Can You Buy Land with an FHA Loan?

With the U.S. real estate market still booming, we have been getting a lot of questions about buying land with FHA loan programs, so we thought it was time to reveal our knowledge. When considering the purchase of land, prospective buyers often look for financing options that offer favorable terms and conditions. The Federal Housing Administration offers a government insured FHA loan that is a very popular choice for many homebuyers due to its lower down payment requirements and more lenient credit standards. However, when it comes to buying land, the rules and limitations of FHA mortgages become a crucial factor to understand.

Can You Purchase Land with FHA Loans?

Technically yes, but the answer is more complex. FHA loans are primarily intended for the purchase of owner-occupied homes, meaning the loan is designed to help you buy a house that you will live in as your primary residence. Therefore, using FHA financing to buy land alone, without any immediate intention to build a home, is generally not permitted. However, there are specific circumstances under which you can use an FHA loan to buy land. Learn more about FHA financing from the Dept, of Housing and Urban Development.

FHA Construction Loans

One way to use an FHA loan to buy land is through an FHA construction loan, also known as an FHA construction-to-permanent loan. According to the RefiGuide, FHA construction loans allow a borrower to purchase land and finance the construction of a new home on that land. The FHA construction loan combines the cost of purchasing the land and building the home into a single mortgage, which can simplify the financing process.

Key Features of FHA Construction Loans:

• Single Closing: The FHA construction loan closes once, reducing the complexity and costs associated with multiple loan closings.
• Interest-Only Payments: During the construction phase, you may only need to make interest payments, making it more affordable until the home is complete.
• Loan Conversion: Once the construction is complete, the FHA construction loan converts into a standard FHA mortgage with regular monthly payments.

To qualify for an FHA construction loan, you must meet the standard FHA loan requirements, including a minimum credit score and a down payment. Additionally, the property must meet specific FHA standards, and the construction must be completed by a licensed contractor.

The Federal Housing Administration allows all these construction costs to be consolidated into a single loan, requiring only a minimum down payment of 3.5%, all accomplished with one closing. This type of loan is called an FHA One-Time Close construction-to-permanent loan. Purchasing land with an FHA mortgage is done in conjunction with an FHA construction loan, which is commonly used for new home construction, including stick-built, modular, and manufactured homes.

Buying Land and Building Later

Another scenario where you might use an FHA loan to buy land involves purchasing a lot with the intent to build a home later. However, this approach can be more complicated. The FHA does not typically allow loans for raw land purchases without immediate plans for construction. Instead, you would need to have a clear and actionable plan to build a home on the land in the near future.

Steps to Buying Land and Building Later:

1. Create a Construction Plan: Develop a detailed plan for constructing your home, including timelines and estimated costs.
2. Secure Builder Approval: Find a builder who is willing to work within FHA guidelines and get their approval for the project.
3. Apply for a Construction Loan: Initially, you might need to secure a short-term construction loan to purchase the land and start construction.
4. Convert to FHA Financing: Once construction is underway or completed, you can then apply to convert the construction loan into a permanent FHA mortgage.

Alternative Home Construction Financing Options

If you are set on purchasing land without immediate plans to build, you might need to explore alternative financing options. Here are a few alternatives to consider:

1. Land Loans: Some lenders offer specific loans for purchasing land. These loans can be more challenging to obtain and often come with higher interest rates and shorter repayment terms than traditional mortgages.
2. Home Equity Loans: If you already own a home with substantial equity, you might use a home equity loan or line of credit to finance the land purchase.
3. Seller Financing: In some cases, the seller might be willing to finance the purchase of the land, allowing you to make payments directly to them instead of through a traditional lender.
4. Personal Loans: Depending on the cost of the land and your financial situation, a personal loan might be an option. However, personal loans typically have higher interest rates and shorter terms than mortgages.

Requirements for FHA Construction Loans

If you decide to pursue an FHA construction loan to buy land and build a home, you’ll need to meet several requirements:

1. Credit Score: Generally, a minimum credit score of 580 is required for an FHA construction loan, though some lenders may require higher scores.(most banks are looking for 640 credit scores)
2. Down Payment: A down payment of at least 3.5% of the total loan amount is needed. This includes both the cost of the land and the construction expenses.
3. Debt-to-Income Ratio: Lenders typically look for a debt-to-income ratio of 43% or lower.
4. Income Verification: You must provide proof of steady income and employment history.
5. Licensed Builder: The construction must be carried out by a licensed and FHA-approved builder.
6. Property Requirements: The home must meet FHA property standards and local building codes.

Advantages and Disadvantages of Using an FHA Loan for Land and Construction

Advantages:

• Lower Down Payment: FHA financing requires lower down payments than conventional loans, making them accessible to more buyers. Ask about 3.5% down payment requirements.
• Flexible Credit Requirements: More lenient credit requirements can benefit those with lower credit scores. Many approved FHA mortgage lenders approve a 580 credit score.
• Combined Financing: The ability to finance both land purchase and construction in one loan simplifies the process.

Disadvantages:

• Mortgage Insurance: FHA mortgages require both upfront and annual mortgage insurance premiums, which can increase overall costs.
• Property Requirements: Strict property standards must be met, which can limit your choices in land and home design.
• Limited Use: FHA home loans cannot be used for raw land purchases without immediate construction plans. Also ask about FHA refinancing.

What is an FHA Mortgage?

An FHA-loan is a mortgage insured by the FHA, designed to help lower-income borrowers obtain home financing. FHA home loans are known for their lower down payment requirements sometimes as low as 3.5% and more flexible credit score criteria compared to conventional loans. These features makes FHA financing particularly attractive to first-time homebuyers or those with less-than-perfect credit.

What is the FHA 203K Loan?

The standard FHA 203(k) program requires a consultant to oversee your project from start to finish. This 203(k) consultant is licensed and typically has a background in home inspections, engineering, or architecture. You can find a consultant in your area by reading more at the HUD FHA 203k website published by the Department of Housing and Urban Development.

Summary of Buying Land with FHA Loans

While you generally cannot use an FHA home loan to buy land alone, you can leverage FHA construction loans to purchase land and build a home simultaneously. This combined financing option offers several benefits, including lower down payments and more flexible credit requirements. However, it also comes with specific requirements and potential drawbacks. If your goal is to buy land without immediate plans to build, exploring alternative financing options may be necessary. By understanding the intricacies of FHA home loans and the available alternatives, you can make an informed decision that aligns with your financial goals and homeownership plans.

Smart Lending will help you find construction lenders that offer land loans and home construction financing that best meets your needs.