Need to pay for a major kitchen remodel? Or maybe you need to buy land and fund the construction of an entirely new home. An FHA construction loan could help. First, you need to understand how this type of home loan works and how it differs from a standard FHA loan.
Weâll review that in this article, and then dive into the requirements for FHA new construction loans.
An FHA construction-to-permanent loan allows you to finance building a new home from the ground up with a single mortgage. This type of loan combines features of a short-term construction loan with a traditional long-term FHA mortgage.
With an FHA construction-to-permanent loan, you can purchase land, pay for construction costs, and end up with permanent financing all wrapped up in one loan. This avoids the need to get separate construction financing that you later have to pay off when the home is complete.
FHA construction-to-permanent loans provide several advantages for home buyers looking to build a new house. However, these loans also come with specific requirements and limitations you need to be aware of.
How Does An FHA Construction-To-Permanent Loan Work?
An FHA construction loan has two phases – the construction phase and the permanent financing phase.
During the construction phase, the lender will disburse the loan funds in installments as certain milestones are reached during the building process. You will only need to pay interest on the disbursed amount during construction.
Once construction is finished and the home passes final inspection, the loan converts into permanent financing. At this point, you will start making principal and interest payments just as you would with a traditional 30-year mortgage.
The conversion from construction loan to permanent loan happens automatically, so you don’t have to worry about applying for a second loan. The single-closing process makes FHA construction-to-permanent loans simpler and more appealing than other construction financing options
Top 5 Benefits Of FHA Construction-To-Permanent Loans
Here are some of the biggest advantages of using an FHA construction-to-permanent loan
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One loan with one closing. You avoid the hassle of obtaining two separate loans for the construction and permanent financing phases.
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Potentially lower rates. You lock in your long-term mortgage rate upfront, protecting you from rate increases during construction.
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Lower monthly payments. You only pay interest on the disbursed amount during construction, keeping payments low.
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Easier to qualify. FHA loans allow lower credit scores and down payments than conventional loans.
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Lower upfront costs. You pay closing costs once instead of twice with traditional construction loans.
FHA Construction Loan Requirements
While FHA construction loans offer more flexible eligibility standards than conventional mortgages, you still need to meet certain requirements:
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Credit score – At least 500, but a 580 score qualifies for a lower 3.5% down payment.
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Down payment – 10% if 500-579 credit score, or 3.5% with a 580+ score.
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Debt-to-income ratio – Maximum of 43% front-end DTI, or up to 50% with compensating factors.
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Loan limits – Varies by county but typically up to $726,525 for a single-family home in most areas.
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Cash investment – You must contribute 3.5%-10% of your own funds toward eligible transaction costs.
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Mortgage insurance – Required upfront mortgage insurance premium and annual premium.
Meeting these requirements is essential for getting approved for an FHA construction-to-permanent loan. Be sure to go over the eligibility criteria closely with your lender.
The Step-By-Step Process For Getting An FHA Construction Loan
Follow these key steps when using an FHA construction-to-permanent loan to build and finance your new home:
1. Find and purchase land – Land can be vacant, have an existing loan, or under contract to be paid off at closing.
2. Get pre-approved – Confirm you meet credit, income, and down payment requirements for the loan amount needed.
3. Select a qualified builder – Builder must have proper licensing and be approved to work with FHA loans.
4. Provide house plans – Floor plans must meet HUD’s minimum property standards and local building codes.
5. Get an appraisal – The lender will order an appraisal to estimate the future value of the home when complete.
6. Finalize loan details and close – Lock in your interest rate and sign documents to secure financing.
7. Request disbursements – Loan funds are released in stages as construction reaches specified milestones.
8. Complete construction – Builder finishes home based on approved plans and schedule.
9. Convert to permanent loan – Loan automatically converts to permanent financing within 60 days of construction completion.
Following this roadmap helps ensure you get from construction loan approval to your finished dream home. Keep your lender informed throughout the process to avoid any hiccups.
Pros And Cons Of FHA Construction-To-Permanent Loans
FHA construction loans have unique advantages but also some potential drawbacks to consider:
Pros
- One loan with one closing
- Combines construction financing and permanent mortgage
- Lock in low interest rates upfront
- Lower monthly payments during construction
- Easier to qualify than conventional loans
Cons
- Stricter requirements than standard FHA loans
- Must use certified builders
- Limited flexibility to make construction changes
- Require upfront and annual mortgage insurance premiums
- Loan limits may be restrictive in some markets
Weighing the pros and cons will help you decide if an FHA construction-to-permanent loan is the right fit for your home building plans and budget.
