Can I Use a Mortgage to Finance an REO Property?

Yes. REO sellers accept offers backed by FHA, VA, and conventional mortgages, but the home must pass the loan's appraisal and property standards. FHA requires a home that is safe, sound, and secure, and Fannie Mae will not buy a loan on a home with defects severe enough to affect safety or structure until they are repaired. Because REO sellers sell as-is and usually will not make those repairs, a home in poor condition often needs a renovation loan, such as an FHA 203(k) or a Fannie Mae HomeStyle mortgage, or cash. Either way, expect the seller to ask for a preapproval letter or proof of funds with your offer.

When does a home's condition block a regular mortgage?

The lender orders an appraisal, and the appraiser reports both value and condition. How a lender evaluates a property covers the full review. The rules that matter most for REO homes:

Vacant REO homes add one more problem: shut-off utilities. An FHA appraiser must try to have them turned on to run the heating, plumbing, and electrical systems. If that is not possible, the appraisal is made subject to a second visit once utilities are restored, and that visit can add repair requirements.

What HUD's financing codes mean

HUD tells you up front whether one of its homes qualifies for FHA financing:

• IN (insurable): eligible for a standard FHA loan as-is.
• IE (insurable with escrow): needs repairs estimated at no more than $10,000. The FHA loan closes with a repair escrow, money set aside at closing to pay for those repairs afterward.
• UI (uninsured): needs more than $10,000 of repairs, so the only FHA option is a 203(k) loan.

Which renovation loans can roll repairs into the mortgage?

A renovation loan adds the cost of repairs to the mortgage, so you buy the home and pay for the work with one loan. The main options:

• FHA Standard 203(k): for major and structural work by a buyer who will live in the home. FHA does not insure investment properties, and its one exception, for HUD-owned homes bought by investors, excludes 203(k) loans. Repairs must cost at least $5,000, the lender selects a HUD-approved 203(k) consultant, and the total loan must fit within FHA's loan limit for your county. FHA 203(k) requirements covers the details.
• FHA Limited 203(k): for nonstructural repairs and minor remodeling, with a consultant optional and the same owner-occupant rule. The $75,000 cap covers total rehabilitation costs, which add fees such as permit and inspection fees, the contingency reserve (a cushion for unexpected repairs), and financed loan fees to the contractor's bid.
• Fannie Mae HomeStyle Renovation: a conventional loan for a primary home of one to four units, a one-unit second home, or a one-unit investment property. On a purchase, renovation costs can be up to 75% of the lower of the price plus renovation costs, or the appraised value after repairs.
• Freddie Mac CHOICERenovation and CHOICEReno eXPress: conventional renovation loans, with CHOICEReno eXPress meant for smaller projects.

Example (HomeStyle): You agree to pay $220,000 for an REO home that needs $70,000 of work, and the appraiser values it at $310,000 after repairs. The lower figure is $220,000 + $70,000 = $290,000. The renovation cap is 75% x $290,000 = $217,500, so the $70,000 of work fits. Your loan amount still depends on the maximum loan-to-value ratio (loan divided by that $290,000 figure) for your loan type and credit.

What do REO sellers require with your offer?

A preapproval, where a lender has reviewed your credit, income, and assets, carries more weight than a prequalification. How to get preapproved lists the documents to gather.

Tell the lender up front that the home is an REO, and ask whether it makes 203(k) or HomeStyle loans before you bid on a home that needs work. Fannie Mae requires 203(k) buyers to add HUD's required contingency language to its contract and will not sign financing addenda that conflict with that contract.

What else changes when you finance an REO?

• FHA's 90-day resale rule does not apply. FHA normally will not insure a purchase within 90 days of the seller acquiring the home. Federal rules exempt REO sales by HUD and other federal agencies, by Fannie Mae and Freddie Mac, and by state- or federally chartered financial institutions such as banks.
• Down payment. FHA's minimum is 3.5% (a 96.5% loan-to-value ratio) with a credit score of 580 or higher. Some HUD homes are offered with a $100 down payment on an FHA loan, and an owner-occupant buying from HUD can ask it to pay actual financing and closing costs of up to 3% of the purchase price. Investors are not eligible for that help.
• Earnest money if financing fails. On a HUD home, an owner-occupant can get the deposit back by giving HUD written documentation from a lender, within 30 days of contract ratification, showing the buyer could not get financing. An investor generally forfeits it. Check other sellers' addenda for their terms.

Run the inspection before your loan is final, since repair findings can change both the appraisal and your budget; why an REO needs an inspection explains what to test. For the pros and cons of REO buying in general, see what an REO property is, and for the foreclosure process that produces these homes, see how foreclosure works.