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Important points
An FHA construction loan is a type of FHA loan that covers the costs of building a home, such as purchasing land or parcels, building materials, and labor costs.
There are two types of FHA construction loans: FHA construction-to-permanent loans and FHA 203(k) loans.
FHA construction loans can be rolled into FHA permanent mortgages.
If you’d rather build a home than buy one, an FHA construction loan may help pay for your project. Like regular FHA loans, this type of loan is insured by the Federal Housing Administration (FHA) and offered by FHA-certified mortgage lenders. Here’s how to get it:
What is an FHA construction loan?
FHA construction loans are a type of FHA loan used for the construction of residential buildings. They function similarly to traditional construction loans by providing short-term financing for a variety of construction costs, from architect fees to certificates of occupancy. Borrowers often convert these loans into long-term mortgages once the home is built.
However, unlike traditional construction loans, FHA construction loans are guaranteed by the FHA. This means you can qualify for a loan with a credit score as low as 580, as long as you have at least a 3.5% down payment.
How do construction loans work?
Construction loans are different from regular home loans. This period typically lasts one year, during which the lender typically makes payments directly to the contractor. Lenders hire inspectors to evaluate the project at various stages and release more funds once everything checks out. Once construction is complete, the loan is converted to a traditional mortgage or the borrower obtains and repays the mortgage.
FHA Construction Loan Types
- FHA construction-to-permanent loans: FHA construction-to-permanent loans finance the basic construction of a home, including the purchase of land and lots, and are then converted to a regular FHA mortgage. This is also known as a one-time loan or a one-time loan. You don’t have to pay closing costs for two separate loans.
- FHA 203(k) rehabilitation loan: FHA 203(k) loans provide financing for the purchase and completion of renovations and repairs to an existing home. There are two types of 203(k) loans. One standard 203(k) for renovations costing $35,000 or more (transitioning to $75,000 or more for FHA case numbers assigned after November 4, 2024), and one for minor It is a limited 203(k) for residential use. Large-scale, low-cost projects. Whichever option you choose, you get one loan to buy and repair your home instead of two.
FHA construction loan requirements
FHA construction loan eligibility requirements are similar to standard FHA loan eligibility requirements, with a few additions.
To qualify for an FHA loan, you must meet at least the following criteria:
- Credit score: At least 580, minimum 500 for at least 10% reduction
- Debt-to-income (DTI) ratio: 43% or less (with some exceptions)
- down payment: 3.5 percent if your credit score is 580 or higher, or at least 10 percent if your credit score is between 500 and 579
- Loan limit: Do not exceed the annual FHA loan limit. For 203(k) loans, do not exceed the lower of the FHA loan limit, the total value of your home plus the cost of improvements, or the value of your home after renovations (use FHA’s search tool). ) to find the limit in your area)
- Mortgage insurance: In most cases, upfront and annual FHA mortgage insurance premiums are paid over the life of the loan.
- Occupancy: primary residence only
In addition to these requirements, FHA construction loans require sufficient documentation detailing your construction or renovation project, including information about the contractors you plan to work with. For standard 203(k) loans, a 203(k) consultant is assigned to estimate the cost of renovations or repairs.
Whether you are obtaining construction through permanent financing or rehabilitation financing, the construction work will also be subject to inspection as the project progresses.
How to get an FHA construction loan
Although you can obtain an FHA construction loan from an FHA-approved lender, not all FHA lenders offer this type of loan. If you’re not sure where to start, search the U.S. Department of Housing and Urban Development’s list of lenders by state or county. If you’re looking for a 203(k) loan, you can also filter for 203(k) lenders.
From there, the process includes connecting with contractors and getting pre-approved for financing. Here’s an overview:
- Prepare your credit and finances. Interest rates on construction loans are often higher than interest rates on regular mortgages. You can get an FHA loan with a relatively low credit score and down payment, but a higher score and a higher down payment can mean lower interest rates and less mortgage insurance. If you’re planning on building a new home, you’ll want to stash some extra for inevitable budget issues during construction. Here we will explain in detail the costs involved in building a house.
- Partner with contractors and real estate agents. Whether you’re building a home or renovating an existing property, you’ll need to work with a contractor to understand costs, develop a plan, and submit the details to your lender for approval. If you have a standard 203(k) loan, you will work with a 203(k) consultant to estimate costs. From there, your real estate agent will help you find the right land, lot, or building contractor.
- Get pre-approved for a construction or renovation loan. You must meet FHA loan requirements and other criteria set forth by your lender. If you qualify, your lender will base your loan amount on the appraised value of your home after construction or renovations.
FHA Construction Loan Alternatives
FHA construction loans are just one type of construction loan. It can be useful for building or renovating a home, but it cannot be used for investment properties or vacation homes, and you will have to pay mortgage insurance premiums, which increases costs. Alternatives to consider are:
- Traditional construction loans: Traditional construction loans, which are more widely available than FHA construction loans, include construction-to-permanent and construction-only options. However, there are two drawbacks to be aware of. First, you’ll need to come up with a higher down payment than if you chose an FHA-backed loan. Second, the minimum credit score for non-FHA-backed construction loan financing is typically higher. That said, unlike most borrowers with FHA loans, you don’t have to pay mortgage insurance for the entire term of your loan.
- Renovation loan: As an alternative to a 203(k) loan, you may also consider a traditional HomeStyle renovation loan, which finances up to 75 percent of your home’s renovated value.
- VA or USDA construction loans: If you are a military member, veteran, or have a low income and want to build a home in a qualifying rural area, consider a VA or USDA loan, respectively. These require no down payment or mortgage insurance and can have flexible credit criteria. However, you will have to pay a one-time funding fee for VA loans and a guarantee fee for USDA loans.
- Home equity options: If you want to improve your home or another property you own, chances are you have enough equity in your current home to make that happen. Depending on your needs and goals, options include a home equity loan (second mortgage) or a home equity line of credit known as a HELOC.
- Refinance and withdraw cash: If interest rates have dropped since you took out your mortgage, you may be able to refinance into a new, larger loan at a lower interest rate to cash out some of your equity and pay for renovations. Generally, this option is best for homeowners who have low interest rates, plenty of capital, and are planning major renovations.
