If you are in the market to build a house, you have unique mortgage needs. Because no lender can provide you with an actual mortgage until there is a house to live in, you need temporary construction financing first to even build the house.
This type of financing can be a bit more difficult to find because of the risk involved, but there is an FHA loan that you can use. It’s called the construction-permanent FHA loan.
What is a Construction-Permanent Loan?
A construction-permanent loan provides you with two types of loans all in one process. You only have to qualify for the loan once and attend one loan closing. The first part of the loan is the temporary or short-term loan. These funds cover the cost of constructing the home including the labor and supplies.
The second part of the loan is the permanent financing, which is your standard mortgage. This is the financing you are likely used to as you can secure 30-year financing for the cost of the home. However, when you build your own home, you need the funds to help pay for the land, supplies, and the contractors to build the home. You can use the construction portion of the loan to purchase the site as well, if you have not already bought it with other funds.
How the Construction Loan Works
The first part of the loan is the most confusing. You will apply for the funds necessary to build the home. The builder will provide you with a contract, which the FHA lender must approve. The FHA lender will then approve you for a loan for that amount, if you qualify.
You attend a closing before any construction activity starts on your home. Rather than the funds getting disbursed right away to the builder, as would happen in a standard developer purchase, the lender puts the funds in an escrow account. Prior to the closing, the lender would have created a disbursement schedule in conjunction with the builder. The lender will then disburse the funds after the closing according to that schedule. However, they will not disburse the funds until they conduct the necessary inspections to make sure the agreed upon work has been completed according to the contract.
Transferring to a Permanent Mortgage
Your FHA loan does not become a permanent mortgage until the construction is complete and the final inspection by the lender or independent agent is done. There also needs to be a Certificate of Occupancy to ensure that the home is livable.
At this point, the loan becomes a permanent mortgage. All funds would have been disbursed by this point. If there are any leftover funds, the lender will apply them to the principal balance of the loan. You cannot receive any cash in hand when it’s all said and done.
Paying the Construction Loan
One of the benefits of the construction portion of the FHA loan is how you pay it. You do not have to pay back any principal during the construction period. You only pay interest on the funds that have been disbursed up to that point. This does mean that your monthly payment will vary from month-to-month, but because it’s interest only, the payments are kept to a minimum.
Once the loan converts to a permanent mortgage, you will pay principal and interest as you would on any other FHA loan.
Qualifying for the FHA Loan
Qualifying for an FHA construction loan is just like qualifying for any other FHA loan. The FHA requires the following:
- 580 credit score
- debt ratio
- Stable 2-years of employment/income
Because of the risk this loan poses, though most lenders require higher credit scores and are a bit stricter with the debt ratio requirements. You may have to check with several lenders before you find one with terms that you can afford.
If you want to build a house, FHA financing may be an option for you. With their one-time close process, it certainly makes paying for new construction much easier. Because the process is more detailed, you’ll want the help of a third party to ensure that all aspects of the building and loan process go as smoothly as possible.