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What is an FHA Construction Loan?
FHA construction loans are a type of FHA loans used to build homes. It functions like a traditional construction loan by providing short-term funding for construction costs, such as land, building materials, and labor. In many cases, borrowers convert these loans into long-term mortgages when the home is built.
However, unlike traditional construction loans, FHA construction loans are insured by the Federal Housing Administration (FHA). This means that if you have a credit score of at least 580, you can pay a down payment of just 3.5%.
How do construction loans work?
Construction loans are different from regular mortgages. They usually have a period of just one year. Meanwhile, lenders regularly inspect their property and release payments (usually directly to the contractor) once the milestone is met. Once construction is finished, the loan will be converted to a traditional mortgage or the borrower will get a mortgage to pay it off.
FHA Construction Loan Requirements
Eligibility requirements for FHA construction loans are similar to those for standard FHA loans, but there are several additions.
To qualify for an FHA loan, you must meet the following criteria:
- Credit score: Lower than 500 when placed at least 580, or at least 10%
- Debt Income (DTI) Ratio: With a few exceptions, it’s not over 43%
- down payment: 3.5% for a credit score of at least 580, or at least 10% for a credit score between 500 and 579
- Loan limit: It’s just the FHA loan limit for that year. For a 203(k) loan, it is just the FHA loan limit, the value after renovation of the home plus the cost of improvement, or the value after renovation of the home, whichever is less. You can use FHA’s lookup tools to search for restrictions in your area.
- Mortgage insurance: In most cases, annual and annual FHA mortgage insurance fees paid for the lifespan of the loan
- Occupation: Main residence only
In addition to these requirements, FHA construction loans require documentation regarding the construction or renovation project and the contractors to be used. For standard 203(k) loans, a 203(k) consultant will be assigned to estimate the cost of remodeling or repairs.
Whether you are getting a comprehensive loan from construction or a rehabilitation loan, the work will be subject to inspection as the project progresses.
Types of FHA Construction Loans
- Permanent loans from FHA construction: A permanent loan from the construction of an FHA will fund the construction of a zero home, including the purchase of land and lots, and then convert it into a regular FHA mortgage. This is also known as a one-off or single-claus loan. There is no need to pay closing costs for two separate loans.
- FHA 203(k) Rehabilitation Loan: The FHA 203(k) loan lends you to the cost of purchasing an existing home and completing renovations and repairs. There are two types of 203(k) loans. A standard 203(k) for renovations over $75,000 and a limited 203(k) for small and inexpensive projects. With either option, you can get one loan instead of two to buy and rehabilitate your home.
How to get an FHA construction loan
You can get an FHA construction loan from an FHA approved lender, but not all FHA lenders offer this type of funding. If you’re unsure where to start, search the U.S. Housing and Urban Development Office’s list of lenders by state or county. 203(k) lenders can also be filtered.
From there, the process involves connecting with the contractor and being approved in advance for funding. The overview is as follows:
- Prepare your credits and finances. Construction loan interest rates are often higher than regular mortgage interest rates. While you can get an FHA loan with a relatively low credit score and down payment, a better score and a higher down payment will help you get a lower fee and reduce your mortgage insurance payments. If you are planning on building a brand new home, you will need to save extra cash due to the inevitable budget overruns that come up during construction. Details on the cost of building a house.
- Partners with contractors and real estate agents. Real estate agents will help you find the right plot, lot, or fixer upper for your land. Also, whether you are planning to build a home or renovate an existing property, you will need to work with your contractor to estimate costs and plan. Your lender wants these to approve your loan. If you have received a 203(k) loan, we will also work with a 203(k) consultant.
- It will be approved in advance for construction or rehabilitation loans. You must meet the requirements for an FHA loan and other criteria set out by the lender. If you are eligible, your lender will base your loan amount on the assessment of your home’s post-construction or rebuilding.
How to Choose a FHA Construction Loan Lender
Many types of mortgage lenders offer FHA loans, but not all offer FHA construction loans. Find FHA-approved lenders in your area on the HUD website or start with a guide to the best FHA mortgage lenders and the best FHA 203(k) rehabilitation mortgage lenders.
Once you’ve found a few lenders you like, research other lenders, such as reading reviews and scheduling chats with lenders. You need to make sure that lenders provide competitive rates and low rates and that the assigned personnel are responsive and helpful. If possible, try hiring three lenders to help you choose the best deal.
FHA Construction Loan Replacement
FHA construction loans are just one type of construction funding. It is useful for building or renovating a home, but cannot be used for investment properties or villas. You will also need to pay a mortgage premium that adds costs. The alternatives to consider are:
- Traditional construction loans: Traditional construction loans, which are widely available than FHA construction loans, include construction to comprehensive construction only options. However, there are two drawbacks. First, you need to devise a higher down payment than if you chose a FHA-backed loan. Second, the minimum credit score for construction loan financing, not backed by the FHA, is usually higher. That said, unlike most borrowers who have FHA loans, they don’t need to pay mortgage insurance for the entire loan term.
- Renovation loan: Instead of a 203(k) loan, you can look into traditional home style renovation loans.
- VA or USDA Construction Loan: If you are a service member or veteran, or if you have a low income and want to build a home in a qualified rural area, consider a VA or USDA loan, respectively. These do not require a down payment or mortgage insurance and can have flexible credit standards. However, you will need to pay a one-time funding fee for your VA loan and you will need to pay a guaranteed fee for your USDA loan.
- Home Equity Options: If you want to improve on your home or another property you own, and if you want to build some shares, consider a home equity loan or home equity credit line known as HELOC.
- Refinance and cash out: If interest rates drop after getting a mortgage, you may be able to refinance into a new, larger loan at a lower interest rate, and you may be able to cash out some of your shares to pay for the renovation. This option is perfect for homeowners who can get a lower fee, have more room, and plan to do extensive modifications.
