Can You Use an FHA Loan to Build a House? A Complete Guide

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.

Building a new home can be an exciting and rewarding experience. However it also requires a significant financial investment. This is where FHA loans can help. An FHA loan is a government-backed mortgage insured by the Federal Housing Administration. One of the key benefits of FHA loans is that they allow you to finance the construction of a new home through either a construction-to-permanent loan or a 203(k) renovation loan.

What is an FHA Construction Loan?

An FHA construction loan lets you roll the costs of building or renovating a home into your mortgage. There are two main types of FHA construction loans

FHA Construction-to-Permanent Loan: This loan combines features of a short-term construction loan with a long-term permanent FHA mortgage. It allows you to purchase land, finance construction costs, and end up with a traditional fixed-rate FHA loan once building is complete – all with a single closing.
FHA 203(k) Loan: The 203(k) program allows you to finance the purchase and renovation of an existing home. You can make minor repairs or major structural changes. There is a “Standard” 203(k) option for renovations over $35,000 that requires a HUD consultant to oversee the work.

The main advantage of an FHA construction loan is the ability to consolidate the entire building process into one loan. This avoids the hassle and fees of obtaining separate construction financing and permanent financing.

FHA Construction Loan Requirements

While FHA construction loans offer more flexible qualifying criteria than conventional loans, you still need to meet certain requirements:

Credit Score: Minimum of 500 credit score, but scores of 580 or higher allow for a lower down payment.
Down Payment: 10% down if credit score is 500-579. 3.5% down if 580 or above.
Debt-to-Income Ratio: Maximum of 43% front-end DTI, or 50% with compensating factors.
Loan Limits: Vary by metro area, but generally up to $726,525 for a single-family home in 2022.
Occupancy: You must intend to occupy the home as your primary residence.

In addition to borrower eligibility, the property, contractor, and building plans must all meet FHA guidelines for safety, livability and quality.

The FHA Construction Loan Process

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

Get Pre-Approved: Talk to a lender and get pre-approved for an FHA loan based on your finances.
Find Land: Use the loan to purchase vacant land or a teardown property to build on.
Hire Contractor: Find a licensed general contractor familiar with FHA guidelines.
Get Appraisal: The lender will order an appraisal to ensure the property meets FHA standards.
Close Loan: Finalize loan documents and close on the mortgage. Money is held in an escrow account.
Construction Begins: The contractor is paid draws from the escrow account as work is completed in stages.
Conversion to Permanent Loan: Within 60 days of completion, the lender converts the construction loan into a traditional fixed-rate FHA mortgage.

Pros and Cons of FHA Construction Loans

Pros:

Low down payment options
Flexible credit score requirements
One closing/one set of closing costs
Finance land purchase, construction, and permanent mortgage

Cons:

Stricter regulations than conventional loans
Requires upfront and annual mortgage insurance
Loan limits may be restrictive in high-cost areas
Appraisal may require property improvements

While FHA construction loans give you more options, make sure to also research conventional construction loans, USDA and VA loan programs, renovation mortgages, and grants or assistance through state/local housing agencies before deciding if an FHA construction loan is the right fit.

Alternatives to FHA Construction Loans

If an FHA construction loan doesn’t meet your needs, here are a few alternative options to consider:

Conventional Construction Loans: Offered by private lenders and homebuilders. Require two separate closings – one for the construction loan and one for permanent financing.
VA Construction Loans: Offered to eligible military homebuyers. Feature flexible guidelines and 100% financing options.
USDA Construction Loans: For low-to-moderate income borrowers in rural areas. Also provide 100% financing.
Renovation Mortgages: Offered by Fannie Mae and Freddie Mac for renovating existing homes. Allow lower down payments than FHA.
State/Local Down Payment Assistance: Check if your state or local housing agency offers down payment or closing cost help for new construction.

Finding an FHA Construction Loan Lender

The most important step is finding a lender experienced with FHA construction lending. Be sure to ask potential lenders:

Do they offer both construction-to-permanent loans and 203(k) renovation loans?
How familiar are they with FHA construction loan guidelines and processes?
Can they provide references from past FHA construction loan customers?

Getting construction loan pre-approval early in the process can also help you determine feasibility and better plan your budget.

The Bottom Line

FHA construction loans allow you to build or renovate a home with a low down payment and flexible credit score requirements. Just be sure to choose an experienced FHA lender, understand all regulations and costs, and have a detailed construction plan and budget in place upfront. This can help ensure a smooth journey from breaking ground to moving into your brand new 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.

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

Can you build a new house with an FHA loan?

Yes, a new home can be purchased with an FHA loan. There are two programs available: You can either buy a home from a builder with a traditional FHA loan or you can use an FHA construction-to-permanent loan to finance the land, construction costs and the finished home.

What credit score do you need for a FHA construction loan?

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.

Is it harder to get a loan to build a house?

Construction-Only Loan These are considered higher risk because of the many variables (builders, approvals) that accompany construction. They often have a higher interest rate, and keep in mind you’ll have to pay a second set of loan fees when you apply for a traditional mortgage.

Will an FHA loan cover land?

Key takeaways. An FHA construction loan is a type of FHA loan that covers the cost of building a home, including the land or lot purchase, building materials and labor. There are two types of FHA construction loans: an FHA construction-to-permanent loan and a FHA 203(k) loan.