Closing Costs: What to Expect When Taking Out a Construction Loan

With a shortage of homes for sale on the market, you may be looking to build your new dream home. Building your own home can be a tremendously rewarding experience. You get to make choices about everything from location and floor plan to colors and landscaping. At the end of the process, you have a truly special place to live, something uniquely yours. But how do you pay for it? And how do new construction loans work?

While a project like building your home can be both exciting and fun, there are many things to consider before you begin building. Probably the most important consideration is how this type of project gets paid for.

Taking out a construction loan to build your dream home can be an exciting yet daunting process. While the prospect of designing and building a home from the ground up is thrilling, construction loans come with plenty of extra fees and closing costs that you need to plan for.

In this article, we’ll break down everything you need to know about closing costs when taking out a construction loan, including:

What are closing costs for construction loans?
Typical closing costs for construction loans
Factors that impact construction loan closing costs
Estimating and budgeting for your closing costs
Ways to reduce closing costs
Closing the loan and next steps

What Are Closing Costs for Construction Loans?

Closing costs refer to the various fees charged by lenders and third parties to finalize and close out a mortgage loan. With a construction loan, closing costs cover the administrative fees, taxes, and other charges needed to set up financing for building a new home.

Closing costs are paid up front when you close on the loan. Typical closing costs for construction loans range from 2% to 5% of the total construction budget. So for a $300,000 build, you can expect to pay $6,000 to $15,000 in closing costs.

Closing costs for construction loans tend to be higher than closing costs for traditional mortgages. This is because construction loans require more oversight, administration, and risk management by the lender.

Typical Closing Costs for Construction Loans

While closing costs vary by lender. below are some of the most common fees charged for construction loan closing

Origination fee: This covers the lender’s costs for processing your loan application. Usually 1-2% of the loan amount.
Appraisal fee: Covers the appraiser’s inspection of the property to establish value. $300-$500 on average.
Credit report fee: Covers pulling your credit report. Usually $50-$100.
Attorney fees: For having a lawyer review the closing paperwork. Varies greatly but often $500-$1000.
Recording fees: Charged by the county clerk to record the deed and mortgage. Based on the loan amount.
Title fees: Paid to a title company to research the property and ensure clear title. Often $1000-$2000.
Survey fee: If required, covers a surveyor mapping the property. $300-$700 typically.
Permit fees: Building permit fees charged by the town/city. Varies based on location and project scope.
Inspection fees: May be required for site, framing, plumbing, etc inspections. $200-$500 per inspection.
Interest payments: Prepaid interest for the first 1-2 months. Depends on your rate and loan amount.
Escrow deposit: Funds held in escrow for taxes and insurance. Often 2 months worth.
Points: Optional fees paid for a lower interest rate. Each point is 1% of the loan amount.

As you can see, closing costs add up quickly! Be sure to budget accordingly.

What Impacts Closing Costs for Construction Loans?

Several factors can cause closing costs for construction loans to be higher or lower:

Loan amount: A higher loan amount means higher fees across the board.
Credit score: Borrowers with lower credit scores often pay higher rates and fees.
Down payment: A lower down payment may lead to higher loan fees.
Interest rate: A lower rate may require buying discount points at closing.
Location: Fees vary by state, county, and municipality. Rural areas tend to have lower costs.
Lender: Smaller lenders tend to charge higher fees than large banks. Shop around!
Loan type: FHA and VA loans have limits on certain closing costs to protect borrowers.

Keep these factors in mind as you shop rates and compare loan estimates from different lenders.

Estimating Your Closing Costs

The only way to know your exact closing costs is to receive a formal Loan Estimate from your lender after applying. But you can make a reasonable estimate beforehand to aid in budgeting.

Here are some tips for estimating construction loan closing costs:

Research typical fees in your state/area. Check sites like Bankrate and NerdWallet.
Assume 1-2% of the loan amount for lender origination fees.
Budget $300-$500 for the appraisal based on property location.
Assume $1000-$2000 for title fees, though rural areas may be less.
Account for permit, inspection, and other municipal fees based on project scope.
Factor prepaid interest, escrow deposits, and points if aiming for a lower rate.
Pad an extra 10% to be safe. Closing fees often end up higher than expected.

Having an estimate will make the actual Loan Estimate less shocking and allow you to plan ahead.

Ways to Reduce Closing Costs

If your estimated closing costs are stretching your budget, here are some tips for reducing them:

Shop lenders to compare fee structures and loan estimates. Local banks and credit unions may offer lower costs.
Negotiate fees like origination charges. Especially if a competitor is offering lower costs.
Buy down your rate with points to lower ongoing interest costs, if break-even period works.
Pay for your own appraisal to avoid markups by the lender.
Apply for down payment assistance programs that provide grants to cover closing costs.
Request a lender credit to offset specific fees like origination costs.
Time your closing to the end of the month/quarter when loan officers have budgets to meet.

