All About FHA Construction Loans
FHA Construction Loans: What You Need to Know
Have you ever wondered, “can I build a house with an FHA loan?” If you can’t find your dream home on the market, you might just want to build it yourself! But traditional construction loans can often be complex and expensive. Did you know you can turn to the trusty FHA to get a home construction loan that won’t completely empty your bank account?
Can You Use an FHA Loan to Build a House?
One of the biggest benefits of FHA construction loans is that you’ll only have to close once. Other kinds of construction financing require you to secure a short-term loan for construction, and later repay that loan by taking out a mortgage.
There are two types of construction loans: one-time close and two-time close. With a two-time close loan, there are very few steps. You get approved. Next, you get an appraisal. Finally, you close on the construction loan. After you build the house, you have to get approved all over again. You need to get another appraisal. After those steps are finished, then you can close on your permanent home loan. This means you’ll have to jump through all the administrative hoops that go with a loan closing—twice.
To use the FHA loan to build a house, it’s a one-time close construction loan. You don’t have to go through the approval process twice. You get upfront approval, get an appraisal up front, and then close. When construction is completed and final inspection is done, a certificate of occupancy is provided. After those steps, the construction loan is converted into a permanent loan. In other words, you won’t have to get approved all over again if you choose an FHA loan to build a home.
What Is a Construction Contingency?
It’s very common for projects of all types to take a little longer or cost more than originally estimated. This can happen for many, many reasons. A construction contingency is an aspect of a construction to permanent loan that helps to cover project cost overruns and change orders from the borrower.
To cover these extra, often unexpected costs, there’s a construction contingency. Usually, a lender increases the builder’s estimate by about 5 percent. In this way, they can have some breathing room for unforeseen charges. If any of the construction contingency funds aren’t used, the difference is applied toward the principal balance of the loan.
What is a Construction to Permanent Mortgage?
The construction to permanent mortgage combines aspects of both a construction loan and a long-term traditional mortgage. With a single loan, a borrower can finance construction of a home and the home mortgage into a single loan. Borrowers must meet several requirements, including:
The borrower must contract with a licensed general contractor. A borrower may be able to fill the contractor role if they are a licensed general contractor.
The borrower should finalize the purchase of the land by the time the construction loan closes. Or, the borrower should have owned the land for no longer than 6 months.
During the construction period, the builder is responsible for covering monthly interest-only payments on the construction loan. This creates a win/win scenario. The builder wins because they know the payment will be made. In other words, the builder doesn’t have to rely on the borrower’s payments to build the house.
And, the borrower wins. Because the builder is responsible for payments, they have an incentive to complete the project. The builder doesn’t want to get stuck with paying the construction loan’s interest payments any longer than necessary. The loan is converted to the FHA loan when the home build is complete. The borrower then takes over making payments on that loan.
How to Use an FHA Construction Loan to Finance Home Renovations
You can also use an FHA construction loan to renovate a home. If you don’t want to build a house, you can remodel to make it perfect for your family. The Federal Housing Administration may be able to help with the FHA 203(k) mortgage program.
There are two main types of 203(k) loans. The first is provides loans up to $35,000. This type of loan is usually used by homeowners who have smaller renovation projects. The other is a larger version that you can use to buy a fixer-upper. The larger type of 203(k) loan can also be used for major renovations.
Like other FHA loans, there are maximum loan limits for a 203(k) mortgage. These loans are constrained by nationwide FHA loan limits.
How to Get an FHA Construction Loan
Getting an FHA loan to build a home is attractive because you have control over every aspect of your new house. But many mortgage lenders require a 10% to 25% down payment when considering the terms for construction loans. FHA construction loans can offer down payments as low as 3.5%. This is very helpful for borrowers looking to build a home.
Below is an overview of the steps you’ll go through to get an FHA construction loan.
First, you should be sure you’re eligible. Make sure you meet the income, asset, and credit score guidelines. If you don’t meet FHA guidelines, you won’t be able to apply for this type of loan. The good news is that the FHA guidelines are easier to meet than traditional mortgages.
Select a Builder
When you’ve been approved for FHA financing, you’ll want to select the right builder for the project. You’ll be spending quite a bit of time with this person and their company over the next several months to a year. It’s a good idea to be sure you get along. In other words, make sure you and your builder have enough chemistry to communicate clearly.
Check out the builder’s portfolio of work. Learn how long they’ve been in business, their specialties, and the types of projects they focus on. Ask how long similar projects have taken to complete. You’ll want to be assured the builder you choose is capable of completing your project not only on time but also within your budget.
Once you select a builder, your lender will need to approve the builder. An FHA construction loan requires approving not only the borrower but the builder as well. Like the borrower, the builder will need to provide a list of documentation to the lender. This may include items like profit and loss statements, licenses, tax returns, references, and so forth. The process of getting your builder approved can take between 2 and 12 weeks.
When both the borrower and the builder are approved, it’s time to select the property where you’ll build the house. Remember that you can use an FHA construction loan to finance the land and the house all in one loan. The FHA doesn’t give any value to existing buildings on the property. They use the appraised value of the property based on the raw land.
When you’ve got your site selected, you’ll get numbers from the builder. These will cover what the costs will be to complete the project. When you’ve come to terms with the builder on these figures, the lender reviews the construction agreement and structures the loan appropriately.