Buying a Foreclosed Home with a USDA Loan: What You Need to Know
Foreclosure happens when a borrower fails to make their mortgage loan payments, and the lender must repossess the home. To recoup their investment, lenders typically sell the home at a reduced price to quickly offload the asset.
A foreclosed property for sale can represent a great bargain for home shoppers. Couple this opportunity with USDA home loan financing, and you might be able to score the best deal possible on a first or subsequent residence.
This guide will help you better understand the different types of foreclosures, how to find foreclosed homes, and the steps involved with purchasing USDA foreclosures.
A foreclosure occurs when a homeowner can no longer keep up with their mortgage payments, causing them to default on their loan. In this scenario, the lender repossesses the property to recover their money.
“Foreclosure is tough for the homeowner affected. But it creates opportunities for next buyers to snag a deal,” says Steven Glick, director of mortgage sales for HomeAbroad.
Several different kinds and stages of foreclosure can lead to opportunities for buyers. Let’s break each down in detail.
In the pre-foreclosure stage, the homebuyer is typically 90 days late on payments, and the original buyer still legally owns the property. In this phase, the owner generally has a handful of options, including:
With pre-foreclosure, USDA borrowers have a chance of purchasing the home from the original owner. The key is having an excellent real estate agent aware of the inventory coming to market.
“There are some obstacles to buying a home at the pre-foreclosure stage, however. For starters, the home may not be for sale at this point, and you won’t have public notices of foreclosure to help you find it in the first place,” says Martin Orefice, CEO of Rent To Own Labs. “Many borrowers who end up in pre-foreclosure eventually get their mortgages back on track rather than selling.”
In other words, you will have to hunt around for pre-foreclosure deals and find a willing seller. Still, it can be a good way to get a property for below-market prices if the owner wants to get out from under their obligation.
Short sales happen when the property owner owes more than the home’s value, and the lender settles by accepting a lesser amount. In this stage, the borrower is already in default or taking on financial hardship, which will likely result in default. Technically, a short sale is not a foreclosure yet: it’s a distressed sale.
“Short sales are somewhat similar to pre-foreclosures, but different. The owner owes more than the home is worth, and the bank agrees to accept less,” explains personal finance expert Andrew Lokenauth. “These can be frustrating, however. I had a short sale that took eight months to close because of all the back-and-forth required with the bank.”
USDA buyers should know that banks often respond slowly to these offers. Additionally, inspections often reveal issues that ultimately dissolve the deal since banks are usually reluctant to assist with repairs.
A sheriff's sale, or trustee sale, is a type of public auction where the lender attempts to recoup their investment. These are the same as the foreclosure auctions you see advertised in newspapers and held on city courthouse steps by local law enforcement.
“This is the lender’s first attempt to sell a foreclosed property after the borrower’s grace period has expired,” continues Orefice. “These are a great place to find the best foreclosed properties out there, and potentially get a good deal. However, because of the auction dynamic involved, it’s important to come to these sheriff sales with a clear sense of the property’s value and a clear spending limit for yourself.”
But be forewarned: USDA buyers usually won’t benefit from participating in a sheriff's sale auction because homes typically sell "as-is" and do not allow for an appraisal (which a USDA loan requires) or inspection.
When the property doesn't sell at auction, the bank carries the burden of the ownership and losses until it is sold.
“Lenders are generally eager to make a deal with bank-owned properties,” Orefice adds. “Consider that paying for property taxes, maintenance, upkeep, and utilities on a foreclosed property quickly eats into the home’s value, and any properties that get to this stage didn’t sell at auction, meaning there’s probably something undesirable about it.”
Like previous foreclosure types, bank-owned properties are sold "as is"; however, unlike auctions, buyers can have the home appraised and inspected.
USDA homebuyers should know that banks don't typically sell directly to the buyer but will instead list the property through a local real estate agent. You can find these properties through an experienced real estate agent, by inquiring with local banks, or on HUD's foreclosure directory.
These include properties repossessed by agencies like HUD or the USDA itself.
“Government-owned properties are similar to bank-owned properties, but are managed by government programs. HUD homes, for example, are foreclosures from FHA loans, and USDA sometimes has its own foreclosed rural properties that can be USDA-loan eligible if they meet specific standards,” notes Glick.
Can you purchase a foreclosure with a USDA loan?
It’s absolutely possible to purchase a foreclosed home with a USDA loan, as long as the home is located in a qualified rural area and you meet other requirements (more on that later).
