Building your dream home can be an exciting yet daunting process. With so many options for financing, it can be challenging to determine the best route to take. One option to consider is an FHA loan. But can you really use an FHA loan to build a house?
The short answer is yes! FHA loans offer a flexible financing solution for constructing a new home Specifically, FHA construction-to-permanent loans allow you to finance the land purchase, construction, and final mortgage with a single loan product
In this comprehensive guide, we’ll explore everything you need to know about using FHA financing for your custom home build. Here’s what we’ll cover:
- What is an FHA loan?
- FHA construction loan options
- How does an FHA construction loan work?
- What are the requirements?
- What are the pros and cons?
- How to find the best lenders
- Alternatives to consider
Let’s dive in!
What Is An FHA Loan?
First things first – what exactly is an FHA loan? FHA stands for Federal Housing Administration. This government agency insures loans made by approved lenders, protecting them against losses if borrowers default.
In exchange for this insurance, lenders are able to offer FHA loans with lower credit score requirements and down payments as low as 3.5% This makes them more accessible for first-time home buyers and borrowers with less-than-perfect credit.
FHA loans can be used to purchase existing homes or refinance existing mortgages. But they can also be used to finance new construction, which is where FHA construction loans come into play.
FHA Construction Loan Options
The FHA offers two main types of construction loans:
-
FHA Construction-to-Permanent Loan – This loan covers purchasing land, paying construction costs, and obtaining final mortgage financing with a single loan and closing. Once construction is complete, the loan converts to a permanent FHA mortgage.
-
FHA 203(k) Loan – This FHA renovation loan allows you to buy and renovate an existing property. You can make minor repairs or significant upgrades with loan proceeds.
Both loans streamline the process of building or renovating a home with FHA financing. But the construction-to-permanent loan is specifically geared for new home construction.
How Does An FHA Construction Loan Work?
An FHA construction loan combines short-term financing for building costs with a permanent mortgage once construction is finished. Here’s a step-by-step overview:
-
Get Prequalified – Work with a lender to get prequalified and determine your maximum loan amount based on your income, debts, and credit score. Shop around to compare offers.
-
Find Land – Identify and place under contract a suitable lot for your new construction. The land purchase can be folded into your total FHA loan amount.
-
Select House Plans – Work with a builder to design house plans and choose finishes that match your budget
-
Complete Loan Process – Provide all required documentation and undergo full underwriting for approval.
-
Close on Loan – At closing, you’ll formally assume title to the land and finalize construction contracts.
-
Construction Begins – The lender will release funds in stages as certain milestones are met during the building process.
-
Full Conversion – Once construction is finished and the home passes inspection, the loan converts to a permanent FHA mortgage.
Throughout construction, you’ll only need to pay interest on the disbursed loan amounts. Once converted to a traditional loan, you’ll begin making principal and interest payments.
FHA Construction Loan Requirements
To qualify for an FHA construction loan, you’ll need to meet certain borrower, property, and contractor requirements:
Borrower Requirements
- Credit score of at least 580
- Debt-to-income ratio below 43%
- At least 3.5% down payment
- 2 years of employment history
Property Requirements
- Must be a single-family home
- Located in an FHA-approved area
- Subject to inspections during construction
Contractor Requirements
- Licensed, insured contractor approved by FHA
- Minimum 2 years experience
- New construction warranty provided
Meeting these requirements upfront ensures you and the lender are protected throughout the building process.
Pros and Cons of FHA Construction Loans
Before committing to an FHA construction loan, weigh the key advantages and potential drawbacks:
Pros
- Lower credit score and down payment requirements
- Streamlined one-time close loan
- Purchase land and finance all costs in one loan
- Fixed interest rate protection after conversion
Cons
- Stricter requirements than conventional loans
- Mandatory mortgage insurance premiums
- Oversight during construction process
- Potentially higher interest rates
While FHA construction loans offer great flexibility, they aren’t right for everyone. Make sure the benefits outweigh any limitations for your situation.
How To Find The Best FHA Construction Loan Lenders
The first step is locating lenders approved to offer FHA construction loans in your state. You can search HUD’s website for approved lending institutions.
Once you’ve compiled a list, compare interest rates and fees to find the most competitive offers. Ask about their specific construction loan requirements, timelines, and processes as well.
Opting for an experienced FHA construction lender can streamline the building process. Lean on their expertise to steer you through the intricacies these loans entail.
