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Credit score needed for a construction loan explained

credit score needed for a construction loan

While there is no one credit score that is required for construction loan approval, lenders typically tend to favor applicants with higher scores and a clean credit history. Purchasing a home is a huge financial endeavor, now more than ever. Since 1999, the average value of a home has more than doubled from $111,100 to over $231,000!1 With home values skyrocketing like that, it’s no wonder so many people seek out financial assistance when it comes to purchasing their homes. If you are looking for assistance with purchasing, building, or renovating a home, you may be wondering what is the credit score needed for a construction loan? 

Here you will learn about construction loans, the FHA, and funding alternatives to consider so you can build or repair your home to your unique preferences. 

Credit Scores and Construction Loans 

Credit Score RangeImpact on Construction Loan Eligibility Typical Interest RatesDown Payment Requirements Additional Considerations 
750 and aboveHigh eligibility; most favorable terms. Lowest available rates. Minimum required (often 3.5-5%).May qualify for premium loan products with additional benefits. 
700 – 749Good eligibility; favorable terms. Lower interest rates. Standard down payment (5-10%).Good balance of rates and terms; some negotiation power. 
650 – 699Moderate eligibility. Moderate interest rates. Higher down payment (10-15%). May require additional documentation or a co-signer. 
600 – 649Limited eligibility. Higher interest rates. Higher down payment (15-20%). Lenders may require additional collateral or guarantees. 
Below 600Low eligibility; restrictive terms. Highest interest rates. Substantial down payment (20% or more). Often requires significant compensating factors like a larger down payment or a co-signer. 
Disclaimer: Please note that the information provided in the chart above is for general informational purposes only and should not be considered as financial advice. Credit requirements and loan terms can vary significantly between lenders and are subject to change based on market conditions and individual financial circumstances. It is recommended to consult with a financial advisor or loan officer for personalized advice and the most current information.

What Is the FHA?

The Federal Housing Administration, or the FHA, is an organization that insures mortgages provided by FHA-approved lenders. Being part of the U.S. Department of Housing and Urban Development’s (HUD) Office of Housing, the FHA insures mortgages for: 

  • Single-family homes.
  • Multifamily properties. 
  • Residential care facilities. 
  • Hospitals.  

The FHA was established in 1934 to service residents of the United States and its territories. About 30 years later, the FHA became part of the Department of Housing and Urban Development in 1965. Since its inception more than 85 years ago, the FHA has helped more than 50 million people with insurance on their mortgages.2 

What Is an FHA Construction Loan?

An FHA construction loan is similar to a traditional FHA loan, except funds are used for construction, not a mortgage. An FHA construction loan gives borrowers more than just a traditional mortgage. It allows them to build their dream home without paying for it with several confusing loans. FHA construction loans generally come in two forms, one-time close loans, and 203(k) loans. 

FHA One-time Close Loans

FHA one-time close loans offer borrowers financing for construction, a lot purchase (if needed), and a permanent mortgage. Typically, all of these costs would be covered under separate loans, accruing separate interest charges, and have separate closing dates. But with the FHA one-time close loan program, all of those costs are covered under one loan. The one-time close loan program also comes with a defined set of rules for how the loan is handled before, during, and after the construction phase. 

 Under this loan program, borrowers can pay for the following: 

  • One-unit, stick-built primary residences. 
  • New manufactured housing for primary residences. 
  • Modular homes. 

Single-wide mobile homes are unfortunately excluded from the FHA one-time close loan program. 

FHA Construction-to-Permanent Loan

The FHA construction-to-permanent program is intended to give contractors a seamless construction process and borrowers a convenient way to purchase everything they need for their dream home under a single mortgage. 

Both sellers and builders can contribute up to 6% toward the borrower’s closing costs or other prepaid expenses. After that, any contributions made will be reduced, dollar-for-dollar, from the borrower’s original construction loan amount.  

