Can You Build a House With an FHA Loan?

You qualified for an FHA loan, but you’ve been looking for the perfect house for months. Perhaps you have specific needs—or maybe you’re just at a life stage when “good enough” isn’t really good enough. Can you build a house with an FHA loan?

The answer could be to build your own home.

Building your own home has a lot of advantages. You get a custom property tailored to your needs. You don’t need to worry about old electrical systems or HVAC systems. 

And you don’t have to fight off the other home buyers in the market.

But how do you finance the building of a house? Can you build a house with an FHA loan?

The Basics of an FHA Construction Loan

An FHA construction loan is a mortgage that the Federal Housing Administration insures, just like a typical FHA loan (there are many types of FHA loans). You can use an FHA construction loan to finance the purchase of land and build a home or to construct a home on a property you already own.

FHA construction loans come in two flavors:

  • Construction-to-permanent. When you complete the home, you borrow to pay for construction and then convert the loan to a standard FHA mortgage. You will have a traditional 30-year permanent loan at the end of the FHA financing process.
  • FHA 203k. This is a repair and renovation loan. You can use it to buy and fix up a house, or you can use it to finance renovations. You can complete a certain percentage of the repairs, but not all. The FHA lender will only lend based on the house’s projected value at the repair’s end.

So, not only can you build a house with an FHA loan, but there are multiple ways to do it.

To qualify for an FHA construction loan, you’ll need a credit score of at least 580. The program requires this, but many lenders have stricter standards. You’ll also need to prove that you have the financial resources to make a down payment and cover the closing costs.

The Advantages of an FHA Construction Loan

There are several advantages to an FHA construction loan.

  • You can finance the purchase of land and the home’s construction all in one loan.
  • You’ll only need a 3.5% down payment, which is lower than you’d need for a typical construction loan.
  • You can lock in a relatively low-interest rate even with bad credit or low income.

FHA loans (mostly) get homebuyers into their first homes. To that end, even the FHA construction loan targets homebuyers with limited cash and income. An FHA loan will be easier to qualify for than a conventional loan, universally—but it’ll be harder to close than a conventional mortgage.

The Disadvantages of an FHA Construction Loan

There are some potential disadvantages to an FHA construction loan.

  • The loan is only available for a limited time, usually 12 months. This can put pressure on you to finish the home quickly.
  • You usually can’t borrow a lot. The maximum loan amount is usually the lesser of two amounts. One limit is based on the county and affordability, and another is a hard limit regarding how much the FHA will insure.
  • You’ll also need to pay for private mortgage insurance (PMI) if you put less than 20% down. This can add to the cost of your loan.

In 2022, the maximum loan limit for an FHA loan was $970,800. County-level restrictions tend to be much lower. In low-wage states, you can expect to tap out closer to $420,680.

But really, the largest disadvantage will be finding a builder. Many builders don’t want to work with FHA loans because FHA loans are so strict about the properties. FHA loan limits can also make FHA loans difficult to utilize if you are in a hot market fully.

Who Qualifies for an FHA Construction Loan?

To qualify for an FHA construction loan, you must prove that you have the financial resources to pay down and cover the closing costs. You’ll also need a credit score of at least 580.

And you’ll have to meet the other, normal requirements: a steady source of income, a good buffer for mortgage payments, and funds for any closing cost not rolled into the cost of the mortgage loan.

Other mortgage products can have fairly strict requirements. VA loans require veteran families, while USDA loans require rural housing. Comparatively, FHA loans are strict regarding the quality of the property and whether it’s habitable, but they’re fairly lax regarding the financial and credit requirements of the borrower.

Next, you’ll need to find a builder willing to work with an FHA loan.

Finding a Builder Who Will Work With an FHA Construction Loan

If you’re having trouble finding a builder who will work with an FHA construction loan, it may be because they don’t understand the program. The FHA has very specific requirements for properties-requirements that not all builders are willing to meet.

