How to Buy Short Sale Homes on FHA

Short sales became the preferred way of disposing of bad assets when they surpassed bank foreclosure sales and accounted for 25 percent of all home sales. A short sale transaction involves selling a home for less than the balance owed on its mortgage. Buyers seeking a bargain can get a short sale for about 25 percent less than a non-distressed sale. Buying the home with a loan insured by the Federal Housing Administration (FHA) can save you additional money up-front on the down payment.

For Homeowners, Not Investors

FHA-insured loans are intended for owner occupants, not investors. Its low down payment requirement of 3.5 percent is intended to help borrowers of modest means, but the increased FHA limits in certain high-cost areas of the country mean borrowers with higher incomes can also benefit from the program. To circumvent the use of its insurance to build an investment portfolio, FHA only gives one loan to a borrower at a time. It requires that the borrower establish occupancy within 60 days of getting the loan and live in the home for the majority of the year.

Pre-qualifying for Short Sales

It is best to get pre-qualified for the loan before searching for a home so that you know exactly how much you have to spend. Short sale brokers and sellers typically want to know that you have your financing in place before they will consider moving forward with your offer. Pre-qualify with an FHA-approved lender by completing a loan application and providing the lender with your financial documentation, including most recent W-2s, tax returns, pay stubs and bank statements.

Finding an Approved Lender

Whether you choose a mortgage broker or commercial bank, the lender must be approved by the Department of Housing and Urban Development (HUD) to participate in FHA programs. The HUD website maintains a list of approved lenders and the insurance programs they specialize in.

Shopping for a Short Sale

Shop for a short sale based on your pre-approved loan amount. It's generally better to look for a home below your maximum price range. This allows you a margin for negotiating the sales price and allows you to increase your sales price if the lender requires you to in order to approve the short sale.

Obtaining an Appraisal

You'll need to pay for the FHA appraisal inspection. Your lender will require an interior and exterior inspection of the home by a HUD-approved appraiser. The appraiser denotes any flaws or repairs needed to meet FHA guidelines and gives the lender an opinion of value. The home must pass the FHA appraisal to gain approval for the loan. The appraisal typically costs between $300 and $400.

Negotiating the Deal

Wait for the lender to respond to your offer with either a counter offer, approval or rejection. If the sale is not approved according to the contract terms set forth in your original offer, revise your offer accordingly. This may entail increasing the sale price or reducing or removing certain conditions. Consult your real estate broker for advice on how to change your offer.

Combination Loan Option for Fixer-Uppers

Short sales often require substantial home improvements because of deferred maintenance, abandonment or vandalism by the financially distressed home owner. FHA offers the 203(k) Rehabilitation program for the acquisition and renovation of such properties. It combines a purchase-money loan with a construction loan, allowing the borrower to complete two tasks without the cost and hassle of obtaining two separate loans. This combination loan requires an additional step of property re-appraisal and an escrow repair account from which to draw repair funds.