FHA construction loans will help cover the costs of your building or renovation project. Plus, they have lower requirements for credit scores and down payments, making this a perfect loan for low-credit homeowners.

With HGTV and home renovation shows all the rage, who wouldn’t want to renovate their own house? It sounds all fun and games until the costs come rolling in and start to quickly pile up. With this in mind, taking out a loan to cover the costs of building or renovating your home is a common way to fund your project.

If you’re looking for a way to fund your home’s construction, FHA loans are a solid choice for low-credit homeowners or people looking for a lower down payment.

Compared to the more-expensive conventional construction loan, applying for an FHA construction loan often requires fewer steps to get approved. Once your project wraps, the FHA construction loan will transition to a permanent loan.

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What is an FHA construction loan?

FHA construction loans can help you cover the costs of building or renovating your home by rolling them into an FHA mortgage loan that you pay off after your project is done.

Everything from building materials to construction work, permitting fees, and even buying the property you’re going to build is covered by your FHA construction loan.

There are two types of FHA construction loans—construction-to-permanent loans and FHA 203(k) rehabilitation loans.

Construction-to-permanent loan

If you’re building from the ground up, a construction-to-permanent loan (aka construction-to-perm) will cover a range of expenses including property, building materials, labor, and permitting fees.

Combining the benefits of a short-term construction loan with those of a regular FHA loan, construction-to-perm loans gives you cash upfront to purchase land and build your new home along with an extended term to pay it off. This loan is converted to a permanent FHA mortgage loan once you’ve finished your project.

FHA 203(k) rehabilitation loan

Also known as a mortgage rehabilitation loan, this option is specific to renovations being done to a home that is already standing (i.e. your current home or a newly-purchased fixer-upper).

Depending on how ambitious your plans are, there are two types of FHA 203(k) rehabilitation loans:

Standard 203(k)s are often assigned for projects costing $35,000 or more—hiring a

203(k) consultant

is required

Limited 203(k) is best for projects less than $35,000 (think: minor remodeling projects or non-structural repairs)—you can consult a 203(k) consultant during your project if you’d like, although this is not required

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Home insurance liability coverage

Requirements for an FHA construction loan

No matter the type of FHA construction loan you choose, the general requirements remain the same. To get an FHA construction loan you will need:

Credit score must be 580 or higher

A debt-to-income ratio that is 43 percent or lower

Minimum down payment of 3.5 percent—alternatively, if your credit score is below 580, a minimum down payment of at least ten percent

Confirm that the desired loan amount does not exceed any FHA loan limits

If applicable, documentation proving that your project will be done with a licensed contractor

If you don’t meet one or more of these requirements, the lender may request a higher downpayment or interest rate, or deny the loan application.

How FHA construction loans work

Once you’ve decided on the type of FHA construction loan for your needs, then it’s time to apply for your loan. Depending on whether you’re getting a construction-to-perm or a 203(k) rehabilitation loan, the steps will differ.

How construction-to-permanent loans work

Of the two loan types, a construction-to-perm loan is more involved because you will likely need to obtain more permits to make sure your newly-constructed home complies with local government codes. Plus, your contractor and detailed construction plan must be submitted for approval before you receive the loan.

Start by applying through an FHA-approved lender—check out the US Department of Housing and Urban Development’s

website for a list

of approved lenders.

Once you’re received preapproval, you’ll need to find a contractor—the law requires that a licensed contractor or builder is hired for any construction-to-perm project. This contractor must meet the FHA’s requirements and be approved by your lender. Contractor requirements include:

Licensure

Liability insurance

Two years or more of experience building houses

An FHA home appraisal will follow to confirm that the proposed building and materials will meet the FHA’s minimum property standards. It’s at this stage that your contractor will need to submit a draft of the construction plans for the lender’s approval.

If your project’s value as appraised by the FHA is enough to cover construction costs, then you’re ready to go! However, you will need to scale back the renovations or pay the difference out of pocket if the appraised value does not cover the costs.

