How to Get an FHA Construction Loan
An FHA construction loan can help you realize your dream of creating your forever home from the ground up, even if you have less-than-perfect credit. As long as you can make a 10% down payment, you may qualify for an FHA construction loan with a credit score as low as 500. Here’s what you need to know about this unique financing option.
What is an FHA construction loan and how does it work?
An FHA construction loan is a mortgage that allows you to roll in the costs of building a home or renovating an existing property. There are two types of FHA construction loans:
FHA construction-to-permanent loan
The FHA construction-to-permanent loan allows you to build a home from scratch. You can use it to buy land, finance construction costs and cover lender fees.
This loan combines the features of a short-term construction loan with a standard, long-term FHA loan. You’ll close once and finance the build the same way you would with any other construction loan. When construction is complete, the loan automatically converts to a permanent mortgage.
Steps to finance a home with a FHA construction-to-permanent loan
Here are the steps you’ll take when financing a home with an FHA construction-to-permanent loan:
1. Get preapproved for an FHA loan
You’ll need to meet with a lender and have them perform a preliminary review of your credit history, income and assets. Once that’s done, you’ll receive a conditional preapproval letter detailing how much money the lender may be willing to lend you once they’ve had a chance to verify your information.
Still choosing a lender? See our picks for the best FHA loan lenders and more.
2. Choose your land
Once you’re approved for a loan, you can use the proceeds to buy land. Most plots are acceptable, however, FHA construction loan rules don’t allow you to build a home on land if it’s near:
- A gas or oil well
- An airport
- An area prone to floods
3. Choose a licensed contractor or builder
FHA construction loan guidelines require you to work with a licensed contractor or builder. The contractor may have to provide documentation to confirm they have the proper licensing and insurance.
4. Get a home appraisal
Your lender will order an FHA appraisal to confirm the building and materials meet FHA’s minimum property standards.
5. Close on the construction loan
If the appraised value is enough to cover your costs, you’re ready to close. If not, you may need to make up the difference or scale back your renovation plans.
6. Request draws as the work is done
As work is completed, the builder will be paid with your written authorization on the schedule you set before closing.
7. Switch to a permanent loan
Once your home is finished and move-in ready, the lender closes out your construction loan and converts it to a permanent mortgage within 60 days.
FHA 203(k) rehabilitation loan
If you’ve found a fixer-upper home to buy, or your current home needs upgrades, an FHA 203(k) loan can help you remodel and roll the costs into your total loan amount.
Unlike an FHA construction-to-permanent loan, the FHA 203(k) program allows you to make minor repairs ($5,000 minimum) or major renovations to an existing home.
→ There are two FHA 203(k) options: limited and standard.
- Limited 203(k) loans: For remodeling projects with a price tag of $35,000 or less, you can make improvements to a one- to four-unit home. For example, you can replace a leaky roof, install new carpet or upgrade your kitchen cabinets.
- Standard 203(k) loans: The standard 203(k) program allows you to tackle bigger renovations on a home you’re buying or refinancing. You can take on a broader range of home improvement projects, including:
- Replacing the plumbing in an older home
- Making a home wheelchair accessible
- Altering the layout or structure
- Adding or enhancing the landscaping
The standard 203(k) program requires a consultant to supervise your project from start to finish. The 203(k) consultant is licensed and typically has a background in home inspections, engineering or architecture. You can find a consultant in your area by checking the U.S. Department of Housing and Urban Development (HUD)’s approved FHA 203(k) consultant list.
Don't forget: Lock in your interest rate during construction
Your interest rate may change while your home is being built. Discuss mortgage rate lock options with your loan officer and ask these questions:
- How much could rates change during construction?
- When can I lock my rate during the FHA loan process?
- What will the rate be on my permanent mortgage?
- Can I float down a rate if it’s lower after my home is built?
How to qualify for an FHA construction loan
Before you can start the construction process, you must meet these key eligibility requirements:
- Credit score: You’ll need a minimum 500 credit score to qualify.
- Debt-to-income ratio: Your debt-to-income (DTI) ratio measures your gross income against your existing debts. It tells the lender if you can comfortably afford to repay the loan. You’ll need a maximum 43% DTI ratio or, in rare cases, 50%.
