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FHA home building loans, also known as FHA construction loans, allow borrowers to finance the construction of a new home or make renovations to an existing home These government-backed loans are insured by the Federal Housing Administration (FHA) and offer more flexible qualifying guidelines compared to conventional construction loans.
In this comprehensive guide we will explain what an FHA home building loan is how it works, eligibility requirements, pros and cons, and alternatives. Whether you want to build a custom home from the ground up or give an old house a complete facelift, an FHA construction loan can be a great option.
What is an FHA Home Building Loan?
An FHA home building loan combines features of a short-term construction loan with a permanent FHA mortgage. There are two main types:
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FHA Construction-to-Permanent Loan – Allows you to purchase land, finance construction costs, and provide permanent financing once the home is built. It is a one-time close loan.
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FHA 203(k) Loan – Enables you to buy and renovate an existing home. There is a Limited 203(k) for renovations under $35,000 and a Standard 203(k) for major overhauls.
The FHA insures these loans, so lenders can offer lower down payments and more flexible credit requirements. Borrowers pay an upfront mortgage insurance premium and ongoing annual premiums.
How Does an FHA Construction Loan Work?
An FHA home building loan works in stages:
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Get prequalified or preapproved for financing. A lender will assess your credit, income, and assets.
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Find and secure land to build on. The property must meet FHA requirements.
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Hire a licensed general contractor. They will provide estimates for the construction.
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Get an appraisal to confirm the home will meet FHA property standards when completed.
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Close on the construction loan. Initial loan proceeds will be placed in an escrow account.
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Request draws from the account as work is completed in stages.
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Once construction is done, convert to a permanent FHA mortgage.
Throughout the process, the lender will oversee construction to ensure quality and prevent fraud. For a renovating using a 203(k) loan, a HUD-approved consultant also provides oversight.
FHA Home Building Loan Requirements
To qualify for an FHA construction loan, you must meet certain criteria:
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Credit Score – Minimum 500 credit score required. 580+ score needs only 3.5% downpayment. 500-579 score needs 10% down.
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Debt-to-Income Ratio – Maximum 43% front-end DTI. Can go up to 50% with compensating factors.
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Down Payment – At least 3.5% down required for 580+ credit score. 10% down required for 500-579 score.
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Loan Limits – Varies by county but typically up to $548,250 for single family homes in 2023.
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Stable Income – Must show reliable income to make mortgage payments. Two years of employment history recommended.
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Cash Reserves – Three to six months of mortgage payments required in liquid reserves.
Meeting these requirements demonstrates you can repay the loan responsibly. The FHA aims to serve underserved borrowers while also limiting risk.
Pros and Cons of an FHA Home Building Loan
Pros
- Low down payment options, as low as 3.5%
- Minimum 500 credit score
- One-time close construction-to-permanent loan
- Renovation financing with 203(k) program
- Streamlined process with single lender
Cons
- Must pay mortgage insurance premiums
- More stringent appraisal and oversight
- Loan limits may be restrictive in some areas
- Can be harder to find than conventional loans
- Tighter lending standards than conventional loans
While FHA construction loans offer more flexibility, they do come with more rules, red tape, and costs compared to conventional mortgages. Shop around to find the best fit.
Alternatives to FHA Construction Loans
If an FHA loan doesn’t meet your needs, here are some other options:
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Conventional Construction Loans – Offered by banks and builders. Require two separate loans – one for construction and one for permanent financing.
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VA Construction Loans – For eligible military members. Offer 100% financing options. Streamlined process.
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USDA Construction Loans – For low-to-moderate income borrowers in rural areas. Also 100% financing.
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Renovation Mortgages – Fannie Mae HomeStyle loan allows 3% down payment on renovations. Freddie Mac CHOICEHome loan also available.
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State/Local Programs – State housing agencies and nonprofits may offer specialized construction loan assistance.
Shop around and compare loan estimates to find the best construction loan for your situation. Consider both government and conventional options.
Applying for an FHA Home Building Loan
Follow these steps when applying for an FHA construction loan:
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Check your credit – Make sure your credit score meets the minimum FHA requires. Review reports and dispute errors.
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Get prequalified – Ask a lender to prequalify you for a loan amount. This estimates how much you may get approved for.
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Choose a lender – Find an FHA-approved lender with construction loan experience. Compare offers from multiple lenders.
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Pick plans/contractor – Create building plans with an architect. Hire a licensed general contractor. Get required permits.
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Submit loan application – Complete full loan application with income/asset documentation. Pay for appraisal.
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Get loan approval – The lender will underwrite and approve your loan if you meet the requirements.
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Close on mortgage – Review closing disclosure, sign loan documents, pay closing costs and make down payment.
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Start construction – Once closed, construction on your new home can begin! Oversee the process closely.
With preparation and perseverance, you can get approved for an FHA construction loan to build your dream home.
Tips for Managing an FHA Home Building Loan
- Review all draw requests thoroughly before approving
- Document progress with photos/videos at each stage
- Ask for lien waivers from subcontractors to avoid claims later
- Keep a contingency fund for unexpected overages
- Make interest payments on time during construction
- Get homeowners insurance in place on day one
- Perform final walkthrough inspection before signing off
- Remember to activate automatic mortgage payments when converting to permanent loan
Staying organized and attentive during the building process will help your FHA construction loan go as smoothly as possible.
Frequently Asked Questions about FHA Home Building Loans
Can I get an FHA construction loan with bad credit?
Yes, you can get an FHA construction loan with a credit score as low as 500, but you will need to make a larger 10% down payment. With a 580+ score, you only need 3.5% down.
How much money do I need to build a house with an FHA loan?
You will need at least a 3.5% down payment. Closing costs are usually 4-6% of the total loan amount. FHA also requires cash reserves equal to 3-6 mortgage payments.
What are the interest rates on FHA construction loans?
FHA construction loans will have similar interest rates to other FHA loan products, though perhaps slightly higher. Rates are tied to current mortgage rates, your credit, and down payment.
Can I do a construction loan myself?
Technically you can act as your own general contractor in most areas. However, FHA loans require licensed contractors due to the higher risks. It’s recommended to hire a professional builder.
How long does it take to get an FHA construction loan?
The approval process usually takes 1-2 months. Construction itself will depend on the size and complexity of your build, but expect 6-12 months until completion in most cases.
The Bottom Line
FHA home building loans allow borrowers to finance construction of a new home or major renovations with low down payments and flexible credit requirements. While they come with more rules, mortgage insurance premiums, and oversight than conventional loans, FHA construction loans open homeownership opportunities to more Americans. If you want to build your dream home but don’t have perfect credit or 20% down, explore your options with an FHA-approved lender today.
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- 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.
- FHA construction loans can be rolled into an FHA permanent mortgage.
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?
An FHA construction loan is a type of FHA loan used to build a home. It works like a conventional construction loan by providing short-term financing for a range of construction costs, from the architect’s fee to the certificate of occupancy. Often, borrowers convert these loans to long-term mortgages once the house is built.
Unlike conventional construction loans, however, FHA construction loans are insured by the FHA. That means if you have a down payment of at least 3.5 percent, you could qualify for the loan with a credit score as low as 580.