FHA Construction Loans: Process & Requirements
What You Should Know
- FHA construction loans allow you to build with a minimum 3.5% down payment.
- The loan amount must be below regional FHA limitations.
- An FHA construction to permanent loan is designed for building a new home.
- An FHA 203(k) loan is designed for renovating an existing home.
An FHA construction loan is a mortgage that allows you to finance the cost of your home's construction. An FHA loan has easier lending requirements than typical construction loans. For example, you can build a house with a credit score as low as 500 to 580. Your minimum down payment can also range from 3.5% to 10%.
As a result, the FHA construction loan allows many to afford the cost of building a house. However, there are some downsides to the loan. This article will compare the different types, requirements, and where to get a loan. Continue reading to learn everything you need to know about FHA construction loans.
Types of FHA Construction Loans
FHA loans are government loans backed by the Federal Housing Administration. They are designed to provide an affordable path to homeownership. FHA construction loans allow you to roll the costs of building or renovating a home into an FHA loan. However, all FHA loans have mortgage insurance premiums (MIPs).
|FHA Construction to Permanent||FHA 203(K) Loan|
|Minimum Down Payment||3.5%||3.5%|
|Purpose||Build a new home from the ground up||Renovate an existing home|
Both FHA construction loans require you to apply using an FHA-approved lender. The qualified lender list can be found on the Department of Housing and Urban Development (HUD) website. Additionally, regional FHA limits dictate the maximum loan size you can receive. After pre-qualifying with a lender, you must choose a contractor. The lender will review the contractor's plans before the final approval.
Option One: FHA Construction to Permanent Loan (C2P)
The FHA construction to permanent loan (C2P) allows you to finance the cost of your home's construction and, once complete, convert it to a permanent mortgage with just one closing. If you already own a parcel of land, you can refinance your land loan into an FHA C2P loan. You can also consider FHA Streamline Refinance that may save you some money in closing costs. The primary benefit of a C2P loan is avoiding two sets of closing costs and not worrying about qualifying for loans again.
As with any construction loan, your lender must approve your contractor's plan before funding begins. Once approved, your lender will provide a draw schedule. This provides your contractor with more money every time they accomplish a milestone.
Most lenders only require you to make interest payments. However, with each draw, your payments will increase. After the construction has ended and you have received a certificate of occupancy, your loan balance will convert to a permanent mortgage. At this point, your payments will amortize over a 15 or 30-year term as with a regular conventional loan.
This type of loan is perfect for those who want to avoid the hassle of two separate loans and two closing costs. You can begin this process by talking with an FHA-approved C2P lender.
Tip: Choosing the Right FHA Construction Loan
If you plan to build a new house from scratch, the C2P loan is probably the better option. If you plan to renovate an existing home, the 203(k) loan may be the better choice. If you are unsure which loan is right for you, speak to a HUD-approved housing counselor. They will help you understand the qualification requirements and process for each loan.
Option Two: FHA 203(k) Loan
The FHA 203(k) loan is perfect for those who want to purchase a fixer-upper or renovate their current home. As with the C2P loan, you will work with your lender to choose a contractor. You will also need to work with a HUD-approved 203(k) consultant.
The difference between the two loans is that the 203(k) loan is for existing homes that need repairs. For example, you could use this loan to buy a home that is in foreclosure. In contrast, a C2P loan is to construct a new home from the ground up.
The 203(k) loan has two sub-options:
- Standard: This option is for homes that need significant repairs. You must complete over $5,000 worth of renovations. However, the mortgage must remain within FHA limits.
- Limited: The Limited is for less expensive renovations with a maximum loan of $35,000.
The loan process for the Standard and Limited 203(k) loans is the same. However, there are different rules for each option. For example, with the Standard option, you can make structural changes to the home. With the Limited option, you can only make cosmetic changes.
You can begin this process by speaking with a HUD-approved 203(k) consultant.
FHA Construction Loan Requirements
There are three broad categories of requirements to receive an FHA construction loan. The conditions apply to both loan options. The three requirement categories include financial, property, and construction.
a) Financial Requirements
There are two subsets of financial requirements depending on your credit score. You must compensate with a higher down payment if you have a lower credit score. Regardless of your credit score, the loan can't exceed regional FHA loan limits. Additionally, if the project isn't HUD-approved, you will need a 10% minimum down payment.
|Minimum 500 Credit Score||Minimum 580 Credit Score|
You must also have a steady income and employment history. If you're self-employed, you must have been so for at least two years. You will also need to provide bank statements and tax returns as proof of income.
b) Property Requirements
First, If you are building a home from the ground up, there are specific land requirements. The FHA won't provide you with a C2P loan if your property is close to:
- An airport
- A gas or oil well
- An area prone to flooding
However, for both types of loans, your property must meet the following criteria
- The home must be your primary residence
- It must be a single-family, condominium, or manufactured home
- The house can't be a rental investment property
c) Construction Requirements
For both types of FHA construction loans, an appraisal is required.
Before you receive financing, you must submit the construction plan to your lender. This includes architectural plans and a cost estimate from a licensed general contractor. The FHA will then approve the project and release the funds you need during construction. If you are a licensed contractor you will not be able to pay yourself for work you do. Many lenders also require you to hire a contractor who is not a family member.
It is important to note that FHA loans require that the property meet all local building codes and zoning requirements. The home must also be secure, safe, and structurally sound. There is also a list of eligible and ineligible costs that are covered by the construction loan.
|Eligible||Ineligible||Luxury item installation (dependant on lender) such as:|
FHA Construction Loan Lenders
Not all lenders offer FHA construction loans. You will need to shop for a lender that provides this loan. Be sure to compare rates, terms, and conditions before you commit to a loan. Below you can find a list of selected lenders who offer FHA construction loans.
