• Preston Morris

Construction Loan Requirements

What Do You Need to Get a Home Construction Loan?

  1. Good to excellent credit. Most lenders will require you to have a credit score of 680 or higher.

  2. A good debt-to-income (DTI) ratio. Many lenders will accept DTI ratios of up to 45%, but lower is better.

  3. Necessary documentation.

What Is A Construction Loan?

A construction loan is a short-term loan that covers only the costs of custom home building. This is different from a mortgage, and it’s considered specialty financing. Once the home is built, the prospective occupant must apply for a mortgage to pay for the completed home. However, there are several other loans available when it comes to home building, from ground-up building to a complete remodel of the entire house. There’s likely a loan out there that’s right for you, whether you’re starting from scratch with a land loan or completely renovating a home.

How to Get a Construction Loan

Before you can get the financing necessary to start your construction project, you’ll need to get approved for a loan. This process is typically more rigorous than for mortgages and other loans because the loan won’t be secured—or collateralized—by a home. In addition to imposing traditional borrower standards, lenders also will need to review and approve architectural plans, an estimated construction timeline and a proposed budget.

To be approved for a construction loan, you will need:

  • Good to excellent credit. To reduce their risk, lenders require borrowers to have a minimum credit score of 680 to qualify for a construction loan. However, some lenders may require a score of at least 720. If you’re planning to build a house, consider taking some time to improve your credit score before applying for a construction loan.

  • Enough income to pay off the loan. In addition to having a strong credit history, you should have enough income to cover payments on your current debts and the new construction loan. To confirm this, your lender will ask for financial statements or other documentation demonstrating your annual income.

  • A low debt-to-income ratio. A borrower’s debt-to-income (DTI) ratio is a comparison of all of your monthly debt payments to your gross monthly income. The lower your DTI, the more cash you theoretically have to make construction loan payments each month. To increase the likelihood that borrowers will be able to make payments, lenders typically require a DTI ratio no higher than 45% when issuing construction loans.

  • A down payment of at least 20%. Borrowers usually are required to make a down payment of at least 20% when taking out a construction loan. However, many lenders require more—between 25% and 30% of the total construction costs. The requirement varies by lender, but if you make a down payment of less than 20% you may have to pay private mortgage insurance (PMI).

  • Project and construction budget approval. Because of the uncertainties involved in building a house, lenders want to see as much detail about the proposed project as possible. Improve your chances of approval by providing documents like a deed (or purchase offer) for the land, complete blueprints and specifications, a detailed line-item budget in the bank’s preferred format, a payment (draw) schedule and a signed construction contract with change order provisions.

  • Builder or general contractor approval. Likewise, you’ll need to demonstrate to the lender that your architect and builder are qualified, licensed and insured. This may involve providing copies of the builder’s insurance certificates, resume and proof of financial stability. You also should include a description of each party’s responsibilities, including the architect, general contractor and anyone else involved in the project.

Pros and cons of an FHA new construction loan

“This loan is designed to combat the more costly and cumbersome traditional construction loan program,” says Preston Morris with Curbieandbessiecapitalinvestments.com

“Otherwise, you’d have to deal with multiple loans, multiple underwrites from different banks and underwriters, multiple appraisals, multiple fees, and multiple possible changes in economic conditions that could impact interest rates in outcomes desired to achieve the end result,” Preston explains.

However, lenders offering FHA new construction loans aren’t easy to find — and it may be difficult to qualify.

Standards aren’t quite as lenient as for a traditional FHA loan. For instance, you need a higher credit score. And there’s a lot more paperwork and red tape involved, so the process will take longer than a traditional mortgage.

You’ll have to decide whether this loan is right for your needs based on your timeline, budget, credit score, and other criteria.

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