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An FHA new construction loan allows you to finance building a new home from the ground up. With this government-backed mortgage, you can purchase land, pay for construction costs, and lock in permanent financing with one loan and one closing.
FHA new construction loans open homeownership possibilities if you don’t have the savings or income to qualify for a conventional construction loan. You can get approved with a credit score as low as 500 and with as little as 3.5% down.
In this comprehensive guide, I’ll explain how FHA new construction loans work, eligibility requirements, pros and cons, and alternatives to consider
What is an FHA New Construction Loan?
An FHA new construction loan combines features of a short-term construction loan with a long-term fixed rate mortgage in one. There’s no need to take out one loan to finance the building phase then replace it with permanent financing when construction is done.
With a new construction FHA loan, you’ll go through one closing and the loan will automatically convert to a permanent mortgage after the home is built.
There are two types of FHA new construction loans:
FHA Construction-to-Permanent – Finances building a home from the ground up on land you already own or purchase.
FHA 203(k) Rehab Loan – Allows you to buy and renovate an existing home that needs repairs or upgrades.
The FHA insures these loans, so lenders can offer more flexible qualifying criteria compared to conventional construction loans. Borrowers have the chance to realize the dream of building their own home, even with less-than-perfect credit or limited savings.
How Does an FHA New Construction Loan Work?
FHA new construction loans follow a six-step process from start to finish:
1. Get Prequalified
Meet with a lender to determine the loan amount and terms you qualify for based on a preliminary review of your finances.
2. Purchase Land
Use FHA loan proceeds to buy land if you don’t already own a suitable lot.
3. Hire a Licensed Contractor
Work with an FHA-approved home builder to create construction plans.
4. Get an Appraisal
The lender will order an appraisal to ensure the property meets FHA minimum standards once built.
5. Close on the Construction Loan
Finalize loan documents and close on the mortgage. Funds will be held in escrow.
6. Draw Funds as Work is Completed
The builder will be paid draws from the loan as phases of construction are finished.
Once the home passes final inspection, the loan converts to a permanent mortgage you’ll repay just like any other home loan.
FHA New Construction Loan Requirements
While FHA new construction loans are more flexible than conventional mortgages, you still need to meet eligibility standards. Here are the key requirements:
Credit Score – Minimum 500 credit score required. With scores of 580 and above, a 3.5% down payment is allowed. With scores between 500 and 579, 10% down is required.
Debt-to-Income Ratio – Your total monthly debt payments, including the future mortgage payment, must be 43% or less of your gross monthly income. Sometimes a ratio up to 50% is allowed.
Down Payment – At least 3.5% down required for borrowers with credit scores of 580 and above. A 10% down payment is required for borrowers with credit scores between 500 and 579. Down payment funds must be your own; gifts are not allowed.
Loan Limits – The loan amount cannot exceed FHA mortgage limits for your county. Base limits range from $294,515 for low cost areas up to $970,800 for very high costs areas in 2023.
Contractor Requirements – Builders must be licensed and approved to work with FHA financing.
Pros and Cons of FHA New Construction Loans
I want to summarize the key advantages and potential drawbacks of using an FHA new construction loan:
Pros
- Only 3.5% down payment required for borrowers with 580+ credit scores
- One loan/closing streamlines the construction process
- May qualify with credit scores as low as 500
- Interest rates are competitive with conventional mortgages
Cons
- Monthly mortgage insurance premiums required
- More requirements than conventional construction loans
- Limited to FHA loan limits in your county
- Requires using an FHA approved contractor
While FHA new construction loans offer more flexibility, it’s important to also consider the tradeoffs versus alternative financing options.
Alternatives to an FHA New Construction Loan
Here are a few other home construction loan programs to consider:
Conventional Construction Loans – Offered by banks and builders, these loans require more cash down, stronger credit, and two separate closings – one for construction financing and one for permanent financing.
VA Construction Loans – Offer qualified military buyers the chance to build a new home with 100% financing and no monthly mortgage insurance.
USDA Construction Loans – Provide 100% financing to build in designated rural areas. Applicants must meet income limits.
State/Local Down Payment Assistance – Check if your state or local housing authority offers help with down payments on newly built homes.
HomeStyle Renovation – Fannie Mae program works like an FHA 203(k) loan but may require less down payment.
Compare costs, terms, eligibility, and pros/cons to choose the best loan for your specific home construction project.
Finding the Best FHA New Construction Loan Lender
Since not all lenders offer FHA new construction loans, finding one who does is an important first step. Here are some tips for choosing the right lender:
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Search HUD’s website – HUD lists FHA approved lenders by state who can potentially finance new construction.
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Ask loan officers about experience – Choose a lender who is very familiar with FHA new construction loans, guidelines, and the building process.
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Compare interest rates and fees – Shop around with several lenders to find the best pricing and avoid excessive lender fees.
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Look for strong customer service – You’ll work closely with the lender during the construction phase, so responsive service is vital.
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Check third-party reviews – Feedback on sites like LendingTree can help identify lenders known for great service and smooth loan processing.
Take the time upfront to select an experienced FHA construction lender. It can make financing your dream home build go much smoother.
What are Current FHA New Construction Loan Rates?
FHA new construction loans typically have similar interest rates to other FHA mortgage products. Rates are competitive with conventional loans.
Here are current sample FHA new construction mortgage rates:
- 30-Year Fixed Rate: 6.25% – 7.00%
- 15-Year Fixed Rate: 5.75% – 6.25%
- 5/1 Adjustable Rate: 5.00% – 5.75%
Actual rates and terms you qualify for will depend on your credit score, down payment, debt-to-income ratio, and other eligibility factors.
Get rate quotes from multiple lenders to find the best FHA new construction loan rate for your situation. Consider a mortgage rate lock to protect yourself from rising rates during the home building process.
How Much Cash Do You Need to Close an FHA Construction Loan?
Your cash required at closing includes:
Down payment – Minimum 3.5% of purchase price if your credit score is 580+ or 10% down with a credit score between 500 and 579.
Upfront Mortgage Insurance – 1.75% of loan amount. Added to loan balance.
Closing Costs – Estimate 2% to 5% of loan amount. Includes lender fees, escrow deposits, and other costs.
Land Payoff – If financing land purchase through the construction loan.
Interest Reserve – Funds to make monthly interest-only payments during build.
Contingency Reserves – 10% to 20% of construction costs recommended to cover any unexpected overages.
Work with your lender to calculate total cash needed so you can prepare in advance for the closing on an FHA new construction loan.
Steps to Getting Approved for an FHA New Construction Loan
Follow these key steps when applying for an FHA new construction loan:
1. Check your credit score and reports – Make sure your credit score meets minimum requirements for FHA financing. Review reports and correct any errors.
2. Calculate your total monthly debt – Mortgage lenders will review your entire monthly debt load when approving a loan. Tally up credit cards, auto, student loans, and other monthly debts.
3. Gather income documentation – Pay stubs, W-2s, tax returns, and bank statements to verify your stable income.
4. Save for your down payment – 3.5% of the purchase price is needed if your credit score is 580+ or 10% down payment for
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.
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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.
FHA One Time Close Construction Loan Explained 2024
FAQ
Can an FHA loan be used to build a house?
What credit score do you need for a FHA construction loan?
When a buyer finances a newly built home with an FHA loan, what does the FHA require the builder to do?
When building a new home when do you start paying mortgage?