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Buying land and building a custom home from the ground up is an exciting prospect for many homebuyers. However, it also comes with complexities and costs that can feel overwhelming, especially when trying to finance the project. This is where FHA construction loans can help.
FHA construction loans allow you to roll the financing for purchasing land and building a new home into one loan product. This streamlines the process and reduces costs compared to using separate construction and permanent mortgages.
In this comprehensive guide, we’ll explain everything you need to know about using FHA financing to buy land and build a home.
What is an FHA Construction Loan?
An FHA construction loan is a mortgage insured by the Federal Housing Administration that lets you finance both the purchase of land and the building of a new home in a single loan
There are two main types of FHA construction loans
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FHA Construction-to-Permanent Loan: This option lets you buy land, pay for construction costs, and receive permanent mortgage financing all with one loan. There’s only a single closing, which saves time and money.
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FHA 203(k) Loan: The 203(k) program allows you to buy and renovate an existing home or build on a property you already own. Renovation costs are rolled into the total mortgage amount.
In both cases, FHA construction loans make building a custom home more feasible for buyers who may not qualify for conventional construction loans that require higher credit scores and down payments.
How Does an FHA Construction Loan Work?
FHA construction loans function differently than regular mortgages. Here’s an overview of the process:
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Get Prequalified: Work with an FHA lender to get prequalified and understand your pricing and loan amount options.
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Purchase Land: Use the loan to buy a suitable lot for building on. The land purchase can occur before, during, or after you apply for financing.
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Finalize Blueprints: Work with an architect and builder to design blueprints and choose finishing details for the home.
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Obtain Permits: Your contractor will pull necessary building permits before construction starts.
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Close on Mortgage: After permits are secured, you’ll close on the construction loan and money will be set aside in an account.
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Draw Loan Funds: As certain stages of construction are completed, the builder requests draws from the loan proceeds to pay for labor and materials.
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Construction Completes: Once the home is finished, the mortgage converts to a permanent loan and you begin making regular principal and interest payments.
FHA Construction Loan Requirements
FHA construction loans have eligibility standards for borrowers, properties, and builders. Meeting these requirements is key for approval:
Borrower Requirements:
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Credit Score of 500+
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Debt-to-Income Ratio Below 43%
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3.5% Down Payment if Credit Score is 580+
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10% Down Payment if Credit Score is 500 to 579
Property Requirements
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Appraisal confirming home plans meet FHA minimum property standards
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Land cannot be in zone prone to natural disasters
Builder Requirements
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Licensed and insured contractor
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Experience with FHA projects
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Willingness to provide regular draw requests and updates
Pros and Cons of FHA Construction Loans
FHA construction loans offer unique benefits but also have some drawbacks to consider:
Pros
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One loan for land purchase + construction
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Lower credit scores accepted
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Smaller down payments than conventional loans
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Interest-only payments during building phase
Cons
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Required mortgage insurance premiums
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More oversight and rules than other loans
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Limited to FHA loan limits in your county
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Loan amount based on future home value, not land cost
Alternative Construction Loan Options
If an FHA construction loan doesn’t meet your needs, here are a few other possibilities to explore:
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Conventional Construction Loans: Offered by banks and builders, these require higher credit and down payments but have fewer rules.
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VA Loans: Eligible veterans can get 100% financing and low rates with a VA construction loan.
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USDA Loans: Very low-income borrowers in rural areas may qualify for this 100% financing program.
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Renovation Mortgages: Fannie Mae and Freddie Mac offer renovation loans that allow more flexibility than FHA.
Finding the Best FHA Construction Loan Lender
Choosing the right lender is key to getting approved for an FHA construction loan and receiving excellent service. Here are tips for picking a lender:
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Compare interest rates and fees from multiple FHA-approved lenders
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Ask about their experience with construction lending and 203(k) loans specifically
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Inquire about servicing during the building phase
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Read online reviews to learn about others’ experiences
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Prioritize excellent communication and responsive loan officers
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Consider small local lenders in addition to national lenders
The Bottom Line
Building a custom home is an exciting adventure. FHA construction loans make the process more feasible by letting you buy land and finance construction with a single loan product.
While FHA construction loans have stricter requirements than conventional mortgages, they offer the benefit of lower down payments and easier qualifying for borrowers. If you’re interested in building your dream home, connect with reputable FHA lenders to learn more about construction loan options.
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How does a construction loan work? Construction loans aren’t like regular mortgages. They typically last for one year, during which time the lender releases payments, usually directly to your contractor. The lender enlists an inspector to evaluate the project at various stages, and releases more funds once everything checks out. Once construction is finished, the loan either converts to a traditional mortgage or the borrower obtains a mortgage to pay it off.
- FHA construction-to-permanent loan: An FHA construction-to-permanent loan finances the ground-up construction of a home — including the purchase of the land or lot — then converts to a regular FHA mortgage. This is also known as a one-time or single-close loan; you won’t have to pay closing costs for two separate loans.
- FHA 203(k) rehab loan: An FHA 203(k) loan finances the cost of buying an existing home plus renovations and repairs. There are two types of 203(k) loans: a standard 203(k) for renovations costing $35,000 or more; and a limited 203(k) for smaller-scale, less expensive projects. Either option allows you to obtain one loan to buy and fix up a home, instead of two loans.
FHA One Time Close Construction Loan Explained 2024
FAQ
Will an FHA loan cover land?
What is the downside of an FHA loan?
Can an FHA loan be used to build a house?
What credit score do you need for a FHA construction loan?