The Bankrate promise
At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here's an explanation for .
- An FHA construction loan is insured by the Federal Housing Administration and covers the cost of the land purchase, building materials, contractor and other labor costs and permits.
- There are two types of FHA construction loans — an FHA construction-to-permanent loan and a FHA 203(k) loan.
- FHA construction loans can be rolled into an FHA permanent mortgage.
The ongoing housing supply shortage means a competitive market tipped in favor of sellers. It may have some home-hunters thinking: If I can’t find a good home, maybe I should buy some land and build one instead.
Of course, building a custom-made home is expensive, and given the current interest rates, constructing your home may feel out of reach. However, if you’re intrigued by the thought but aren’t sure if you can afford it, an FHA construction loan could help make your dream a reality.
What is an FHA construction loan?
You cannot finance building a house with a regular mortgage since there’s no existing residence to use as collateral. Instead, you use a home construction loan, a short-term financing method. Typically equipped with a one-year term, these loans cover the costs of constructing a home, from the architect’s fee to the certificate of occupancy. Sometimes, they can be converted to a long-term mortgage after the house is built.
An FHA construction loan works similarly: Insured by the Federal Housing Administration (FHA), it covers costs for the purchase of land, building materials, contractor and other labor costs and permits. It also allows you to roll the costs of building or renovating a home into an FHA mortgage.
Just like a traditional FHA loan, these loans make it possible (depending on the lender and other factors) to build a home with as little as a 3.5 percent down or a credit score as low as 500. However, be prepared to put down a higher down payment if your credit score is under 580.
Types of FHA construction loans
The types of FHA construction loans include:
FHA construction-to-permanent loan
An FHA construction-to-permanent loan is a new construction FHA loan, meaning it finances the ground-up construction of a new home. This loan type combines the features of a conventional short-term construction loan with those of a regular FHA loan. It provides you with the cash upfront to purchase land and build a home, then converts to a permanent mortgage once the construction is complete.
FHA 203(k) loan
An FHA 203(k) loan, also known as a mortgage rehab loan, provides the funds to cover the home’s cost and the price of necessary repairs or renovations. It’s used to finance not so much a new build as heavy-duty renovations or remodeling of an existing home, like a fixer-upper. This loan allows you to purchase and upgrade an existing home, or renovate a home you already own through a single mortgage (either a fixed-rate loan or an adjustable-rate mortgage).
There are two types of 203(k) loans: the standard 203(k) and the limited 203(k). The standard 203(k) loan generally finances larger renovation projects costing $35,000 or more and requires the use of a 203(k) consultant. The limited 203(k) loan covers minor remodeling and non-structural repairs costing up to $35,000. You can work with a 203(k) consultant as you progress through a limited 203(k) project, but it’s not required.
How to get an FHA construction loan
For either type of FHA construction loan, you’ll first need to apply through an FHA-approved lender. You can find a list of qualified lenders through the U.S. Department of Housing and Urban Development (HUD). There are also FHA construction loan requirements that you must meet (more on that below). After the FHA construction loan lender determines what you qualify for, you’ll choose a contractor for the project. Your lender will need to review all of your contractor’s plans before you can close on the loan. After closing, you can begin the construction or renovations.
Note that with any FHA loan, including a construction loan, you must pay mortgage insurance premiums. These include a one-time upfront premium, which is 1.75 percent of the loan amount, plus an annual premium that varies by the loan and can be paid in monthly installments.
How to get an FHA construction-to-permanent loan
With an FHA construction-to-permanent loan, you obtain the construction loan and permanent mortgage at the same time. In turn, you only need to close on the loan once. It starts as a short-term construction loan, and once the construction phase is complete, it switches to a mortgage to finance your home.
There are several steps involved in getting an FHA construction-to-permanent loan, including:
1. Select your land: The first step is to purchase land on which you’d like to build a home.
2. Obtain FHA loan pre-approval: Applicants must meet FHA loan requirements, including having a credit score of at least 500 and a debt-to-income ratio that is typically no more than 43 percent.
3. Select a contractor or builder: Before you can proceed with a construction-to-permanent loan, your lender will need to sign off on the contractor you choose. The professional you select may also need to provide documentation proving they hold the necessary licenses.
4. Appraisal: Once your contractor has drafted your project plans, you’ll need to arrange for an FHA appraisal of your soon-to-be-built property’s future value. Your lender will base your loan amount and down payment on that appraisal and put you on a draw schedule for the loan based on the project’s phases.
5. Closing: If the appraisal establishes that the value of the building is high enough to cover loan costs, the next step is to close on the loan. In some cases, depending on what the appraisal shows, you may be required to revise your plans to reduce project costs.
6. Pay the builder: As work progresses, you will draw on the loan to pay the builder following a payment schedule that is established at the outset of the project.
