Can You Build A Home With an FHA Loan?
Good news: you can take out a single loan to buy a piece of land, build a home from scratch, and get a permanent mortgage on the finished home.
And you can do it without perfect credit or a large down payment.
This three-in-one mortgage is known as the "FHA Permanent Construction Loan". It saves time, hassle and money by funding the entire home construction process with one loan product.
However, these loans can be difficult to find. And the requirements are stricter than traditional FHA loans. So you should know what to expect before you apply.
Check your eligibility for construction loans (April 14, 2021)
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What is an FHA construction loan?
Do you want to build a new home from scratch and simplify the financing process? Check out an FHA home loan, also known as an FHA permanent construction loan.
This loan option includes financing a property purchase, building a home, and a permanent mortgage on the completed home – all in one one-time graduation loan.
Rather than having three separate loans for the purchase of land, home construction, and the mortgage that would require separate paperwork and closing costs, an FHA construction loan simplifies matters by bringing it all into one underwriting process.
These loans are also supported by the federal housing administration.
Advantages and disadvantages of an FHA home loan
"The purpose of this loan is to combat the more expensive and cumbersome traditional home loan program," says Brandon Mushlin of BuildBuyRefi.com.
"Otherwise, you'd have to deal with multiple loans, multiple underwritings from different banks and underwriters, multiple appraisals, multiple fees, and multiple possible changes in economic conditions that could affect the interest rates of the results to get the bottom line," said Mushlin explained.
However, lenders offering FHA homeowner loans are not easy to find – and it can be difficult to qualify.
Standards aren't quite as lenient as they are on a traditional FHA loan. For example, you need a higher credit score. And it involves a lot more paperwork and red tape, making the process longer than a traditional mortgage.
You need to decide whether this loan is right for your needs based on your schedule, budget, credit rating, and other criteria.
Review Your Construction Loan Options (April 14, 2021)
How a one-time FHA construction loan works
A. Donahue Baker, Co-Founder and President of Money Avenue, says there are essentially four steps to building an FHA permanent loan.
“First, you will be qualified by an approved lender. Then your building contractor and general contractor will qualify for the loan. Next, your home design plans are qualified for the loan. Finally, complete the loan and start building your dream home, ”he says.
1. Find the land you are going to build on
When it comes to buying land, you have options.
It could be empty land that you already own and that has paid off. Land with an existing loan from a bank or private party, the balance of which must be paid back upon closing; or land that you would like to contract to be paid out on completion.
"The land shouldn't require demolition of the property or have multiple lots on it," warns Richie Duncan, senior loan officer for Nationwide Home Loans Group.
2. Get pre-qualified for funding
Before you can finalize your budget and blueprints, you need to get pre-qualified with a lender. The prequalification process determines how much you qualify for and what your lender's credit limit is.
"If you haven't already selected the land and owner, your prequalification could expire and market conditions such as rising interest rates could greatly reduce the amount you can borrow," notes Duncan.
Hence, you may want to have a contractor selected before starting the mortgage process.
But understand that you won't know how much you have approved to borrow – or even if you qualify – until you speak with an FHA-approved home loaner.
3. Hire a contractor and make plans
You can start the process without having yet selected a builder. However, the builder you choose must be willing to work with the FHA home loan program ("not every builder will," says Mushlin).
Whenever possible, consider choosing a contractor who has worked with the FHA construction program as this can make the process go smoothly and avoid major problems.
4. Complete the loan process and start building
After your land and building contracts are agreed, a valuation can be ordered to determine the projected value of the property based on a completed home.
“During this time, your credit will be assessed and your land and construction contracts will be drawn up and approved. Your lender will also confirm that you have homeowner insurance, set up your title, and calculate any final numbers for the underwriting, ”says Duncan.
"As soon as the underwriters have signed out, the construction team has signed out, the documents are drawn and you go to the conclusion."
After completing the loan, construction can begin.
Funds from the loan will be held in an escrow account and your contractor will be paid in installments after each phase of construction is completed.
FHA construction loan requirements
Several rules apply to FHA loans for permanent construction, including requirements for the borrower, property, and contractor.
Down payment of at least 3.5%. This is the minimum for FHA fundingCredit score of 640 or higher. Technically, you only need 580 FICO points to qualify for FHA. However, Mushlin says that in his experience, a higher credit score of at least 640 is typically required for the FHA construction programClean credit rating. You must not have experienced bankruptcy in the past two yearsDebt-To-Income Ratio (DTI) below 43%. This means that your monthly debt – including future mortgage payments – will be no more than 43% of your monthly pre-tax income You need to review two years of employment and income. For W-2 borrowers, this means the last 60 days of payroll, the last two years of W-2, and your last two annual tax returns. Self-employed borrowers are required to submit complete personal and business tax returns for the past two years, as well as any related tax plans
In addition, all FHA borrowers are required to pay a Mortgage Insurance Premium (MIP) which protects the lender in the event of foreclosure.
