If you are looking for a home on a tight budget, a short sale might be the way for you. A short sale happens when the seller owes more on their loan than what their home is worth and decides to sell their house for less than what they owe on the mortgage.
The lender will forgive the remaining balance on the loan since it is usually cheaper than going through the whole foreclosure process. This means that you, a home buyer, can get a below-market deal on the property.
Most importantly, you can use an FHA loan to achieve this.
What is a Short Sale?
First, let’s understand what a short sale is.
According to the NAR, “A short sale is a transaction in which the lender, or lenders, agree to accept less than the mortgage amount owed by the current homeowner.”
This usually happens when a homeowner is in a dire financial situation and can no longer make the monthly mortgage payments. They decide to sell it before the bank forecloses them. All the proceeds go to the lender and the remaining balance is forgiven.
Although the lender may lose money in the process, they will allow this to happen since the foreclosure process is typically more pricey.
What is an FHA Loan?
FHA loans provide more flexibility when it comes to qualifications. The FHA does not give loans but rather, insures approved lenders. This assurance is why the FHA loan has a low credit score (580) and down payment (3.5%) requirements, making it a popular loan choice for many first-time home buyers.
There are a few different options for refinancing an FHA loan. You can refinance into a conventional mortgage, which is not insured by the government and may have stricter lending requirements. You can also refinance into a new FHA loan, which can be a good option if you want to lower your monthly payments or change the terms of your loan.
FHA allows you to buy any property, given that it follows the guidelines that they have set.
- The property must be used as a primary residence. FHA is quite strict when it comes to the purpose of the purchased property. It is meant for owner-occupied homes only and you will not be granted the loan if you will use the home as an investment property, vacation home, commercial building, etc.
- 1-4 unit property. The FHA allows you to buy a property with 1-4 units. Properties with 5 units and above will not be approved for the loan.
- The property must meet safety standards. FHA loans are big on the safety and livability of the house. They will not loan you a home that has mold, a leaking roof, and other issues.
How to Buy a Short Sale With an FHA Loan
Buying a short sale with an FHA loan is a lot like buying any other property, but the waiting time can be longer. You can expect to wait from a few weeks to several months – there is no exact time frame when it comes to short sales.
Here are some important steps to remember to make the process easier and shorter.
Get pre-approved
Find a reputable FHA lender and provide the necessary documents to get you
pre-approved. It is important to do since it ensures that no one is wasting their time and that you have an actual chance of getting approved for the loan.
The loan officer will also be able to tell you how much you can afford for the loan so keep that in mind once you start shopping for short sales.
Finding for potential short sales and inspection of the property
Buying a short sale may mean that the condition of the property is not the best. This can actually be good for you since the poorer state of the property turns off other potential buyers.
Also, note that buying a short sale is buying the property “as-is.” Any repairs that need to be done will fall on you, the buyer. Make sure to calculate the possible repairs and their approximate value to ensure that you’ll be able to profit from them.
However, the FHA will not approve a loan for a property that does not pass their health and safety standards. If the short sale is in a bad condition, you can opt to get an FHA 203(k) loan which rolls in together your mortgage and rehabilitation/renovation payments.
Add the right people to your team
Buying a short sale is difficult to navigate on your own. Make sure to do research and add only the right people to your team. The right lender, real estate agent, and even lawyer are essential to ensure that your path to homeownership will be a smooth one.
Closing costs
With short sales, you can only negotiate with the seller’s lender to pay for the closing costs. They may pay for all of it, none of it, or a portion of it. But note that they will be taking into consideration every dollar they spend. If they deem that they can get a better profit out of a foreclosure, your offer may be rejected.
Short Sale FHA Loan Requirements
With an FHA loan, you can buy any property as long as it meets the guidelines stated above. When it comes to your requirements as a borrower to qualify for an FHA loan, below are the standard requirements.
- Credit score. Your credit score must be 580 or above to qualify for a 3.5% down payment on the loan. If your credit score is lower than 580, you will have to pay a downpayment of at least 10%.
- DTI. In general, your Debt-to-Income ratio must be 43% or lower. Higher DTI can be considered if you have compensating factors like a higher down payment or a high credit score.
- Stable employment and income. The FHA will also be asking for 2 years’ worth of employment and income through W-2 forms, tax returns, income statements, and whatnot.
Can You Get an FHA Loan After a Short Sale?
Let’s say that you were the one who sold your house through a short sale. Maybe you were in a bad financial position then and are ready to become a homeowner again. The FHA will allow you to get an FHA loan but certain rules may dictate your eligibility.
How Long After Short Sale For FHA Loan
According to HUD 4000.1, 3 years must pass after your short sale before you can get another FHA-insured mortgage.
HUD 4000.1 also clarified that “This three-year period begins on the date of transfer of title by Short Sale.” But there are also exceptions to the 3-year rule if the borrower experienced extenuating circumstances.
A borrower may also be exempted from the 3-year rule if:
“From the date of case number assignment for the new Mortgage:
- All Mortgage Payments on the prior Mortgage were made within the month due for the 12 months preceding the Short Sale; and
- Installment debt payments for the same time period were also made within the month due.”
Requirements For FHA Loan After Short Sale
The requirements for FHA loans after a short sale remain the same for those who are buying a home for the first time. As stated earlier, these include proof of:
- Credit score equal to or higher than 580
- DTI of at most 43%
- Stable income
The hard part of going through a short sale is building up your credit score. Since a short sale is reported as “not paid in full” in your credit history, it will negatively impact your score.
It’s also important to remember that although the FHA insures loans for those with scores as low as 580, some lenders will have different requirements.
The Bottom Line
If you want to buy a short-sale property with an FHA loan, the process is similar to getting any other property. But know that the process may take longer.
If you are the one who had to short sale on your previous property and want to get a new FHA loan, the process is also the same with any other applicant. You just have to wait three years and build up your credit score.
Short sales can get quite confusing, especially when navigating it alone. Whether you’re a seller or a buyer, don’t hesitate to contact us if you have any questions.
