Do you want to buy a home but are scared off by the sticker price?
Homeownership is seemingly unobtainable for those with a low income or poor credit score, but some government agency programs are designed to help provide loans for those who need them most.
Knowing about the many loan options out there can potentially save you thousands of dollars in the home buying process.
If you’re looking to save money when buying a home, read on to see just what a HUD loan is and if it could be right for you.
What is a HUD Loan?
The Department of Housing and Urban Development (HUD) was created in 1965 to oversee various housing and federal programs. The HUD oversees the Federal Housing Administration (FHA). Although slightly different, HUD and FHA loans are commonly used interchangeably.
The HUD enforces the Fair Housing Act and offers various community assistance programs.
HUD loans aren’t issued by the HUD but rather by HUD-approved private lenders. The FHA then insures the loan against loss.
These mortgage loans allow potential homebuyers the opportunity to purchase affordable housing. However, while more affordable, homebuyers still owe a down payment.
For loans over $50,000, there is a minimum 2.25% down payment owed. For loans less than that, just 1.25% down is needed. The necessary 1.5% fee on the value of the home can be financed with the loan. All buyers are required to pay mortgage insurance.
There are also special assistance and buyer programs through HUD.
Many first-time-buyer programs exist to level the homeownership playing field. The agency incentivizes buyers to use a HUD loan by offering these special programs. Here are some of the programs:
- One Dollar Program: Low to moderate income families can purchase HUD homes for as low as $1 as long as the home has been on the market for over six months.
- Good Neighbor Next Door Program: Provides 50% off the purchasing price of homes in revitalization areas to public servants like emergency medical technicians, police, and firefighters.
- HUD $100 Down Program: Forgoes the typical 3.5% down payment for owner-occupant buyers – only $100 is needed for a down payment.
- Housing Choice Voucher Program (Section 8): Provides a recurring subsidy for low-income families to help them afford their monthly mortgage payments.
What is an FHA Loan?
The FHA provides mortgage insurance to approved lenders, even if their credit score is low – a perfect credit history is not needed to secure an FHA loan. Even those who have gone through foreclosure or bankruptcy are eligible for an FHA loan.
To qualify for the home loan, borrowers need at least a 580 credit score. With that credit, borrowers need just 3.5% down, and the FHA will cover the rest. For those with a credit score ranging from 500-579, at least 10% down is needed.
A Mortgage Insurance Premium (MIP) is paid to the FHA. Borrowers pay both the MIP and monthly loan payments. With a down payment of 10% or more, borrowers are only on the hook for 11 years – anything less, and the MIP is paid for the entire mortgage term.
How Do HUD Loans work?
Homebuyers are able to buy a home with little money down because the FHA insures HUD loans. Loans that lenders otherwise might not want to offer are made possible by the FHA. Without the FHA, lenders would not offer buyers low-interest rates, affordable down payment amounts, or lend to those with low credit scores.
A secondary assurance is offered to private lenders in the form of mortgage insurance that the buyer pays. HUD borrowers pay an upfront mortgage insurance premium (UMIP) and a monthly premium. The monthly premium can be included in the loan.
The HUD loan program can be used to buy or refinance a property.
HUD loans are offered for HUD homes. HUD homes are also homes that have been foreclosed after being bought with an FHA loan.
When an FHA homeowner can’t keep up with their mortgage payment and mortgage defaults occur, they become a HUD home. Because the FHA insured the home, it steps in and pays the remainder of the mortgage to the lender if the borrower defaults.
The government will then sell the newly seized home to try and recoup the loss. The government often sells the home below market value to encourage first-time homebuyers.
The home is sold “as-is”, meaning there is no requirement to improve and repair the home before closing.
Who Are HUD Loans For?
HUD programs are for home buyers with a below-average credit score or those without the funds for a typical down payment. There is a low credit score requirement of 500-580, and the highest down payment that can be made is just 3.5% down.
There is also a debt-to-income ratio of 43%, but exceptions can be made for those who don’t fall within that requirement.