With some savvy negotiating and shopping around, you may be able to reduce your closing costs by 10-20% or more.

Closing the Loan and Next Steps

Once all fees have been paid and documents signed, the construction loan closes and funds are disbursed. Be prepared to bring a cashier’s check to closing to pay your closing costs and down payment.

After closing, the fun part begins! You’ll work with your contractor to break ground, manage construction draws, and complete the building process. Your lender will assign a construction loan administrator to oversee the project and schedule inspectors.

Before you know it, your custom dream home will be complete and you’ll be ready to move in! Enjoy the process and your beautiful new construction.

Key Takeaways on Construction Loan Closing Costs

Closing costs are a necessary part of securing financing to build a home. While they may seem expensive, keeping these points in mind will help you plan and budget:

Aim to budget 2-5% of total construction costs for closing fees.
Shop multiple lenders and negotiate to reduce costs.
Time your closing carefully to take advantage of incentives.
Don’t be afraid to pay a bit more upfront for a better long-term rate.
Focus on the excitement of building your custom home!

With an understanding of what closing costs entail, you can take the first step towards making your dream home a reality.

the construction loan process

Unless you have the cash on hand to fund your construction project, youre going to need a construction loan in order to finance the cost of the building project –and sometimes the purchase of the land itself.

A construction loan is a short-term loan that covers the cost of construction until the home is complete, and a traditional mortgage can be taken out. New construction financing differs from resale finance because the home itself doesn’t exist. This means if the payments stop and the lender needs to foreclose, they must finish constructing the house first. Naturally, this makes construction loans riskier and lenders more wary.

If you’re on the fence about building your own home – and curious about funding options, here’s a look at what you should know about new home construction loans.

what is a construction loan?

A home construction loan gives you the funds needed to build a house on a piece of land, typically for one year, during the construction period. Construction loans are used to cover all sorts of things that go into building a home: land, labor, permits, and building materials. Depending on the lender you choose, there can be different requirements youll need to meet or limitations that you might find with the loan. For example, a construction loan doesnt usually cover the home furnishing aspect of a home, although it may cover things like permanent fixtures throughout the walls of the interior and necessary appliances, such as fridges and washing machines. Home construction loans are used when you have purchased a piece of land and are ready to build. A land loan is often used when you want to buy land but arent quite ready to construct your dream home.

New Construction Loans | Mortgage Tips| The Differences In Closing Costs

FAQ

Is a construction loan harder to get than a mortgage?

In general, it is harder to qualify for a construction loan than for a traditional mortgage. Most lenders require a credit score of at least 680 — which is higher than what you’d need for most conventional, VA and FHA loans.

How much are closing costs in Texas on new construction?

How Much Are Closing Costs in Texas? In Texas, the average closing costs for buyers are typically 2–6% of the home’s purchase price. Sellers can expect to pay around 6–10% of the home’s purchase price (including real estate agent commissions).

What happens at the end of a construction loan?

After construction concludes, you’ll secure a separate traditional loan. Construction–to–permanent loan: In this situation, you’ll obtain only one loan. At first, the loan pays for the home’s construction costs. Then, after you move in, the loan converts into a permanent loan.

Are construction loan fees capitalized or expensed?

Direct costs of construction should be capitalized.

Do construction loans include closing costs?

Construction loans also include closing costs like other types of home loans. Like interest rates for other types of loans, rates on construction loans generally vary based on the borrower’s creditworthiness, the size of the loan and the loan term.

What are the different types of construction loans?

There are different types of construction loans available to borrowers, which are designed to suit various financial needs. With a construction-to-permanent loan, you borrow money to pay for the cost of building your home. Once the house is complete and you move in, the loan is converted to a permanent mortgage.

Does a construction-to-permanent loan require a second closing?

“Not all lenders offer a construction-to-permanent loan, which involves a single loan closing,” says Kaminski. “Some require a second closing to move into the permanent mortgage, or an end loan.” Unlike traditional mortgages, which carry fixed rates, construction loans usually have variable rates that fluctuate with the prime rate.

How do you pay off a construction loan?

You can settle the debt either in cash or by obtaining a mortgage to pay it off. Construction-only loans can ultimately be costlier than their construction-to-permanent cousins, especially if you have to finance the repayment. That’s because you complete two separate loan transactions and pay two sets of fees.