- Down payment: You’ll only need a 3.5% down payment if you have at least a 580 credit score. However, you’re required to put down 10% if your credit score is between 500 and 579.
- Loan amount: You’ll need a loan amount that doesn’t exceed local FHA loan limits.
Want to make sure your credit score is high enough? Get your free credit score on LendingTree.
Pros and cons of FHA construction loans
Pros
Provides flexible qualifying requirements: FHA accepts credit scores as low as 500, provided you’re able to make a 10% down payment. However, if your score is at least 580, you’ll only be required to put down 3.5%.
Offers the ability to do one closing: In more traditional financing scenarios, you’d have to take out two separate loans — a construction loan and a permanent mortgage. This means attending two closings and paying two sets of closing costs. With the FHA construction loan, you only have to go through the process once.
Gives options for multiple types of construction projects: Between the FHA construction-to-permanent loan for new builds and the FHA 203(k) program for fixer-upper homes, an FHA construction loan has you covered no matter what type of construction project you have in mind.
Cons
Requires mortgage insurance: FHA borrowers must pay two types of mortgage insurance: an upfront fee worth 1.75% of the loan amount and an annual premium that costs between 0.15% and 0.75% of the loan amount. Unlike private mortgage insurance, this requirement can’t be waived once you build up more equity in your home.
Sets specific limits on your loan amount: The FHA sets annual limits on how much you’re able to borrow. For 2023, the limit for most areas is $472,030. However, it extends to $1,089,300 in select areas where the cost of living is much higher.
Imposes more requirements than other loan types: FHA construction loans come with more red tape than some other loan options. For example, the FHA appraisal sets specific health and safety requirements that aren’t typically found with conventional loans.
Alternatives to an FHA construction loan
Conventional construction loan
Your local bank or homebuilder may offer their own construction loans. When the home is finished, you’ll need to pay off the construction financing with a permanent loan. This is also called a two-time close construction loan, since you’ll close twice and pay closing costs on both loans.
See current conventional mortgage rates.
State and local programs
Local nonprofit organizations and government agencies, like your state or city housing authority, could have programs available to assist lower-income borrowers. You may qualify to receive down payment assistance for use with a new construction or home renovation mortgage.
VA construction loan
Eligible military borrowers may be able to build a home with 100% financing by using a construction loan guaranteed by the U.S. Department of Veterans Affairs (VA). VA construction loans are available with a one-time or two-time closing option.
See current VA mortgage rates.
USDA construction loan
Low- to moderate-income borrowers may be able to build a home in rural areas designated by the U.S. Department of Agriculture (USDA) with this program. The program also offers 100% financing.
Fannie Mae HomeStyle® Renovation loan
This conventional renovation loan works like the FHA 203(k) program, except that it allows for down payments as low as 3% with a minimum 620 credit score. An added bonus of the HomeStyle loan: You can roll some of your monthly mortgage payments into the loan amount if you can’t live in the home while it’s undergoing repairs. You also have the option to do some of the repairs yourself.
Freddie Mac’s renovation loans
If you have a renovation planned, Freddie Mac has two loan options for you. The CHOICERenovation® loan is meant for large-scale renovations, financing up to 75% of the home’s value. Meanwhile, the CHOICEReno eXPressSM mortgage is for smaller-scale changes and finances up to 15% of the home’s value. Other qualifications will vary, depending on the mortgage you currently have and how many units your home has.
Frequently asked questions
FHA construction loans require a minimum 500 credit score, but that flexibility comes with a 10% down payment requirement. That said, if you have a 580 score or higher, you can get away with only putting down 3.5%.
Although FHA loans have many benefits, there are a few disadvantages. For one, you’ll have to pay two types of mortgage insurance on the loan. You’ll also have to deal with more red tape — like operating under the supervision of an FHA consultant — than you would if you chose another loan type.
If you’re in the market for an FHA construction loan, you can use HUD’s FHA-approved lender search tool to find available lenders in your area. When you talk to them, be sure to specify that you’re looking for a construction loan so you find a lender who has the experience you need.