When many people think of the Federal Housing Authority, also known as the FHA, they think of traditional home loans for low income families in HUD homes. However, the federal government will also finance custom home projects in certain situations. Typically referred to as construction loans, these FHA mortgages pay for both the structural construction of a home as well as the cost of the home and property involved.
Differences
One of the things borrowers will notice with an FHA construction loan is the fact that an insurance premium is required immediately. Because these types of loans involve construction, it raises the risk of the loan far more than conventional home financing that already has a built home to use as collateral. Also FHA construction loans have looser rules than traditional home loans financed by the federal government. 
They need to; construction requires some flexibility at times as changes come up midstream trying to complete the project.
Figuring out how much borrowing will occur can be a bit of a guessing game unlike built homes. No construction project is exactly the same even if building the same kind of house. This is because materials as well as contractor services can vary with resource markets and fluctuating prices. It’s a good idea to develop a budget plan with an experienced construction manager so that the potential lender feels comfortable with the estimates for the loan amount.
Federal construction loans can be used on existing homes where the project involves some kind of a renovation or extension of the existing home. In such cases, the FHA loan will finance the project and will likely use the existing home as collateral to ensure repayment.
Application Criteria and Process
In some respects, FHA construction loans will be similar to traditional home loans in the application process. A borrower will still need to provide an extensive amount of personal data and financial information. Much of this data is either to provide contact information for followup should there be payment problems later on as well as screening elements to weed out bad applicants.
A borrower’s good credit rating is also an important requirement. A construction loan is no different than a traditional home loan; both are asking someone to lend money and take a risk on a promise of repayment. However, FHA loans in general tend to be easier to get than private home loans. That said, if a person already has a bad past record with previous loans or has a record of bankruptcy, then approval can very well be denied outright.
Ultimately, even an FHA construction loan will use the financed property and eventual structure as collateral for the loan. So the property parcel and location information will be required as well. A number of assessments and appraisals will take place over the life of the project until the home is finished. Each one will assess and report the value of the construction until finished, reporting back to the lender for evaluation.
Some FHA loans work in a two-step process rather than one. An initial loan will be provided to pay for the construction phase. Once it is completed, a second loan will be processed to actually finance the cost of the work and the final cost of the finished house. The second loan incorporates the building cost loan as well as the final expenses for fees, permits, and taxes. The second loan becomes the end mortgage the homeowner will pay until paid off years later.
Benefits
The clear advantage of an FHA construction loan over other private financing is the fact that federal home loans are far cheaper. Because the federal government is underwriting the financing, a processing lender’s risk is limited. This in turn lowers the interest rate charged on such loans, which can be a significant cost savings over the life of such a mortgage.
Additionally, approval criteria on FHA loans tends to be easier, so for those with less-than-stellar credit records getting a home loan can be much easier. Many FHA loans are designed for lower income borrowers to get into homes, specifically providing aid to borrowers who would otherwise never qualify on an income basis.
