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How to use an FHA construction loan to build your dream home
If you need financial help to build your dream home from scratch or even just to remodel your bathroom, an FHA construction loan can help. FHA loans are geared toward people with relatively low credit scores and down payment savings, making FHA construction loans great options for first-time home buyers who want to build a home or buy a fixer-upper.
Learn more: What is a construction loan?
In this article:
What is an FHA construction loan?
An FHA construction loan is a type of FHA loan that helps you cover the cost of building a home or renovating an existing property. Like standard FHA mortgages, these construction loans are government-backed loans insured by the Federal Housing Administration. And because they are less risky for lenders than many other types of loans, they come with less stringent borrower eligibility criteria. For example, you could qualify with a credit score as low as 580-500 if you’re willing to put 10% down.
How do FHA home construction loans work?
There are two types of FHA construction loans: construction-to-permanent loans and FHA 203(k) loans. Here’s how each works.
FHA construction-to-permanent loan
FHA construction-to-permanent loans allow you to build a home from the ground up. You can use the funds to buy land, finance construction, and cover closing costs. Once the home is built, your construction loan will automatically convert to a permanent loan with terms that usually last 15 or 30 years. You’ll then make regular monthly payments on your mortgage until you pay it off.
FHA 203(k) loan
You can use an FHA 203(k) loan to fund the purchase of an existing house plus the cost of renovations and repairs. There are two types of FHA 203(k) loans: standard and limited. Standard 203(k) loans are designed to cover renovations costing $35,000 or more, and limited 203(k)s are for smaller-scale remodeling projects with price tags of less than $35,000.
Dig deeper: 4 types of home renovation loans and how to choose
Requirements for FHA construction-to-permanent loans
Borrower requirements
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Credit score and down payment. You need a minimum credit score of 500 to qualify, provided you’re willing to make a 10% down payment. You can also get an FHA construction loan with a 3.5% down payment and a 580 credit score.
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Debt-to-income ratio. Your debt-to-income (DTI) ratio is calculated by dividing your minimum monthly debt payments by your monthly gross income, which helps lenders gauge whether you can afford to repay the loan. Most FHA lenders like to see a DTI ratio of 43% or lower, though there may be some exceptions.
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Loan amount. If you’re using an FHA construction loan to buy a home (rather than fix one up), the amount you borrow cannot exceed local FHA loan limits. For 2024, it’s set at $498,257 for single-family home loans in most U.S. counties, though that amount can reach $1,724,725 in more expensive areas like Alaska and Hawaii.
Property requirements
The home you’re building must be on of the following types of eligible properties:
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Site-built housing (one to four units)
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Qualifying condo units
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Manufactured housing
Contractor requirements
FHA construction-to-permanent loans require that your FHA lender approve the contractor who builds your home.
Learn more: 12 types of houses for buyers and renters
Requirements for FHA 203(K) loans
Borrower requirements
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Credit score and down payment. You only need a minimum credit score of 500 if you make a 10% down payment. You can also get an FHA 203(k) loan with a 3.5% down payment if you have a 580 credit score.
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Debt-to-income ratio. Most FHA mortgage lenders prefer to work with borrowers who have a DTI ratio of 43% or less, though there may be some exceptions.
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Loan amount. Standard 203(k) loans cover major renovations with no maximum repair cost, and limited 203(k) loans are for relatively minor repairs up to $35,000. You can borrow up to $50,000 with a 203(k) loan if you live in an Opportunity Zone, though. Ask your lender or real estate agent about borrowing limits where you live.
Property requirements
The home you’re renovating must be one of the following eligible property types:
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Single-family home
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Two- to four-family unit townhouses
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Manufactured homes
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Mixed-use properties that are mainly residential
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Condos
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HUD Real-Estate Owned properties
Contractor requirements
For a standard 203(k) loan, you must work with an FHA-approved 203(k) Consultant who will review your plan, approve it, and oversee the project during construction. FHA-approved 203(k) Consultants are not required for limited 203(k) loans.
How to get an FHA construction-to-permanent loan
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Find a piece of land to build your property on. If you’re building a home from scratch, you’ll first have to select a plot of land to serve as the foundation for your new home.
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Choose a contractor or builder. Next, you’ll hire a lender-approved contractor to build your home, which you can find by searching the HUD’s list of lenders by state or county.
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Get preapproved. Once you’ve found an eligible contractor, the next step is to find an FHA-approved lender and apply for preapproval so you can finalize your budget and building plans. (It helps to apply with more than one lender so you can find the best deal.) If you are preapproved, your lender will base the loan amount on the appraised value of the home after construction or after renovation.
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Submit your loan application. The last step is to submit your loan application. Be prepared to provide information such as an estimate of your monthly income and debts, proof of employment, and tax returns. Lenders will also consider your credit score and other financial information to assess your credit risk.
Read more: How to get preapproved for a home loan
How to get an FHA 203(k) loan
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Find a lender. As with an FHA construction-to-permanent loan, you can find a lender for your FHA 203(k) loan through the U.S. Department of Housing and Urban Development website's search tool.
