Construction Loans Vs Renovation Loans
Construction loan funds can be used to pay for land, supplies, labor, and other costs related to building a home.
But what if you want to buy a fixer-upper home instead?
In this case, youll want to pursue a rehab loan instead of a construction loan. The funds from a rehabilitation or renovation loan can cover the expenses involved with repairing or remodeling an existing home.
One popular renovation loan is an FHA 203k rehab loan.
This allows you to borrow funds to purchase the home as well as pay for desired or needed repairs or renovations, says Paul Welden, director of The 203k Contractor Certification Program.
FHA 203k loans cannot be used for new construction. And they can only be used on existing one- to four-unit properties that have been completed for a minimum of one year.
Welden adds that an FHA 203kloan requires a minimum of 3.5 percent down whichis quite a bit less than the 10 to 20 percent required for a construction loan.
Similar to construction loans, interest rates for the FHA 203k can be up to one percentage point higher than for a traditional FHA mortgage loan.
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How Much Down Payment For Construction Loan
But the cash you need for a deposit, a down payment and closing costs could be a little different when youre purchasing new construction. or as much as 5 percent of the purchase price, depending.
Should mortgage rates continue higher, buyers may have to save more for a larger down payment or simply buy less expensive homes, as each marginal increase in rates has a big impact on how much you.
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 youre serious and have the funds available to.
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Want More Information About One
We have done extensive research on the FHA , the VA and the USDA One-Time Close Construction loan programs. We have spoken directly to licensed lenders that originate these residential loan types in most states and each company has supplied us the guidelines for their products. We can connect you with mortgage loan officers who work for lenders that know the product well and have consistently provided quality service. If you are interested in being contacted by a licensed lender in your area, please send responses to the questions below. All information is treated confidentially.
FHA.com provides information and connects consumers to qualified One-Time Close lenders in an effort to raise awareness about this loan product and to help consumers receive higher quality service. We are not paid for endorsing or recommending the lenders or loan originators and do not otherwise benefit from doing so. Consumers should shop for mortgage services and compare their options before agreeing to proceed.
Please note that investor guidelines for the FHA, VA and USDA One-Time Close Construction Program only allows for single family dwellings and NOT for multi-family units . In addition, the following homes/building styles are not allowed under these programs: Kit Homes, Barndominiums, Log Cabin Homes, Shipping Container Homes, Stilt Homes, Solar or Wind Powered Homes.
Construction Loan Vs Home Equity Line Of Credit
When making home improvements, you may want to select between a construction loan and a home equity line of credit. A HELOC is a line of credit a lender gives to the borrower against the equity in their home.
- A HELOC has a fixed interest rate repaid over the home loan term, which is typically 15 to 30 years.
- A construction loan will have higher monthly payments because of its limited term, usually three to five years.
- Youâll typically pay less interest for a construction loan than for a HELOC because construction loans have a fixed interest rate over a short duration, while youll generally repay a HELOC over many years.
- Borrowers typically repay a HELOC in interest-only payments for the initial five to 10 years. The interest rate will increase when you begin making principal payments.
Construction loans arenât only for building a new home â they can also be an excellent loan option for home improvements.
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What Are The Requirements For A Home Construction Loan
Unless you get a home construction loan through a government agency, like the FHA or the VA, youll typically need to meet conventional mortgage requirements, including having a credit score of 620 or higher and a debt-to-income ratio below 45%. Depending on the lender, you may be required to make a substantial down payment, possibly up to 20%.
In addition to all the requirements for a traditional mortgage loan, youll also need to show the construction plans, schedule and contract that you have with a licensed builder or contractor.
Applying For A Construction Loan
If youve been pre-approved, the building appraises within the lending limits, and you show up with full documentation and a reputable contractor, you should have no problem obtaining the loan. If you are an owner-builder, you will have the additional task of convincing the lender that you can get the project completed on time and on budget. The more cost documentation you bring the better since cost overruns are the number-one problem with inexperienced builders. Hiring a construction manager may help you put together a credible package and secure the loan.
