How Much Down Payment Do You Need for a Construction Loan?

Taking on a construction project to build your dream home can be an exciting endeavor. However financing the construction comes with its own set of challenges especially when it comes to the down payment. Unlike a traditional mortgage, lenders typically require a higher down payment percentage for a construction loan. Here’s what you need to know about down payments for construction loans.

What is a Construction Loan Down Payment?

A construction loan down payment refers to the amount of money you need to pay upfront when taking out a loan to finance the building of a new home This upfront payment is very similar to a down payment on a mortgage for an existing home However, construction loan down payments tend to be higher, often 20% or more of the total loan amount.

The down payment gives the lender reassurance that the borrower is invested in the project. It also provides the lender some cushion if the borrower defaults, since the down payment helps offset any losses.

Typical Down Payment Percentages

Construction loan down payment requirements can vary by lender, but tend to fall into these general ranges:

• 20% to 25% – This is the most common down payment range for a construction loan. Putting 20% down or more shows the lender you are financially committed to the project.

• 15% to 20% – Some lenders may offer loans with around 15% to 20% down to borrowers with excellent credit and financial profiles. This range is less common but can provide more flexibility.

• 10% to 15% – Only a handful of lenders offer construction loans with 10% to 15% down. These programs are rare and usually have strict eligibility requirements.

• Owner-builder exception – If you are building the home yourself and act as the general contractor, some lenders may not require any down payment at all. However, you usually need construction experience.

As you can see, 20% or higher is the most prevalent down payment requirement for construction loans. It’s significantly higher than the 3% to 5% down payment typically needed for a conventional mortgage. Meeting this higher threshold can make getting approved more challenging.

Why Are Construction Loan Down Payments Higher?

There are a few key reasons why lenders require larger down payments for construction loans versus mortgages:

• No collateral – With a mortgage, the home being purchased acts as collateral for the loan. With a construction loan, there is no existing home to serve as collateral until the project is finished. The down payment helps offset this increased risk.

• Shorter term – Construction loans generally have terms of 1 year or less. This gives the lender less time to recoup the money if the borrower stops making payments, increasing risk. The down payment provides the lender more protection.

• Lack of payment history – When borrowing for an existing home, lenders can look at the payment history of utilities, rent, or an existing mortgage. With a construction loan, no such history exists. A larger down payment helps mitigate the uncertainty.

• Unpredictable costs – Construction projects often go over budget due to unforeseen costs. The higher down payment gives wiggle room if expenses end up higher than expected.

Due to these risks, lenders view construction loans as riskier than mortgages. The larger down payment requirement helps compensate for the increased chance of default.

Tips for Saving for a Construction Down Payment

Because construction loan down payments are steep, you need to plan your finances carefully. Here are some tips that can help you amass the down payment:

• Start saving early. Give yourself plenty of time to accumulate at least 20% of the projected construction costs. Building up adequate savings may take years.

• Reduce spending on non-essentials. Cut back on dining out, entertainment, vacations and other discretionary expenses. Shift that money into your construction down payment fund.

• Increase income if possible. Consider taking on a side job or freelance work to bring in extra money that you can direct fully toward your down payment savings.

• Choose less expensive interim housing. While building, consider living in more affordable temporary housing so you can save more aggressively.

• Ask for gift help. Family members may be able to gift you some funds to help you meet the down payment requirement. Every bit helps.

With diligent saving, sufficient time, and careful planning, you can potentially fund the required down payment for a construction loan. Just be prepared for the higher financial hurdle compared to a traditional mortgage.

Construction Loan Down Payment by Type

Construction loan down payment requirements can also vary depending on the type of construction loan:

• Construction-to-permanent – Since these loans convert to a mortgage, down payments are often around 25%. This cushions the lender until permanent financing begins.

• Construction-only – May require 25% to 30% down since the loan must be fully repaid after 12 months or less. Provides more protection for the lender.

• Owner-builder – Sometimes no down payment is required since the borrower also acts as contractor. Reduces lender risk on the project.

• Renovation loan – Usually range from 15% to 25%, depending on renovation scope. Down payment correlates with the project complexity.

Always confirm specific down payment requirements with lenders, as they can differ. But in most cases, expect to put down 20% to 25% or more.

Is a Lower Down Payment Possible?

While rare, some options may help you get a construction loan with less than 20% down:

• Borrow against assets – Some lenders may allow you to borrow against existing assets like stocks or mutual funds to help cover the down payment.

• Partner financing – The lot developer or contractor may help finance part of the down payment to incentivize using their services.

• County or state assistance – For low or moderate income households, grants and low interest second loans to cover the down payment may be available.

• Material supplier financing – Suppliers with whom you have an established relationship may help finance materials, indirectly lowering the down payment amount.

• Lender exceptions – A few lenders offer unique low down payment construction loan programs, but eligibility is very restricted.

Unless you have a special circumstance, assume you will need 20% down or more for a construction loan. Budgeting for this larger requirement is key to successfully financing your custom build.

What if the Down Payment is Unaffordable?

If you are unable to save the 20%+ down payment a construction loan requires, you have a few options:

• Shift goals – Consider purchasing an existing home instead that requires only 3% to 5% down with a standard mortgage.

• Use a HELOC – If you have sufficient equity in an existing home, a HELOC may provide funds for the construction down payment.

• Land/interim financing – Explore financing the land purchase separately to lower the construction loan down payment needed.

• Construction in phases – Build in phases (like first building a smaller guest house) which breaks costs into multiple smaller loans.

• Contractor financing – Ask contractors if they offer any financing that could cover a portion of the down payment.

• Downsize plans – Modify blueprints to build a smaller home that requires less upfront investment.

For most borrowers, a 20% down payment on a construction loan is difficult or impossible to manage. Carefully researching alternative options and adjusting plans can help make your dream home a reality even with limited funds.

The Bottom Line

Construction loans offer a way to build your perfect custom residence. But in exchange for the flexibility they provide, lenders require larger down payments – often 20% or more of the total construction costs. Coming up with such a substantial down payment can prove challenging. Assessing all available options and compromises is crucial if your financial resources are limited. With proper planning, a construction project can transform into your own ideal home.