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FHA construction to permanent loans allow borrowers to finance the construction of a new home and get a permanent mortgage in a single transaction. This convenient loan program eliminates the hassle of applying for two separate loans.
In this comprehensive guide, we will explain what an FHA construction to permanent loan is, how it works, its requirements, and its pros and cons We aim to provide homebuyers with all the key details they need to determine if this mortgage option is suitable for their new home construction project
What is an FHA Construction to Permanent Loan?
An FHA construction to permanent loan combines a short-term construction loan with a permanent FHA mortgage into a single loan. It allows borrowers to purchase land, finance construction costs, and lock in long-term financing with only one loan application and one closing
Here’s how it works in three main phases
Phase 1: Construction Loan
- Borrower closes on the construction loan and financing is secured
- Funds are disbursed in draws as construction milestones are met
- Borrower makes interest-only payments on the disbursed amount
Phase 2: Construction Period
- Home is built over an estimated construction timeline
- Draws are requested by the contractor as work is completed
- Borrower continues making interest-only payments
Phase 3: Permanent Mortgage
- Once construction is finished, the loan converts to a permanent FHA mortgage
- Borrower begins making principal and interest payments
- Loan is amortized over its full term like a traditional mortgage
This consolidated process makes it easier on the borrower by eliminating duplicate fees, paperwork, and the need to requalify for a second loan.
FHA Construction Loan Requirements
While FHA construction loans offer more flexible qualifying standards than conventional loans, borrowers must still meet certain requirements:
Credit Score: Minimum 500 credit score required. Above 580 allows lower 3.5% down payment.
Down Payment: 10% down if 500-579 credit score; 3.5% down if 580+ credit score.
Debt-to-Income Ratio: Maximum 50% total debt-to-income ratio.
Loan Limits: Varies by county, typically up to $970,800 for a single family home.
Mortgage Insurance: Upfront 1.75% fee plus annual 0.45% – 1.05% premium.
Contractor Requirements: Licensed, insured contractor experienced with FHA guidelines.
Appraisal: Home plans must meet FHA minimum property standards.
Homebuyer Education: Required for first-time homebuyers.
Meeting these requirements demonstrates to the lender your ability to repay the loan. It also ensures the new home is built properly to FHA standards.
The Pros and Cons of FHA Construction Loans
| Pros | Cons |
|---|---|
| Lower credit score requirements | Upfront and annual mortgage insurance premiums |
| Smaller down payment options | More paperwork and requirements than conventional loans |
| One loan with one closing | Strict contractor qualifications |
| Interest-only payments during construction | Loan limits may be restrictive in high cost areas |
| Convert to permanent mortgage | Reduced flexibility or customization |
The pros include easier qualifying standards, lower down payments, and the simplified process. However, borrowers also sacrifice some flexibility and pay mortgage insurance.
Essentially, FHA construction loans provide home financing options for those who may not qualify through conventional channels. But this expanded access comes with more rules and regulations attached.
Steps to Getting an FHA Construction Loan
Follow these steps when using an FHA construction to permanent mortgage:
1. Find Land for Your New Home
Search for a suitable lot that meets FHA site requirements. The land can be purchased with the loan proceeds.
2. Get Prequalified and Select a Contractor
Get prequalified with a lender to determine your affordability. Also choose a licensed general contractor.
3. Complete Loan Application and Submit Home Plans
Apply for financing and provide detailed drawings and specifications for review.
4. Obtain Appraisal Based on Home Plans
The lender will order an appraisal to validate the future home value.
5. Close on Mortgage and Finalize Construction Agreement
Final loan approval is followed by closing. Then finalize construction timelines and draw schedule.
6. Make Interest-Only Payments During Construction
Contractor submits draw requests as work is completed. You make interest-only payments.
7. Convert to Permanent Mortgage After Construction
The home must pass a final inspection. Then the loan converts to a permanent mortgage.
Following this process allows everything to go smoothly from construction to permanent financing.
