FHA Construction Loan Guide

The FHA construction loan program is in high demand as more and more consumers see the value in building a home with government insured construction financing. Many people dream of having a home altered to suit their needs and wants. But constructing the home of your dreams isn’t a piece of cake. To make this dream a reality, you have to make many decisions and one of the most important ones is getting the correct loan.

Depending on the project, you might also need to consult with a loan advisor to ensure your construction project complies with FHA construction loan guidelines. A construction loan backed by the Federal Housing Administration differs from a traditional mortgage in that it is used to fund the building or renovation of a home, whereas a traditional mortgage is used solely to purchase an existing home.

What Is an FHA Construction Loan?

FHA construction loans are there to help you build your dream home or alter an existing home to your needs, but like every other good thing, it has some eligibility criteria that need to be met to avail of this loan.

If you’re considering getting a FHA construction loan, here’s a detailed guide to its eligibility criteria, requirements, and guidelines. Does FHA offer a construction to permanent mortgage loan?

Among many government financing options, FHA renovation loans stand out as the only option for people who are looking to build a new home or make substantial renovations to their existing homes.

This home construction financings are specifically designed for borrowers who want financial support to build their homes and need support throughout the construction process with financing and long-term mortgage benefits. Let us take a look at FHA Construction Loans!

Why Choose FHA Construction Loans?

The traditional loans usually facilitate the purchase of existing homes, whereas the FHA construction loans are specifically for new construction, major renovations, or rehabilitation projects. These loans aim to fund both the construction phase and mortgage payments once the project is completed.

The Federal Housing Association (FHA) operates under the U.S. Department of Housing and Urban Development (HUD). FHA loans are famous for their lenient qualification criteria, such as lower down payment requirements and flexible credit scores, which make them accessible to a broader range of borrowers compared to conventional loans.

Some of the major differences that set FHA loans apart from conventional loans are:

One-Time Close Structure is a distinctive feature of FHA construction loans where the borrower only goes through one closing process. This loan finances the construction phase and then automatically converts into a traditional FHA mortgage once construction is complete. To know more about it, watch this video, FHA One-Time Close Construction Loans. The next best thing to sliced bread!

FHA loan limits vary county-wise, which may influence the total amount you can borrow under this program. While FHA loans typically require a lower down payment i.e. approximately 3.5% of the total loan amount, construction loans have additional requirements of contingency funds, to ensure the completion of the project.

FHA construction financing are flexible in credit score requirements, hence they are more accessible to borrowers with lower credit scores. The house should be built by FHA-approved builders because compliance with FHA standards and regulations is mandatory and these builders are aware of the changes in FHA construction.

During the construction process, the FHA provides oversight to ensure that the project meets specific quality and safety standards. This oversight helps protect both the borrower and the lender, ensuring that the home being constructed or renovated is a sound investment.

Types of FHA Construction Loans

FHA offers two separate loans i.e. FHA 203(k) loans and FHA construction loans, both of which serve different purposes. To learn more about these loans, read the comparison below:

FHA 203(k) Loan:
FHA 203(k) loans are designed for purchasing a home that needs renovations or repairs. It allows borrowers to finance both the purchase of the home and the cost of repairs or renovations into a single loan.

There are two types of FHA 203(k) loans. A standard 203(k) loan is used for more extensive renovations that exceed $35,000, including structural repairs and major remodeling.

Whereas a limited 203(k) loan is used for minor repairs and upgrades that do not exceed $35,000.

FHA Construction Loan:

FHA construction loans are specifically for new construction or substantial rehabilitation of an existing property. They finance the construction phase and automatically convert it into a permanent FHA mortgage once construction is complete.

This is a one-time close (OTC) process where there is only one application and one closing for both the construction loan and the permanent mortgage. An additional requirement for this loan is that an FHA-approved builder or contractor should be hired who meets FHA construction standards. Also consider other new home construction loans from private money and portfolio lenders.

What is a FHA construction to permanent loan?

The FHA construction-to-permanent loan allows you to build a home from the ground up.

It can be used to purchase land, finance construction costs, and cover lender fees.

The FHA construction to permanent loan merges the features of a short-term construction loan with those of a standard, long-term FHA loan.

An FHA construction to permanent loan begins as a short-term construction loan.

According to FHA rules, your lender must approve the contractor you have chosen to build your home. Once approved, your FHA approved lender will create a draw schedule for the loan based on the estimated construction timeline. With each draw, your contractor will be paid to ensure the continuation of the construction process.

After the construction is complete, your mortgage lender will convert the short-term construction loan into a permanent mortgage, typically with terms lasting 15 to 30 years. You will then make regular monthly payments until the loan is paid off.

How To Apply For An FHA Construction Loan?

There are a few steps involved in applying for an FHA construction loan. Let us have a look at them:

Find an FHA Construction Loan Lender

The first thing is to look for approved FHA construction loan lenders. For this, you can do your research online but the most authentic is to refer to HUD’s lender list and search for your state. The approved FHA construction lenders are listed there and you can easily get your hands on them.

