How Much Money Do You Need For A Construction Loan?

Taking out a construction loan to build your dream home can be an exciting prospect. With a construction loan you can customize and design every aspect of your home exactly the way you want. However, construction loans also require more cash upfront compared to a traditional mortgage. So how much money do you really need to get a construction loan approved?

Down Payment Requirements

The biggest factor determining how much money you need for a construction loan is the down payment requirement. Construction loans for new construction generally require a down payment of at least 20% of the total project cost, which includes both the cost of the land and the cost of the construction.

However, the specific down payment requirements can vary depending on the lender and the circumstances of the loan. Here are some key things to know:

• Some lenders may require an even higher down payment of 25-30% for a construction loan.

• If you put down less than 20%, you may have to pay private mortgage insurance (PMI).

• Borrowers with excellent credit scores and financial history may qualify for lower down payments in some cases.

• Special programs like VA and USDA loans allow qualified borrowers to get a construction loan with 0% down.

When estimating your down payment, make sure to factor in the costs of both the land purchase and the construction. Getting accurate quotes for materials, labor, and other construction costs is crucial to determining your total project budget.

Closing Costs

In addition to the down payment, you also need cash on hand for closing costs when getting a construction loan. Closing costs typically range from 2-5% of the total loan amount. Some common fees include:

• Origination fees to the lender to process the loan application

• Appraisal fees to value the land

• Title fees for insurance and escrow services

• Recording fees to file paperwork with the county

• Credit report fees

• Mandatory inspections during construction

Construction loans tend to have higher closing costs overall compared to mortgages. You’ll likely have to pay closing costs twice – once when you close on the construction loan and again when you convert it to a mortgage after completion. Shop around with multiple lenders to find the best rates and fees.

Interest Reserves

Another cost to factor in is interest reserves, which are escrowed funds used to pay the monthly interest during construction.

Interest reserves ensure you won’t have to pay anything out of pocket until the home is completed. The lender will calculate the required interest reserve by estimating your projected monthly loan payments multiplied by the number of months expected for construction.

Interest reserves are optional but can provide more financial flexibility during the building process. Just know that any unused reserves get credited back to your loan balance when construction is done.

Contingency Funds

It’s also smart to have a contingency fund when getting a construction loan to cover unexpected overages. Construction projects often end up costing more than originally budgeted.

Many lenders require a contingency reserve of 10-20% of the total construction costs. This provides a buffer in case you need to spend more on materials, labor, or other surprise costs.

If you end up not needing the contingency funds, they also get credited back toward your overall loan balance. Having extra reserves gives you greater peace of mind in case any unplanned expenses pop up.

Tips for Reducing Cash Needed

While construction loans do require more money upfront, there are some strategies you can use to reduce the amount of cash needed:

• Shop around for lower fees: Compare multiple lender quotes to find the best rates and lowest closing costs. Even small differences can save thousands.

• Leverage your land’s equity: If you already own the land, you may be able to use its equity to lower your down payment.

• Wait to build: Save up your down payment longer to reach 20% and avoid PMI.

• Use seller concessions: Ask the seller to cover some closing fees in the land purchase contract.

• Provide sweat equity: Offer to provide some labor yourself to reduce construction costs.

• Build in phases: Complete sections slower as your budget allows.

• Get a business line of credit: Use a LOC as a contingency fund for overages during construction.

Sample Construction Loan Costs

To give you a better idea, let’s look at estimated costs for a sample $300,000 construction loan:

• Land Purchase Price: $50,000

• Construction Costs: $250,000

• Total Project Cost: $300,000

• 20% Down Payment: $60,000

• Closing Costs @ 4%: $12,000

• 1 Year Interest Reserve: $15,000

• 10% Contingency: $30,000

Total Cash Needed = $117,000

This example individual would need around $117,000 available in cash or other liquid assets to comfortably finance a $300,000 construction project. The costs can be higher or lower for your specific loan depending on your financial situation, credit, project size, lender fees, and other factors.

Get Multiple Loan Estimates

Ultimately, the best way to determine how much money you’ll need for a particular construction project is to get multiple loan estimates from lenders. Loan officers can provide a detailed cash-to-close estimate tailored to your actual loan amount and financial details.

Having a solid budget and understanding of construction loan costs is key to making your new home build financially successful. Be sure to find a lender who clearly explains all fees, reserves, and down payment requirements upfront. With the right preparation and financing, you can turn your dream home into a reality.