FHA New Home Construction Loans

Does your credit report show a score of at least 500? If it does, you may qualify for an FHA construction loan that enables you to purchase land and build a new home. Existing homeowners could also use FHA loans for refurbishments that add value to their properties. Because the Federal Housing Administration provides guarantees, lenders may approve loans to individuals with lower credit ratings and enough cash for a down payment of no more than 10%.

New Home Construction Versus Fixer-Upper Funding

Before filling out a mortgage application, review your options to determine which type of loan and property purchase works best for you. Your hoped-for dream home, for example, may not be available or its location may not accommodate your lifestyle or commuting needs. You could instead consider applying for an FHA construction-to-permanent loan and use the funds to buy land and build your home in an ideal location.

Referred to as a "CP" or "construction-to-perm" loan, this government-insured mortgage program makes it easy for borrowers with less-than-stellar credit to qualify. With a one-time closing, you could obtain funding to both purchase the land and hire developers to build your home. When the builder completes the work, your FHA construction loan converts into a regular mortgage with a 15- or 30-year repayment plan.

If, on the other hand, you found a great fixer-upper home, but you have concerns about the cost of the needed repairs, you could apply for an FHA 203(k) rehabilitation loan. This loan program works well for homeowners looking to refinance their mortgages or make improvements to their current homes. By increasing your property's value through improvements, you could then sell your home, repay the loan and spend the cash proceeds as you wish.

Building a Home Covered by an FHA Construction Loan

Depending on the amount of funding you qualify for, an FHA construction loan can cover both the land purchase and the construction costs. The first steps to new homeownership are getting your loan in preapproval status and finding the land for your home's construction. The FHA, however, has strict criteria for approving the land purchased through its loans. When searching for acceptable plots of land on which to build your home, the location must not be in a flood zone, and it must also be far from oil or gas wells. An additional requirement is that there are no airports in the vicinity.

After your preapproval and finding a plot of land that meets the FHA’s criteria, the next step is to research licensed builders or contractors to construct your home. Because of the FHA's strict requirements, you will need to hire an insured general contractor with a valid license. Your builder can help you design the construction plans and also prepare the documents that you’ll need to submit to your lender.

When you’ve found the land and chosen an approved contractor, you're ready to move ahead with the FHA construction loan. Lenders typically perform property appraisals to verify that the land and building materials meet the FHA's standards. Before the closing, your lender may need to confirm that the property's appraised value covers both the land and construction expenses. If the appraisal exceeds the mortgage amount, you may need to supply some additional cash. You could also ask the builder to proactively revise your plans to fit within the loan amount.

Your Home’s Construction May Occur in Phases

Some FHA construction lenders approve their borrowers but do not provide the cash in one lump sum. Your lender may work closely with your builder and monitor your home's construction schedule. The lender may pay the builder in increments as the contractor completes each phase of your home’s construction. Upon completion of each construction milestone, your builder makes a request for you to authorize the next payment draw from your lender.

During the course of your home’s construction, your lender may require you to make interest-only payments. An FHA construction loan may come with a variable interest rate. If your contractor needs to pause the construction and doesn't finish the project on time your loan's interest rate may change. If you're concerned about changes in your interest rate, you may ask your lender about locking in the rate so that it stays the same throughout the life of the loan.

Renovate Property To Increase Its Market Value

You may have certain skills that enable you to determine whether renovating rundown homes could enable them to become profitable based on market trends. If so, there is a type of FHA loan that could fund a fixer-upper property or remodel your current home. With minor upgrades or improvements, properties located in desirable areas could increase in value. Eligible borrowers must, however, occupy and insure their properties.

To qualify for this type of FHA construction loan, referred to as an insured 203(k) rehabilitation mortgage, borrowers must follow guidelines established by the Department of Housing and Urban Development. HUD must approve the activities slated for renovations. Borrowers generally don't choose their builders, and licensed contractors must submit documents describing the costs of the project and a timeline for completion.

The FHA backs two different 203(k) rehabilitation loans. The first is a limited 203(k) loan and covers up to $35,000 in renovations. If you need substantial remodeling that goes beyond that amount, you may apply for a standard 203(k) loan, which requires working with a project supervisor experienced in engineering or inspections. The FHA also allows changing a home's structure or installing medical equipment to accommodate a homeowner's medical disability.

Compare Your Funding Options

Freddie Mac covers two loan types that are comparable to the standard 203(k) FHA rehabilitation loan. The cost of the repairs relative to your home's value determines which one you may apply for. For those homeowners who can make repairs on their own, Fannie Mae backs a loan that doesn't require living in the property undergoing renovations. The Fannie Mae loan requires borrowers to have at least a 620 credit score.

If your goal is flexibility, you may find that an FHA construction loan could provide lower down payments and greater savings on insurance than conventional mortgages. Before deciding on your lender and best funding arrangement, contact us to review all of the financial options available for your project.