When building or renovating a home, the financing options and requirements can feel overwhelming. However, an FHA construction loan can simplify the process, combining both construction and mortgage financing into a single, convenient loan.
Whether you’re a first-time homebuyer dreaming of a custom-built home or a homeowner looking to revamp your space, an FHA construction loan could be your ideal solution. Its flexible credit and down payment requirements make building your perfect home more accessible than ever.
Two Types of FHA Construction Loans
There are two primary types of FHA construction loans — the FHA Construction-to-Permanent Loan and the FHA 203(k) Rehab Loan. Notably, the Construction-to-Permanent Loan is also called the FHA new construction loan, FHA building loan, or FHA one-time close construction loan.
Both loan options have unique advantages depending on your needs:
FHA Construction Loan Options
| Loan Type | Best For | Benefits |
|---|---|---|
| FHA Construction-to-Permanent Loan | New builds | Combines construction and mortgage into one, simplifies the process |
| FHA 203(k) Rehab Loan | Renovations of existing properties | Bundles renovation costs with a mortgage; great for older homes |
Each loan type serves a different purpose, but they both streamline the often complex construction financing process, making it accessible to a wider range of buyers and homeowners.
How FHA Construction Loans Work
Securing an FHA construction loan might seem complex, but breaking it down step by step makes the process more manageable and easier to understand.
Let’s dive into how it all works so you know what to expect.
Step 1: Pre-Approval
Before you start dreaming up blueprints, you need to get pre-approved for an FHA construction loan. This involves assessing your income, credit score, and financial history. Your FHA lender also checks your debt-to-income ratio (DTI) to determine your eligibility.
Step 2: Find a Licensed Contractor or Consultant
When using any type of FHA construction loan, you must use a licensed contractor. The FHA also allows borrowers to act as the builder on their own homes as long as they are licensed.
It’s advantageous to find a builder who has experience working with FHA loans, since they will need to follow strict guildelines to ensure that their work passes FHA minimum property standards. Your contractor also must provide you with a one year Builder’s Warranty to protect against default materials, equipment or workmanship supplied.
Step 3: Loan Underwriting
Once you select your builder and finalize your plans, the lender moves into the underwriting phase. This includes appraisals to estimate the home’s future value and a thorough review of your finances.
Step 4: Construction Phase
During construction, the lender releases funds in phases based on the work completed. The best part? With an FHA one-time close construction loan, you don’t have to re-qualify for a mortgage after construction finishes.
Step 5: Move-In & Loan Repayment
Once the construction is complete, your loan converts to a normal mortgage. You then start making regular monthly payments, just like any other home loan.
FHA Construction Loan Requirements
To qualify for an FHA loan, you’ll generally need a minimum credit score of 580, although some lenders may require a higher score to reduce risk. The down payment requirement is at least 3.5% of the total loan amount, which is more accessible than many conventional loans, and you can even use gift funds from family members to cover this cost.
FHA loans also require a mortgage insurance premium (MIP) that must be paid for the life of the loan unless you provide a 10% down payment at closing.
Additionally, since FHA loans are meant for primary residences, you must reside in the home for at least one year.
Additionally, once construction or renovation is complete, the property must undergo a final inspection to confirm its value and ensure it meets FHA standards.
FHA Construction-to-Permanent Loan Requirements
This loan type is designed specifically for new builds, combining construction and permanent financing into a single, streamlined package. For this, the builder must be licensed and provide a fixed-cost contract that outlines all construction details, ensuring the lender that the project is handled by a qualified and reliable professional. Additionally, you’ll need to provide detailed documentation, including construction plans, a timeline, and cost estimates. Lenders require this comprehensive breakdown to confirm the project’s viability and alignment with FHA guidelines.
FHA 203(k) Rehab Loan Requirements
There are two different types of FHA 203(k) loans – Standard 203(k) and Limited 203(k) – one for larger and one for smaller renovations. The Standard 203(k) loan is designed for existing properties needing major renovations while the Limited 203(k) is great for smaller renovations. This loan is a great option for those looking to buy or refinance a home and renovate it into their dream space.
To qualify for an FHA 203(k) loan, the property must be at least one year old.
For larger projects, an FHA-approved consultant oversees the renovation plan, ensuring that all work meets FHA standards and is completed on time. The consultant guides you through the complexities of a major renovation, assisting with budgeting, planning, and managing the construction timeline, which provides added peace of mind throughout the process.
How To Get an FHA Construction Loan
To get an FHA construction loan, you simply need to find an FHA-approved lender who offers them. Currently, Neighbor’s Bank does not offer FHA construction loan financing.
Finding a lender who offers FHA building loans can be challenging because of the inherent risks involved in construction, however, HUD offers a tool that can help you find a list of lenders near you.
FHA Construction Loan Alternatives
If you find it difficult to secure an FHA construction loan, here are some alternatives to help you achieve your home building or renovation goals:
- Conventional Construction Loans: These may have stricter credit and down payment requirements but offer similar benefits.
- USDA Construction Loans: Great for rural areas, these loans are zero-down but have location restrictions.
- VA Construction Loans: Available for eligible Veterans and service members, offering low or no down payments.
- Home Equity Loans: If you already own a home and have built up equity, a home equity loan could fund your construction project.
Remember, construction loans are riskier for lenders, so it’s essential to weigh your options carefully.
