Can You Build a Home With an FHA Loan?

Yes, you can build a new home using an FHA loan The Federal Housing Administration (FHA) offers two main programs that allow you to finance construction of a new residence – the traditional FHA loan and the FHA construction-to-permanent loan

Buying a Newly Built Home With a Traditional FHA Loan

If you want to purchase a home that is already completed or nearly finished with construction you can get a traditional FHA loan. This works similarly to an FHA purchase loan for an existing house.

Here is the process

• Get prequalified or preapproved for an FHA loan. This ensures you are eligible and gives you a price range for your home search.

• Find a home built by a builder that is move-in ready or close to completion. It must be a 1-4 unit single family home or condo.

• Make an offer and go under contract once the home is in a complete enough stage for an appraisal.

• The lender will order an FHA appraisal to ensure the property meets FHA minimum standards.

• At closing, the FHA loan funds are used to pay the builder and you take ownership of the newly constructed house.

So with a traditional FHA mortgage, you don’t finance the construction itself. But you can buy a newly built home as long as it is finished or almost complete at the time of purchase.

Building a Home from Scratch With an FHA Construction Loan

If you want to build a home from the ground up on land you own or purchase, an FHA construction-to-permanent loan allows you to finance the entire process in one loan.

Here are the main steps to getting an FHA construction loan:

• Find and purchase land, if you don’t already own a suitable lot. The land must meet FHA requirements.

• Work with a lender to get preapproved for an FHA construction loan. This preapproval letter will show estimates of what you can afford to build.

• Hire a general contractor or builder that has experience with FHA guidelines. They must be properly licensed and insured.

• Finalize blueprints and floor plans for the home.

• The lender will order an FHA appraisal to estimate the value of the home once construction is complete.

• At closing, loan funds are put into an escrow account to be released in draws as construction milestones are met.

• You make interest-only payments during the building phase.

• When construction is finished, the loan converts to a permanent FHA mortgage and you begin making principal and interest payments.

So the FHA construction loan combines short-term financing for construction with long-term permanent mortgage financing all in one loan. This avoids the need for two separate loans and closings.

FHA Construction Loan Requirements

To qualify for an FHA construction-to-permanent loan, you must meet these basics:

• Credit score of at least 500

• Total debt-to-income ratio below 43% (or 50% with compensating factors)

• 10% down payment if your credit score is 500-579

• 3.5% down payment if your credit score is 580+

• Loan amount below FHA lending limits for your county

In addition, you need to use a contractor approved to work with FHA loans. The lender will order an appraisal to estimate the value of the home once construction is complete.

The home must be a single family property and meet all other FHA eligibility standards. The land must also meet FHA site requirements.

The Pros and Cons of FHA Construction Loans

Pros

• Low down payments, as little as 3.5% if your credit score is 580+

• Available even with lower credit scores starting at 500

• One loan for the land purchase, construction, and permanent mortgage

• Only one closing so you save on closing costs

• Interest-only payments during construction so payments are lower

Cons

• Stricter requirements than conventional construction loans

• Limited to single family properties, not condos or multi-unit buildings

• Requires mortgage insurance for the life of the loan

• Loan amounts cannot exceed FHA lending limits

• More rules and oversight than other construction loans

So FHA construction loans provide flexible credit guidelines for borrowers who may not qualify for conventional loans. But you trade off more requirements and less flexibility on the property type and loan amount.

Alternatives to FHA Construction Loans

If an FHA construction loan doesn’t work for you, here are some alternatives to consider:

• Conventional construction loans from banks and mortgage lenders provide more flexible options but require higher credit scores and down payments.

• VA construction loans offer 100% financing for eligible military members.

• USDA construction loans provide 100% financing for low- to moderate-income borrowers in rural areas.

• State and local housing programs may offer down payment assistance grants or low interest construction loans depending on your location and income.

• Owner-builder construction where you act as your own general contractor and pay for materials and labor as you go. This avoids financing altogether but requires expertise.

Finding the Right FHA Construction Lender

Not all lenders offer FHA construction loans, so finding one familiar with these products is key. Here are some tips for picking the best FHA construction loan lender:

• Ask current FHA lenders if they handle construction loans or can refer you to a partner company that does.

• Search HUD’s list of FHA-approved lenders and ask if they do construction lending.

• Look for local and regional banks and credit unions that advertise construction loans.

• Read reviews and compare interest rates and fees once you have a few options.

• Make sure to ask about their experience with FHA construction loans specifically.

The bottom line is that FHA construction loans make it possible for a wide range of buyers to build a new home to their specifications without needing perfect credit or a large down payment. Just be sure to pick an experienced lender and contractor to ensure the process goes smoothly from start to finish.