Looking for a home that’s built for your family’s needs? A construction loan could be your solution.
Through a construction loan, you can access the funds you need to build a home fit exactly to your needs.
You want to be in charge in creating the home of your dreams—and building is the best option.
What is a New Construction Loan?
A construction loan is set up to offer home construction funding for a limited period of time—the length of time it will take to construct your new home—which is typically 12 months. You will be given a line of credit, which your builder will use to to submit “draw requests” to your lender in order to have cash to pay for materials and labor. In the meantime, you’ll be making interest-only payments while your home is being constructed.
What You Need to Know About a New Construction Loan
Down Payment Requirement for a Construction Loan
If you plan to build a home through a construction loan, plan to offer a 20% down payment of the total construction loan in order to show your lender that you’re serious and have the funds available to pay off the loan. Most lenders won’t lower the 20% down payment requirement, and some even require a 25% down payment. Lenders need to be confident about the borrower they’re lending to for a construction loan—if the borrower backs out halfway through, the lender is not only on the hook for the funds, but they don’t even have a fully-constructed home to sell.
Importance of a Trustworthy Builder for a Construction Loan
Contracting a trustworthy builder is essential in any construction or remodel project, but it’s especially vital when it comes to qualifying for a construction loan. Lenders will typically want to see that the builder you select has a solid reputation and a history of accurately quoting the cost of building previous homes. Not only is having an accurate estimate of costs important in selecting a builder, but they need to be known for finishing projects on time. Since construction loans are only available for a pre-established period of time, accessing funding after the loan period has passed can be challenging. Due to these reasons, most lenders won’t want to offer a loan to a borrower who plans to self-construct their home.
Owning the Lot for New Construction Home
The good news for borrowers who don’t already own the land they plan to build on is that construction loans can often include the cost of both the house and the land. The total amount of the loan will be higher if you’re buying the land as well, so plan to account for that when saving for your 20% down payment.
If you already own a lot and are making current payments on it, the new construction loan will first go toward paying off the lot.
Construction Loan FAQs
How much can I afford for a newly constructed home?
Calculating the affordability a new construction home can be challenging compared to buying an already-built home. Plan out how much it will cost to design and then build the home—working with a lender who can provide an accurate estimate of the cost for materials and labor will help—and the type of location you plan to build (by water, in the mountains, in a suburban neighborhood?). After the estimation is complete, talk with lenders to find out how much you can qualify for in a construction loan. A pre-qualification will give you a ballpark range of how much you can qualify for, but an approval will give you a firm amount of how much you can borrow, and if your budget fits the estimated cost of the house.
What is a Two Step Loan?
Two Step Loans are better for custom-built homes. You’re splitting up the construction loan and the mortgage. Construction will complete, then you will start shopping around for a mortgage. With two step loans, more flexibility is available for the final cost of your home, and extension of the construction loan is easier to maneuver. However, you’ll pay for closing costs twice since they’ll be paid for in the construction loan, and again for the regular mortgage.
What is a One Step Loan?
After construction of your home is completed, the loan will roll right into a predetermined mortgage plan—one where you will only have to pay the closing costs once. These are called “One Step Loans.” This mortgage is agreed upon before construction starts, and is best for homes that can be accurately quoted prior to construction. There isn’t as much flexibility for changes or upgrades in your home during construction with One Step Loans, because the loan amount can’t be changed since the mortgage is already established. However, in addition to only having to pay closing costs once, you won’t have to worry about finding a mortgage after your home is completed because it will already be set up.
When do I start making mortgage payments on my newly-constructed home?
Once construction of your new home is completed, you will issue a certificate-of-occupancy, and full-payment will be made to your builder from the lender. Mortgage payments will start after those items are complete.
Can I use any builder for my new construction loan?
Builders for new construction homes will need to be approved by the lender. Lenders frequently have a questionnaire for the builder to fill out to check out their previous work and see if past projects were completed on time and on-budget. Lenders may also need to run a business credit report on the builder you select to make sure there aren’t any tax-related delinquencies in the builder’s past. Having confidence in the selected builder is not only a vital item for the lender, but also for you as the borrower. Because the lender will be able to more-thoroughly examine the builder’s financial history, you can know that the right builder is selected for the job if the lender gives their stamp of approval. When evaluating lenders, be sure to choose ones that have completed at least two construction jobs similar to your own in the past two years.
Have a question or want to talk with a lender about construction loans?