Choosing the Best FHA Construction Lender
Not all mortgage lenders offer FHA construction loans. When selecting a lender, look for the following:
- Experience with FHA construction-to-permanent financing
- In-house underwriters familiar with program guidelines
- Ability to float-down interest rates during construction
- Strong contractor relationships for smooth draws
- Customized loan options like fixed or adjustable rates
We recommend getting quotes from multiple lenders to compare interest rates and fees. Smaller banks and credit unions are more likely to cater to FHA construction loans than bigger banks. An experienced loan officer is key to guiding you through the process.
What Are the Interest Rates on FHA Construction Loans?
FHA construction loans may offer slightly higher interest rates than conventional mortgages. Rates are also driven by market conditions and your specific qualifications as a borrower.
Here are some typical rate ranges:
FHA 30-Year Fixed Rate: 4.50% – 5.25%
FHA 5/1 Adjustable Rate: 3.25% – 4.00%
Always compare quotes from multiple lenders. Ask if they offer rate locks during construction. Paying discount points can also secure a lower rate.
Alternatives to FHA Construction Loans
If you don’t qualify for an FHA construction loan, here are a few alternative financing options:
- Conventional construction loans – Require higher credit and down payment.
- VA construction loans – For qualifying military borrowers.
- USDA construction loans – For properties in rural areas.
- State/local construction loans – Check state and county programs.
- Renovation loans – Finance home improvements.
Carefully compare all programs for which you may qualify. An experienced loan officer can help you evaluate the pros and cons of each.
FAQs About FHA Construction Loans
Can I get an FHA loan for a new construction home?
Yes, FHA construction to permanent loans allow you to finance the building of a new home on vacant land.
What credit score is needed for an FHA construction loan?
The minimum credit score is 500 but a score above 580 qualifies for the lowest down payment of 3.5%.
How much down payment is required?
10% down if your credit score is 500-579. 3.5% down if your credit score is 580 or above.
How long does the construction phase last?
The construction phase typically ranges from 6-12 months but can vary based on the size and complexity of the home.
Do I need a contractor to get an FHA construction loan?
Yes, FHA requires you to use a licensed general contractor experienced in their guidelines.
The Bottom Line
FHA construction to permanent loans allow borrowers to finance the building of a new home and setup permanent financing with one single loan. They offer flexible qualifying standards but also require more paperwork.
Carefully consider both the pros and cons when determining if an FHA construction loan is the right solution for your new home building project. Be sure to work with an experienced lender and contractor to ensure the process goes smoothly.
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- An FHA construction loan is a type of FHA loan that covers the cost of building a home, including the land or lot purchase, building materials and labor.
- There are two types of FHA construction loans: an FHA construction-to-permanent loan and a FHA 203(k) loan.
- FHA construction loans can be rolled into an FHA permanent mortgage.
If you’d rather build a home than buy one, an FHA construction loan could help pay for the project. Like a regular FHA loan, this type of financing is insured by the Federal Housing Administration (FHA) and offered by FHA-approved mortgage lenders. Here’s how to get one.
FHA construction loan requirements
The qualifying requirements for an FHA construction loan are similar to those for standard FHA loans, but with a few additions.
To qualify for any FHA loan, you’ll need to meet the following criteria, at minimum:
- Credit score: At least 580, or as low as 500 if putting down at least 10 percent
- Debt-to-income (DTI) ratio: No more than 43 percent (with some exceptions)
- Down payment: 3.5 percent with a credit score of at least 580, or at least 10 percent with a credit score between 500 and 579
- Loan limits: No more than the FHA loan limits for the year; for 203(k) loans, no more than the FHA loan limits, the home’s after-renovation value plus improvement costs or the home’s after-renovation value, whichever is less
- Mortgage insurance: Upfront and annual FHA mortgage insurance premiums, paid for the life of the loan in most cases
- Occupancy: Primary residences only
On top of these requirements, FHA construction loans require satisfactory documentation detailing the construction or renovation project, including information about the contractor you plan to work with. For a standard 203(k) loan, you’ll be assigned a 203(k) consultant to estimate the remodeling or repair costs.
Whether you get a construction-to-permanent or rehab loan, the work will also be subject to inspection as the project progresses.