FHA New Construction Loan Requirements: A Guide to Building Your Dream Home

Buying a newly constructed home can be an exciting experience. Working with a builder gives you the flexibility to customize the layout, choose your finishes, and end up with a brand new house built just the way you want it. But coming up with the down payment for a new build can be tough. An FHA new construction loan offers more lenient underwriting so you may still be able to finance that custom home even if your credit isn’t perfect.

In this guide, I’ll walk through fha new construction loan requirements so you know what it takes to qualify. I’ll also outline the process for getting one of these unique mortgages.

Overview of FHA New Construction Loans

FHA new construction loans help make owning a new home possible when you can’t afford a giant down payment. These government-backed mortgages are insured by the Federal Housing Administration (FHA).

You can use FHA financing in a couple different new construction scenarios:

• Construction-to-permanent loan: This combines a construction loan with a permanent FHA mortgage in one loan. It works for building a home from the ground up on land you purchase.

• 203(k) renovation mortgage: The FHA 203(k) loan lets you buy and renovate an existing home that needs work. You can do major renovations or more minor updates.

In both cases, FHA new construction lending offers perks like low down payments and flexible credit requirements. Keep reading to learn more about qualifying for one of these unique loans.

FHA New Construction Loan Requirements

While FHA loans offer more lenient qualification guidelines than conventional mortgages, you still need to meet certain requirements to get approved Here are the key eligibility criteria for FHA new construction loans

Credit Score

Most mortgage lenders require a minimum credit score of 620 for approval. But with an FHA loan you can get financing with a score as low as 500. Here’s how the FHA credit score guidelines break down

• 500 to 579: 10% minimum down payment
• 580 and above: 3.5% minimum down payment

The lower your score, the larger down payment you’ll need to qualify. If your credit is damaged, taking time to improve your score before applying can help you keep down payment costs down.

Debt-to-Income Ratio

Your debt-to-income (DTI) ratio measures your total monthly debt payments against your gross monthly income. It gives lenders an idea of how much wiggle room you have in your budget to take on a new mortgage payment.

FHA requirements say your DTI ratio should be less than 43%. But in some cases, you may qualify with a ratio up to 50% if you have strong compensating factors like a hefty down payment or ample cash reserves.

Down Payment

The FHA minimum down payment is just 3.5% if you have a credit score of 580 or higher. With a lower 500 to 579 score, your required down payment jumps to 10%.

Either way, you get more affordable options than a conventional loan that requires 20% down. And you can use gifts from family members or down payment assistance programs to cover the down payment if needed.

Loan Limits

The FHA sets limits on the maximum loan amount you can borrow based on average home prices in your county. For a single family home in 2023, the standard limit is $502,000. But for pricier areas, it goes up to $1,089,300.

Your lender will ensure the loan amount you’re approved for doesn’t exceed the limit for where you’re buying.

Cash Reserves

Lenders want to see you have adequate savings set aside after closing on the mortgage. While cash reserve requirements vary by lender, typically you need enough savings to cover two monthly mortgage payments.

Construction-to-Permanent Loan Process

If you want to build a home from the ground up, an FHA construction-to-permanent loan simplifies the process. Here are the usual steps to get one of these mortgages:

1. Get pre-approved

You’ll need to apply and get a pre-approval letter from a lender before you do anything else. Pre-approval shows sellers and builders you’re a serious buyer.

2. Find land to purchase

Use your pre-approval letter as you shop for land to build on. Location near flood zones or other hazards may disqualify some lots.

3. Choose a contractor

Your lender will want to see your contractor has the right licensing, bonding, and insurance before approving the loan.

4. Get the property appraised

The lender will order an appraisal to ensure the property meets FHA minimum standards and that the value is there to support the loan amount.

5. Close on the construction loan

At closing, you’ll finalize the loan documents and the lender will place the funds in an escrow account to make payments during each phase of construction.

6. Pay the builder as work is completed

The builder submits draw requests to the lender as they hit milestones outlined in the construction contract. The lender releases funds from escrow to pay the builder for completion of each stage.

7. Convert to a permanent loan

Once construction is wrapped up, the lender automatically converts the construction loan into a permanent FHA mortgage.

203(k) Renovation Loan Process

If your plans involve remodeling or renovating an existing property rather than building new, the 203(k) program can help. Here are the usual steps to getting an FHA 203(k) renovation mortgage:

1. Find a property and make an offer

Start the process by finding a home you want to purchase that needs updates. Make an offer, negotiate terms, and enter into a purchase agreement with the seller.

2. Get pre-approved

Work with a lender that offers the 203(k) program to get pre-approved. They’ll look at your income, assets, debts, and credit to determine potential loan parameters.

3. Hire a 203(k) consultant

This FHA-approved consultant will inspect the property and draw up a detailed renovation proposal including timelines and costs for all improvements.

4. Review loan terms

The lender will determine the mortgage terms including loan amount and interest rate based on the purchase price plus estimated renovation costs.

5. Close on the loan

At closing, you’ll provide the down payment and sign the final loan documentation. The lender puts renovation funds into an escrow account.

6. Complete repairs and renovations

Once you close, contractors can start work. The consultant inspects the work and requests draws from the escrow account to pay contractors.

7. Make mortgage payments

After all work is done, you’ll begin making principal and interest payments on your FHA mortgage.

Alternatives to an FHA New Construction Loan

FHA loans come with some limitations, like required mortgage insurance you have to pay. If you want to avoid this added cost, some alternative new construction loan options include:

• Conventional construction loan – Your local bank may offer a construction loan that you later pay off with a conventional mortgage. These typically require a higher credit score and down payment than an FHA loan.

• VA construction loan – Veterans and active duty military may qualify for a VA construction loan with 100% financing and no down payment required.

• USDA construction loan – For building in rural areas, USDA construction loans offer 100% financing to income-eligible borrowers.

• Renovation mortgage – Conventional renovation loans like the Fannie Mae HomeStyle program compete with the FHA 203(k) loan with benefits like lower mortgage insurance.

Shop around and compare mortgage rates and terms to choose the most affordable option that aligns with your new construction plans.

FAQs About FHA New Construction Loans

If you’re considering an FHA new construction loan, you probably still have plenty of questions about the details. Here are answers to some of the most frequently asked questions:

How soon can construction start?

For new construction, lenders usually require having a building permit in place before releasing funds to start construction. Some also require seeing completed foundations before disbursing additional funds.

How long do I have to complete construction?

The timeline will be laid out in your construction contract, but typically FHA allows 6-12 months to finish new builds. For renovations, the 203(k) program gives you 6 months.

What happens if construction goes over budget?

Cost overruns are fairly common in construction projects. You’ll either need to pay the difference out-of-pocket or apply for a loan modification if costs exceed your loan amount.

Can I act as my own general contractor?

Yes, you’re allowed to act as your own general contractor in an FHA new construction loan. This gives you flexibility but also means taking on risk if the project goes off track.

How much down payment do I need for new construction?

On an FHA loan,