To apply for a loan, youll need the following, in addition to the standard financial information required for any bank loan:
- Building lot details: a deed or offer to purchase, documentation of protective covenants and other deed restrictions
- A clear description of responsibilities of the architect , and the general contractor, construction manager, or yourself if you are an owner-builder.
- The builders resume, insurance certificates, and credit and banking references
- Complete set of blueprints and specifications
- Materials list in the banks format
- Line-item budget in the banks format
- A draw schedule consistent with the lenders disbursement procedures.
- A signed construction contract, including start and completion dates, and provisions for change orders
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The Two Loans Do Have Some Similarities:
- Most lenders will require at least a 10% down payment
- The equity position will be based on the LESSER of the cost of acquisition or finished appraised value
- The borrower typically makes interest-only payments only on the portion of funds used during construction
- The borrower/builder will take draws as needed to cover materials and labor completed
- The borrower AND builder will need to be fully approved by the construction lender
How Do Construction Loans Work And What Are The Requirements
See Mortgage Rate Quotes for Your Home
If you dont have the funds on hand to build your dream home, youll need a construction loan. How do construction loans work? Theyre different from traditional home loans in terms of how funds are distributed and how the loan is structured. Construction loans are short-term loans that cover the cost of building a home. Learn more about how construction loans work.
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When Does The Mortgage Payments Start On A Pre
You start making mortgage payments on the final closing costs, not on the occupancy fee. Generally, the occupancy periods are 3 to 6 months before the final closing date. Final closing is when the condo building is officially registered with the city and when youll receive the title to your pre-construction condo unit. Closing costs include development levies, warranty fees, legal fees and land transfer tax.
Instead of your mortgage, youll have to pay the builder occupancy fees from the time of occupancy to final closing.
How Construction Loans Work
If you plan to self-build, youll need to explore the specialized finance available to you. A construction loan, also known as a construction-to-permanent loan, a self-build loan, or a construction mortgage, is one of these.
A construction loan is typically a short-term loan used to cover the cost of building your home. During the construction phase, the loan is released gradually as the work progresses. Typically, you will only pay interest on the loan during this time. This keeps payments low but doesnt reduce the principal loan balance.
Construction loans generally have variable rates that are higher than traditional mortgage loan rates. Once construction on your house is completed, you can either refinance the construction loan into a permanent mortgage or get a new loan to pay off the construction loan
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Are There Higher Qualification Requirements For Construction Loans
Yes, construction loans often come with higher qualifying standards in terms of score requirements and down payment amounts. Usually a minimum 20% down payment is required, and a 25% down payment requirement is not uncommon. In addition, most construction loans require a minimum credit rating of 620.
How To Choose A Construction Loan Lender
Remember that not every mortgage lender offers a construction product, says Ray Rodriguez, TD Banks regional mortgage sales manager for New York. When you find a few lenders that do, compare their rates and terms. He also recommends getting prequalified before you even think about blueprints.
Get prequalified before you even think about blueprints.
“The last thing you want to do is spend a lot of money on plans and specs, only to find out you cant get a loan because of your credit score,” Rodriguez says.
Building a home takes a long time and the process has a lot of moving parts, so you must select your financing with care.
“Some lenders do an outstanding job of managing borrower and builder expectations,” Faries says. He recommends looking for an experienced construction lender that can lead you through the process with minimal frustration.
A 20% to 30% down payment is typically required for a new construction loan. The requirements for construction loans are more stringent because theres no collateral to back up the loan as there would be with a traditional mortgage.
While the requirements vary by lender, construction loan lenders may require a credit score of 680 or higher, a down payment of up to 30% and for your debts to total no more than 45% of your income.
About the authors:Linda Bell is a mortgage writer and spokesperson for NerdWallet. She has won multiple awards, including one for a series on minority discrimination in the housing industry.Read more
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How Much Is Mortgage Loan Insurance
The range of mortgage loan insurance fees that you need to pay lies between 0.6% and 4.5%. This fee depends on the amount of down payment thats needed to secure your condo.
If your down payment is huge, the lesser the fee/premium of your mortgage loan insurance.
