If you are building your own home, you have to come up with the financing for it. Unlike when you buy a home from a builder in a subdivision, you are in charge of paying for everything up front. When you buy from a builder, the builder fronts the costs, minus any earnest money they require from you.
Unless you have hundreds of thousands of dollars in cash lying around, chances are you will need some type of loan. Since most lenders aren’t willing to give a mortgage on a home that doesn’t exist yet, your best bet is to try the FHA construction-to-permanent loan.
What is the Construction-to-Permanent Loan?
When you build your own home, you need funds up front to cover the cost of building the home. This is the construction loan part of the process. The lender provides funds to help you pay for the cost of building the home. It helps the builder pay for the materials and the labor necessary to build your home.
Once there is a home and you have the occupancy certificate enabling you to live in the home, you can have a traditional mortgage. As you can see, though, this means two different loans. Usually, that means two loan applications, two loan processes, and two closings. It also means a lot of headaches.
With the FHA construction-to-permanent loan, you have one application, one loan process, and one closing. It’s a simplified process that leaves you with the funds you need to build and live in the home. The lender will provide the funds necessary to pay the contractor to build your home for the construction portion of the loan. Once the home is ready for you to live in, it transfers into a permanent mortgage, which you make regular mortgage payments on, just like any other FHA loan.
How Does the Process Work?
First, you must find a willing FHA lender. Just because a lender offers FHA loans doesn’t mean they will offer the construction loan. Some lenders avoid these types of loans because of their risk. They are lending you money to build a home, which means there’s no collateral for the lender to rely on. If you walked away from the home, you would leave the lender with a large loss.
Once you find a lender, you’ll apply for the loan as you would any other FHA loan. You must prove to the lender that you have:
- Decent credit history with at least a 580 credit score (most lenders require a higher score)
- Low enough debt ratio (31% housing ratio and 41% total debt ratio)
- Stable income
- Stable employment
- Assets to cover the down payment and closing costs
Each lender may have additional requirements depending on the situation. The less risk you pose to the lender, the fewer compensating factors they will require.
Who Can Build the Home?
Since you are borrowing funds to build your home, the FHA lender has a say in who builds your home.
For starters, it can’t be you. Even if you work as a builder, most lenders won’t’ let you build your own home. It’s not that you aren’t qualified to build it, but unless you can prove that you have the time and the resources to do it, the lender will require you to pay a general contractor to build the home.
The chosen contractor must be licensed, prove that he has the experience necessary to build the type of house you want and that he can do so on a relatively short timeline. In some rare cases, lenders do allow you to build your own home, but it’s a rare scenario.
What do you Pay?
Just like the standard FHA loan, you’ll need just 3.5% down on the home. That’s a steal if you think about it, especially since there isn’t any collateral at the start of the process.
In addition to the down payment, you’ll be responsible for the interest payments on the amount borrowed for the construction loan. Once the loan transfers to a permanent loan (once you move into the home), you’ll then pay principal and interest as you would on a standard mortgage.
The FHA construction-to-permanent loan makes it easier for you to build your own home without needing a large down payment. Other programs may offer the construction loan, but for much higher fees and with a much higher down payment. The FHA offers this beneficial program to help middle-income families build their own homes if they so desire.