Everything You Need to Know About FHA Construction-to-Permanent Loans

An FHA construction-to-permanent loan, also known as a one-time close loan or a single close loan, allows you to finance the construction of a new home and get a permanent mortgage in just one loan and one closing. This type of financing can make building a custom home more affordable and accessible, especially for buyers who may not qualify for a traditional construction loan.

In this comprehensive guide, we’ll explain what an FHA construction-to-permanent loan is, how it works, requirements to qualify, pros and cons, interest rates, how to find lenders, and alternative options.

What is an FHA Construction-to-Permanent Loan?

An FHA construction-to-permanent loan combines a short-term construction loan with a traditional long-term mortgage into one FHA-insured loan. This versatile financing option allows you to

• Purchase land
• Finance construction costs
• Pay lender fees
• Convert to a permanent mortgage after building is complete

With a construction-to-permanent loan, you only go through one loan application process, one closing, and have one loan to pay off when construction is finished. There’s no need to reapply for or refinance into permanent financing later on.

This consolidated approach can save time, hassle, and money on closing costs compared to other types of construction loans. FHA construction-to-permanent loans are government-backed, which provides more flexible qualifying criteria for borrowers.

How Does an FHA Construction-to-Permanent Loan Work?

FHA construction loans function similarly to other types of construction mortgages during the building phase. Here’s an overview of the process:

1. Get Pre-Approved Work with an FHA lender to get a pre-approval letter estimating your loan amount

2. Purchase Land: Use loan proceeds to buy land if you don’t already own a lot.

3. Hire Contractor: Select a qualified licensed contractor or builder.

4. Finalize Plans: Work with contractor to complete building plans and get required permits.

5. Appraisal: The lender will order an appraisal to estimate the property’s value when construction is finished.

6. Loan Closing: Review loan documents and close on the construction loan.

7. Construction Begins: Your contractor starts building once permits are secured.

8. Draw Requests: As work is completed, the lender disburses payments to the contractor per the draw schedule.

9. Conversion to Permanent Loan: When construction is done, the loan converts to a traditional 30-year fixed-rate mortgage.

One of the biggest benefits of this loan is only having a single closing. You won’t have to undergo a second round of paperwork, underwriting, and closing costs when it’s time to switch to permanent financing. The construction loan simply converts to a permanent mortgage automatically.

FHA Construction Loan Requirements

To qualify for an FHA construction-to-permanent loan, you must meet certain criteria for your credit, income, debt-to-income ratio, and down payment amount. Here are the key eligibility requirements:

• Credit Score: Minimum 500 credit score required, 580 for lower down payment

• Down Payment: At least 10% down if credit score is 500-579, or 3.5% down with 580+ credit

• DTI: Maximum debt-to-income ratio of 43% (or up to 50% with compensating factors)

• Income Verification: Provide 2 years of employment history and income documentation

• Mortgage Insurance: Upfront and annual mortgage insurance premiums required

In addition to these standards for borrowers, there are also requirements for the property, construction plans, contractor, and completion timeframe when using an FHA construction loan.

The Pros and Cons of FHA Construction Loans

FHA construction-to-permanent loans offer unique benefits, but also have some potential drawbacks to consider.

Pros:

• One loan/one closing simplifies process
• Lower credit scores and down payments accepted
• Finance land purchase, construction, and permanent mortgage
• Fixed low interest rate locked in for life of loan

Cons:

• Stricter requirements than conventional loans
• Must use licensed contractor
• Monthly mortgage insurance premiums
• Loan limits may constrain project size

As with any mortgage, your individual scenario determines whether an FHA construction loan is the right fit or if another type of financing is better suited for your needs.

Interest Rates on FHA Construction Loans

Interest rates on FHA construction loans tend to run 1-4% higher than current rates for traditional 30-year fixed-rate mortgages. Rates can vary depending on your credit score, debt-to-income ratio, down payment amount, and other qualifications.

The actual interest rate offered will depend on current market rates at the time of application and factors specific to your financial situation. Work with multiple lenders to shop for the most competitive rate on your FHA construction loan.

Once your permanent mortgage kicks in, you will have a fixed interest rate for the life of the loan, generally 30 years. This provides long-term stability and predictability in your monthly payments.

How to Find Lenders for FHA Construction Loans

FHA construction loans may be harder to find than conventional mortgages, but there are lenders that offer these one-time close loans. Here are some tips for tracking down FHA construction loan lenders:

• Check HUD’s website for FHA-approved lenders in your state

• Ask your real estate agent for local lender recommendations

• Search online for “FHA construction loans”

• Compare rates and terms from multiple lenders

• Look for lenders experienced with FHA construction-to-permanent loans

• FHA.com, New American Funding, and Navy Federal Credit Union are some lenders to consider.

Connecting with the right lender can simplify the process of securing your FHA construction loan and building your dream home.

Alternatives to FHA Construction-to-Permanent Loans

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

Conventional construction loans – Require higher credit scores and down payments, offer flexible guidelines.

VA construction loans – 100% financing for eligible military homebuyers.

USDA construction loans – 100% financing for low-to-moderate income buyers in rural areas.

Homestyle Renovation – For renovating and remodeling, minimum 3% down payment.

Two-time close loans – Separate construction loan and permanent mortgages, two closings.

Home equity – Use equity in current home to finance construction project.

Research multiple construction loan programs to find the right fit based on your financial situation, project timeline, property location, and credit/income qualifications.

The Bottom Line

FHA construction-to-permanent loans let you build and finance a new home in one simplified process. This unique loan provides flexible qualifying requirements and consolidates construction financing with a permanent mortgage into one single closing.

While FHA construction loans have more requirements compared to conventional options, this program makes owning a custom built home possible even with lower credit scores and smaller down payments. Just be sure to work with an experienced lender familiar with FHA guidelines to ensure your project stays on track.