USDA loans do not require a down payment, making them an excellent choice for foreclosures. It's not uncommon to find foreclosed homes needing a little extra love, and the money saved by not having a down payment can help cover needed renovations.
| Pros | Cons/Risks |
|---|---|
| Lower price: Foreclosures often sell below market value, stretching your budget in rural areas. | As-is condition: Many foreclosures need repairs, and USDA’s strict standards might reject homes with extensive issues. |
| No down payment: USDA loans require 0% down, freeing cash for minor repairs or closing costs. | Competition: Cash investors often outbid USDA buyers, especially at auctions or for hot properties. |
| Low interest rates: USDA loans typically have competitive rates, saving you money long-term. | Appraisal hurdles: If the home doesn’t meet USDA’s livability standards, the deal could fall through. |
| Rural focus: USDA loans align perfectly with foreclosures in eligible rural areas, where deals are common. | Hidden costs: Unexpected repairs or liens can eat into your savings. |
| Equity potential: Buying low can build equity if you fix up the home over time. | Longer process: USDA underwriting and foreclosure negotiations can take weeks or months. |
Like any other home for sale, the foreclosed home must meet certain requirements to be guaranteed by the USDA.
“USDA loans are designed for rural and suburban homes, so the property must be in a USDA-eligible area,” Glick points out. You can check if a property is in an eligible area through USDAloans.com’s Property Eligibility Tool. The home also needs to meet USDA’s decent, safe, and sanitary standards, which means it’s livable without major issues like a busted roof or no running water,” Glick points out. “When it comes to foreclosed homes, this can be tricky since many are sold as-is.”
More specifically, the home must meet HUD property guidelines, including:
USDA loans can be used for foreclosed farm properties, but they must be in a USDA-qualified rural area, and the home must be your primary residence. USDA loans can cover residences with small acreage or outbuildings used for personal non-income producing purposes, such as a barn for your horses.
“The land itself must also support residential use and cannot be used primarily for income generation, like renting it out, running a business out of it, or farming commercially,” Lokenauth mentions. “For example, I helped a family buy a gorgeous five-acre foreclosed property that’s a perfect mix of home and hobby farm.”
If you’ve got your eye on a HUD foreclosure (from an FHA loan), it must follow HUD’s property guidelines, which closely align with USDA’s. The residence must have working utilities, a sound structure, and no major health or safety hazards.
When it comes to foreclosed rural land, a livable home that meets USDA standards must be on that property – it cannot be an empty parcel.
Buying a foreclosure with USDA financing tends to align with the traditional steps of buying a home. Here’s what’s typically involved, from start to finish:
More often than not, a property listing will present acceptable purchase types upfront, such as:
Local newspapers and bank websites also host listings for upcoming public foreclosures.
Your real estate agent may also be helpful with their connections and experience by knowing what is coming to market before auction, or pre-foreclosure.
Many X factors come into play when attempting to buy a foreclosed property with USDA financing. Experts recommend carefully considering the following:
Yes, you can use a USDA loan to purchase a HUD home, including a HUD foreclosure, so long as the property meets USDA requirements. HUD homes are foreclosures from FHA-insured loans repossessed by HUD and sold as-is. The HUD residence must be in a USDA-eligible rural area and meet the same decent, safe, and sanitary standards as any USDA property.
If the USDA appraiser discovers issues with a foreclosed property, it can seriously complicate matters. USDA appraisals are strict to ensure the home is decent, safe, and sanitary. If the appraiser discovers issues like a broken HVAC system, a leaky roof, or mold, the home will not qualify until those issues are addressed. If the problems are minor, you might be able to negotiate with the seller to fix them before closing. If the repairs are extensive, the seller could refuse to fix them, in which case you could either walk away or find a lender willing to hold funds for post-closing repairs. The bottom line is that if these issues cannot be resolved, the USDA will not approve the loan, and you’ll need to find another property.
If a foreclosed home requires repairs, you can perform these after closing on a USDA loan. However, the home must meet USDA’s minimum standards before closing. Note that USDA loans don’t permit major rehab upfront, as FHA 203(k) loans do. If the appraiser finds minor problems, you can try to get the seller to resolve them or use a repair escrow to cover costs at closing. For larger repairs, you’ll need to cover them yourself out of pocket after closing. USDA does not restrict post-closing renovations; in other words, you can improve the residence after you close, so long as you have the cash or a separate home improvement loan to pay for these improvements.
To outmaneuver rivals like home flippers and investors also vying for a foreclosed property, it’s important to take proactive steps. First, get preapproved for a USDA loan early to demonstrate you are serious and financially ready. Second, try to target HUD homes, which give owner-occupants a 30-day priority bidding period before investors can jump in – a huge advantage for USDA buyers. Also, partner with a savvy agent who knows foreclosures and USDA loans. Additionally, make a competitive offer, and consider including an escalation clause, if allowed, to increase your bid slightly above others, up to your max budget. Avoid excessive contingencies in your offer, and be ready to close on the seller’s timeline. Lastly, take a closer look at less competitive properties that may not be on investors’ radar.
Yes, you can use a USDA loan to purchase a short sale property, provided it’s in an eligible area, it will be your primary residence, and the home meets USDA appraisal and property condition standards. Keep in mind that short sales can take extra time for lender approval, and the property might need repairs to qualify, so everything must line up for the deal to work.
