Buying or building a new home is an exciting time. However it can also be overwhelming to navigate the mortgage process and determine what loans you qualify for. If you’re interested in building a home from the ground up an FHA building loan may be a great option thanks to flexible credit requirements. But before you apply, it’s important to understand the key FHA building loan requirements.
In this comprehensive guide we’ll break down exactly what an FHA building loan is, who qualifies and what you need to do to get approved. Whether you have perfect credit or less-than-stellar credit, FHA building loans open the door to homeownership for many borrowers who might not qualify through conventional loans.
What is an FHA Building Loan?
An FHA building loan, also called an FHA construction loan, allows you to finance the construction of a new home from start to finish. The Federal Housing Administration (FHA) is a government agency that guarantees these loans, allowing for more flexible underwriting guidelines than conventional loans.
There are two main types of FHA building loans
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FHA Construction-to-Permanent Loan: This option lets you use one loan to finance the purchase of land, construction costs, and then convert to a permanent mortgage once building is complete. You only go through one loan closing.
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FHA 203(k) Rehab Loan: Allows you to finance the purchase and renovation of an existing fixer-upper home through one FHA-insured loan.
The main benefit of FHA building loans is that they open doors for borrowers who may not qualify for other mortgages. They offer low down payments and flexible credit requirements. The trade-off is that you’ll pay mortgage insurance premiums for the life of the loan.
FHA Building Loan Requirements
While FHA loans allow for more flexibility, you still need to meet certain criteria to qualify. Here are the key FHA building loan requirements:
Credit Score
- Minimum 500 credit score required
-Scores between 500-579 require 10% down payment
-Scores 580+ qualify with 3.5% down
Down Payment
- 10% down required for borrowers with credit scores between 500-579
- 3.5% down payment required for 580+ credit scores
Debt-to-Income Ratio
- Maximum 50% debt-to-income ratio
-Ideal ratio is 43% or less
Mortgage Insurance
- Upfront mortgage insurance premium of 1.75%
- Annual mortgage insurance premium between 0.45% – 0.85%
Loan Limits
- Varies by county, typically up to $970,800 for single family homes
Construction Timeline
- Construction must be completed within 365 days
Licensed Contractor
- Must use a licensed and insured contractor
Let’s break down these requirements in more detail:
Credit Score Requirements
The minimum FHA credit score requirement is 500, which is significantly lower than what conventional loans allow. This makes FHA building loans accessible for borrowers will less-than-perfect credit.
With that said, your down payment requirements differ depending on your credit score:
- 500-579 credit score: 10% down payment required
- 580+ credit score: 3.5% down payment required
The higher your credit score, the lower down payment you’ll need. But even if your score is on the lower end, an FHA loan provides a path to homeownership.
Down Payment Requirements
FHA loans are well-known for allowing low down payments. Here are the down payment requirements:
- For borrowers with credit scores between 500-579, a minimum 10% down payment is required.
- If your credit score is 580 or above, you can qualify with just 3.5% down.
Your down payment can be gifted by a friend or relative. The funds just need to be documented properly.
Debt-to-Income Ratio
Your debt-to-income (DTI) ratio compares your total monthly debt payments to your gross monthly income. FHA building loans allow for more flexibility with DTI ratios up to 50% in some circumstances.
However, an ideal DTI is 43% or less. The lower your ratio, the better mortgage terms you may qualify for. Paying down debts can help improve your DTI prior to applying.
Mortgage Insurance Requirements
With an FHA loan, you’ll pay two types of mortgage insurance:
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Upfront Mortgage Insurance Premium: This is a 1.75% fee you pay at closing, based on the total loan amount.
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Annual Mortgage Insurance Premium: The ongoing premium you pay ranges between 0.45% – 0.85% of the loan amount per year.
Unlike conventional loans, FHA mortgage insurance is required for the life of the loan, even once you’ve built substantial equity. However, there are ways to cancel FHA mortgage insurance once your equity reaches 20% and you hit the seven year mark.
Loan Limit Requirements
FHA loans have county-specific limits on the maximum loan amount you can borrow. For a single family home in 2023, the standard limit is $970,800.
High-cost areas like San Francisco and New York City have higher limits approved by the FHA. You can look up the limits in your county to determine the max loan amount you may qualify for.
