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Construction loans are available to borrowers who would rather build a new home than purchase an existing one. These types of loans differ from FHA-insured 203(k) Rehab Loans in that this type covers the cost of the construction only, rather than the cost of purchasing an existing home + the cost of renovations. In most cases, a general contractor handles the heavy lifting (no pun intended) of the building process. However, some lenders may offer an “owner/builder” construction loan for those borrowers who are managing the building process themselves. In this case, a lender will likely require proof of licensing and education and/or experience in home building, among other requirements.
While construction loans are intended to finance only the cost of building, some lenders also may offer a construction-to-permanent option, in which a construction loan is converted to a traditional mortgage after construction is completed. Often, borrowers will make interest-only payments, but will end up being more expensive over the life of the loan. Make sure to shop around for the best rates available if you’re considering this option.
Although banks will require you to provide them the specific plans for your project, constructions loans are much more flexible with their terms and guidelines compared to traditional loans.
While you’re constructing your home, you only get to pay interest on your loan – it gives you a lower monthly obligation and more time to save up.
If you take this type of loan, the lender will demand a deeper and closer look at how you plan to proceed with your project. This is good for you because an independent party will scrutinize your plans to see if everything is in order. This will entail you to submit to the bank a clear timeline or schedule of the construction and the details of your construction plan.
As is typical with any type of loan, you’ll want your credit to be in tip-top shape. Construction loans and mortgages, especially, require good credit to get approved, so make sure to review your credit report many months before you’re in the market and work to increase your score.
Generally, lenders want the borrower to cover between 20% to 25% of the construction project's costs with their down payment.
Lenders like to see that the borrower has carefully planned out their construction project before borrowing funds. Many financial institutions offering construction loans will want to see plans and specifications of the house.
You should already have a builder lined up to work with on your project before you apply for financing. You should make sure that your builder is licensed and insured residential builder.
You need more than just financial projections and detailed building plans when you apply for a construction loan. You also need to have an appraisal performed. This appraisal will detail what the value of both the building structure and land the structure is on will be once the project is complete.