Seeing your dream home come to life right in front of your eyes is an incredible process. It’s something you’ve waited so long for, and you’ve picked out every little detail down to the colors, patterns, and finishes. There’s no denying that building your dream home requires many steps.
One of the most significant milestones comes when it’s time to put money on the table. If you’re trying to plan out the timeline or anticipate the next check you need to write, here’s an explanation of how you can approach the deal.
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:
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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.
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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.
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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.
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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:
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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.
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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.
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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.
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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:
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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.
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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.
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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.
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Choose less expensive interim housing. While building, consider living in more affordable temporary housing so you can save more aggressively.
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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:
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Construction-to-permanent – Since these loans convert to a mortgage, down payments are often around 25%. This cushions the lender until permanent financing begins.
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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.
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Owner-builder – Sometimes no down payment is required since the borrower also acts as contractor. Reduces lender risk on the project.
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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:
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Borrow against assets – Some lenders may allow you to borrow against existing assets like stocks or mutual funds to help cover the down payment.
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Partner financing – The lot developer or contractor may help finance part of the down payment to incentivize using their services.
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County or state assistance – For low or moderate income households, grants and low interest second loans to cover the down payment may be available.
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Material supplier financing – Suppliers with whom you have an established relationship may help finance materials, indirectly lowering the down payment amount.
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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:
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Shift goals – Consider purchasing an existing home instead that requires only 3% to 5% down with a standard mortgage.
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Use a HELOC – If you have sufficient equity in an existing home, a HELOC may provide funds for the construction down payment.
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Land/interim financing – Explore financing the land purchase separately to lower the construction loan down payment needed.
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Construction in phases – Build in phases (like first building a smaller guest house) which breaks costs into multiple smaller loans.
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Contractor financing – Ask contractors if they offer any financing that could cover a portion of the down payment.
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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.
When is the down payment due on a new construction home with builder financing?
To start construction and set up builder financing, you’ll need to put down a builder deposit, which can feel like a down payment. You will also need to pay another down payment when you set up your mortgage after construction is complete.
Generally, the builder deposit is 10% of the total construction costs before construction begins. Once you’ve paid the builder deposit, you may have to pay the full cost of custom upgrades and change orders.
After construction is finished, you’ll take out a mortgage to pay off the builder and buy the lot. This mortgage will require a down payment, which could vary from 3.5% up to 30%, depending on the program and lender.
- The builder finances the construction themselves.
- The buyer must pay a “builder deposit,” which means around 10% in earnest money.
- The buyer might need to pay for any additional upgrades or changes to the new construction home.
- When construction is complete, the buyer must obtain a standard mortgage.
- The buyer has to pay a down payment and closing costs when setting up the mortgage loan.
Financing a New Construction Home
When the down payment is due depends on how you’ve decided to finance your new construction project. There are several ways to go about this, including:
- Builder financing
- Construction-only loan
Each of these approaches requires you to put down a different amount at different points within the process. Some methods will require multiple down payments and require you to pay closing costs more than once, while others help simplify the process but require more money up-front.
Let’s go through your financing options one by one.
Production homes are built to your liking, but they use floor plans (and sometimes materials) from a large builder, who may be building similar homes for multiple clients. You’ll then work with the builder to customize the details, like flooring and cabinets. Production homes are most found in new developments where you can purchase a lot and the soon-to-be-built home as a package.
Production homes are most often available with builder financing. This means the builder finances construction, and when construction is complete, you’ll need to obtain a mortgage. Once it is time to obtain the mortgage, the process is similar to buying an already-built home.
Can I use my land as down payment for a construction loan?
FAQ
What is the lowest down payment for a construction loan?
Are construction loans difficult to get?
What is the minimum FICO score for a construction loan?
How much is a down payment on a construction loan in Texas?
How much down payment do you need for a construction loan?
Usually, a minimum 20% down payment is required, and a 25% down payment requirement is not uncommon. In addition, most construction loans require a minimum credit rating of 620, if not higher. Can I use any excess funds for home furnishings?
Can you get a construction loan without a downpayment?
Getting a construction loan without a down payment can be challenging, as most lenders require at least some down payment.However, there are a few options you might consider: 1.**Government-Backed Loan
How do I pay off a new construction loan?
Enough income to pay off the loan. In addition to having a strong credit history, you should have enough income to cover payments on your current debts and the new construction loan. To confirm this, your lender will ask for financial statements or other documentation demonstrating your annual income.
How do construction-to-permanent loans work?
For construction-to-permanent loans, the home will serve as collateral for the mortgage once construction is complete. Getting approval for a construction loan might seem similar to the process of obtaining a mortgage, but getting approved to break ground on a brand-new home is a bit more complicated.