You may have heard or read testimonials about FHA loans — how a friend or relation who would not have qualified for a mortgage was able to own a house.
Yes, the FHA construction loan can prove helpful for anyone aiming to become a house owner, including you.
This page provides you with the basic things you need to know about the FHA construction loan, how it can help you, the eligibility requirements, and how you can apply when you are ready to.
What Is an FHA Construction Loan?
An FHA construction loan is backed by the Federal Housing Administration to help persons cover building expenses such as land purchase, building materials, construction wages, and permitting fees.
The construction loan allows you to roll over the costs of building a house into an FHA mortgage loan.
While most persons obtain FHA construction loans for building their houses, the loan is also applicable for renovating an old house before buying it.
How Does an FHA Construction Loan Work?
An FHA Construction Loan works by combining the advantages of a traditional FHA loan with that of a short-term construction loan. This enables you more access to a loan despite a relatively low credit score and ensures more relaxed lending requirements.
Traditional FHA loans typically come with less stringent requirements than typical mortgages.
They require lower credit scores and are favorable to persons with lower debt-to-income ratios and if they can provide a larger down payment. However, FHA loans do not allow rollovers.
While other short-term construction loans may be prompt at providing financial help, they tend to come with strict requirements and higher interest rates. This makes several persons who genuinely need loans unable to access them.
An FHA construction loan accumulates the advantages of both kinds of loans while minimizing the challenges involved in obtaining them.
Therefore, it can be the most suitable for persons who do not meet the requirements of a conventional mortgage but still desire to build a house.
Types of FHA Construction Loans
There are two types of FHA construction loans:
- FHA Construction-to-Permanent Loan
- FHA 203(K) Loan
FHA Construction-to-Permanent Loan
The FHA construction-to-permanent loan helps finance a home’s construction from ground to finish.
By combining the features of a short-term construction loan with that of the regular FHA loan, this loan grants access to upfront cash for purchasing land and building the house.
Once the construction is complete, the loan will be readily converted to a permanent mortgage.
FHA 203(K) Loan
This loan covers the finances for renovating a home through a single mortgage. This could be a house you already own or one you want to buy.
The FHA 203(K) loan is also known as the mortgage rehabilitation loan and is further divided into two types:
- The Standard 203(K) Loan: This loan usually works for financing larger renovation projects costing $35,000 or more. Obtaining this loan requires you to hire a 203(K) consultant.
- The Limited 203(K) Loan: This loan would help cover minor renovations such as non-structural repairs and remodeling. When obtaining this loan, it is not a compulsory requirement to work with a 203(K) consultant.
How to Get an FHA Construction Loan
Irrespective of whichever FHA construction loan you are applying for, you will need to apply through an FHA-approved lender. You will find a list of US-approved lenders through the Department of Housing and Urban Development (HUD).
The lender would determine what kind of FHA construction loan you qualify for, after which you can hire a licensed contractor for your housing project.
The role of the lender also includes approving the contractor’s plans and budgets. It is only upon approval that you can close on a loan and begin the project.
Some subtle differences may apply in how you get each type of FHA construction loan. Nevertheless, your lender would be able to guide you through each step of the way.
FHA Construction Loan Requirements
These are the general requirements for applying for any kind of FHA construction loan:
- A minimum credit score of 580 points. A credit score of 500 may be allowed if you are putting a down payment of 10 percent.
- A debt-to-income (DTI) ratio of 43 percent or less. An FHA lender may also offer some flexibility here.
- A down payment of no less than 3.5 percent or 10 percent if your credit score is lower than 580.
- A loan budget that does not exceed FHA loan limits.
- Documentation that proves you will be working with a licensed contractor for the housing project. You may need to work with certain kinds of contractors depending on the type of FHA loan you are applying for.
Note that you must be willing to submit your project plans to the lender for review to qualify for an FHA construction loan.
Also, an FHA construction loan requires you to pay mortgage insurance premiums. These include a one-time upfront premium and an annual premium. The upfront premium is fixed at 1.75 percent of the amount of your loan. The annual premium may vary per year, and you can pay it in monthly installments.
What are FHA Loan Limits?
Like we already mentioned, your budget for construction must not exceed FHA loan limits to be eligible for one.
The FHA loan limits are the maximum amounts the Federal Housing Administration is willing to give as loans for each home construction or mortgage loan category.
The Federal Housing Commission understands that the cost implication for constructing or renovating a home will vary depending on the type of house, size, location, and other factors.
The limit serves as a guide to what each prospective borrower should expect from FHA as loan.
Loan limits are calculated and updated annually and will vary based on local housing values and property type. The FDA may increase loan limits after examining the budgets presented by borrowers when applying for a loan.
The table below will guide you on what to expect as loan limits for each type of house in low-cost and high-cost areas of the US.
FHA Loan Limits for 2022
| Housing Type | Most Areas (Low-Income to Moderate Income) | High-Cost Areas |
| Single Unit | $420,680 | $970,800 |
| Duplexes | $538,650 | $1,234,050 |
| Triplexes | $651,050 | $1,502,475 |
| Four Units | $809,150 | $1,867,275 |
There are tools and websites online that can help you find the specific loan limit for your state or county since there may still be slight variations in value.
Conclusion
The FHA construction loan provides an even ground for most persons to access construction loans they may not be eligible for with other common loan types.
The down payment is also relatively lower, and the loan will work for you whether you are building a new house or renovating an old one.