Down Payment on a Construction Loan: What to Expect and How to Prepare

Taking out a construction loan to build your dream home is an exciting endeavor. However, construction loans have unique requirements, especially when it comes to the down payment. Understanding what to expect and how to prepare can help you get approved and make the financing process go smoothly.

In this comprehensive guide, we’ll explore key questions on down payments for construction loans, including:

• How much do you need for the down payment?
• When is it due?
• What are the options to meet the requirement?
• How can you get prepared?

Let’s dive into the details.

Overview of Construction Loan Down Payments

With a construction loan the down payment works a bit differently than a conventional mortgage. Here are some key facts

• Down payments are usually 10-20% of total project cost.
• The land purchase can count toward the down payment if bought separately.
• It’s typically due in installments at stages during the build.
• You may need to fund cost overruns beyond the down payment.

The specifics on down payment amount, timing, and responsibilities can vary by lender. Carefully reviewing the loan requirements is important.

How Much Down Payment Is Needed?

For a construction loan, you’ll typically need a down payment of 10-20% of the total projected cost. This factors in:

• Purchase price of the land if not already owned.
• Budgeted costs for building the home.
• Improvements like a garage, deck, or landscaping.
• Any soft costs for permits, fees, and professional services.

If the land value is at least 10-20% of the total, that equity can count toward the down payment in many cases

For example, if you purchase land for $100,000 and the build is budgeted at $300,000, the total project cost is $400,000. With 10% down, you’d need $40,000. The $100,000 land covers that requirement so no additional down payment is due.

However, the lender could require extra funds in reserve to cover potential budget overages during construction. Ask your lender for complete details.

When Is the Construction Down Payment Due?

Rather than paying the full down payment upfront like a conventional mortgage, construction loan down payments are broken into installments that align with phases of the project.

A typical funding schedule could look like:

• 10% at land acquisition
• 10% when construction starts
• 10% after framing is complete
• 10% upon receipt of certificate of occupancy

This schedule reduces upfront costs and ensures adequate funds are available through each milestone. Change orders or budget increases can alter the amounts and timing for installments.

If you already own the land, expect to make an initial down payment to the lender to secure the loan. Then additional installments fund at construction milestones.

Having cash reserves above the down payment minimums provides a buffer for unexpected overages.

Where Does the Down Payment Money Come From?

Construction loans allow flexibility in meeting down payment requirements. Common sources include:

• Personal savings – The most straightforward route. Ideal for those with sufficient cash reserves.

• Sale of current home – Proceeds from selling a current house provide funds. Requires timing the sale and build.

• 401K or IRA – You may qualify to use retirement savings and avoid penalties. Consult your tax advisor.

• Gift from family – Parents sometimes assist children with part of the down payment as a gift. Lenders will require documentation.

• Home equity line – Tapping available equity from an existing home through a line of credit.

• Secured loan – Assets like stocks/bonds may be used to secure a loan for the down payment amount.

The right option depends on your financial situation. Discuss the possibilities with your lender early in the process.

Tips for Preparing for Construction Down Payments

Building adequate funds to meet construction loan down payments takes planning and discipline. Here are key tips:

• Start saving early – Set aside a percentage of your income monthly in a dedicated account. Time gives savings a chance to grow.

• Reduce spending – Cut discretionary expenses like dining out and vacations in the months leading up to construction.

• Boost income – Take on a side gig or seasonal work for extra earnings to bolster your down payment fund.

• Minimize existing debt – Pay down high-interest debts so you have less monthly obligations.

• Check credit – Maintain a strong credit score to ensure you get the best loan terms.

• Have a budget buffer – Overestimating costs by 5-10% helps ensure you have a cushion for unexpected overages.

With prudent saving, spending adjustments, and careful budgeting, you can build up your down payment fund over time.

Handling Budget Increases and Change Orders

Cost increases during construction may mean you need to pay additional down payment installments beyond the original budgeted amount. Common scenarios include:

• Change orders for upgrades like high-end finishes
• Additions like a detached garage or finished basement
• Lumber, metal, and other material costs going up
• Delays leading to increased labor, permit, and carrying costs

Ideally, you’ll have cash reserves or available equity to cover these increased down payments when they occur. Discuss setting aside a contingency fund with your lender.

Managing and limiting changes and upgrades helps contain costs to avoid much higher down payments.

Working with the Right Construction Lender

The construction lender you choose can significantly impact the loan terms, down payment, and overall experience. Be sure to shop around and compare:

• Down payment percentages and installment schedules
• Funding timeframes and draw processes
• Budget tracking and cost overrun support
• Customer service and communication practices

Local community banks and credit unions often offer more flexibility than national lenders. An experienced loan officer guides you through the process.

Ask trusted real estate pros, friends, and family for lender recommendations.

How Construction Down Payments Impact Your Budget

Beyond just saving for the down payment, be sure to factor the installment amounts into your broader household budget:

• Account for increased housing costs after moving from renting to ownership.
• Be conservative on the timeline to avoid paying both rent and construction loan costs simultaneously.
• Understand the loan terms so you know costs for a construction delay or extension.
• Have a plan to furnish and landscape the home, which has its own set of expenses.

Thoroughly planning your budget helps avoid financial strain during the construction process.

Options If You’re Short on the Down Payment

Despite your best efforts at saving and preparing, sometimes you fall a bit short on construction loan down payment funds. Two options to close the gap include:

• Negotiate with the lender – If you’re close to the minimum, the lender may be flexible on accepting a slightly lower down payment, perhaps with a slightly higher interest rate.

• Explore down payment assistance programs – Federal, state, and local programs exist that provide grants or loans to cover a portion of required down payments for eligible home buyers based on need.

Depending on how much you need to fund, it may be possible to find a solution to address a down payment shortfall. Be open and honest with your lender.

Partner with a Reputable Builder

An experienced local home builder is a valuable partner in navigating down payments and the overall construction loan process. Benefits include:

• Accurate budgeting based on years in the business.
• Advice on managing change orders and cost overruns.
• Guidance on the construction timeline for financing needs.
• Access to trusted subcontractors and suppliers to minimize delays.

Invest in a builder with a track record of delivering quality projects on time and on budget.

The Bottom Line

Construction loans provide flexible financing options to build a custom dream home. While the down payment structure differs from standard mortgages, proper preparation and planning enables meeting requirements in planned installments.

Choosing the right lender and builder gives you the best chance for construction success. With a disciplined savings strategy and the right partners, you’ll be well on your way to enjoying the home you’ve always wanted.

The upfront effort pays off for years to come when you can celebrate milestones in a house tailored to your needs – all made possible by the foundation of an adequate down payment.