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 new home is an exciting yet challenging process While conventional mortgages are commonly used to purchase existing homes, many homebuyers don’t realize that FHA loans can also be used to finance new construction
An FHA construction loan allows you to build a home from the ground up using financing insured by the Federal Housing Administration (FHA) These government-backed loans offer distinct advantages for borrowers who want more flexibility and affordability when building their dream home
In this comprehensive guide, we’ll explain everything you need to know about using FHA financing to build a new house.
What is an FHA Construction Loan?
An FHA construction loan is a mortgage issued by an FHA-approved lender to finance the construction of a new home It provides a single loan that covers purchasing the land, paying construction costs, and securing permanent financing once the home is completed
Rather than needing separate loans for the land, construction, and eventual mortgage, an FHA construction loan combines everything into one. This consolidated approach simplifies the process, requiring only a single application and closing.
With an FHA construction loan:
- You can buy land and build a home from scratch
- Finance up to 100% of construction costs
- Convert the loan to a permanent mortgage after building is complete
- Avoid costs and hassles of multiple loan applications/closings
FHA construction loans feature low down payments and flexible credit requirements that make building a home accessible even if you don’t have perfect credit or substantial cash reserves.
FHA Construction Loan Requirements
While FHA construction loans offer more flexibility than conventional mortgages, you still need to meet certain eligibility standards to qualify:
Credit score: At least 500 FICO for a 10% down payment, or 580 for 3.5% down
Down payment: As little as 3.5% of the total construction costs
Debt-to-income ratio: Typically 43% or lower
Mortgage insurance: Upfront and annual premiums (can be cancelled later)
Construction timeline: Must be completed within 365 days
Licensed contractor: Builder must be approved to work with FHA loans
Inspections: Mandatory at various stages to ensure quality standards
Primary residence: You must occupy the home as your primary residence
Loan limits: Vary by county but typically around $400,000-$500,000
Meeting these requirements ensures you and your lender can successfully finance and complete construction without excessive risk.
How Does an FHA Construction Loan Work?
FHA construction loans disburse money in installments as you reach agreed-upon milestones during the building process. Here are the basic steps:
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Get prequalified by an FHA lender to see your estimated rate/terms
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Find land to build on
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Select contractor who can work with FHA
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Complete loan application & get approved
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Close on mortgage & start construction
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Receive disbursements as work is completed
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Make interest-only payments during construction
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Home is inspected when finished
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Loan converts to permanent mortgage
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Start making principal & interest payments
Streamlined draws and interest-only payments help reduce costs during the build. And converting to a traditional mortgage eliminates the hassle of arranging permanent financing after the construction period.
Benefits of an FHA Construction Loan
FHA construction loans offer homebuyers several advantages compared to conventional building loans:
Lower down payments – As low as 3.5% down rather than 20%
More flexible credit – Open to borrowers with credit scores as low as 500
Single-close convenience – One loan for land, building, and permanent mortgage
Lower payments during construction – Interest-only payments keep costs down
Government-backed – FHA insures your lender against default
No second appraisal needed – Home value already determined
No need to requalify for permanent financing – Loan converts automatically
Eligible properties – Build on land or as part of approved condo/subdivision
For buyers who don’t have a lot of cash or pristine credit, FHA construction loans make building a home accessible and affordable.
Disadvantages to Consider
While they offer more flexibility, FHA construction loans also have some limitations to factor in:
Higher interest rates – Usually 0.5 to 1% higher than normal FHA loans
Mortgage insurance – Required for the life of the loan
Strict contractor requirements – Limits builder options
More complex process – Extra steps and requirements vs. conventional loans
Closing costs – Must be paid upfront from your own funds
Time pressures – Construction must be completed within 12 months
Lower loan limits – Vary by county but typically under $500,000
Upfront costs – May need to pay for land, permits, fees at closing
For buyers with strong credit or higher incomes, conventional construction loans may offer cheaper rates and higher loan amounts. But they require larger down payments and lower debt-to-income ratios.
Finding the Best FHA Construction Loan Lender
The first step in getting an FHA construction loan is finding a lender who offers this type of financing. Here are some tips for choosing the right lender:
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Search HUD’s website – They provide a list of approved FHA lenders
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Ask about experience – Pick a lender who regularly handles these loans
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Compare interest rates – Rates can vary significantly between lenders
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Check reviews – Choose a lender known for great service
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Ask about the process – Make sure they can guide you through each step
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Compare fees – Closing costs, origination fees, and other charges
Taking the time to shop around ensures you find the most affordable FHA construction loan and personalized service. Online lenders, credit unions, and community banks are all worth considering.