FHA 203(k) Construction Loan 

An FHA 203(k) Construction Loan, also called an FHA 203(k) Rehabilitation Mortgage, is used for the purpose of repairing or renovating a home/residence. Furthermore, an FHA 203(k) renovation loan may also be used to purchase or refinance a property or residence that is in need of repairs or renovations. 

While there is no minimum repair cost FHA borrowers must meet in order to qualify for a 203(k) rehabilitation loan, there are restrictions on the type of work that is covered under this limited loan program. 

FHA 203(k) loans and one-time close loans also share a few core similarities; they are: 

  • Both loans can be used to pay for major renovations such as load-bearing walls. 
  • Both loans prohibit cash out for the borrower, which means all the funding used as a draw or paid out of escrow must be intended for specific expenses that are directly related to the borrower’s construction project.  
  • Borrowers may have to live elsewhere during construction under each loan type. 
  • Under both loans, the borrower will negotiate interest rates and agree upon a construction project timeline with the lender. 

Do You Need a Good Credit Score To Get FHA Construction Loans?

When it comes to any type of loan, the higher your credit score, the more likely it is that you will receive loan approval with a higher loan amount, lower interest rates, and more flexible repayment terms. However, that doesn’t mean you can’t qualify for an FHA construction loan if you have less-than-perfect credit. 

In order to qualify for a loan with a low 3.5% down payment, borrowers must have a minimum credit score of 580. Borrowers who do not meet that requirement are required to contribute a 10% down payment, which may make it more challenging to find construction or home repair loans with bad credit

Ways To Boost Your Credit Score for a Construction Loan

If you have a credit score of 500 or lower, you may want to hold off on submitting your FHA construction loan application until you can bump your score up. That way, you have a better chance of qualifying for competitive construction loan rates and a decent loan amount. 

You can also take advantage of the tips below for some assistance with improving a bad credit score before applying for an FHA loan.

Check Your Credit Report

Before you apply for your FHA construction loan, take a look at your most recent credit report and make sure everything is accurate. Look out for inconsistencies, evidence of someone taking out a loan or opening an account in your name, or false late or missing payment records. Some borrowers experience problems during their application process because of faulty errors found on their Equifax, Experian, or TransUnion credit reports. You can potentially boost your credit by several points or more just by having incorrect information removed from your credit report! 

You can get a copy of your credit report for free once a year from each of the three major credit bureaus. Or, you may check your unofficial credit report for free at any time with most bank account or credit card providers. 

Sign Up for Reward Programs

If you have subscriptions like Netflix or Hulu, you may be able to use those to help boost your credit! Reward programs like Experian Boost take subscription payments and other bills and add them to your credit report. That way, you can benefit from making all of your payments on time. 

Clean Up Your Existing Debt

Another way to boost your credit is to focus on paying off your debt. The less debt you have, the better your debt-to-income ratio will be, making you more appealing to lenders. One of the most effective ways to make sure you stay on top of your monthly debt payments is to sign up for automatic payments. That way, you know all of your payments are being made in full and on time! 

Other FHA Construction Loan Requirements

Below are other factors lenders take into consideration before approving borrowers for FHA construction loans. 

Debt-to-Income Ratio

When determining approval for your loan, a construction loan lender will look at your debt-to-income ratio. Your debt-to-income ratio refers to your income compared to how much debt you owe. The reason lenders look at your income and debt is to ensure that they do not grant approval for a loan or construction loan payments that borrowers cannot afford. 

Down Payments

FHA one-time close loans have a minimum down payment of 3.5% of the total purchase amount. This minimum is also up to the borrower’s FHA county lending limit. Sometimes, borrowers may be able to forgo a down payment if they are landowners of property that has positive equity and that property is the intended site of the borrower’s home construction. In other words, if the borrower plans to build their home on a piece of property with positive equity, they may not have to contribute a down payment. 

With the 203(k) loan option, borrowers may apply for financial assistance for their down payment. Most other FHA construction loans, such as the FHA one-time close mortgage, VA construction loans, and USDA construction loans, do not offer assistance when it comes to the down payment. 

