What Is A Construction Loan
A home construction loan is a short-term, higher-interest loan that provides the funds required to build a residential property, explains Janet Bossi, senior vice president at OceanFirst Bank in New Jersey.
These loans are usually one year in duration, during which time the property must be built and a certificate of occupancy issued, Bossi says.
Do You Have Homeowners Insurance In Place
Even though you dont live in the home yet, your lender will likely require a prepaid homeowners insurance policy that includes builders risk coverage. This way, if something happens during the construction process the halfway-built property catches on fire, or someone vandalizes it, for example you are protected.
Determine The Lenders Ratios
It is important to remember that your home affordability should not be determined based on the total cost that you can afford but rather on the monthly expense that you can afford. The common term for this is debt-to-income ratio . Lenders calculate two ratios and the lower amount out of the two are used at the end. These two ratios are called, the front-end ratio and the back-end ratio. Here is a helpful debt-to-income ratio calculator.
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What Monthly Expenses Do You Have
! Please enter an amount less than }.
Estimate your monthly expenses such as groceries, transportation, child care, insurance, shopping, media and regular contributions to savings.
Please do not include rent or housing expenses.
If you’re buying a home with a spouse, partner, friend or family member, include their monthly expenses as well.
If this amount is higher than your monthly income before taxes, please contact us to discuss your options.
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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 youre serious and have the funds available to pay off the loan. Most lenders wont lower the 20% down payment requirement, and some even require a 25% down payment. Lenders need to be confident about the borrower theyre lending to for a construction loanif the borrower backs out halfway through, the lender is not only on the hook for the funds, but they dont even have a fully-constructed home to sell.
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What Does A Construction Loan Cover
A construction loan can be used to cover the cost of the land, contractor labor, building materials, permits and more. While items like home furnishings generally are not covered within a construction loan, permanent fixtures like appliances and landscaping can be included.
Its important to discuss these items with your lender, specifically what will be included in your loan-to-value calculation, according to Steve Kaminski, head of U.S. residential lending at TD Bank.
Oftentimes, construction loans will include a contingency reserve to cover unexpected costs that could arise during construction, which also serves as a cushion in case the borrower decides to make any upgrades once the construction begins, Kaminski says. Its not uncommon for a borrower to want to elevate their countertops or cabinets once the plans are laid out.
How To Calculate Affordability
Zillow’s affordability calculator allows you to customize your payment details, while also providing helpful suggestions in each field to get you started. You can calculate affordability based on your annual income, monthly debts and down payment, or based on your estimated monthly payments and down payment amount.
Our calculator also includes advanced filters to help you get a more accurate estimate of your house affordability, including specific amounts of property taxes, homeowner’s insurance and HOA dues . Learn more about the line items in our calculator to determine your ideal housing budget.
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What Happens When You Go Over Budget On A Construction Loan
It can happen that in the process of building your house, some of your actual expenses turn out to be higher than what you had forecasted before you started the project. Some of the typical unforeseen costs include increased price of materials, additional labor needed or special permits required. Unfortunately, if for any reason, your construction project goes over budget, you will have to pay the difference out of pocket, or take out a second loan to cover the difference.
What If I Dont Qualify
If your application is denied or you decide youd like to first work to improve your credit to potentially increase your odds of loan approval, keep the following tips in mind:
- Make timely payments on all bills, including loans and credit cards
- Pay off your credit card balances on time and in full every month
- Dont open multiple new accounts at the same time
- Try to avoid closing any open credit cards, regardless of how infrequently you use them
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Prepare For A Sizeable Down Payment
At a minimum, most lenders require a 20% down payment on a construction loan, and some require as much as 25%. Why are the down payment requirements so high? Because construction loans are viewed as higher risk than a traditional mortgage loan, and the lender wants to ensure you dont walk away from the project.
Getting A Mortgage When Building Your Own Home
Lea Uradu, J.D. is graduate of the University of Maryland School of Law, a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, Tax Writer, and Founder of L.A.W. Tax Resolution Services. Lea has worked with hundreds of federal individual and expat tax clients.
Whether youre an adventurous person, a DIY expert or simply a persnickety home buyer, the thought of building your own home might be a thrilling prospect. After all, when you choose to build your own abode, you get to call all the shots. That means you can determine the precise layout, dictate the exact number and type of rooms, handpick all the finishes and even add an indoor pool, an aquarium wall or a stairway slide, for that matter.
While building a one-of-a-kind home from the ground up may sound exciting, financing such a major undertaking is an entirely different story. Obviously, the majority of home buyers dont have enough money tucked away to cover the construction costs of their custom home which means theyre going to need a loan. Unfortunately, landing a loan for a self-build project is easier said than done.
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The Construction Loan Rate
With a construction loan, as with all other loans, you must pay interest on the money you borrow. Typically, construction loans are variable rate loans, and the rate is set at a spread to the prime rate. Essentially, this means that the interest rate is equal to prime plus a certain amount. If the prime rate is 3%, for example, and your rate is prime-plus-one, then you would pay a 4% interest rate .
In many cases, construction loans are also set up as interest-only loans. This means you only pay interest on the money you have borrowed instead of paying down any part of the principle loan balance. This makes payment of construction loans more feasible.
You also pay only on the amount that has been paid out already. For instance, if you are borrowing $100,000, and only the first $10,000 has been paid out, you pay interest only on the first $10,000 and not on the full $100,000. You need to make monthly payments for this loan just as with a conventional loan so your monthly payments should start low when only a small amount has been borrowed, and gradually increase as more of the money is paid out to your builder.
