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Whether you want to build the home of your dreams, or fix up and live in a property, one of your main questions may be how to pay for it. There is an option that allows you to pay for it with an average credit score — and a relatively small down payment.
This option is an FHA Construction Loan.
In this article, we’ll break down an FHA Construction Loan as well as alternative options so that you can get a property of your dreams financed.
What is an FHA Construction Loan?
A FHA construction loan allows you to roll the costs of building or renovating a home into a single FHA mortgage loan.
The FHA construction loan, backed by the Federal Housing Administration (FHA) covers expenses such as the purchase of the land and construction fees.
There are two different types of FHA construction loans. We’ll explore each in depth next.
FHA Construction Loan Types
The FHA 203(k) Rehabilitation Loan
The FHA 203(k) rehabilitation loan is suitable if a property needs a fair amount of renovation.
It allows you to finance the purchase or refinance along with the renovation of a “fixer upper” home through the same mortgage.
The loan allows you to roll up to $35,000 into the mortgage to cover:
- additional renovations
Depending upon the amount of rent you’re receiving, you could even live rent free.
The FHA Construction-to-Permanent Loan
The FHA’s construction-to-permanent loan is designed for buyers looking to build and finance a new property.
The loan pays for the construction of the home, and when completed, it turns into a permanent loan that the homeowner pays month to month.
Advantages of a FHA Construction
It can be used if you are an investor purchasing a property to house hack that needs renovations or if you are a homeowner seeking funds for updating the house.
Disadvantages of a FHA Construction Loan
You may have to pay mortgage insurance when you close on the property and pay an annual premium that is paid monthly.
How FHA Construction Loans Work
When you take out an FHA construction loan, you will need to work with a licensed contractor or builder.
Your lender will ask for an appraisal of the property to make sure the building and materials meet with the FHA's property standards.
If you are building a new home, you will request “draws” to pay the builder according to a schedule that is set before the closing.
When the construction is completed, your loan will be converted into a permanent mortgage.
Applying for an FHA Construction Loan
You are required to have:
- credit score of 580 or above
- debt-to-income (DTI) ratio of 43% or below
You will need a 10% down payment, or just 3.5% if the project is HUD-approved.
Keep in mind the FHA construction loan amount cannot exceed area limits.
To get started, look for a 203k consultant in your local area.
Alternatives to an FHA Construction Loan
If you are looking for financing with different advantages and disadvantages, here are some alternatives to an FHA construction loan:
- A conventional construction loan
- State and local programs
- Fannie Mae and Freddie Mac construction loans
- USDA construction loans
- VA construction loans
You may also qualify for a private construction loan with better terms.
The Bottom Line: FHA Construction Loan
FHA construction loans provide the opportunity to build your dream home.
FHA construction loans also provide the opportunity to purchase a property that needs renovation at a good price and fix it up. For those looking to make extra income, you can then house hack your way to paying off the property — and even live rent free.
Whether or not you choose to utilize a FHA construction loan, ensure that you understand the intricacies of the loan you do choose.