FHA Construction Loan Requirements: A Complete Guide for 2023

An FHA construction loan allows you to finance the building or renovating of your dream home. With an FHA-insured mortgage, you can qualify with a low down payment and credit scores as low as 500. However, FHA construction loans come with more requirements compared to a regular FHA loan.

In this comprehensive guide we’ll explain all the key FHA construction loan requirements so you can successfully navigate the process. We’ll cover

• Borrower eligibility
• Property and land requirements
• Contractor qualifications
• Loan limits and down payments
• The construction process
• Completing the project

Plus, we’ll outline the differences between FHA construction-to-permanent loans and 203(k) rehab loans.

Overview of FHA Construction Loans

FHA construction loans help borrowers finance the building of a new home or the renovation of an existing property. With a single loan, you can purchase land, pay for construction costs, and end up with permanent mortgage financing all in one.

These mortgages are insured by the Federal Housing Administration (FHA). The FHA will protect the lender from defaults, allowing more flexibility for borrowers.

There are two types of FHA construction loans

• FHA construction-to-permanent loan – This loan is used to build a home from the ground up. You can buy land and finance all construction costs. At the end, the loan converts to a permanent mortgage.

• FHA 203(k) rehab loan – With this loan, you purchase and renovate an existing home. It allows you to finance repairs or renovations of $5,000 or more.

Both loans simplify the process by combining construction financing and your permanent mortgage into one loan. Now let’s look at the specific FHA requirements.

FHA Construction Loan Borrower Requirements

As the borrower, you’ll need to meet certain criteria to be eligible for an FHA construction loan. Here are the key requirements:

Credit score – You’ll need a minimum credit score of 500 to qualify. But if your score is 500-579, you’ll need a 10% down payment. With a score of 580 or above, you can put down 3.5%.

Debt-to-income ratio – Your DTI measures your income against current debts. It must be 43% or lower. Sometimes 50% DTI is allowed.

Down payment – With a 500-579 score, you need 10% down. With a 580+ score, you need 3.5% down.

Loan amount – Your loan amount can’t exceed FHA mortgage limits based on your area.

Homeownership education – You must complete a homebuyer education course if you haven’t owned a home in the past three years.

Underwriting approval – The lender will verify your income, assets, employment, and creditworthiness.

Occupancy requirements – For construction-to-permanent loans, you must move in within 60 days of completion. For 203(k) loans, you must live in the home as your primary residence.

Meeting these requirements ensures you have the means to successfully take on an FHA construction loan.

FHA Construction Loan Property Requirements

The property and land you plan to build or renovate on must also meet FHA standards:

• The land cannot be in an area exposed to natural disasters or environmental hazards. This includes flood zones, earthquake zones, and areas near gas wells or airports.

• For new construction, the land can’t have existing dwellings that need to be demolished or removed.

• The property must be in decent condition and meet FHA minimum property standards and local building codes after renovations are completed.

• An FHA appraisal is required to determine the property’s value and ensure it meets requirements.

• The appraised value after construction or renovations must be high enough to cover your loan amount and costs.

These property conditions ensure the home will be a sound investment once completed.

FHA Construction Contractor Requirements

For either type of FHA construction loan, your builder or contractor must meet certain qualifications:

• They must have all required state and local licensing and be properly insured.

• They should have past experience with FHA construction loans. New builders may not understand all requirements.

• The contractor may need to provide referrals or examples of past projects.

• For 203(k) rehab loans, the contractor must be accepted by the lender.

Having an experienced FHA contractor is key to ensuring the project stays on track. Be sure to vet options thoroughly.

FHA Construction Loan Amounts and Down Payments

FHA construction loans come with loan limits and down payment options:

• The maximum FHA loan limit for most areas in 2023 is $485,000. High-cost areas have higher limits up to $970,800.

• The minimum down payment is 3.5% with a 580+ credit score. With a 500-579 score, 10% down is required.

• You can receive gifts from relatives or nonprofits for your down payment under certain conditions. The gift can’t be repaid.

• Your down payment can come from savings, stocks, bonds, or real estate you already own. Cash on hand is preferable.

Always keep FHA loan limits and down payment options in mind when selecting your land and designing plans.

The FHA Construction Process

Now let’s walk through the general construction process from start to finish:

1. Find and prepare your land or existing home for renovations.

2. Get pre-qualified/pre-approved with an FHA lender.

3. Finalize builder and design plans.

4. Complete loan underwriting and appraisal.

5. Close on the construction loan.

6. Builder completes work in stages.

7. Arrange inspections after each stage.

8. Make interest-only payments during construction.

9. Complete final inspection and convert to permanent loan.

10. Begin making principal + interest payments.

It’s critical to follow this structured process to ensure proper oversight and approval. Rushing through stages can jeopardize loan approval.

Completing the FHA Construction Project

Once construction reaches completion, there are a few final steps:

• The lender will order a final inspection to ensure all work meets FHA guidelines.

• You must occupy the home as your primary residence within 60 days of project completion.

• For 203(k) loans, all renovations must be finished within 6 months. But you can ask for a 6 month extension if needed.

• The construction loan will convert to a permanent mortgage within 60 days after completion.

• You will begin making principal and interest payments at this point.

• Your mortgage insurance will switch from construction rates to standard rates.

Carefully follow all completion requirements to avoid issues converting to your permanent mortgage.

FHA Construction-to-Permanent vs. 203(k) Loans

While FHA construction-to-permanent loans and 203(k) rehab loans share similarities, there are some key differences:

Construction-to-Permanent

• Used to build a new home
• Can finance land purchase
• Minimum credit score is 500
• Maximum loan amount follows FHA limits
• Converts to permanent mortgage after building complete

203(k) Rehab Loan

• For renovating existing homes
• Credit score must be 580+
• Limited to $35K in repairs or up to 75% of property value
• Requires a consultant to oversee renovations
• Becomes permanent mortgage after renovations

Alternatives to FHA Construction Loans

If you don’t qualify for an FHA construction loan, here are some alternative options to consider:

• Conventional construction loans – Offered by banks and builders, these also require two separate loans but may have lower credit score requirements.

• VA construction loans – No down payment is required and limits are based on your COL. Must be eligible military member.

• USDA construction loans – 100% financing available in designated rural areas for low-income borrowers.

• HomeStyle renovation loans – Offered by Fannie Mae, these allow 3% down payments and more flexible renovations.

• State/local construction loan programs – Check if your state or city offers special loans or grants for construction projects.

The Bottom Line

While FHA construction loans offer nice perks, like low down payments and flexible credit requirements, they come with much more oversight throughout the construction process.

Be sure you fully understand all the FHA borrower, property, contractor, and completion requirements before applying. Finding an experienced lender familiar with FHA loans is key.

If you don’t meet eligibility or would prefer less red tape, check into alternative loan options that may better suit your scenario. But for many borrowers, an FHA construction loan can make building a custom