An FHA construction loan can help you realize your dream of creating your forever home from the ground up, even if you have less-than-perfect credit. As long as you can make a 10% down payment, you may qualify for an FHA construction loan with a credit score as low as 500. Here’s what you need to know about this unique financing option.
Building a new home can be an exciting yet daunting process While having a custom-built home allows you to get exactly what you want, financing construction costs can be tricky, especially for buyers with less-than-perfect credit This is where FHA loans can help.
An FHA construction loan lets you use a government-backed mortgage to finance building a new home or renovating an existing property. With flexible credit requirements and low down payments, FHA construction loans make owning your dream home more accessible.
In this comprehensive guide, we’ll cover everything you need to know about using an FHA loan to build a house, including:
What is an FHA Construction Loan?
An FHA construction loan combines features of a short-term construction loan with a traditional FHA mortgage into one loan. This streamlines the process so you only have to close once on the loan that will finance the building phase and then convert to a permanent mortgage when construction is complete.
There are two main types of FHA construction loans:
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FHA Construction-to-Permanent Loan: Finances construction of a new home from the ground up. Allows you to purchase land and pay for materials and labor costs.
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FHA 203(k) Rehab Loan: Covers renovations and repairs when buying a fixer-upper home. Can finance minor updates or major overhauls.
FHA Construction Loan Requirements
While FHA construction loans are more flexible than conventional mortgages you still need to meet certain criteria to qualify
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Credit Score: Minimum 500 credit score required. Score of 580+ reduces down payment to 3.5%.
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Down Payment 10% down required for 500-579 credit score 35% down for 580+ score,
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Debt-to-Income Ratio: Maximum 50% debt-to-income ratio.
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Loan Limits: Vary by county, but most areas limited to $472,500 for 2023.
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Mortgage Insurance: Upfront and annual mortgage insurance premiums required.
Meeting these requirements is the first step to getting approved for an FHA construction loan.
How to Get an FHA Construction Loan in 5 Steps
If you meet the basic eligibility criteria, follow these key steps to get an FHA-backed construction loan:
1. Get Prequalified
Work with an FHA lender to assess your finances and get prequalified for a loan amount. This shows lenders you’re a serious buyer so you can move quickly when you’re ready to build.
2. Find Land
Search for and select land to build your home on. FHA has guidelines on eligible locations. Your lender can advise if the land will qualify.
3. Pick House Plans
Create preliminary house plans and get estimates from contractors. Lender will want to review plans to approve design.
4. Find an FHA Builder
Hire a contractor approved to work on FHA construction loans. Their experience with the program is key.
5. Close on Your Loan
After appraisal, you can close on the construction loan. Funds will be disbursed in stages as work is completed.
Once construction is done, the lender converts the loan to a permanent FHA mortgage.
Pros and Cons of FHA Construction Loans
FHA construction loans offer unique benefits but also come with some potential drawbacks to consider:
Pros
- One loan/one closing simplifies process
- Low down payments as low as 3.5%
- Flexible credit requirements
- Finance custom-built home you design
Cons
- Limited availability and stricter rules than traditional FHA loans
- Mortgage insurance premiums required
- Oversight required during construction phase
- Can’t exceed FHA loan limits
For buyers with lower incomes or credit scores, the pros often outweigh the cons of construction loans. But it’s important to weigh both when deciding if it’s the right financing option for your build.
Alternatives to FHA Construction Loans
If an FHA construction loan doesn’t work for you, here are some alternatives to consider:
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Conventional Construction Loans from banks and credit unions. Will require two separate loans – one for construction and one for permanent mortgage.
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VA Construction Loans for eligible military members. Feature 100% financing options with more flexible rules than FHA.
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USDA Construction Loans for low-income buyers in rural areas. Also offer 100% financing.
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Renovation Mortgages like Fannie Mae HomeStyle loans allow renovations but have higher credit score requirements.
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203(k) Consultants can advise on renovation projects even if you don’t use 203(k) loan.
Shopping around and comparing programs can help you find the best construction loan for your needs and budget.
FAQs about FHA Construction Loans
Can I build a house with an FHA loan?
Yes, the FHA construction loan program allows you to build a new home from the ground up when you qualify for the mortgage. It combines construction financing with a permanent home loan.
How much does it cost to build a house with an FHA loan?
Closing costs are typically 2-5% of the mortgage amount. You’ll also need a 3.5-10% down payment depending on your credit score. FHA loans have limits on the maximum amount you can borrow.
What credit score is needed for an FHA construction loan?
You can get an FHA construction loan with a credit score as low as 500, but will need 10% down. With a 580+ score, you only need 3.5% down. The better your credit, the better your interest rate.
Can I act as my own contractor with an FHA construction loan?
No, FHA guidelines require that you use a licensed, approved contractor on all new construction and renovations financed with an FHA construction loan.
How much cash do I need to build a house?
Beyond your down payment, you’ll need cash to cover closing costs, additional construction overages, and costs to furnish the new home. It’s smart to have contingency savings when taking on a construction project.
The Bottom Line
FHA construction loans allow buyers with lower credit scores and incomes to build and finance their dream homes. Just be prepared for a more rigorous process than conventional mortgages. Working with an experienced FHA lender and contractor is key to ensure your build goes smoothly.
Don’t forget: Lock in your interest rate during construction
Your interest rate may change while your home is being built. Discuss mortgage rate lock options with your loan officer and ask these questions:
- How much could rates change during construction?
- When can I lock my rate during the FHA loan process?
- What will the rate be on my 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 and roll the costs into your total loan amount.
Unlike an FHA construction-to-permanent loan, the FHA 203(k) program allows you to make minor repairs ($5,000 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 upgrade your kitchen cabinets.
- 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 (HUD)’s approved FHA 203(k) consultant list.