What’s the Process for Getting Approved?
Once you select a lender, the process involves a few key steps:
Prequalification – Gives you an early rate/term estimate
Submit application – Includes financial docs, construction plans, etc.
Home appraisal – Ensures land value supports building costs
Underwriting – Verifies you meet all FHA requirements
Loan approval – Final terms provided based on official review
Closing – Sign documents and pay associated fees/costs
Start construction – Builder begins work once loan funds
From prequalification to final loan approval takes 30-60 days. Then you can close on the mortgage and break ground on your new home.
Alternative Construction Loan Options
If you don’t qualify for an FHA loan, here are a few other home construction loan options:
Conventional loans – Require higher credit scores and 20% down
USDA loans – 100% financing for low-income borrowers in rural areas
VA loans – No down payment for qualifying veterans
Renovation loans – Finance improvements to existing homes
State/local programs – May offer grants, low rates, or down payment help
Owner financing – Some sellers provide in-house financing
Custom builder programs – May include partnerships with lenders
Hard money loans – Asset-based financing from private lenders
Shopping around helps you find the most affordable building loan or alternative financing for your situation.
The Bottom Line
Thanks to their low down payments, flexible credit requirements, and consolidated one-loan process, FHA construction loans make it feasible for many buyers to build their dream home.
While FHA construction loans have some limitations on loan amounts and stricter qualification standards, they open new construction possibilities if you don’t have the resources for a large down payment or don’t meet stringent conventional loan requirements.
By understanding the costs, process, and benefits, you can determine if an FHA-backed mortgage is your ticket to building your own home. With the right financing approach, you can construct your ideal property and enjoy all the features you want in the home you’ve always envisioned.
Alternatives to an FHA construction loan
Your local bank or homebuilder may offer their own construction loans. When the home is finished, you’ll need to pay off the construction financing with a permanent loan. This is also called a two-time close construction loan, since you’ll close twice and pay closing costs on both loans.
Pros and cons of FHA construction loans
Provides flexible qualifying requirements: FHA accepts credit scores as low as 500, provided you’re able to make a 10% down payment. However, if your score is at least 580, you’ll only be required to put down 3.5%.
Offers the ability to do one closing: In more traditional financing scenarios, you’d have to take out two separate loans — a construction loan and a permanent mortgage. This means attending two closings and paying two sets of closing costs. With the FHA construction loan, you only have to go through the process once.
Gives options for multiple types of construction projects: Between the FHA construction-to-permanent loan for new builds and the FHA 203(k) program for fixer-upper homes, an FHA construction loan has you covered no matter what type of construction project you have in mind.
Requires mortgage insurance: FHA borrowers must pay two types of FHA mortgage insurance: an upfront fee worth 1.75% of the loan amount and an annual premium that costs between 0.15% and 0.75% of the loan amount. Unlike private mortgage insurance, this requirement can’t be waived once you build up more equity in your home.
Sets specific limits on your loan amount: The FHA sets annual limits on how much you’re able to borrow. For 2023, the limit for most areas is $472,030. However, it extends to $1,089,300 in select areas where the cost of living is much higher.
Imposes more requirements than other loan types: FHA construction loans come with more red tape than some other loan options. For example, the FHA appraisal sets specific health and safety requirements that aren’t typically found with conventional loans.
FHA One Time Close Construction Loan Explained 2024
FAQ
What credit score do you need for a FHA construction loan?
Is it harder to get a loan to build a house?
What credit score is needed to build a house?
Will an FHA loan cover land?
Can you build a house with an FHA loan?
With an FHA construction loan, you have the flexibility to buy a parcel of land, build a home from scratch, finance a permanent mortgage on the completed home, or even purchase and renovate a fixer-upper, all with a single loan.
Should I get an FHA construction loan?
If you’d rather build a home than buy one, an FHA construction loan could help pay for the project. 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. What is an FHA construction loan?
Can I build a home on land if I’m FHA approved?
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: 3. Choose a licensed contractor or builder FHA construction loan guidelines require you to work with a licensed contractor or builder.
What can I do with an FHA construction loan?
With an FHA construction loan, you have the flexibility to buy a parcel of land, build a home from scratch, finance a permanent mortgage on the completed home, or even purchase and renovate a fixer-upper, all with a single loan. Check your construction loan eligibility. Start here