The most popular program BuildBuyRefi offers is their FHA one-time close loan. This program is available in all 50 states and only requires a 3.5% down payment. However, to qualify, you must have a minimum credit score of 620.
Academy Mortgage Corporation offers FHA 203(K) loans in select states. Eligible renovation examples include kitchen and bath updates, painting, landscaping, plumbing and more.
Homebridge FHA 203(k) loans are available in certain states. The program is only available to primary residences. Keep in mind, 203(k) loans are for renovating an existing home and not constructing a new one. Homebridge does not offer a construction to permanent FHA loan.
FHA Construction Loan Process
Now that you understand the requirements to get an FHA construction loan, you can begin the process. Two different starting points are depending if you want to build a home from the ground up (C2P) or renovate an existing home (203(k)).
Build a New Home: Construction to Permanent
If you want to build a new home on raw land, the process begins with finding an FHA-approved lender and submitting a loan application. The application will include proof of income, bank statements, tax returns, and employment history. You will also need to provide the lender with a detailed construction plan.
After the loan application is approved, the lender will issue a commitment letter. This letter outlines the loan terms and conditions. The next step is to finalize a licensed builder to construct the home. Once you have found a builder, they must follow the FHA's guidelines.
The builder will begin construction and submit periodic invoices to the lender. The lender will then release funds based on the work completed. The payments will go directly to your contractor. The construction loan typically lasts for 12 months with fees for extending. During this phase, you will only need to make interest-only payments. However, with each draw, the payment will increase.
Once you receive an occupancy certificate, the loan will convert to a permanent mortgage. During this phase, you will make interest and principal payments as you would with a regular mortgage. A construction to permanent loan benefit is the seamless transition from construction to a regular mortgage.
Renovate an Existing Home: FHA 203(k)
If you want to renovate an existing home, the first step is to find a HUD-approved lender. After you submit a loan application, the lender will order an appraisal. This appraisal will include the property's value and the cost of the proposed renovations.
Once the loan application is approved, the lender will issue a commitment letter. This letter outlines the loan terms and conditions. The next step is to find a licensed contractor to perform the renovations. Once you have found a contractor, they must follow the FHA's guidelines.
The contractor will begin renovations and submit periodic invoices to the lender. The lender will then release funds based on the work completed.
FHA Construction Loan Alternatives
If you don't meet the requirements for an FHA construction loan or if you would like to explore other financing options, there are a few alternatives.
Fannie Mae HomeStyle
The HomeStyle renovation mortgage is very similar to the FHA 203(k). Both programs allow you to finance the costs of renovations or repairs into your mortgage.
To qualify, you must have at least a 3% to 5% down payment. You may be eligible for a 3% down payment through the Fannie Mae HomeReady program. However HomeReady has an income limitation of 80% of your area’s median income. If you exceed this amount, you’ll need a minimum 5% down payment for the HomeStyle program.
HomeStyle also requires a minimum 620 credit score and to prove that you have the financial ability to make the monthly mortgage payments and cover the renovation costs.
Aside from the tougher qualification criteria, the primary difference is a HomeStyle loan can be used for secondary and investment properties. An FHA 203(k) can only be used for primary residences.
Conventional construction loan
A conventional construction loan is a short-term loan used to finance the building of a new home. These loans are typically interest-only during construction. Once the home is complete, it will not automatically convert to a traditional mortgage.
The most significant advantage of a conventional construction loan is that you can avoid paying private mortgage insurance (PMI). However, there are typically minimum 20% down payment requirements.
Conventional construction-to-permanent loan
A conventional C2P loan is the non-FHA equivalent. This also allows you to finance the construction of a new home and roll the construction cost into the mortgage. Similarly, these loans are interest-only during construction and convert to a traditional mortgage once the home is complete.
By selecting the conventional option, you won't need to pay private mortgage insurance (PMI). There will also be no maximum FHA limits. However, the conventional loan requires a 20% down payment.
Home equity loan
A home equity loan is a type of second mortgage. This loan allows you to borrow against the equity in your home to finance a renovation or the construction of a new home. The interest rate on a home equity loan is usually lower than the interest rate on a construction loan. However, you must have at least 20% home equity in your primary residence to qualify. You can also use a home equity line of credit (HELOC) with an interest-only period.
A cash-out refinance allows you to take equity out of your home to finance renovations or the construction of a new home. The mortgage payments are typically lower than other financing options since you're essentially combining two loans into one.
This is only available if you have significant equity in your primary residence. You'll also need to qualify for the new loan amount, which can be difficult if you're self-employed.
A personal loan is an unsecured loan that can be used to finance the construction of a new home. The interest rate on a personal loan is usually higher than the interest rate on a construction loan. Additionally, your loan amount will not be as large as a mortgage. This is why a personal loan is best reserved for a renovation.
You can finance home construction with a credit card, but it's not recommended. Credit cards typically have high-interest rates, which will increase the cost of your project. It's also difficult to borrow a large amount of money with a credit card.
If you're determined to use a credit card, make sure you have a plan to pay off the balance quickly. You can make more than the minimum payment each month or transfer the balance to a 0% APR credit card.
Frequently Asked Questions
The absolute maximum loan amount depends on your regional FHA loan limit. The 2022 limit ranges from $420,680 to $970,800. You can visit our FHA Loan Limits By County page to learn more.
The time it takes to get an FHA construction loan varies. It can take anywhere from 30 days to a few months.
FHA construction loans typically have stricter requirements, such as a higher credit score. They can be a good option if you don't qualify for a conventional construction loan.
FHA construction loans are designed for borrowers who want to build a new home. FHA 203(k) loans are for borrowers who want to renovate an existing home.