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Create a rehab proposal. Along with the typical mortgage application documents, you’ll need to provide a rehab proposal that describes the work to be done on your property and an estimate of how much the renovations will cost.
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Work with a 203(k) Consultant. If you’re considering a standard FHA 203(k) loan, you’ll work with a 203(k) consultant to estimate costs and create a rehab proposal. The HUD offers a tool for finding a 203(k) Consultant. Note that you don’t need to work with a Consultant for limited 203(k) loans, which are for smaller home projects.
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Submit your loan application. Once your rehab proposal and other required documentation are ready, submit your loan application and await lender approval. Once approved, you’ll close on the loan.
Pros and cons of FHA construction loans
As with all home loans, FHA construction loans come with perks and downsides. Make sure you’re fully aware of both before making any decisions.
Pros
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Low down payment requirements: FHA loans require a relatively low down payment — as little as 3.5% of the purchase price.
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Lenient credit score requirements: FHA loans accept credit scores as low as 500, provided you can put down 10%. (You can also put 3.5% down with a 580 credit score.)
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Simplifies the financing process: You can finance both the land purchase and the home's construction with a single FHA loan, which means you’ll only have to go through the closing process once.
Cons
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Requires mortgage insurance premiums: All FHA borrowers are required to pay both an up-front mortgage insurance premium (MIP) and an annual MIP, which increases your overall loan costs. The up-front MIP costs 1.75% of your loan amount, and the annual premium varies depending on the size, term, and loan-to-value ratio of your mortgage.
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Stricter approval process: FHA construction loans typically have a more rigorous approval process than conventional loans. For example, FHA construction-to-permanent loans require you to work with a contractor, and standard FHA 203(k) loans require you to work with an FHA-approved 203(k) Consultant.
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Higher interest rates: Construction loans may charge higher interest rates than traditional mortgages. Why? Because lenders could end up with a partially completed house on their hands if the borrower defaults on the loan.
Read more: How to get the lowest mortgage rates
FHA construction loan alternatives
An FHA construction loan is a solid financing option if you need to borrow money for the construction or renovation of a home, but it’s not your only choice. Consider these alternatives to see if they’re a better fit.
USDA one-time close construction loan
USDA one-time close construction loans are backed by the U.S. Department of Agriculture and designed to help people build their dream homes in eligible rural areas with 100% financing. To qualify, you’ll need to meet the lender’s credit score and DTI ratio criteria, as well as meet stringent USDA property requirements.
VA one-time close construction loan
VA one-time close construction loans (also called VA construction-to-permanent loans) are backed by the U.S. Department of Veterans Affairs and are designed to help veterans, service members, and families become homeowners. Unlike FHA construction loans, which require a 3.5% or 10% down payment, VA one-time close construction loans provide up to 100% financing.
Dig deeper: What is a VA construction loan, and how does it work?
Conventional construction-to-permanent loan
Unlike one-time construction loans through the USDA or VA, conventional one-time close construction loans aren’t backed by any government agencies. But this means they typically offer more flexibility regarding which contractor you can work with and your project scope. To qualify for a construction-to-permanent loan backed by Fannie Mae, you must have a credit score of 700 or higher and put down at least 5%.
Freddie Mac renovation loan programs
Like Fannie Mae, Freddie Mac is a government-sponsored enterprise that purchases, guarantees, and securitizes home loans. Freddie Mac offers two renovation loan programs: the CHOICERenovation® mortgage and the CHOICEReno eXPress® mortgage.
The CHOICERenovation® loan allows you to finance both the purchase and renovation of a property, similar to an FHA construction-to-permanent loan. The CHOICEReno eXPress® mortgage offers faster approval and funding for small-scale renovations, sort of like the FHA 203(k) loan. If you’re trying to decide whether a Freddie Mac or FHA construction loan is a better fit, talk with a few lenders about your options.
Tapping home equity
While you can refinance into an FHA 203(k) loan to make improvements, it’s not your only option. If you have enough equity in your home, consider using a cash-out refinance, home equity line of credit (HELOC), or home equity loan to access cash for home repairs and renovations. All lenders are different, but most will require you to have at least 20% equity built up in your home before you can qualify for these options.
Dig deeper: How to choose between a HELOC and home equity loan
FHA construction loan FAQs
Do I make too much for an FHA construction loan?
There’s no minimum or maximum income limit for you to qualify for an FHA construction loan. However, lenders will consider other financial factors, such as your credit score and debt-to-income ratio, to make sure you can comfortably manage the loan without risk of default.
What is the downside of an FHA construction loan?
One of the biggest downsides of an FHA construction loan is that you’ll have to pay mortgage insurance premiums regardless of your down payment amount. FHA construction loans also have strict requirements for appraisals and inspections compared to other types of mortgages.
Who offers FHA construction loans?
You can use HUD’s FHA-approved lender search tool to help you discover available lenders in your area, but just know that not every mortgage lender offers FHA construction loans. New American Funding and Flagstar Bank are two well-known national lenders that offer FHA construction loans.
This article was edited by Laura Grace Tarpley.
