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.
Buying or building a home is likely one of the largest financial decisions you’ll ever make. For many, financing a newly constructed home may seem out of reach. However, FHA loans make it possible for borrowers to build their dream home even with limited funds or less-than-perfect credit.
What is an FHA Loan?
FHA loans are government-insured mortgages backed by the Federal Housing Administration (FHA) These loans require lower down payments and have more lenient credit standards compared to conventional mortgages As a result, FHA loans open homeownership opportunities to buyers who may not qualify for other loan programs.
The FHA insures lenders against losses, allowing them to offer mortgages to buyers with down payments as low as 3.5% of the purchase price. FHA loans also only require a minimum credit score of 580 to qualify.
Can FHA Loans Be Used For New Construction?
Yes FHA loans can be used to finance new home construction. The FHA offers a specialized product called the FHA construction-to-permanent loan that combines features of a construction loan and a traditional FHA mortgage into a single loan.
This consolidated approach simplifies the process, saves on closing costs, and provides home buyers building a new residence with permanent FHA financing from day one.
How Does an FHA Construction Loan Work?
FHA construction loans are disbursed to the borrower in stages as construction milestones are met. An initial draw covers purchase of the land and other prep work. Subsequent draws are issued after inspections approve framing, roofing, plumbing, electrical, drywall, and other major components.
The buyer makes interest-only payments on the amount disbursed during the building phase. Once construction is finished, the loan converts to a permanent mortgage, and principal and interest payments begin.
What Are the Benefits of an FHA Construction Loan?
FHA construction loans offer several advantages over conventional construction loans:
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Lower down payment – Only 3.5% is required compared to 15-20% on conventional loans
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More flexible credit guidelines – Minimum 580 FICO score instead of 620+ for conventional
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Lower closing costs – Single-close loan means lower fees
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Interest-only payments – Payments are lower during the building phase
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One-time close – No need to requalify for permanent financing later
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Mortgage insurance – Provides lender protection on high loan-to-value loans
FHA Construction Loan Requirements
While FHA construction loans are more accessible than conventional mortgages, you still must meet certain eligibility standards:
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Credit score – At least 580 FICO for 3.5% down payment
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Debt-to-income ratio – Total debt obligations cannot exceed 43% of income
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Down payment – Minimum 3.5% from your own funds
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Homebuyer education – Online course required for first-time buyers
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Stable income – Two years consistent employment history
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Property approval – Home must meet FHA property standards
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Contractor approval – Licensed builder with minimum two years experience
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Inspections – Mandatory inspections at multiple stages
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Loan limits – Varies by county but typically capped around $650,000
Meeting these requirements takes some preparation but worthwhile for the benefits of an FHA construction loan.
How to Get an FHA Construction Loan
Follow these steps when applying for an FHA construction loan:
1. Check your eligibility. Confirm you meet all minimum FHA requirements before moving forward.
2. Get prequalified. Work with a lender to get a preapproval letter verifying you qualify.
3. Find land to purchase. FHA loans can be used to buy the lot or land to build on.
4. Select a qualified builder. Your contractor must meet FHA approval standards.
5. Submit construction plans. Blueprints must align with FHA building codes and requirements.
6. Complete the loan application. Provide all required documentation to your lender.
7. Close on the mortgage. After approval, you’ll close on the construction loan.
8. Begin construction. Once closed, construction on your new home can start.
9. Make payments. You’ll make interest-only payments during the building phase.
10. Complete construction. Arrange final inspections once home is finished.
11. Convert to permanent loan. Construction loan transitions to traditional mortgage.
Follow this roadmap and you’ll be well on your way to owning your brand new, custom-built home.
Mistakes to Avoid With FHA Construction Loans
When applying for an FHA construction loan, keep these pitfalls in mind:
- Not checking your eligibility and credit score in advance
- Neglecting required homebuyer education and counseling
- Forgetting to budget for closing costs and prepaid items
- Failing to shop for the best rates and fees from multiple lenders
- Selecting a builder who isn’t approved for FHA financing
- Not reviewing inspection reports and construction draws closely
- Making changes to plans without lender approval
- Missing mortgage payments during the construction phase
Avoiding these mistakes upfront will help ensure your loan and building process go smoothly.
Alternatives to FHA Construction Loans
An FHA construction loan is just one financing option for new builds. Here are a few other choices to consider:
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Conventional construction loans – Require larger down payments and higher credit scores but feature lower rates
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VA loans – Offer 100% financing and flexible credit guidelines for veterans and service members
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USDA loans – Feature 100% financing and low rates for low-income borrowers in rural areas
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203(k) rehab loans – Finance renovations to existing properties needing improvements
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Renovation mortgages – Special programs offered by Fannie Mae and Freddie Mac
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State/local programs – May provide grants, low-rates, or other incentives for construction financing
Talk to a loan officer to determine which loan type best suits your needs and financial situation.
The Bottom Line
Yes, FHA loans can absolutely be used to finance construction of a new home! FHA construction loans help make building a custom property affordable for buyers unable to pursue conventional mortgages.
These government-backed loans offer low down payments, flexible qualifying guidelines, and the ability to consolidate construction financing and permanent mortgages into one loan. While FHA construction loans have specific requirements, they open new home construction possibilities if you’re willing to do some homework upfront. Consult a lender to start the journey toward building your dream home.
What is an FHA construction loan and how does it work?
An FHA construction loan is a mortgage that allows you to roll in the costs of building a home or renovating an existing property. There are two types of FHA construction loans:
The FHA construction-to-permanent loan allows you to build a home from scratch. You can use it to buy land, finance construction costs and cover lender fees.
This loan combines the features of a short-term construction loan with a standard, long-term FHA loan. You’ll close once and finance the build the same way you would with any other construction loan. When construction is complete, the loan automatically converts to a permanent mortgage.
Here are the steps you’ll take when financing a home with an FHA construction-to-permanent loan:
1. Get preapproved for an FHA loan
You’ll need to meet with a lender and have them perform a preliminary review of your credit history, income and assets. Once that’s done, you’ll receive a conditional preapproval letter detailing how much money the lender may be willing to lend you once they’ve had a chance to verify your information.
2. Choose your land
Once you’re approved for a loan, you can use the proceeds to buy land. Most plots are acceptable, however, FHA construction loan rules don’t allow you to build a home on land if it’s near:
- A gas or oil well
- An airport
- An area prone to floods
3. 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.
4. Get a home appraisal
Your lender will order an FHA appraisal to confirm the building and materials meet FHA’s minimum property standards.
5. 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.
6. Request draws as the work is done
As work is completed, the builder will be paid with your written authorization on the schedule you set before closing.
7. Switch to a permanent loan
Once your home is finished and move-in ready, the lender closes out your construction loan and converts it to a permanent mortgage within 60 days.
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 One Time Close Construction Loan Explained 2024
FAQ
Can an FHA loan be used to build a house?
What credit score do you need to build a house?
Will an FHA loan cover land?
How long do you have to live in a building after an FHA loan?