Construction Timeline
With an FHA construction loan, you’ll work with a home builder to determine a reasonable construction schedule. However, the work must be completed within 12 months. FHA guidelines require construction to be finished within 365 days.
If extenuating circumstances cause delays, you may be able to apply for one 180-day extension. But the entire building process cannot exceed 18 months.
Licensed Contractor
To qualify for FHA financing, you must work with a licensed and insured general contractor. They should have documented experience successfully completing projects similar to the home you want to build.
Your lender will want to review the contractor’s credentials and portfolio before approving the loan. This helps mitigate risk and protect you as the borrower.
How to Apply for an FHA Building Loan
If you meet the FHA building loan requirements, follow these steps to get started:
1. Check your credit and get pre-qualified
Order your credit reports and confirm your scores meet the minimum 500 FHA requirement. Then, consult with a mortgage lender to get pre-qualified for a loan amount.
2. Find land to purchase
Work with a real estate agent to identify land to buy for your new construction home. It must meet FHA safety and zoning requirements.
3. Select house plans and get an estimate
Work with an architect and general contractor to create house plans and get an itemized cost estimate.
4. Submit financing request and paperwork
Provide all required documentation to your lender, including income verification, assets statements and a construction cost breakdown.
5. Get land appraised
The lender will order an appraisal on the land you plan to purchase to ensure it meets FHA property standards.
6. Close on the construction loan
After the land appraisal comes back at the expected value, you’ll close on the construction loan.
7. Make draws as building progresses
As construction moves forward, the contractor will request disbursements from the loan as scheduled milestones are met.
8. Convert to permanent loan
Once construction is complete and you obtain an occupancy permit, the lender converts the construction loan into a permanent mortgage.
While the process involves many steps, an FHA building loan provides the financing you need to turn construction dreams into a reality!
Pros and Cons of FHA Building Loans
FHA building loans offer many advantages thanks to flexible government-backed financing. But there are also some potential drawbacks to weigh:
Pros
- Low 500 minimum credit score requirement
- Down payments as low as 3.5%
- Finance land purchase, construction, and permanent mortgage with one loan
- Construct home to your desired specs
Cons
- Mortgage insurance for life of the loan
- More closing costs than conventional loans
- Stricter appraisal and inspection requirements
- Must use licensed contractor
- Limited flexibility to make changes once building starts
While they involve more upfront effort, FHA construction loans allow many borrowers to build a custom home that fits their needs and budget.
Alternatives to FHA Building Loans
If you don’t qualify for an FHA building loan or want to consider other options, here are a few alternatives:
- Conventional construction loans from banks and credit unions
- VA loans – 0% down payment loans for veterans
- USDA loans – 0% down loans for rural and suburban areas
- Renovation loans like Fannie Mae HomeStyle for fixer-uppers
Each type of loan has its own qualification criteria, so be sure to discuss all of your options with a lender. An FHA building loan provides more flexibility than conventional mortgages
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.
Get prequalified or preapproved for financing
Before you can finalize your budget and building plans, you need to get prequalified or preapproved with a fha-approved lender. The prequalification process will determine how much you qualify for and what your lender’s borrowing limits are.
“If you don’t have the land and builder chosen yet, your prequalification or preapproval could expire and market conditions like interest rates increasing could heavily reduce the amount you can borrow,” Duncan notes.
So, you might want to have a contractor selected even before you begin the mortgage process.
But understand you won’t know how much you’re approved to borrow — or even if you qualify — until you’ve spoken with an FHA construction loan-approved lender.
FHA One Time Close Construction Loan Explained 2024
FAQ
Can an FHA loan be used to build a house?
What is the maximum DTI for a FHA construction loan?
What is the minimum FICO score for a construction loan?
What is the minimum requirement for FHA?
How do I qualify for an FHA Building Loan?
To qualify for any FHA building loan, you’ll need to meet certain requirements. Credit score: You’ll need a FICO® credit score of at least 500 if you want to qualify for an FHA loan requiring a minimum down payment of 10% of your home’s purchase price.
What is an FHA construction loan?
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.
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?
What is the minimum credit score for an FHA construction loan?
If you’re making a down payment of 3.5 percent, the minimum credit score for an FHA construction loan is 580. If you have at least 10 percent to put down, you could qualify with a score as low as 500. Autumn Cafiero Giusti is an award-winning journalist with over two decades of professional experience.