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Building a house from scratch can be a great opportunity to get the home you’ve always wanted. But construction costs can add up quickly and timelines can be unpredictable. Luckily, a variety of construction loans provide the upfront cash needed to pay for the land, materials and labor to build a new house.
Getting a construction loan to build your dream home can seem daunting. With stricter eligibility requirements compared to regular mortgages, many wonder – are construction loans hard to get?
The short answer is yes, construction loans tend to be more difficult to obtain than traditional mortgages. However with proper planning and preparation getting approved for a construction loan is very achievable.
In this comprehensive guide, we’ll walk through everything you need to know about getting a construction loan, including
- What is a construction loan and how does it work?
- Construction loan requirements
- The construction loan process
- Tips for improving your chances of approval
- Construction loan alternatives
What Is A Construction Loan And How Does It Work?
A construction loan is a short-term loan used to finance the building of a new home. The funds can be used to purchase land, pay for materials, labor, and other costs during the construction period.
Unlike a traditional mortgage, a construction loan is not secured by the completed home itself. Instead, construction loans are issued in draws – installments paid out at different stages of the building process.
Construction loans typically have variable interest rates, higher than rates for conventional mortgages. And the full loan balance comes due once construction is complete, usually within 12-24 months.
At this point, borrowers must pay off the construction loan or convert it into permanent financing. This involves applying for a traditional mortgage to pay off the construction loan.
Construction Loan Requirements
Construction loans have stricter eligibility standards compared to regular mortgages. Common requirements include:
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Credit score – Most lenders require a minimum credit score of 680. But some may require 720 or higher. The higher your score, the better your chances.
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Down payment – Expect a down payment between 20-30% of total project costs. The more you can put down, the better.
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Income and assets – You’ll need enough steady income and assets to qualify for the loan amount needed. Lenders generally look for a debt-to-income ratio below 45%.
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Construction plans – Detailed plans, budget, timeline, permits, and a builder’s contract are usually required. Lenders want to see a well-thought-out project before lending.
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General contractor – An experienced, licensed contractor is key. Provide their credentials and project history to the lender.
Meeting these requirements demonstrates you can repay the loan and complete the project. Falling short on any could lead to denial.
The Construction Loan Process
Getting a construction loan involves many steps:
1. Prequalification – Talk to lenders to get prequalified and understand your options. This early stage is key for planning.
2. Choose plans/contractor – Have detailed floor plans made. Vet and choose your general contractor thoroughly.
3. Loan application – Apply with your lender of choice. Be ready to provide all required financial records, plans, budget, contractor docs, etc.
4. Appraisal and approval – The lender will appraise the project and underwrite the loan for approval. Expect lots of documentation and back-and-forth here.
5. Closing and funding – If approved, you’ll close on the loan and the first draw will fund to start construction! Future draws fund later per the draw schedule.
6. Construction monitoring – The lender will monitor progress throughout construction before approving each additional draw.
7. Loan payoff – Once construction completes, you must pay off the construction loan or convert it to a traditional mortgage via a second application.
As you can see, it’s a lengthy process requiring tons of prep work. The more buttoned up your plans are early on, the smoother it will go.
Tips For Improving Your Chances
Here are some tips to boost your odds of getting approved:
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Have an excellent credit score – Take time to improve your score above 720 before applying. Pay down debts, dispute errors on your credit reports, and don’t take on new credit too close to applying.
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Make a large down payment – Put down 30% or more if possible. This shows the lender you’re financially committed to the project.
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Lower your DTI – Reduce recurring debts so more of your income can go towards the construction loan.
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Have a solid project plan – Work with architects and contractors to have professional floor plans, budget, timeline, etc. Choose an experienced general contractor. Leaving out details could lead to denial.
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Get prequalified – Talk to multiple lenders to assess qualification beforehand. This lets you evaluate options early.
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Have funds in reserve – Lenders want to see you have reserves to cover cost overruns. At least 10-20% above the projected construction costs is recommended.
Following these tips sets you up for success. But ultimately, the best thing you can do is be informed and patient. Do your homework to understand what lenders look for. Be ready to provide all required documentation. And be prepared for a lengthy process requiring persistence.
With the right prep work and expectations, construction loans are very obtainable for most people.
Alternatives To Construction Loans
If you get denied for a construction loan, there are a few alternatives to consider:
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Renovation loan – Some lenders offer renovation loans to update existing homes. Requirements are less stringent than construction loans.
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Home equity loan – If you have sufficient equity in an existing property, a home equity loan or line of credit can provide funds for a construction project.
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Owner-builder loan – These loans fund construction by owner-builders. But you usually need home building experience.
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Personal loan – An option if you need smaller amounts of cash. But interest rates are usually higher.
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Paying cash – Self-funding the project avoids financing altogether. But this ties up personal capital for long periods.
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Delaying/phasing projects – Consider building in phases using personal savings to avoid needing large loans.
The bottom line is construction loans are challenging to get, but can be obtained with proper planning, preparation, and persistence. Following the guidance above will help set you on the path to getting approved. And working closely with your lender will make navigating the process much smoother.
How long does it take to get a construction loan?
Application approval times depend on the specifics of the project and if lenders are provided with a complete package of materials. The loan approval process may span as much as 45 days.
How do I qualify for a construction loan?
In addition to meeting the lender’s borrowing standards, you’ll also need to provide building plans, an estimated construction timeline and a proposed budget for approval. The construction loan lender must also approve your choice of builder.