How to Get an FHA Construction Loan
If you’ve always dreamed of building your own home, but your credit scores aren’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 credit score requirement of 500 with a 10% down payment, which means 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, construction and 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. FHA 203(k) programs can be used to buy or refinance a fixer-upper home.
How FHA construction loans work
FHA construction-to-permanent loans
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 steps you’ll take when financing a home with an FHA construction-to-permanent loan:
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
- Located in an area prone to floods
Get preapproved for an FHA loan.You must meet the minimum qualifying requirements for an FHA loan, including:
- A credit score of at least 580
- A debt-to-income (DTI) ratio of no more than 43%
- A 3.5% down payment for a HUD-approved project
- A 10% down payment if the project is not HUD-approved
- A loan amount that doesn’t exceed area FHA loan limits
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.
Get a home appraisal.Your lender will order an appraisal to confirm the building and materials meet FHA’s minimum property standards.
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.
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.
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.
Tip: Lock in your interest rate during construction
While your home is being built, your interest rate may change. Discuss rate lock options with your loan officer and ask these questions:
- How much might rates change during construction?
- When can I lock in the rate during the FHA loan process?
- What will the rate be on the permanent mortgage?
- Can I float down a rate if it’s lower after my home is built?
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 the home 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 coat of fresh paint on your home’s inside.
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, such as:
- Replacing the plumbing in an older home
- Making a home wheelchair accessible
- Altering the layout or structure
- Adding or enhancing 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
Your local bank or homebuilder may offer their own construction loans. When the home is done, 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 close twice and pay the closing costs on both loans.
More commonly known as a “one-time close construction loan,” you’ll start with a loan to cover the costs of building the home. The permanent loan automatically replaces the construction loan when your home is completed.
VA construction loan
Eligible military borrowers may be able to build a home with 100% financing with 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. However, the 10% down payment requirement is pricier than other construction loan options.
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 620 or higher 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 remodeling.