Buying or building a new home is an exciting milestone in life. But it also requires a significant financial investment. If you don’t have enough cash savings for a down payment and closing costs, financing the purchase makes homeownership possible. An FHA loan is a popular mortgage option for first-time homebuyers and others because it requires a low down payment of just 3.5%. But can you use FHA financing to build a custom home?
The answer is yes. You have two options for using an FHA-insured mortgage to build a house:
FHA Construction-to-Permanent Loan
An FHA construction-to-permanent loan combines the construction loan and permanent mortgage into one loan. This avoids having to apply and close on two separate loans.
Here’s how it works:
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You purchase the land or lot you want to build on. This purchase can be included in the FHA loan.
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The lender sets aside the approved mortgage amount to fund draws during construction Draws are payments made to contractors as work is completed
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Once construction is finished, the loan converts to a permanent FHA mortgage.
Benefits of this option include
- Only one loan application and set of closing costs
- Lock in today’s interest rates for the permanent mortgage
- Move right from construction to permanent financing
Downsides are that construction loans typically have higher rates and the builder must be FHA-approved.
FHA 203(k) Rehab Loan
Another choice is the FHA 203(k) mortgage. While designed for remodeling and renovations, this loan can also be used to build a home.
With the 203(k), you can purchase land and finance the construction through one mortgage. Costs that can be rolled into the loan include:
- Land purchase
- Construction materials
- Labor
- Architect and permitting fees
- Other construction-related expenses
As with the construction-to-permanent loan, the 203(k) avoids having to apply for and close on two separate loans.
FHA Loan Requirements
To qualify for either type of FHA-insured construction loan, you must meet these minimum requirements:
- Credit score of at least 580
- Debt-to-income ratio under 43%
- 3.5% down payment with credit score of 580+
- Upfront and annual mortgage insurance premiums
For new construction, requirements also include:
- Builder must be FHA-approved
- Funds to cover cost overruns recommended
The home must become your primary residence. FHA loans can’t be used for vacation homes or investment properties.
How to Get an FHA Construction Loan
Follow these steps to get an FHA loan to build a custom home:
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Find a lender – Connect with a lender approved for FHA construction lending. Check the HUD website for options.
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Select a lot/land – Work with a real estate agent to identify the property you want to build on if not already owned.
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Choose a builder – Select a construction company or custom home builder. For construction-to-permanent loan, builder must be FHA-approved.
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Apply for loan pre-approval – Get pre-approved for the FHA construction loan and permanent mortgage.
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Finalize building plans/costs – Work with lender and builder to finalize budget and specifications.
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Close on the loan – Finalize paperwork and close on the construction loan.
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Start building – After closing, construction will begin. Oversee progress and authorize draw payments.
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Complete construction – Once home is finished, construction loan converts to permanent mortgage.
An FHA loan can make building a custom home more affordable. Construction-to-permanent and 203(k) mortgages let you combine construction financing with the permanent home loan. Meet with a lender to discuss your options and get started on the path to building your dream home.
FHA construction loan interest rates
Interest rates for FHA construction-to-permanent loans are generally higher than rates for other loan types. “Typically, borrowers often see rates around 2% to 4% higher [than current mortgage rates],” says Duncan. In comparison, the rate on a conventional construction loan might be approximately 1% higher than market rates.
Julie Aragon, Julie Aragon, CEO and founder of the Julie Aragon Lending Team, explains that mortgage lenders view these loans as a greater risk because the home, which normally serves as collateral, does not yet exist. “Interest rates for these FHA loans can also fluctuate based on the creditworthiness of the borrower and other factors,” she adds.
To secure the best interest rate on your FHA construction loan, focus on improving your credit score, reducing your debt-to-income ratio, and saving for a larger down payment. Shopping around and comparing offers from multiple lenders can also help you find the most competitive rates and terms for your specific situation.
Find the land you’ll build on
When it comes to purchasing land, you have several options:
- You can use vacant land you already own that is fully paid off.
- You can buy land with an existing loan from a bank or private party, with the remaining balance to be paid off at closing.
- You can place land under contract, with the payment to be completed at closing.
“The land should not require a teardown of the property or have multiple properties on it,” cautions Richie Duncan, senior loan officer with Nationwide Home Loans Group.
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FAQ
Can you build a house on an FHA loan?
What credit score do you need for a FHA construction loan?
What credit score is needed to build a house?
Can you get a mortgage on a house you want to build?
Can I build a home on land if I’m FHA approved?
Once you’re approved for an FHA loan, you can use the proceeds to buy land on which to build a home. Most plots are acceptable, but FHA construction loan rules don’t allow you to build a home on land that is near certain prohibited sites (3). Choose a licensed contractor or builder to work with for your FHA construction project.
Can you build a house using an FHA loan?
An FHA construction loan allows you to build a house from scratch or purchase and renovate a fixer-upper with a single loan. You also have the option to finance a permanent mortgage on the completed home.
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?
How can I get an FHA construction loan?
To get an FHA construction loan, you need to search for FHA lenders on the US Department of Housing and Urban Development’s (HUD) website. Not all FHA lenders offer construction loans, so you need to be patient and willing to shop around for the right mortgage company.