Maximum Loan Amounts

FHA loans also have restrictions as to how much funding they can provide. Maximum loan amounts for construction loans can vary depending on the state you live in. 

Alternative Home Construction Loans

Whether you are looking for a long-term or short-term construction loan, the funding options below may be able to provide you with the money you need. 

Personal Installment Loans

Personal installment loans are one of the most versatile personal loan types available for borrowers with just about any credit. Unlike 203(k) construction loans, personal installment loans pose no restrictions as to what type of construction or repairs qualify for funding, which gives borrowers the freedom to use their funding for just about anything they want! 

Credit Unions

Credit Unions are a type of nonprofit organization that provides loans to its members. Since credit unions only provide loans to their members, you will have to join if you want to seek out funding. In order to join a credit union, you may have to meet requirements like: 

  • Living in a specific area. 
  • Working in a particular field. 
  • Having a certain credit score. 

VA Construction Loan

A VA loan is funding intended specifically for veterans. Veterans often have difficulty finding good deals on funding due to factors like a lack of credit history or a lower credit score. VA loans seek to rectify this issue by providing financing designed specifically for veterans.  

USDA Construction Loan

A USDA loan is funding backed by the United States Department of Agriculture, also known as the USDA. This type of funding is meant to help people with a low to moderate-income in small communities looking for loans with low down payments and interest payments. 

State or Local Funding

There are also state and local programs designed to help people in need when it comes to home repair or construction. Low to moderate-income borrowers can rely on sources like their state government, nonprofit organizations, or their local housing authorities for help with home repair or construction funding. 

FAQ: Construction Loans and Credit 

How does a construction to permanent loan differ from a traditional mortgage in terms of credit requirements?

A construction to permanent loan often has more flexible credit requirements compared to a traditional mortgage. This is because the loan transitions into a permanent mortgage, providing more security to the lender.

What factors, besides credit, do lenders consider for a new construction loan?

Lenders for a new construction loan typically look at your debt-to-income ratio, employment history, and the potential value of the completed property, in addition to your credit.

Can future homeowners borrow money through a construction to permanent loan with moderate credit?

Yes, future homeowners can borrow money through a construction to permanent loan even with moderate credit scores. Lenders may require other strengths in your application, such as a lower debt-to-income ratio or a larger down payment.

How do construction loans work for individuals with lower credit scores?

Individuals with lower credit scores might find construction loans work by offering higher interest rates or requiring a larger down payment. Some lenders might also suggest a co-signer to improve loan terms.

What is the role of a loan officer in helping applicants with varied credit scores secure a construction to permanent loan?

A loan officer assists applicants in understanding the requirements for a construction to permanent loan, including how credit scores affect loan terms, and helps find the best loan options based on the applicant’s financial situation.

How does gross monthly income impact the approval process for a conventional construction loan?

For a conventional construction loan, your gross monthly income is crucial in determining your debt-to-income ratio, a key factor lenders use to assess your ability to repay the loan.

How do closing costs for an FHA loan compare to those of a permanent mortgage in typical construction loans?

In a typical construction loan scenario, closing costs can vary widely. However, for an FHA loan, these costs are often lower compared to a permanent mortgage in traditional construction loans. This is because FHA loans are designed to be more affordable, with specific guidelines set by the government to keep costs within a reasonable range.

A Word From CreditNinja About Credit and Construction Loans 

CreditNinja always encourages you to check your credit before applying for any type of loan, including construction loans. That way you can start researching the right type of lender who offers products that will work well for you. 

Want to learn more about online loans, handling your finances, and more? Head on over to the CreditNinja blogroll for hundreds of free resources! 

References:
1. Median Home Values by State | Experian
2. Federal Housing Administration | HUD.gov / U.S. Department of Housing and Urban Development (HUD)
3. FHA One-Time Close Construction Loans in 2022 | FHA
4. FHA Credit and Your FHA Loan in 2022 | FHA
5. 2022 FHA Loan Lending Limits | FHA
6. FHA Construction Loans Compared With FHA 203(k) Rehab Loans | FHA

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