How to Get an FHA Construction Loan

If you’ve always dreamed of building your own home, but your credit score isn’t high enough for a regular construction loan, an FHA construction loan can help. Backed by the Federal Housing Administration, FHA construction loans have a minimum 500 credit score requirement with a 10% down payment — meaning you could build your dream home, even with less-than-perfect credit.

What is an FHA construction loan?

An FHA construction loan is a mortgage that allows you to roll in the costs of building a home from the ground up. There are two types of FHA construction loans: the construction-to-permanent loan and the FHA 203(k) loan.

Construction-to-permanent loan: Typically called a construction-to-perm loan, this is an all-in-one FHA loan to build a house. You can roll the costs of buying your own land, paying for the construction and covering the lender fees into one loan.

FHA 203(k) rehabilitation loan: If you like a home that needs serious TLC and upgrades, the FHA 203(k) program offers two renovation loan options, which can be used to buy or refinance a fixer-upper home.

How FHA construction loans work

FHA construction-to-permanent loan

The FHA construction-to-permanent loan combines the features of a short-term construction loan with a standard, long-term FHA loan. You’ll close once, and the loan automatically converts to your permanent mortgage when construction is complete.

Here are the seven steps you’ll take when financing a home with an FHA construction-to-permanent loan:

1. Choose your land.
   You need to own the land you’ll be building the home on, or use the loan proceeds to buy it. FHA construction loan qualifications don’t allow you to build a home on land if it’s:
   • Near a gas or oil well
   • Near an airport
   • Near an area prone to floods
2. Get preapproved for an FHA loan.
   You must meet the minimum qualifying requirements for an FHA loan, including:
   • A credit score of at least 500
   • A debt-to-income (DTI) ratio of no more than 43% or, in rare cases, 50%
   • A 3.5% down payment if you have at least a 580 credit score and/or the build is a HUD-approved project; 10% down if your credit score is between 500 and 579 and/or the project isn’t HUD-approved
   • A loan amount that doesn’t exceed area FHA loan limits
3. Choose a licensed contractor or builder.
   FHA construction loan guidelines require you to work with a licensed contractor or builder. The contractor may have to provide documentation to confirm they have the proper licensing and insurance.
4. Get a home appraisal.
   Your lender will order an FHA appraisal to confirm the building and materials meet FHA’s minimum property standards.
5. Close on the construction loan.
   If the appraised value is enough to cover your costs, you’re ready to close. If not, you may need to make up the difference or scale back your renovation plans.
6. Request draws as the work is done.
   As work is completed, the builder will be paid on the schedule you set before closing, with your written authorization.
7. Switch to a permanent loan.
   Once your home is finished and ready to live in, the lender closes out your construction loan and converts it to a permanent mortgage within 60 days of the construction loan’s closing.

FHA 203(k) rehabilitation loan

If you’ve found a fixer-upper home to buy, or your current home needs upgrades, an FHA 203(k) loan can help you remodel and roll the costs into your total loan amount.

Unlike an FHA construction loan, the FHA 203(k) program allows you to make minor repairs (projects must total $5,000 at minimum) or major renovations to an existing home.

There are two FHA 203(k) options: limited and standard.

Limited 203(k) loans: For remodeling projects with a price tag of $35,000 or less, you can make improvements to a one- to four-unit home. For example, you can replace a leaky roof, install new carpet or put a fresh coat of paint on your home’s interior.

Standard 203(k) loans: The standard 203(k) program allows you to tackle bigger renovations on a home you’re buying or refinancing. You can take on a broader range of home improvement projects, including:

• Replacing the plumbing in an older home
• Making a home wheelchair accessible
• Altering the layout or structure
• Adding or enhancing the landscaping

The standard 203(k) program requires a consultant to supervise your project from start to finish. The 203(k) consultant is licensed and typically has a background in home inspections, engineering or architecture. You can find a consultant in your area by checking the U.S. Department of Housing and Urban Development’s approved FHA 203(k) consultant list.

Alternatives to an FHA construction loan

Construction loan

Your local bank or homebuilder may offer their own construction loans. When the home is finished, you’ll need to pay off the construction financing with a permanent loan. This is also called a two-time close construction loan, because you’ll close twice and pay the closing costs on both loans.

State and local programs

Local nonprofit organizations and government agencies, like your local housing authority, could have programs available to assist lower-income borrowers. You may be able to receive down payment assistance for use with a new construction or home renovation mortgage.

VA construction loan

Eligible military borrowers may be able to build a home with 100% financing, by using a construction loan guaranteed by the U.S. Department of Veterans Affairs (VA). VA construction loans are available with a one-time or two-time close option.

USDA construction loan

Low- to moderate-income borrowers may be able to build a home in rural areas designated by the U.S. Department of Agriculture (USDA) with this program. The program also offers 100% financing.

Fannie Mae HomeStyle Renovation® loan

This conventional renovation loan works like the FHA 203(k) program, but allows for down payments as low as 3% with a minimum 620 credit score. An added bonus of the HomeStyle loan: You can do some of the repairs yourself — and roll some of your monthly payments into the loan amount — if you can’t live in the home while it’s undergoing repairs.

Freddie Mac’s renovation loans

If you have a renovation planned, Freddie Mac has two loan options for you. The CHOICERenovation® loan is meant for large-scale renovations, financing up to 75% of the home’s value. Meanwhile, the CHOICEReno eXPressSM mortgage is for smaller-scale changes, and finances a maximum of 15% of the home’s value. Other qualifications will vary, depending on the type of mortgage you currently have and how many units your home has.