Within sixty days after the project has ended, the lender will close out your construction loan. At this point, you must be living in your remodeled home or using it as a second home for the FHA construction loan to become a permanent mortgage. To close out the loan, your property will be visited by a government inspector to make sure your completed project is up to code.

Key takeaway: A construction-to-permanent loan helps offset the costs of building a house and can transition to a permanent mortgage after the project. To qualify, you’ll need to abide by government regulations.

How FHA 203(k) rehabilitation loan work

FHA 203(k) rehabilitation loans are easier to navigate because the house is already standing, bypassing the contractor and construction approval part of the process. This loan type does not have as involved an application process—simply apply at your bank or preferred lender.

When applying for this type of loan, you will need to provide these documents:

Bank statements proving the ability to pay a down payment

Proof of two established credit accounts (i.e. car loan and a credit card)

Valid government-issued ID, such as a driver's license or passport

Proof of a Social Security number (i.e. social security or taxpayer’s card)

Original pay stubs, W-2 forms, or valid tax returns from the past two years

Signed and dated letters indicating the source and amount of any monetary gifts—these must explicitly state the money does not need to be repaid

Though the process is fairly straightforward, you will need to hire a consultant. All 203(k) loan programs require that an approved consultant supervise the project. If you’re looking for someone to fill this role, the U.S. Department of Housing and Urban Development has a list of

approved FHA 203(k) consultants

in your area.

MORE:

Can you negotiate upgrades on new construction homes?

What are the pros and cons of FHA construction loans?

Like with all loans, FHA construction loans have their upsides and drawbacks.

Pros

FHA construction loans are well-liked for a few key reasons:

Available to borrowers with a lower credit score

Lower down payment requirement compared to conventional construction loans

The one loan will fund the purchase and renovation of a property, or purchase property and building a home from the ground up

Cons

That said, FHA construction loans have their drawbacks:

Borrowing limits may not cover the costs of your project

Borrowers are required to pay for mortgage insurance

Alternatives to an FHA construction loan

Even if an FHA construction loan doesn’t meet your needs, there are other options offered through private construction lenders, federally-backed programs, or government-sponsored programs.

Some of the most common alternatives to FHA construction loans are:

Conventional construction loan: You’ll need to make a downpayment of twenty percent or more and meet a more extensive list of requirements. However, these loans can cost less for high credit score borrowers

State and local programs: Typically offered to low and moderate-income borrowers

Fannie Mae and Freddie Mac construction loans: These private loans help finance new construction and renovation projects

USDA construction loan: These construction-to-perm loans are available for low to moderate-income borrowers whose projects are in an

eligible rural area

VA construction loans: Open to military members and veterans, these loans do not require down payments or mortgage insurance and will often have low-interest rates

Finding affordable home insurance

Mortgage insurance is required to obtain an FHA construction loan. Even after your project is finished, having an insurance policy to protect your house in the case of disaster will likely win you a better payment on your mortgage insurance.

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FAQs

What is a permanent loan taken out after a construction loan?

When your construction project wraps up, the money you borrowed as a construction loan will be transferred into a permanent mortgage loan. This loan will be paid off over time like any other mortgage loan.

What are the requirements to get an FHA construction loan?

No matter the type of FHA construction loan you opt for, there are a few key requirements you’ll need to meet:

Credit score must be 580 or higher

A debt-to-income ratio that is 43 percent or lower

Minimum down payment of 3.5 percent—alternatively, if your credit score is below 580, a minimum down payment of at least ten percent

Confirm that the desired loan amount does not exceed any FHA loan limits

If applicable, documentation proving that your project will be done with a licensed contractor

Do FHA loans require homeowners insurance?

No! FHA construction-to-perm loans require you to have mortgage insurance, not homeowner’s insurance. However, having homeowner’s insurance will likely get you a better rate on your mortgage insurance. Not to mention that your new home will be protected from unexpected damages.

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