FHA Construction Loan Requirements

The second step is to check if you meet the eligibility criteria for an construction financing. This includes checking credit score, income verification, and DTI ratio requirements of your county. Consult with the lender to understand their specific requirements and guidelines.

Gather Documentation
Prepare the necessary documentation to support your loan application. This typically includes:

• Driver’s license or any other valid ID i.e. passport
• Tax returns
• W-2 Forms
• Bank statements for the past two months
• Statements for any other liquid assets
• Written verification of employment (VOE)
• Credit report
• Purchase Agreement or Construction Contract
• Appraisal Report
• Builder/Contractor Information
• Project Plans and Permits
• FHA required Insurance

Choose an FHA-Approved Builder or Contractor

For FHA construction loans, you must work with an FHA-approved builder or contractor to ensure they follow FHA construction standards and guidelines.

Select the Loan Type
From multiple FHA construction loans, choose the type of FHA construction loan that best suits your needs, i.e. FHA 203(k) standard, limited, or FHA construction loan.

Submit your application
After going through the above process, you can now submit your application. To know more about the FHA construction loan and process, visit here.

Eligibility Criteria for FHA Construction Home Loans

As per FHA construction loan guidelines, there’s a set of eligibility criteria that one has to meet to be a part of this loan program. The eligibility criteria are as follows

Minimum credit score
The better the credit score, the higher your approval chances with the FHA construction loan.

It’s recommended to have a credit score of 580 or above, with this you’ll only be required to make a down payment of only 3.5%. However, even with a score between 500 and 579, you might still qualify for an FHA loan. But the lower the credit score, the higher would be the down payment, at times increasing up to 10%.

Debt-to-Income Ratio
For FHA construction loans, another key factor is the debt-to-income ratio. FHA considers your DTI ratio which compares your monthly debt payments to your income. A lower DTI shows you have room to make additional loan payments.

Generally, a DTI of 50% or below is considered favorable, but the FHA allows a higher threshold of 57% for borrowers with strong credit scores. While some FHA approved lenders may show flexibility in individual cases, keeping a maintainable DTI shows that you can handle additional loan payments.

Property Eligibility
The FHA construction loan can be taken for new construction of a single-family home, renovation or rehabilitation of an existing single-family home, or conversion of a property from a single-family residence to a multi-unit property (up to four units).

FHA-Approved Builder
The construction can only be done by an FHA-approved builder as they are well aware of FHA standards and security guidelines.

Down Payment
As per FHA guidelines for construction loans, the minimum down payment before financing is up to 3.5% while the maximum can go up to 10% even. It depends on several factors like Monthly Income, Minimum Credit Score, etc.

Occupancy
The sole purpose of FHA construction loans is to provide FHA borrowers with a home and it should be occupied within 60 days of closing. FHA construction loans are not for investment purposes.
Income verification For employed homeowners, a steady stream of income is mandatory and to prove it W-2 forms and tax returns are to be provided in order to verify their income. Self-employed or business people need to provide additional documentation like profit and loss statements and business tax returns.

Advantages of FHA Construction Home Loans

There are many advantages of FHA construction loans as compared to traditional loans ranging from simple procedures to better rates. Let’s see them in a little detail below:
The OTC feature simplifies the loan process by eliminating the need for two separate loans: a construction loan and a permanent mortgage.

• Homeowners can take advantage of the lower down payment requirement typical of FHA loans.
• FHA loans are known for accommodating borrowers with less-than-perfect credit histories or limited financial resources, broadening access to homeownership.
• These home construction loans often come with competitive interest rates, which can be appealing over the life of the loan.

FAQs on FHA Construction Loans in 2024

Can you build a house with an FHA loan?

An FHA construction home loan offers the flexibility to purchase land, build a house from scratch, finance a permanent mortgage on the completed home, or even buy and renovate a fixer-upper, all with a single loan.

What are the eligibility requirements for an FHA construction loan?

The eligibility requirements include credit score, income, and debt-to-income ratio criteria. Additionally, the property must meet FHA standards, and an FHA-approved builder must oversee the construction. Visit here for more tips on securing an FHA Construction loan.

What other loans and HELOC credit lines are available for construction financing?

There are a handful of home construction and HELOC loans available to qualified borrowers. Each type of construction mortgage has its own niche worthy investigating.

What types of properties can be financed with an FHA construction loan?

FHA construction loans are to support homeowners to build or renovate their living space and these loans are not for investment purposes. The properties that can be built under this loan are a new single-family home or renovate an existing single-family home.

How do FHA construction loans compare to traditional construction loans?

The major difference between an FHA construction loan and a traditional loan is OTC which is a time close. There is no need for two separate loans one for construction and the other for permanent financing. It is a simpler loan that combines the two of them into one making it easier for the borrower.

The RefiGuide is happy to connect you with mortgage lenders who offers FHA construction loans to people with all types of credit.

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