Alternative Construction Loan Options
FHA construction loans aren’t your only choice for financing a new home build. Here are a few other construction loan alternatives to consider:
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Conventional construction loans – Offered by banks and homebuilders, these require two separate loans and closings.
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VA construction loans – No down payment required and more flexible credit guidelines for qualifying veterans.
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USDA construction loans – 100% financing available in designated rural areas for low-to-moderate income borrowers.
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State/local construction loan programs – Some agencies offer down payment assistance programs usable with construction loans.
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Renovation loans – Fannie Mae HomeStyle and Freddie Mac CHOICE Renovation loans allow renovations along with a purchase or refinance.
Compare costs, eligibility terms, and features to pick the construction loan that best matches your home building plans and budget.
7 Key Questions To Ask When Applying For An FHA Construction Loan
If you’re considering an FHA construction-to-permanent loan, here are some important questions to ask upfront:
- What are the credit score and down payment requirements?
- What loan limits and rates are available in my area?
- How will the construction draws and disbursements work?
- Can I lock in my long-term mortgage rate now?
- How much are the upfront mortgage insurance premiums?
- What happens if construction goes over budget?
- Can I make changes to the construction plans later?
Getting clear answers to these questions from your lender at the outset ensures you fully understand how an FHA construction loan works and avoids surprises down the road.
Wrap Up
FHA construction-to-permanent loans allow you to build and finance a new home in one loan. This streamlines the process and makes owning a custom-built home more affordable.
Despite their benefits, FHA construction loans have stricter eligibility standards and limitations to be aware of. Weigh the pros and cons carefully and shop multiple lenders to find the best FHA construction loan option for your home building plans.
FHA Building Loan Requirements
To qualify for any FHA building loan, youâll need to meet certain requirements.
- Credit score: Youâll need a FICO® credit score of at least 500 if you want to qualify for an FHA loan requiring a minimum down payment of 10% of your homeâs purchase price. If your credit score is at least 580, you can qualify for an FHA loan with a minimum down payment of 3.5%. Remember, not all lenders will approve you for an FHA construction loan if your credit score is lower than 580.
- Debt-to-income ratio (DTI): Your debt-to-income ratio (DTI) measures the relationship between your gross monthly income â your income before taxes are taken out â and your monthly debts. Most lenders want your total monthly debts to be no more than 50% â 57% of your gross monthly income.
- Down payment requirements: A lower down payment is one of the main benefits of an FHA construction loan. Many construction loans require a down payment of at least 10%. Depending on your credit score, you may qualify for an FHA construction loan with a down payment of just 3.5%.
Alternatives To FHA New Construction Loans
FHA-insured construction loans arenât your only choice to finance the construction or renovation of a home. You can turn to several alternatives â some of these options are also insured by a government agency.
You can fund a new home construction with a VA construction loan â a mortgage insured by the U.S. Department of Veterans Affairs (VA). The main benefit of a VA construction loan is that you donât have to make a down payment at all. The catch? Not everyone can qualify for a VA loan. You must be an eligible veteran or active-duty member of the U.S. Military, or an eligible spouse, to qualify for a VA construction loan.
The U.S. Department of Agriculture (USDA) offers its own construction-to-permanent loan. Like a VA loan, you wonât have to provide any down payment when taking out a USDA construction loan. The challenge here, though, is that not everyone can qualify for one of these loans, either. You must be buying or building a home in an area that the USDA considers rural. To find out whether the land on which you want to build is eligible, check the USDAâs property eligibility site.
FHA Construction to Permanent Financing
FAQ
How does an FHA construction-to-permanent loan work?
What credit score do you need for a FHA construction loan?
Can an FHA loan be used to build a house?
What is the downside of an FHA loan?
What is an FHA construction-to-permanent loan?
An FHA construction-to-permanent loan is a hybrid loan that combines the elements of a short-term construction loan with a traditional FHA mortgage. It can be used to acquire land, finance construction costs, and cover lender fees.
What is a construction-to-permanent loan?
A construction-to-permanent loan is a short-term construction loan that only lasts throughout construction. Once construction is over, it is converted to a standard primary mortgage by the lender.
Is an FHA construction loan suitable for me?
An FHA construction loan could help pay for the project if you’d rather build a home than buy one. 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. Should I get an FHA construction loan?
What are the different types of FHA construction loans?
There are two main types of FHA construction loans: an FHA construction-to-permanent loan covers the costs of buying land and building a home. The other type is for buying an existing home that needs renovations.