Starting The Process Of A New Construction Loan
The initial steps of obtaining a construction loan are similar to buying an existing house:
Your next financing steps will depend on whether you have decided to buy a production or custom home.
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How To Choose A Construction Loan Lender
Theres a lot to consider when choosing a construction loan lender, and its easy to get overwhelmed. For that reason, it can be tempting to settle for the first lender you find. You shouldnt make this decision in haste. Make sure you choose a lender that fits your unique needs by asking these questions:
- What types of construction loans do you offer?
- What interest rates are available? Are they fixed or variable?
- Do you charge closing costs or other fees?
- Can I use the equity I have in my land toward a down payment?
- How do you pay construction drawsas a percentage of completion or based on a set schedule?
- Can the builder request a first draw to pay for materials?
How Long Does It Take To Get A Home Construction Loan
A 90-day approval process on construction loans is common, because the lender must approve the project and the builder, not just you.
The builders construction plans should include floor plans, ceiling heights, timetables everything it will take to create your dream home. Experienced builders will likely already know about your lenders requirements.
When the lender has your builders construction plans in hand, it will appraise the value of the home upon its completion.
Construction loan approval often takes up to 90 days. Building the home itself can take anywhere from 4 months to over a year.
Your lender will also evaluate your personal finances during the approval process.
For most programs, you need a solid credit history, a good FICO score, and a reliable income. You may have to make loan repayments during construction. Lenders prefer you have adequate savings for cost overruns and unexpected costs.
Most lenders are helpful in this process, even providing builder approval packages.
However, approval policies, costs, and loan terms can vary significantly. So compare construction loan costs to see what you can afford and interview lenders carefully before applying for loans.
What Are Other Homeownership Expenses
There are all sorts of other expenses you should consider when figuring out how much of a home you can realistically afford. From things like condo fees to maintenance fees and renovations, youll have to consider these expenses in full. Being a homeowner also involves paying for occasional repairs or replacements of appliances or other similar expenses. You might also need to budget money to purchase new furniture or even, decorate your new place. Keep in mind that all of these expenses add up.
How Do I Estimate Construction Costs
Estimating the construction cost means simply finding outhow much it costs to build a house. There are several factors that contribute to the construction cost of a house:
How Much Down Payment Do I Need
- Sales price is calculated based on the cost of the land/lot plus the cost of construction
- If the property has been owned for more than 12 months, the fair market value may be used to calculate total purchase price
- The end or “as constructed value” of the home may be greater than the sales price calculated for down payment
- Any funds used towards construction such as architectural plans, building permits, cash used to purchase the lot, etc. may be included as part of the down payment talk with a Mortgage Loan Officer for more details.
Pay A Large Down Payment
A higher down payment will help you get a more affordable loan. If you are set on a certain mortgage amount, consider saving for a few extra years to raise your down payment. Alternatively, you could seek out additional sources of income to increase the amount that you can afford to save.
One option available to first-time homebuyers is the Home Buyers Plan. This incentive allows first-time buyers to withdraw up to $35,000 from their RRSP, tax-free, to put towards a down payment. If you are buying with a partner, you can collect up to $70,000 in total. But be warned, this is essentially a loan from your future self after a 2 year grace period, you will need to repay any amount you take out in 15 years. It is up to you to decide on getting money for your home now against saving for retirement later.
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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 homeworking with a lender who can provide an accurate estimate of the cost for materials and labor will helpand the type of location you plan to build . 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.
How Do Home Construction Loans Work
If youre building a home, you’re probably already considering a plot of land or a neighborhood that’s being developed. Because of this, most construction loans cover the price of the land as well as the cost of construction.
This added complexity means that construction loans come with more lender involvement than standard home loans. Lenders will want to see your plans for building the home, including an estimated schedule and a budget. These plans will help determine how much money you need in the loan.
Once youve secured a loan, the lender pays the builder in intervals that follow each phase of construction. The payment frequency is organized into a draw schedule that’s decided between you, the lender, and the builder. At each scheduled step, the lender usually checks on the progress of construction before releasing additional funding.
Prior to the completion of construction, you only make interest payments. Repayment of the original loan balance only begins once the home is completed. These loan payments are treated just like the payments for a standard mortgage plan, with monthly payments based on an amortization schedule.
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Importance Of A Trustworthy Builder For A Construction Loan
Contracting a trustworthy builder is essential in any construction or remodel project, but its 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 wont want to offer a loan to a borrower who plans to self-construct their home.
Can You Increase Construction Loan Amount
A construction home loan usually has a key feature described as a progressive drawdown. You increase the total amount you ve borrowed gradually as you need to make each payment during the construction phases. During the first twelve months, you will usually only need to pay the interest on the total amount borrowed.
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Different Types Of Home Construction Loans
There are two main types of construction loans: a stand-alone construction loan and a construction-to-permanent loan. While both types of construction loans often include the cost of the land, this isn’t always the case. Make sure youre aware of what expenses a lender is willing to finance, and what the origination process would be like if you worked with them.
Stand-alone construction loan: If you take a stand-alone loan, you’ll eventually need a separate mortgage loan after construction is completed. The lender offers the first loan as an advance for the construction, and you only pay interest during this time. After the house is built, you will pay off the construction debt in the form of a traditional mortgage.
If you can only afford a small down payment, or you own a home now and will be selling later, a stand-alone loan allows you to put more money down after selling. However, you dont have the option to lock in a mortgage rate while you have the stand-alone loan, so you could end up facing higher rates when it’s time to secure a mortgage.
Construction-to-permanent loan: This is a loan that combines the construction loan and standard mortgage, so you dont have to refinance after construction or go through another closing process. The lender converts the construction loan into a mortgage after construction.