7. Convert to a permanent mortgage: During construction, your FHA construction loan lender might only require you to make interest payments. Once construction is complete, your lender will convert your construction loan to a permanent mortgage, usually with a 15- or 30-year term. Then, you’ll make payments on your mortgage just like a regular home loan.
How to get an FHA 203(k) loan
The steps to get an FHA 203(k) loan include:
1. Submit an application: An FHA construction loan lender requires information regarding your income, assets and credit score.
2. Make renovation plans: You’ll also need to provide lenders with information about your renovation goals, including a cost estimate that your contractor provides.
3. Get a consultant: If you’re seeking a standard 203(k) loan, the lender will require you to work with a consultant — you can locate one via HUD’s 203(k) consultant database.
4. Home appraisal: The lender will order a home appraisal as part of the application process, as well as to determine the home’s value once renovations are complete.
5. Finalize loan: The next step is to finalize the loan amount and how your lender will distribute funds to the contractor.
6. Final inspection: After renovations are complete, an appraiser will conduct a final inspection.
7. Convert to permanent mortgage: Your lender closes the FHA construction loan, and your loan is converted to a permanent mortgage.
FHA construction loan requirements
FHA construction loan requirements are similar to standard FHA loans, but with a few additions. To qualify for any FHA loan, you must meet the following criteria:
- Credit score: Meet the minimum credit score for a construction loan of 580 or higher (or at least 500 if putting down 10 percent)
- Debt-to-income ratio: Have a debt-to-income (DTI) ratio of no more than 43 percent (although there might be some flexibility here)
- Down payment: Make a down payment of at least 3.5 percent (or at least 10 percent if your credit score is lower than 580) of the new home’s estimated value
- Loan limits: Ensure your desired loan amount does not exceed FHA loan limits
On top of this, FHA construction loan requirements ask you to provide documentation showing a licensed contractor will do the work. For a standard 203(k) loan, you’ll also need to work with an approved 203(k) consultant. In addition, for any kind of construction loan, you’ll need to submit your project plans to your lender to review.
Alternatives to an FHA construction loan
There are other types of construction loans — either federally-backed or sponsored by a state or local government — that offer relaxed lending requirements to specific groups that qualify. There are also private construction loans that may offer better terms if you meet the qualifications.
- Conventional construction loan – Banks and other lenders offer conventional construction loans. They may be harder to obtain than an FHA construction loan, often requiring a down payment of 20 percent or more, but they can cost less if you have a higher credit score.
- State and local programs – New construction and home rehabilitation loans may be available for low- to moderate-income borrowers through the local government, nonprofit organizations or local housing authority.
- Fannie Mae and Freddie Mac construction loans – Fannie Mae offers a few different loan types to help finance new construction and home renovations. These include construction-to-permanent financing for new builds and the HomeStyle Renovation loan for improvements to a home you own or plan to purchase. Freddie Mac’s CHOICERenovation loan also provides financing for renovations.
- USDA construction loan – The U.S. Department of Agriculture administers construction-to-permanent loans to low- to moderate-income borrowers wanting to build a home in an eligible rural area.
- VA construction loans – Military members and veterans can obtain a VA construction loan guaranteed by the U.S. Department of Veterans Affairs. No down payment or mortgage insurance is necessary, and these loans often offer lower interest rates, as well.
FAQ about FHA construction loans
To offer FHA construction loans, lenders must be approved by the U.S. Department of Housing and Urban Development. You can view a comprehensive list of FHA-approved lenders on the HUD website, or check out Bankrate’s guides, like our best FHA mortgage lenders and best FHA 203(k) rehab mortgage lenders.
Assuming that you’re making the standard FHA down payment of 3.5 percent, the minimum credit score for a construction loan is 580. Otherwise, you can apply for a new construction FHA loan with a credit score as low as 500, but in that case, you’ll need to make a 10 percent down payment.
FHA construction loans are accessible to borrowers with a lower credit score than what’s required for conventional loans (620 minimum, typically), including applicants who have a credit score as low as 500. In addition, unlike conventional construction loans that typically require a down payment of 20 percent or more, you can obtain an FHA construction loan with a much smaller down payment. Borrowers can also use a single FHA construction loan to both buy and substantially renovate a home. Or you can use it to finance the construction of a new build that converts to a long-term mortgage.
There are limits on the amount you can borrow with an FHA construction loan. In addition, all FHA loans, including FHA construction loans, require the borrower to pay mortgage insurance premiums (MIP). These loans also come with a more complicated review and oversight process. Contractors and builders must be approved and meet FHA licensing and insurance requirements. In addition, standard FHA 203(k) loan-financed projects require a supervisor.
Interest rates will fluctuate over time, so the best time to lock in your interest rate is while your home is under construction. Be sure to ask your loan officer how much they think rates might change during construction and when you are able to lock in the rate. It’s also a good idea to ask what your rate will be on your permanent mortgage.