Mutations in ATP-binding cassette A3 (ABCA3), a phospholipid transporter critical for surfactant homeostasis in pulmonary alveolar type II epithelial cells (AEC2s), are the most common genetic causes of childhood interstitial lung disease (chILD). Treatments for patients with pathological variants of ABCA3 mutations are limited, in part due to a lack of understanding of disease pathogenesis resulting from an inability to access primary AEC2s from affected children. Here, we report the generation of AEC2s from affected patient induced pluripotent stem cells (iPSCs) carrying homozygous versions of multiple ABCA3 mutations. We generated syngeneic CRISPR/Cas9 gene-corrected and uncorrected iPSCs and ABCA3-mutant knockin ABCA3:GFP fusion reporter lines for in vitro disease modeling. We observed an expected decreased capacity for surfactant secretion in ABCA3-mutant iPSC-derived AEC2s (iAEC2s), but we also found an unexpected epithelial-intrinsic aberrant phenotype in mutant iAEC2s, presenting as diminished progenitor potential, increased NFκB signaling, and the production of pro-inflammatory cytokines. The ABCA3:GFP fusion reporter permitted mutant-specific, quantifiable characterization of lamellar body size and ABCA3 protein trafficking, functional features that are perturbed depending on ABCA3 mutation type. Our disease model provides a platform for understanding ABCA3 mutation-mediated mechanisms of alveolar epithelial cell dysfunction that may trigger chILD pathogenesis.