FHA MIP has an upfront cost of 1.75% of the loan amount (which can be placed on the mortgage) and an annual fee typically 0.85% of the loan amount that is paid monthly.
MIP is usually required for the life of the loan. However, homeowners can often refinance to cancel mortgage insurance and lower their monthly payments once they have 20% home equity.
The loan must meet the FHA loan limits. Your total loan amount cannot be greater than your county’s maximum loan limit. In 2021, most counties have a maximum credit limit of $ 356,362The property must be eligible. The types of homes that can be built include single family homes, condominiums in approved projects or legal stages, and prefabricated homes. The main residence of the house must be a condominium. The property must be in an FHA approved areaThe property needs to be inspected. "Inspections must be carried out by ICC-certified inspectors or a third party who is a registered architect or civil engineer," said J. Keith Baker, chairman of the Mortgage Banking and Financial Services Curriculum at Dallas College
Requirements of the contractor
Finally, the FHA must approve the contractors you choose, who require a license, liability insurance, and at least two years of home construction experience
You also need to get a new building guarantee from the builder.
Any funds remaining after construction has started must be transferred directly to your loan capital. You cannot keep them as cashback.
FHA construction lender
Be warned: it is not easy to find FHA construction loans or lenders who offer these loans.
"It is even more rare to find a lender who processes these loans quickly and efficiently and who has a full team," says Mushlin.
Fortunately, you can visit the US Department of Housing and Urban Development (HUD) website to search for FHA lenders, although not all FHA lenders offer FHA construction loans.
Bottom line: If you want an FHA construction loan, you need to be patient and willing to look for the right mortgage company.
This can make the process more complicated than a traditional home builder loan – but there are real benefits for those who do the job.
Interest Rates on FHA Construction Loans
Expect the interest rate you will pay on an FHA permanent construction loan to be higher than other types of loans. "Typically, borrowers often see interest rates that are 2% to 4% higher than current mortgage rates," says Duncan.
In comparison, the interest rate on a conventional construction loan could be around 1% higher than the market interest rate.
Julie Aragon, CEO and Founder of the Julie Aragon Lending Team, says lenders generally view these loans as a greater risk because the house that is usually used as collateral does not yet exist.
"The interest rates on these FHA loans can also fluctuate based on the borrower's creditworthiness and other factors," she says.
FHA Home Loans versus FHA Loans of 203,000
It's easy to confuse an FHA permanent construction loan with another FHA product: the FHA 203k rehab loan. However, these are very different types of mortgages.
The FHA home loan is intended for building land. The mortgage of 203,000 euros is intended for the purchase and repair of an existing upper house.
Like the FHA home loan, the FHA 203 (k) rehab loan is supported by the federal government. and it bundles your home purchase and rehab costs into one loan.
The 203k standard allows you to do some serious structural work – including converting a single family home to an apartment building (or vice versa). But you can't use it to buy land and build a brand new home from scratch.
However, there are advantages to the 203k program. For example, FHA 203k home renovation loans are far more common than FHA permanent construction loans. You will find it easier to find a lender and a low interest rate.
Additionally, the 203,000 loan can be a fixed or floating rate mortgage, your down payment can be up to 3.5%, and you typically only need a 620 credit score to qualify.
Check Your FHA 203k Loan Eligibility (April 14, 2021)
Construction loan alternatives
If you can't find an FHA home builder loan lender or you don't qualify for this program, don't despair. There are other loan options that you can pursue.
“Borrowers can consider a lot of loans to buy the property, as well as a traditional home loan to cover construction costs, and then a traditional mortgage loan to pay for the permanently completed home. However, you don't have the benefit of a single assessment or degree, ”says A. Donahue Baker.
Veterans and active service members can choose a VA construction loan instead, which is very similar to the FHA program. There are some great advantages, however: the Department of Veterans Affairs does not require a down payment, and there is no monthly mortgage insurance.
Alternatively, if you choose a USDA-approved rural area to build, you can qualify for a USDA loan to build a permanent building. USDA does not require a down payment and allows you to combine land purchase, construction costs, and the permanent mortgage loan into one loan product.
The right type of construction loan for you will depend on your location, credit score, down payment, and construction goals.
The interest rates, requirements, and loan amounts can vary widely between home loan programs. So be sure to compare the options and find the best financing option for your new home.
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