HUD homes are first available to those who qualify for the loans. Unless a home goes un-purchased for over six months, investors cannot buy the home. First-time homeowners also take precedence and those who intend to occupy the home for at least one year.
A stipulation is that the homeowner must not have purchased another HUD home within the last 2 years, and they must reside in the new home for at least 1 year.
There is a special section of the HUD loan. Section 184 loans are available to Native Americans looking to finance a home as a primary residence. The loan can be used to either buy, build, rehabilitate, or refinance a home.
What To Expect When Buying a HUD Home
Buying single family homes through a HUD loan differs from the conventional mortgage process.
These homes aren’t listed on popular listing services and are instead listed on the government website HudHomeStore.com.
A HUD-approved real estate agent is needed to view the homes. These homes are sold at auction. Bids placed through the HUD-approved agent will be accepted for 30 days after listing. After the 30 day window, HUD reviews all bids and selects the highest offer.
If no offer is deemed high enough, another window opens. This time, investors are allowed to bid.
HUD will contact the agent who submitted the winning bid and will provide a settlement date. Closing typically lasts 30-60 days.
While the bidding process differs from that of the traditional home-buying method, the financing aspect is quite similar.
HUD homes can be purchased with a conventional loan secured through Fannie Mae or Freddie Mac. VA loans can be used if the buyer is a qualified veteran, current service member, or spouse. FHA loans can be used for those struggling financially.
FHA 203(k) loans can be used for those looking to both buy the home and repair it. This is a good option if the home needs to be rehabilitated before becoming move-in ready.
Home inspections aren’t required as part of a HUD loan, but it is always a good idea to know as much about a house before buying it. A home inspection will let you know how much time, effort and money will need to go into the house to make it inhabitable.
Pros and Cons of HUD Loans
HUD loans are a fantastic way for people to own a home who otherwise wouldn’t be able to afford to. However, there are some drawbacks to HUD loans that aren’t an issue with other loan types.
Pros:
- Easy to qualify for
- Low down payments
- Priority over investors
- Closing cost assistance
Cons:
- Requires mortgage insurance
- Lower loan limits
- Long term insurance costs
- Home is sold “as-is”
- Must use a HUD agent
Pros and Cons Explained
Pros:
- Easy to qualify for: HUD loans typically have easier requirements to hit when compared to other loan types. Through FHA insurance, lenders are able to accept lower credit scores and less money down.
- Low down payments and home costs: As little as 3.5% down is needed for a HUD loan. And, as the government is looking to recoup the cost of a foreclosed home, the homes are often sold slightly under market value.
- Priority over investors: Investors are only allowed into the auction after a 30-day owner-occupier window has been closed.
- Closing cost assistance: Up to 5% of the purchase price will be paid towards closing costs.
Cons:
- Requires mortgage insurance: Upfront and monthly mortgage insurance is required. Upfront premiums are 1.75% of the base loan amount. The monthly insurance depends on the loan amount and can be factored into the loan itself.
- Lower loan limits: The HUD loan comes with lower loan limits than conventional loan options. The maximum loan amount for a single-family home is $356,362.
- Long-term insurance costs: HUD borrowers might have to pay the mortgage insurance through the life of the loan. However, it is possible for it to be canceled.
- Home is sold “as-is”: Unlike conventional loans where homes must be repaired as needed, HUD homes are sold as-is – no repairs need to be completed before closing, no matter what condition the house is in.
- Must use a HUD agent: A HUD-approved agent is needed to view and bid on a home.
Wrapping It Up
A HUD home can be an excellent option for those who have been priced out of the market.
HUD makes homeownership affordable for those who qualify, but it does come with stipulations that may last for the entire term of the loan.
Because the homes are sold as-is, there is a chance the house isn’t even worth the purchase price.
Just like when buying a home through conventional means, complete your due diligence when buying a HUD home. These homes have the potential to be great deals, but they may also come with some risks.
