Everything You Need to Know About FHA Construction to Permanent Loans

FHA construction to permanent loans are a great option for financing the building of a new home from the ground up. With this type of loan, you only need to close once and can roll the construction loan into a permanent mortgage after the build is complete.

As someone who has worked in real estate and mortgage lending for over 15 years I’ve helped many clients through the process of obtaining an FHA construction loan. In this detailed guide, I’ll walk you through exactly how these unique loans work, their pros and cons, eligibility requirements and alternatives you may want to consider.

What is an FHA Construction to Permanent Loan?

An FHA construction to permanent loan combines features of a short-term construction loan with a standard FHA-insured mortgage into one loan. Here’s how it works in a nutshell:

• You get a single loan to finance the purchase of land and construction of a new home.

• The loan starts as a short-term construction loan to fund the building costs.

• Once construction is finished, the loan converts to a permanent FHA mortgage.

• You only have to close once on this type of loan.

The main advantage of this structure is that you avoid having to qualify, close, and pay closing costs twice on two separate loans. With a construction to permanent loan, the construction financing and permanent financing are bundled together into one FHA-backed loan product.

How Does the FHA Construction to Permanent Process Work?

Here are the basic steps involved in getting an FHA construction to permanent loan:

1. Get Pre-Approved for an FHA Mortgage – You’ll need to have your credit, income, and assets verified upfront to get a pre-approval letter from a lender. This confirms you qualify for the loan amount needed to cover construction.

2. Purchase the Land – Use the loan proceeds to buy land to build on after getting the green light from your lender. There are some FHA requirements around the location.

3. Select a Licensed Contractor – You must use a properly licensed and insured contractor or home builder. They’ll provide documentation to the lender.

4. Get an FHA Appraisal – Ensures the plans meet FHA minimum property standards and determines the value after construction.

5. Close on the Construction Loan – Initial closing is only on the construction financing portion. If the appraisal value doesn’t fully cover costs, you may need to pay the difference.

6. Draws are Made During Construction – Your contractor gets paid draws throughout the building process based on a schedule you establish upfront.

7. Loan Converts to Permanent Financing – Once the home is finished, the lender converts the construction loan into a standard FHA mortgage within 60 days.

One of the big benefits of this structure is only having to close once. You also lock in your long-term interest rate upfront in most cases.

What are the Basic FHA Construction Loan Requirements?

While FHA construction loans are more flexible than conventional loans, you still need to meet some basic eligibility standards:

• Credit Score – At least 500 is required, but many lenders want higher scores of 580+ for approval.

• Down Payment – 10% is required for 500-579 credit scores. With 580+ scores, down payments as low as 3.5% are allowed.

• Debt-to-Income Ratio – Your DTI needs to be below 43% in most cases. Some exceptions up to 50% are made.

• Loan Amount – This needs to conform to FHA mortgage limits based on location, which range from $420,680 to over $1 million.

• Mortgage Insurance – You’ll pay an upfront mortgage insurance premium of 1.75% of the loan amount plus ongoing annual premiums between 0.45% to 1.05% of the original loan amount.

Meeting these requirements is essential to get approved. I always recommend having a mortgage broker or lender verify you pre-qualify before moving forward.

What are the Pros and Cons of FHA Construction Loans?

FHA construction loans offer some nice perks but also come with drawbacks to weigh:

Pros

• Lower credit score requirements – 500 FICO minimum

• Smaller down payments than conventional loans

• Only one loan closing

• Interest rate locked upfront in most cases

• Ability to build on land outside city limits

Cons

• Required mortgage insurance premiums

• More stringent appraisal requirements

• Limited maximum loan amounts set by FHA

• Not available from all lenders

• Can’t use for extensive renovations on existing homes

As you can see, FHA construction loans provide nice flexibility but do come with some limitations and costs.

What are Some Alternatives to FHA Construction to Permanent Loans?

Some other options to consider are:

• Conventional Construction Loans – Require better credit and more cash down but avoid mortgage insurance.

• VA Construction Loans – For eligible military members; no down payment required.

• USDA Construction Loans – 100% financing available in designated rural areas for low-income borrowers.

• Renovation Loans – FHA 203k and HomeStyle Renovation for renovating existing homes.

• Cash-Out Refinance – If you have equity, you can tap it to finance construction.

Each option has its own pros and cons, so make sure to discuss the alternatives with a loan officer. An experienced lending professional can help you identify the most suitable loan product for your unique situation.

Tips for Getting Approved for an FHA Construction Loan

Based on my experience as a loan officer, here are some tips that can help your FHA construction loan get approved:

• Seek out lenders that specialize in construction loans – not all lenders offer them!

• Get pre-qualified to determine your loan amount and interest rate upfront.

• Be ready to make a larger down payment if your credit score is below 580.

• Review the contractor requirements and provide all needed documentation.

• Make sure the land doesn’t violate any of the FHA location rules.

• Have plans for the home ready for the appraiser to review.

• Be prepared to cover any costs that come in over the appraised value.

• Ask if you can lock in your permanent loan rate upfront while construction is ongoing.

• Set up draws to pay the contractor incremental based on the completed work.

Following these tips will give you the best shot at smooth sailing through the construction loan process.

Answers to Frequently Asked Questions about FHA Construction Loans

Here are some quick answers to common questions about FHA construction loans:

How much can you borrow with an FHA construction loan?

• Up to 96.5% of the home’s appraised value after construction, provided you meet the minimum FHA credit score and down payment requirements.

Can you get an FHA construction loan for an existing home renovation?

• No, you need to use the FHA 203k renovation program for financing major renovations of existing homes with FHA.

What credit score is needed for an FHA construction loan?

• A minimum of 500 FICO is required, but many lenders want to see higher scores of 580 and above for approval.

Is mortgage insurance required for FHA construction loans?

• Yes, you must pay the upfront mortgage insurance premium and ongoing annual premiums. This is a requirement of all FHA loans.

How long does the construction phase usually last?

• The construction period can range anywhere from 6 months to 1-2 years depending on the size of the home being built. The lender will establish a deadline for completion.

When do you lock in your permanent loan rate?

• In most cases, you’ll choose to lock in your long term mortgage rate at the initial closing, before construction even begins. But this isn’t required in all cases.