The most important requirement is that the property be “new construction.” This means that the home cannot have been previously occupied. The home must be built on land considered new construction, too.

The second most important requirement is that a licensed and insured builder has to build the home. The FHA must approve this builder.

To find an approved builder, you can contact the FHA directly. Your lender may also furnish a list of approved builders.

FHA Construction Loans vs. Conventional Construction Loans

A conventional construction loan will provide you with more freedom. FHA properties have to meet fairly rigorous requirements. However, you will likely need to put down significantly more for a conventional construction loan. Conventional construction loans are also harder to qualify for.

FHA Construction Loans vs. USDA Loans

USDA loans are very similar to FHA loans. The government backs USDA loans similar to FHA loans. They may have no down payment at all. But your household will need to be low-income or moderate-income, and you will need to purchase a property in a rural area.

FHA Construction Loans vs. Builder Financing

If you’re struggling with FHA loans, consider builder financing. Most major construction companies offer builder financing; smaller ones do not. New construction companies can determine what they want to require for things like down payments, so frequently, builder financing has favorable terms.

Builder financing will also give you more freedom in using your loan.

For example, with an FHA loan, you’ll have to inspect the plans before any work begins. With builder financing, the new construction company will oftentimes provide its inspector, who will sign off on the work as it’s completed. This saves time and money.

Can an FHA Construction Loan Fall Through?

Yes, an FHA construction loan can fall through. The most common reason a loan falls through is because the property doesn’t meet the FHA’s guidelines. It may not meet the standards of safety and habitability that FHA requires.

Otherwise, you could not qualify for the loan or not have the down payment available once the loan goes to close. This could happen, for instance, if you lose your job while the house is being built.

What happens if the loan falls through after the house has been built? This will most likely happen on the builder’s side, not yours. You will likely have to work to determine how to meet FHA’s standards, or you will need to walk away.

Talk to your lender if you’re worried about your loan falling through. They can help you understand the risks and ensure you take all the necessary steps to avoid problems.

What If Your FHA Construction Goes Over 12 Months?

If your FHA construction goes over 12 months, you can likely extend the loan. However, you must prove that the delays were due to factors beyond your control.

You will also need to have a new property appraisal done. This ensures the home’s value hasn’t changed since the last appraisal.

Extending an FHA construction loan is possible, but you should avoid it if you can. Keep track of where the builder’s progress is to avoid surprises. Building a house certainly isn’t a hands-off experience. You will be checking in frequently.

Conclusion

An FHA construction loan can be a great option if you’re looking to buy land and build a new home. But it’s also complicated. You must find a builder, draw plans, and regularly interface with the FHA.

Find a builder experienced in dealing with FHA construction loans; it will make the entire process much easier. Don’t be afraid to ask your lender when you doubt the FHA’s requirements.

Bottom line: You can use an FHA construction loan to build a house, but it will take work. Expect to be very involved in the process.

FAQs

Can FHA be used for land?

You can use an FHA construction loan to purchase land and build a house simultaneously. But an FHA construction loan is not meant to purchase land without development. Getting a land loan can be very hard if you aren’t rolling it into a construction loan.

What would disqualify a house from FHA?

The house would need to fail an FHA inspection. The most common reason for this is if the property is considered “uninhabitable.” This can be due to several reasons, such as a lack of running water, electricity, or structural damage. 

But it could also be something less obvious. For instance, if the builder didn’t install a new stove yet because they wanted you to pick it out, the property would still be considered uninhabitable for now… even if the stove is on its way.

What is FHA new construction?

FHA new construction loans are meant for properties that are being actively and newly built. The land on which the property is built must also be new; in other words, it can’t have a previous house.

Is it harder to get a home loan to build?

It can be. Construction loans are generally more complicated and have stricter requirements than standard home loans. But it’s not impossible to get a construction loan. You must ensure you’re working with an experienced lender and builder. 

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