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  • Writer's picturePreston Morris

Requirements for a Construction Loan

  • A Qualified Builder And/Or Construction Team. To get a bank, lender or institution to finance your home building project, you must have hired a reputable, licensed builder with the documentation to prove it. ...

  • Detailed Description of the Construction Plan. ...

  • Appraisal. ...

  • Sizable Downpayment.

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Construction Loans vs. Owner-Builder Construction Loans

Borrowers who intend to act as their own general contractor or build the home with their own resources are unlikely to qualify for a construction loan. These borrowers will have to take out a variant called an owner-builder construction loan. It can be difficult to qualify for these loans. Therefore, potential borrowers must offer a well-researched construction plan that convincingly lays out their home-building knowledge and abilities. The borrower should also include a contingency fund for unexpected surprises.

Example of a Construction Loan

Jane Doe decides that she can build her new house for a total of $500,000 and secures a one-year construction loan from her local bank for that amount. They agree on a drawdown schedule for the loan.

In the first month, only $50,000 is required to cover costs, so Jane takes only that amount—and pays interest only on that amount—saving money. Jane continues to take funds as they are needed, guided by the drawdown schedule. She pays interest only on the total that she has drawn down rather than paying interest on the whole $500,000 for the entire term of the loan. At the end of the year, she refinances with her local bank the total amount of funds she has used into a mortgage for her dream home. Follow Curbie & Bessie Capital

How to Get a Loan to Build a House

Starting the Process of a New Construction Loan

The initial steps of obtaining a construction loan are similar to buying an existing house:

  1. Meet with a lender to get pre-approved for the amount you can afford.

  2. Develop your wish list, including locations and features.

  3. Visit new home communities and builders in your selected price range. An experienced real estate agent can be a valuable resource.

Your next financing steps will depend on whether you have decided to buy a production or custom home.

Buying Within a Development

If you buy from a builder who is constructing multiple houses within a specific development, a practice called production building, the financing process will be very similar to buying an existing house. In most cases, the builder can arrange financing for you—but make sure it is a competitive offering. The main difference from other loans is that you apply for your loan when you sign the contract with the builder, but you don’t lock in the loan terms until the property is complete.

Buying a Custom-Built Home

If you’re having a house built on your own lot with your own design, you have many more financing options, but there are more steps involved. Unless you are paying in cash, you will need to arrange for a construction loan. These are not as widely available as regular home loans, so you may have to shop around. Some lenders provide a one-step loan that is interest only while the house is being built and then converts to a mortgage once construction is finished. The advantage is that you will have to pay closing costs only once. Some lenders, however, prefer a less risky two-step process. This requires you to take out an interest-only loan for construction and then refinance into a regular mortgage when the house is completed. The short-term interest-only loan is usually at a prime-plus rate, while the later portion reflects regular mortgage interest rates.

Strong Credit Requirements

Construction loans are considered higher risk. You will need strong credit and a down payment of 20% to 25%. The specific down payment requirement is determined by the cost of the land and planned construction. If you already own the land, you can use it as equity for your construction loan.

Your lender will check the credit and credentials of your builder as well. Drawdowns on the funds are usually at prescribed completion points, requiring that inspectors approve the progress.

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