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A Federal Housing Administration (FHA) loan is the only home mortgage insured by the government in the USA. It is one of the largest construction mortgage insurers in the world and is part of the U.S Department of Housing and Urban Development (HUD). FHA provides mortgage insurance on loans given by FHA-approved lenders.
FHA is known for its low-cost down payments and credit score requirements more than any loan lender. They provide loans for buying a home, building a new property, or rehabilitating an existing home.
This article discusses the features, types, and basic requirements to get an FHA construction loan.
Features of FHA Construction Loan
- FHA loan system is mainly designed to help low-to-moderate-income families attain homeownership. They are considered the best choice for first-time home buyers.
- FHA does not directly lend anyone money for a construction mortgage. Based on the approval for the loan, a bank or any financial institution that works for FHA issues the loan amount.
- The details of FHA lenders are provided on the FHA website. Each lender differs based on their interest rates, customer support, and the ease of the application process.
- In this mortgage system, the FHA guarantees the loan. This guarantee makes bank approval easy as the lender takes less risk. Because of this, it is called an FHA-insured loan.
- A person who qualifies for an FHA loan is initially required to purchase the mortgage insurance, and the premium payment goes to FHA. This insurance premium is used by FHA for mortgage insurance programs to benefit homebuyers, renters, and communities.
- An FHA loan requires the loan qualifier to pay two mortgage insurance premiums (MIPs)-upfront MIP and annual MIP. These premiums are paid monthly.
- These insurance payments are deposited into an escrow account owned by the U.S. Treasury Department. If the person defaults on their mortgage, the funds go to the mortgage repayment.
Types of FHA Construction Loans
The two main types of FHA construction loans are:
- Construction-to-permanent loans or one-time close loans
- 203(k) rehabilitation loans
1. FHA’s Construction-to-Permanent Loan
The FHA’s One-Time Close Loans are designed for buyers planning to build a new property. Here, the buyer obtains both a construction loan and a permanent mortgage at the same time. During the construction phase, only the interest needs to be paid. Once the construction is complete, the lender converts the construction loan to a permanent mortgage for 15 to 30 years. This then becomes a regular home loan, and it is closed at once.
2. FHA’s 203(k) Rehabilitation Loans
This type of loan is designed for buyers purchasing an existing home. The loan is used for minor renovation works.
Requirements for FHA Construction loans
The criteria to obtain FHA construction loans are given in Table-1.
|Construction-To-Permanent Loan||203(k) Rehabilitation Loan|
|The contract must be made with a builder who is a licensed general contractor.||The bids and contracts for renovation works must be prepared by approved contractors. The documents must detail the renovation type, cost, and timeline of the project.|
|Must own or purchase the lot on which the planned property is built.||Must be the owner and primary occupant of the property planned for rehabilitation.|
|Must pay at least 3.5% down payment ( FHA minimum)||Must pay at least 3.5% down payment ( FHA minimum)|
|Must pay upfront and annual mortgage insurance premium||Must pay upfront and annual mortgage insurance premium|
|A credit score of at least 500 is eligible for a limited loan and for maximum financing, a score of 580 or above is required, depending on the lender.||A credit score of at least 500 is eligible for a limited loan, and for maximum financing, a score of 580 or above is required, depending on the lender.|
|Must not have any delinquencies or defaults on an FHA loan in the last three years||Must not have any delinquencies or defaults on an FHA loan in the last three years|
|Must perform only the eligible activities approved by HUD|
Pros of FHA Construction Loan
- FHA construction loans are accessible to individuals with credit scores as low as 500.
- FHA demands a lower down payment (around 3.5 percent) than conventional construction loans.
- FHA loan can be used to purchase a home or renovate or build a new property.
Cons of FHA Construction Loan
- FHA construction loan allows borrowing a lesser amount compared to conventional construction loans.
- All FHA construction loans require the borrower to pay for mortgage insurance.
If one is planning to choose an FHA loan, it is essential to find a lender, builder, and contractor experienced with these unique types of FHA construction plans as FHA demands additional paperwork and documentation before the loan approval.
A Federal Housing Administration (FHA) loan is the only home mortgage insured by the government in the USA. It is one of the largest construction mortgage insurers in the world and is part of the U.S Department of Housing and Urban Development (HUD).
The two main types of FHA construction loans are construction-to-permanent loans or one-time close loans and 203(k) rehabilitation loans.
The benefits of FHA loans over conventional construction loans are:
1. FHA construction loans are accessible to individuals with credit scores as low as 500.
2. FHA demands a lower down payment (around 3.5 percent) than conventional construction loans.
3. FHA loan can be used to purchase a home or renovate or build a new property.
What is Construction Mortgage?