This can be beneficial if you don’t have a large sum saved for a down payment.
• Flexible Credit Requirements: FHA loans are more lenient with credit scores compared to conventional loans. This means you can easily qualify for the loan, even if your credit scores aren’t perfect.
• Lower Closing Costs: With FHA loans, sellers can contribute up to 6% of the purchase price for closing costs, which cuts down on what you pay upfront.
• Fixed-Rate Options: You can get fixed-rate mortgage options with FHA loans. This way, you know exactly what your monthly payments will be and make budgeting a lot easier.
• Assumable Loans: FHA loans are assumable. In other words, a future buyer of your home can take over your existing FHA loan at the same interest rate. This can be an attractive feature when selling your home, especially in high-interest-rate environments because it means buyers can avoid higher interest rates and potentially lower their monthly payments. Plus, assuming an FHA loan often means lower closing costs compared to getting a new mortgage.

Disadvantages of FHA Loans

• You Pay More in Mortgage Insurance: Taking out an FHA loan means you’ll pay more because of upfront mortgage insurance premiums (UFMIP) and annual mortgage insurance premiums (MIP). These payments can increase your monthly payments.
• Lower Loan Ceiling: FHA loans might limit how much you can borrow, especially in pricier areas. This lower loan limit can restrict your housing choices.
• Property Standards: FHA rules regarding properties could narrow down your choice of homes, especially if you’re looking at homes that need major repairs.
• Extra Paperwork: Getting approved for an FHA loan could take longer because it needs more documents and checks than regular loans.
• Resale Limitations: When buying a property, FHA loans typically have stricter rules about the condition of the property. While the rules are designed to ensure that the property is in a safe and livable condition, they can limit what kinds of homes you can get or need extra fixes before closing.

Benefits of RenoFi Loans

While FHA loans are similar to conventional loans, RenoFi offers a new loan that allows you to borrow against the future value of your property post-renovation, rather than borrowing against its current value. 

While a traditional 90% LTV HELOC may sound like a viable option to fund a home renovation project, it often doesn’t work because the available equity isn’t enough to tackle your entire wishlist. One way to solve for that is to take into account the After Renovation Value of your home and use that to increase the available equity - this is what RenoFi loans do. 

For example, imagine your home is currently valued at $500,000 and your outstanding mortgage balance is $400,000. You are planning a renovation and expect that the after renovation value of your home would be approximately $640,000. Your current loan-to-value ratio (LTV) is at 80%, which means that you effectively can’t borrow anything to fund your renovation. A RenoFi loan, however, would allow you to go as high as 150% LTV or 90% LTV using the after renovation value.

So in this example, while using a standard home equity loan results in your borrowing power being $0, a RenoFi loan allows you to borrow up to $176,000 thanks to the after renovation value of your home!

If you are considering a home renovation, RenoFi is by far the smartest way to finance your project. Learn more and explore your borrowing options here.

Things to Consider When Buying a House at an Auction With an FHA Loan

Here are a few important factors to keep in mind when you’re thinking of buying a home with an FHA loan:

1. Understand Auction Terms

First off, get familiar with the auction’s terms and conditions. Your best move is to call and chat with someone at the front desk. Find out if they accept FHA loans or if it’s strictly cash or conventional loans only. If they don’t take FHA loans, you might have to look for another auction house. This might mean searching outside your preferred buying area.

2. Talk to Your Lender

Be open with your lender about your plans. Make sure they’re on board with you using an FHA loan for the auction. It’s super important to know the maximum price you can bid before you bid. If you bid over that amount, you’ll need to dig into your own wallet to cover the difference.

3. Check Payment Deadlines

Find out from the auction how long you’ve got to come up with the full bid amount. Sadly, many auctions want payment usually within one to seven days.

4. Get Your Pre-Approval in Order

Some auctions won’t let you throw in a bid without a pre-approval letter from your lender. This step is important to show you’re serious and financially ready.

Should You Take Out an FHA Loan?

Before deciding, carefully think about your financial situation. If your credit score is on the low side, an FHA loan might be your best bet. It is more flexible on credit scores and usually requires you to make a smaller down payment. So, you should definitely consider this option if you’re short on cash upfront, and especially if you’re a first-time buyer.

However, remember to weigh the advantages and downsides we discussed earlier. This will help you decide if an FHA loan is the right move for you.

Final Thoughts

Can I buy a house at auction with an FHA loan? Of course, you can! However, keep in mind that buying a foreclosed home with an FHA loan can be a risky move. That said, it can be a smart investment if you take the time to do some thorough research and inspection.

If you’re considering applying for an FHA loan, make sure to do your homework and get the property inspected thoroughly. And don’t forget to seek advice from experts to make sure this option suits your goals.

If you’re planning to make some improvements to your new home, RenoFi loans are the smartest way to finance a home renovation project. Unlike traditional loans, which are based on your current home value or require you to refinance your primary mortgage and give up your low rate, RenoFi loans are based on the After Renovation Value of your home. This allows you to borrow on average 11x more, get a low monthly payment, and keep your low rate on your first mortgage. 

Need some guidance? We’re here to help. Reach out today if you’re thinking of buying a foreclosed home with an FHA loan or have any questions.