Construction Loan Down Payment Requirements: What You Need to Know

Taking out a construction loan to build your dream home can be an exciting yet daunting process. One of the most important factors to consider is the down payment requirements, which are often higher for construction loans compared to conventional mortgages. Meeting the down payment requirements ensures you get approved for the loan and sets you up for success throughout the construction process. In this article, we’ll break down everything you need to know about construction loan down payments.

What is a Construction Loan?

A construction loan is a short-term loan used to finance the building of a new home The loan covers costs like purchasing land, materials, labor, permits, architect fees and more Construction loans are issued in stages as construction progresses, with the lender dispersing payment once certain milestones are reached. This protects the lender by ensuring the work is completed before they release additional funds.

Construction loans typically have variable interest rates and last around 6-24 months. Once construction is complete, borrowers often refinance into a conventional mortgage. Construction loans require more complex applications and approval processes compared to standard mortgages.

Why is the Down Payment Higher?

Down payments for construction loans tend to be 20-30% of the total project costs, while down payments on conventional mortgages are usually 3-20%. There are a few reasons for this:

No existing collateral: With a regular mortgage, the lender can foreclose on the home if you default. But construction loans aren’t backed by an existing structure, so there’s more risk for lenders. A higher down payment helps mitigate this.
Cost overruns: Construction projects often go over budget. Lenders want to see you have extra cash on hand to cover unexpected costs that arise during the build.
Proof of financial readiness: A 20%+ down payment shows the lender you can handle a major financial commitment. This gives them confidence you’ll be able to keep up with payments.
Lower monthly payments Since the down payment is larger, the amount you have to finance is smaller This keeps monthly payments manageable.

Typical Down Payment Requirements

While specific down payment requirements vary by lender, here are some general guidelines:

20-30% down: This is the standard for most construction loans. 20% is the minimum to avoid paying private mortgage insurance (PMI).
650+ credit score: Most lenders want to see good credit to approve a construction loan. Scores under 650 make approval unlikely.
45% DTI or lower: Your debt-to-income ratio compares your monthly debts to income. Most lenders want this below 45% so you can afford payments.
3-6 months of mortgage reserves: Lenders often require you to have 3-6 months of mortgage payments available in savings as a cushion.
No missed mortgage payments: On-time mortgage payment history helps your chances of approval.

Tips for Saving for Your Down Payment

Since construction loan down payments are steep, here are some tips for saving:

Reduce spending in areas like dining out, entertainment, shopping and vacations. Stick to a detailed budget that maximizes savings.
Increase your income by asking for a raise, finding a higher paying job, freelancing or starting a side business. The extra income goes straight to savings.
Sell assets you no longer use like cars, boats, collectibles, unwanted gifts and old electronics.
Save windfalls like bonuses, tax refunds, inheritance money and insurance claim payouts.
Live with family to eliminate housing costs and ramp up savings during your construction loan down payment saving stage.
Take advantage of employer matched retirement contributions and then redirect that portion of your paycheck to savings.
Choose a high-yield savings account so the money you’re saving earns interest.

Lower Down Payment Options

If you’re having trouble saving enough for a 20-30% down payment, here are some options that allow lower down payments:

VA loans: No down payment required for veterans, active military and surviving spouses. Funding fees apply.
USDA loans: No down payment on loans in designated rural areas. Guarantee and annual fees apply.
FHA loans: Only 3.5% down required. Must use an FHA approved lender and pay mortgage insurance.
Portion of land value: Some lenders let you put down 10-20% cash and use equity from land you already own for the remainder.
Seller financing: In some cases, sellers may finance up to 90% of the construction costs at a higher interest rate.
203(k) rehab loans: FHA product that lets you finance purchase and renovation with only 3.5% down.

When is the Down Payment Due?

With a construction loan, your down payment funds are due at three key points:

At loan closing – You’ll need to provide the agreed upon down payment amount in order for the loan to be finalized.
On completion – If construction goes over budget, you may need to bring extra down payment funds to closing on the permanent mortgage.
During construction – Your lender may require you to fund a portion of each draw request, usually 10-20% of that draw amount.

Work with your lender to understand the specifics on when your down payment installments will be due. Time it right so you have the cash ready when it’s needed.

Using Equity and Land

If you already own the land you plan to build on, or have considerable home equity, you may be able to put those assets toward your construction loan down payment. Here’s how it works:

Land equity: If you own the land free and clear, some lenders will let you use a portion of the land value to cover the required down payment. Often they’ll let you apply up to 70-80% of the land value towards the down payment.

Home equity: If you have substantial equity in an existing home, you can tap into it via a cash-out refinance or home equity loan. You can then use those funds for your construction project down payment.

Bridge loan: This short-term loan uses your existing home’s equity as collateral while you build the new home. When the new home is done, you sell the old home and repay the bridge loan.

Be aware that lenders will strictly evaluate your ability to handle both housing payments during the construction phase if using equity or land value.

Down Payment Sources to Avoid

While it’s tempting to look for down payment funds from any source possible, some sources are red flags to lenders:

⛔️401(k) or retirement account withdrawals – Raiding retirement savings to fund a down payment looks risky.

⛔️Taking on new debt like personal loans or credit cards – Construction loans already have high DTI requirements.

⛔️Gifts that need to be repaid – Lenders can’t verify the source of funds or if you’ll be able to repay it.

⛔️Unverified sources – All down payment funds must be documented and verified by underwriters.

⛔️Down payment assistance programs – These programs are usually not allowed with construction loans.