To cover your premium, you can pay the money as a part of your loan. Or, you can pay it in a lump sum. In this instance, you will have to pay the same interest rate for it as you will be paying for your overall loan.
Best Online Borrower Experience: Normandy
Normandy
For borrowers looking to secure a loan from an online lender, Normandy offers a seamless application process, with fast funding and the option to prequalify.
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21 day average closing time
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Required down payment of 10% to 20%
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Only available in 15 states
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620 minimum credit score recommended
Normandy is headquartered in Rochester, NY, but is fully licensed to offer their construction loan in 15 states. Their loan amounts range from $100,000 to $5 million. They have several construction loans such as a loan if you are the actual builder, another if you are hiring a builder, and loans to finance a newly built home that a builder built on speculation. Normandy also offers renovation construction loans for when the house is built but needs extensive renovation work requiring a licensed contractor.
Normandy could qualify you for a 10% down payment for properties appraised for $548,250 or less, and 20% down for properties appraised above that mark. You can wrap the land purchase into the construction loan, but youll still have to come up with 25% of the lands purchase price in cash.
Normandy has an easy-to-find section on its homepage for borrowers to apply for pre-qualification, request construction draws, and make payments toward their loan. This convenience makes Normandy our best for online borrower experience.
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Construction Loan Down Payment
There are three factors to consider when trying to estimate your construction loan down payment. You will need to know the total cost of construction, the amount of the loan you are requesting and the appraised value of your completed home. Once you have these 3 figures, you can approximate your down payment for your construction loan.
For example, if the bank determines the finished home to be appraised at $700,000, you can estimate that the bank will lend you 80% or $560,000. The down payment will end up being the cost of construction minus the value of your loan. So for this example, your down payment will be $700,000 – $560,000 or $140,000. This method will give you an approximation for your down payment. If money is tight, and you need a more exact determination, contact a lender and talk specifics with them directly. Lenders can always give you a more detailed analysis including current rates.
Finding The Right Lender
Most construction loans are issued by banks, not mortgage companies, as the loans are typically held by the bank until the building is complete. Since construction loans are more complicated and variable than mortgages, you will want to work with a lender experienced in these loans. And given that not all banks offer all types of construction loans, you should talk to at least a few different banks to see what is available in your community.
You can learn a lot by listening to the lenders policies on draw schedules, inspection and payment procedures, and qualification rules, which will vary from bank to bank. Also banks can be a big help in creating a realistic budget for your project the biggest challenge for most homeowners . Following the banks budgeting format can help you with cost control and can also help you obtain a loan from that bank.
Some banks use loan officers employed by the bank, while others work primarily with independent loan officers. In either case, you want a loan officer experienced in construction loans and one who will walk you through the process and protect your best interests.
Also different lenders have different policies around construction loans. For example, if you have a mortgage on your current home that you are selling, some lenders will not count that against your borrowing limits. Otherwise you may need to sell your first house before you can obtain a construction mortgage to build your new home.
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Things The Lender Will Need From The Builder
In addition to the criteria youll need to meet, here are some things the lender will need to see from the builder as well:
- Project description
- Banking info, profit and loss statement
- Budget for project
- Specs that support the terms of the contract
- Job cost
- approximate appraised home value of completed home
- estimated interest rate on the loan
Do I Have To Make Monthly Payments On Construction Loans
You still have to make monthly payments on your construction loan, even if construction is ongoing and your home is not occupied. Some lenders, such asMeridian Credit Union, only require monthly interest-only payments during construction. You will be required to make principal and interest payments once construction is complete.
Some construction lenders may even allow you to use future construction draws to pay for interest on the loan.
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How To Get Home Construction Loans To Build Your Custom Home:
A down payment of at least 5-10% of the total value of your building project will be required. If your building project is projected to be $300,000 you will need a minimum down payment of $15,000 to $30,000.
Owner Builder Loans can be an exception to the above down payment requirements. Owner builder loans often require nothing down because banks assume the homeowners will have a minimum of 10% equity in the project by virtue of the owner-builder participation.
