People who want to get a FHA or VA construction loan are usually in an exciting time of life. Building your own home or rehabbing your home is a great way to enjoy the American dream of home ownership. The purpose of this article is to review how VA and FHA construction loans work. With this basic understanding, you will be better prepared for your home construction or rehabilitation project.
Types of FHA Construction Loans
- Construction and permanent mortgage loan: This is a loan that you can use for both construction and for the permanent mortgage once the home is complete.
- 203k rehab mortgage: This type of rehab loan can be suitable if you are refinancing or buying a home that is in need of repair or rebuilding.
The big advantage of these FHA construction loan programs is that they put the purchase and construction costs into a single loan. So, rather than borrowing with a short-term loan and then repaying the loan and getting a permanent mortgage, you are just doing the entire loan process one time. This means a lot less paperwork, stress, as well as lower fees and closing costs.
An FHA-backed construction-permanent loan is both a construction short term loan and a long term residential mortgage. This type of loan is usually needed for the home buyer who buys a plot of land himself and uses a contractor to build the home. Closing on the loan happens before the construction of the house starts, such as when the land purchase is finalized. Funds for the construction project are put into an escrow account. They are then released in stages are milestones in the construction process are met. This will typically involve several inspections done by an independent party to check on progress. FHA usually has a final inspection required to verify that construction has been done properly.
Major advantages of the FHA construction loan are:
- Down payments as low as 3.5% in many cases depending upon your credit and income
- Pay interest only while the home is being constructed
- Easier qualification for people who have at least a 620 credit score
- Some lenders may allow a higher debt to income ratio
An FHA construction loan requires you to have the land for six months or less when you apply for the loan. After the loan closes, the lender disburses fund from the construction loan over time. The 203K loan rates remain competitive as well.
An FHA 203k loan comes in two different types, depending upon your project needs:
- A streamlined FHA loan that offers as much as $35,000 in upgrades and repairs. It is common for example for a home buyer to obtain this money to do things to make the home more livable, such as remodel the kitchen, paint the entire interior and buy new carpeting.
- A standard FHA loan for bigger projects and can be done either with an original purchase or refinance. Even if the home has to be torn down and completely rebuilt, it is possible to get this type of FHA 203k loan.
To qualify for a 203k loan, you need to be an owner/occupant of the property. This type of loan can be used on properties from one to four units. It is required to borrower at least $5000, and you can borrow enough to finance 110% of the home’s expected value after you improve it. The interest rate on this type of loan will be a bit higher than on a standard loan. This is partly because lenders have to spend more time and money keeping track of the project and handling how money is paid out.
The 203k loan must use licensed contractors to complete the work, and they will need to know early on that you are using a 203k FHA loan. The FHA process requires certain paperwork and rules so you will need to work with a contractor who is familiar with the FHA way of things.
FHA borrowed funds is often one of the most affordable ways to have rehab work done on your property. But remember that you will have to pay for mortgage insurance and you have to pay fees for each of your monthly payments. Before you get too excited, check with a loan officer to make sure that you meet the FHA-loan requirements for this type of construction loan.
VA Construction Loans
Building a home with a VA construction loan is possible but can be challenging. Borrowers can use their VA entitlement to get a mortgage to build a new property, but it can be difficult to find a lender that will issue a VA construction loan. This is more difficult now in the wake of the housing and mortgage crisis of a decade ago.
However, what is happening more often now is veterans who want to build their own home get a construction loan through a local builder. Then as the home building process is completed, the borrower can refinance the construction loan into a long term VA mortgage.
Some builders may have special programs for veterans who want to build their own home. Make sure you do your homework on the company and determine that it is a good builder with a long term track record of success. But once the home building process is done, you should not have major difficulty converting that loan to a permanent VA loan. Just be sure that the home has had a VA appraisal and all work was done by a builder with a valid VA builder ID. Of course before making big plans, it makes sense to speak with a loan officer to verify you meet the VA-loan requirements for this type of home rehab program.