Alternatives To Consider
If an FHA construction loan isn’t the right fit, here are a few alternatives worth exploring:
-
Conventional Construction Loans – Require better credit and income yet offer greater flexibility.
-
VA Construction Loans – Offer zero down payment options for eligible veterans.
-
USDA Construction Loans – Provide 100% financing for low-income borrowers in rural areas.
-
Renovation Loans – Allow you to finance the purchase and remodel of an existing home.
-
State/Local Construction Loan Programs – May provide down payment help or special financing options.
Compare all your options to find the optimal loan program for your construction plans and financial situation.
The Bottom Line
Yes, you can absolutely use an FHA loan to build a custom home! FHA construction-to-permanent loans provide an accessible financing solution with the purchase of land, payment of construction costs, and final mortgage wrapped into one loan.
Just be sure to select an approved lender, understand all requirements upfront, and prepare for oversight throughout the building process. While FHA construction loans may not be the easiest option, they open the door to homeownership for buyers who otherwise may not be able to achieve their dream of building a home.
FHA construction loan lenders
Finding FHA construction-to-permanent loans and FHA-approved lenders offering these loans can be challenging. Additionally, “Finding a lender that will process these loans quickly, efficiently, and is staffed with a full team is even rarer,” says Mushlin with BuildBuyRefi.com.
To streamline your search, visit the US Department of Housing and Urban Development’s (HUD) website to search for FHA lenders. Although, keep in mind that not all FHA-approved lenders offer FHA construction loans.
When seeking an FHA construction loan, patience and willingness to shop around for the right mortgage lenders is essential. While the process may be more complex than obtaining a traditional construction loan, those who persevere can reap significant benefits. To increase your chances of success, research lenders thoroughly, gather all necessary documentation, and be prepared to provide detailed information about your construction project.
FHA construction loan requirements
Several rules apply to FHA construction-to-permanent loans, including requirements for the borrower, the property, and the contractor. These FHA construction loan requirements ensure that all parties meet the necessary standards for a successful construction project.
This is the minimum down payment for FHA construction loans. A higher down payment may be required depending on your credit score and other factors.
Technically, 580 is the minimum fico score for construction loan. However, Mushlin says that in his experience, a higher credit score of at least 640 is usually needed for the FHA construction-to-permanent loan program.
You must not have experienced bankruptcy in the last two years. Other negative credit events, such as foreclosures or collections, may also impact your eligibility.
That means your monthly debts — including future mortgage payments — don’t take up more than 43% of your monthly pre-tax income. A lower DTI may be required depending on your credit score and other factors.
For W-2 borrowers, that means the last 60 days of pay stubs, the last two years of W-2s, and your last two annual tax returns. Self-employed borrowers will need to provide the last two years of full personal and business tax returns as well as all tax schedules involved.
In addition, all FHA borrowers are required to pay mortgage insurance premium (MIP), which protects the lender in case of foreclosure.
FHA MIP has an upfront cost equal to 1.75% of the loan amount (which can be rolled into the mortgage) as well as an annual charge typically equal to 0.85% of the loan amount and paid monthly.
However, homeowners can refinance later to cancel mortgage insurance and lower their monthly payments once they have reached 20% equity in their home.
The types of homes eligible to be built with an FHA construction loan include single-family homes, condominium units in approved projects or legal phases, and manufactured homes. The home must be owner-occupied as your primary residence. And, the property must be located in an FHA-approved area.
Your total loan amount can’t be higher than your county’s maximum loan limit. In 2024, most counties have a max borrowing limit of $.
FHA construction loans require thorough inspections to ensure the property meets all necessary standards and regulations. These inspections must be carried out by qualified professionals at various stages of the construction process.
“There is a requirement that inspections be performed by ICC-certified inspectors or a third party who is a registered architect or structural engineer,” says J. Keith Baker, chair of curriculum for Mortgage Banking and Financial Services at Dallas College.
The FHA must approve of your chosen licensed contractors, who are required to have needed licensure, liability insurance, and a minimum of two years of experience building homes.
You must also receive a new construction warranty from the builder. This warranty protects you against defects in materials and workmanship for a specified period after the home is built.
Any remaining funds after construction ends must be applied directly toward your loan principal — you can’t keep them as cash-back.
FHA One Time Close Construction Loan Explained 2024
FAQ
Can you build a house on an FHA loan?
Is it harder to get a loan to build a house?
What credit score do you need for a FHA construction loan?
What is a good credit score to build a house?
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?
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.
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.