The bottom line is that the down payment should come from your own savings or verifiable assets like home equity. Avoid any questionable sources of down payment funds.

Preparing for Construction Loan Approval

Because construction loan down payment requirements are steep, preparing in advance is crucial for approval. Here are some tips:

Start saving early and make it a budget priority -aim for 20-30% down.
Keep credit scores above 700 and debt-to-income ratio below 45%.
Research lenders known for approving construction loans. Have financing pre-approved before you buy land.
Only purchase land you can afford to make a 20% down payment on plus construction costs.
Make sure you have funds for closing costs and 6 months of mortgage payments in reserves.

The more prepared you are with a sizeable down payment, the smoother the loan approval process will be.

The Down Payment is Just the Beginning

While the down payment gets you approved and construction started, it’s just one piece of the financing puzzle. Be ready to also fund:

Closing costs on the construction loan
Paying the builder draw requests as work is completed
Unexpected overages if the project goes over budget
Down payment on the permanent mortgage once construction is finished

Carefully calculate the total cost to completion and have those funds lined up. A strong down payment is certainly important, but it’s also crucial to have financial resources secured for the entire build.

Partner With the Right Construction Lender

Finding the right lender who will work with you to get approved is key. Look for lenders that:

Offer construction loans and have experience with the process
Are willing to finance the type of project you have planned
Will allow you to leverage land or home equity you have
Will provide clear expectations for down payment requirements

How Much Down Payment Do I Need To Build A House?

Building a custom home can be an exciting process, but its essential to understand the financing options available to you. Unlike buying an existing home, where you typically secure a mortgage to cover the purchase price, building a new home requires a construction loan.

A construction loan is a short-term loan that covers the cost of building the home. These loans typically require a new construction down payment of at least 20% of the total project costs, which includes both the cost of the land and the cost of the build. Construction loans transform into typical 30-year loans after construction is complete.

The new construction down payment is a crucial aspect of the construction loan because it helps to mitigate the risk for the lender. When you make a significant down payment, the lender is more likely to approve your loan and offer you more favorable terms. Most importantly, the value of the lot can be used as collateral for the loan, which removes the requirement of bringing any more cash into the deal or reducing the cash you need to put down.

Its important to note that the down payment required for a construction loan can vary depending on the lenders policies and the specific projects characteristics. Some lenders may offer more flexible terms, such as lower down payment requirements, but may charge higher interest rates or have more stringent qualification criteria.

In summary, you will need a down payment to build a house that is generally 20% of the all-in project costs, with the value of the lot used as collateral for the loan.

When is the Down Payment Due To Build A House?

construction loan down payment requirements

The approach you take when purchasing a lot for a new construction home will impact the down payment to build a house and the timeline of when you need to pay it. Buildable recommends allocating between 25% to 35% of your all-in budget towards the purchase of the land. If you pay cash for the lot and the value of the lot is at least 20% of the full project, you will not need to make any additional down payment for the construction loan. The value of the lot will serve as collateral for the construction loan.

If you obtain a lot loan to purchase the land, you may need to make a down payment of as little as 25% of the lands value at the time of purchase. Once you have secured the lot loan, you can then obtain a construction loan later in the process, which will absorb the lot loan. For the construction loan, you will typically need to make a down payment of at least 20% of the full project cost and we estimate this full down payment will be due 8-10 months after purchasing the land once you are moving forward with a construction loan.

In summary, if you pay cash for the lot (and it’s at least 20% of the project value), you may not need to make a down payment, whereas if you obtain a lot loan, you will need to make a down payment at the time of purchase. You will then need to make an additional down payment when obtaining the construction loan, typically at least 20% of the full project cost. Its important to speak with your lender and builder to understand the specific down payment requirements and timing for each stage of the home building process.

Can I use my land as down payment for a construction loan?

FAQ

What is the lowest down payment for a construction loan?

Often, borrowers convert these loans to long-term mortgages once the house is built. Unlike conventional construction loans, however, FHA construction loans are insured by the FHA. That means if you have a down payment of at least 3.5 percent, you could qualify for the loan with a credit score as low as 580.

Are construction loans difficult to get?

The loan may require a larger down payment (likely 20%) than a traditional mortgage (3.5% or even lower). The process of obtaining a construction loan can be more complex and time-consuming than getting a traditional mortgage.

What is the minimum FICO score for a construction loan?

Minimum FICO score for construction loan: 580-640 Technically, 580 is the minimum fico score for construction loan. However, Mushlin says that in his experience, a higher credit score of at least 640 is usually needed for the FHA construction-to-permanent loan program.

How much down payment do you need for a construction loan?

Borrowers usually are required to make a down payment of at least 20% when taking out a construction loan. However, many lenders require more—between 25% and 30% of the total construction costs. The requirement varies by lender, but if you make a down payment of less than 20% you may have to pay private mortgage insurance (PMI).

What are the requirements for a construction loan?

Let’s delve into the details: 1.**Down Payment**: Construction loans typically require a **minimum down payment of 20%**.This ensures that you have some equity in the project from the outset.

Do construction loans require a 620 credit score?

Yes, construction loans often come with higher qualifying standards in terms of credit score requirements and down payment amounts. 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.

Do you need a down payment for an FHA construction loan?

Down payment requirements: A lower down payment is one of the main benefits of an FHA construction loan. Many construction loans require a down payment of at least 10%. Depending on your credit score, you may qualify for an FHA construction loan with a down payment of just 3.5%.