For many homeowners, building a custom home is a dream come true But constructing a new house requires major financing Construction loans allow you to finance the building process before converting to a traditional mortgage once the home is move-in ready.
A key factor in assessing construction loan affordability is estimating your interest-only payments during the building phase. Construction loan calculators can simplify the process of projecting your payments and evaluating loan options.
Let’s walk through the step-by-step process of using online calculators and other tools to forecast construction loan interest payments.
How Construction Loan Interest Works
With a construction loan, you only pay interest on the money borrowed during the building phase – typically 6-12 months. You do not pay down principal at this stage.
Once the home is completed, the loan converts to a standard fixed-rate mortgage amortized over 15 or 30 years At that point, your payments cover both principal and interest
Only paying interest while the home is under construction keeps payments low during the build. But it means you’ll accrue interest charges that get added to the overall loan balance before amortization begins.
Key Inputs for Calculating Interest
To estimate your monthly interest-only payments you’ll need to gather a few key inputs
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Loan amount – The total amount you’ll borrow, including the construction costs and land purchase if needed.
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Interest rate – The current rate lenders are offering on construction loans. This is usually adjustable during the build stage.
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Loan term – The number of months your construction loan period will last before converting to a mortgage. Often 6-12 months.
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Start date – When you expect to begin making payments and accruing interest charges.
With these inputs, you can use a construction loan calculator to estimate the monthly interest-only payments.
Step 1: Determine Your Loan Amount
Add up all projected costs associated with the construction project:
- Land acquisition costs
- Permitting and other fees
- Builder fees
- Materials and labor
- Contingencies for overages
This total projected budget will form your loan amount. If you already own the land, only include the new home construction costs.
Tip: Get quotes from builders and add at least 10% overage allowance. Construction costs often run higher than initial estimates.
Step 2: Check Current Interest Rates
Reach out to several lenders and inquire about current construction loan rates. Rates are usually adjustable and priced as a spread over an index like the Prime Rate.
For example, rates may be quoted as Prime + 1%, with a floor at 5%. If the Prime Rate is 4%, your actual rate would be 5% (the floor).
Comparison shop rates just like you would for a normal mortgage. Your credit, income, and down payment factor into the rate offered.
Step 3: Define the Loan Term
Most construction loans have terms of 6-12 months. The term needs to be long enough to complete all construction based on timelines provided by your contractor.
Opt for a longer term if your project has greater complexity or uncertainty. That provides a buffer in case of delays.
Step 4: Select a Start Date
When do you plan to break ground and start making loan payments? Choosing a future start date allows you to estimate payments based on when construction will actually commence.
Step 5: Input the Data into a Calculator
With your key inputs determined, go to an online construction loan calculator. Input the:
- Loan amount
- Estimated interest rate
- Number of months for the construction term
- Expected start date
The calculator will output an estimate of your monthly interest-only payments during construction.
For a $300,000 loan at 5% interest over 12 months, for example, the monthly payment would be around $1,250.
Step 6: Repeat for Various Scenarios
Now that you have the basics down, you can repeat the process varying the inputs to explore different loan amounts, rates, terms, and timelines.
Determining the monthly payments under different conditions allows you to stress test the financing and prepare for alternative scenarios.
Playing with the numbers gives you maximum flexibility to structure the loan in an affordable way. Being able to make the interest-only payments comfortably is key.
Other Factors that Impact Affordability
Along with the basic interest payment estimates, also consider:
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Total interest paid – At higher rates, you may accrue substantial interest during construction. This gets added to your loan balance before amortization starts.
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Risks of delays – A longer construction timeline means more interest charges. Build in a buffer in case projects get extended.
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Conversion costs – Once the home is complete, you’ll convert to a traditional mortgage. Closing costs apply for the new loan.
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Loan qualifying – You’ll likely need to re-qualify for the permanent mortgage based on updated financials once construction is done.
Next Steps After Calculating Payments
Once you’ve explored various payment scenarios, you can move forward confidently in applying for construction financing. Be sure to:
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Verify you can afford the estimated monthly payments based on your current income and expenses.
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Shop multiple lenders and compare loan estimates. Go with the best overall value based on rates, fees, and terms.
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Examine the loan agreement carefully. Confirm you understand the conversion process and costs.
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Get qualified for the permanent mortgage early. That makes conversion smooth once the home is move-in ready.
With the right construction loan payments calculations in place early, you can build your dream home stress-free and within budget. Use free online tools to forecast costs, then work with an experienced lender to bring your plans to life.
Types of Real Estate Construction Loans
There are two types of real estate construction loan: a stand-alone construction loan, and a construction-to-permanent loan. Though sharing the commonalities already mentioned, they differ in the benefits they could present to you, as a borrower.
- Stand-alone construction loans: the name of this loan is a little confusing, as it WILL include a longer-term mortgage as well. But the unique trait here, is the construction loan is handled as a separate loan to the mortgage that follows – the lender uses the first loan, to get you locked into securing the larger second one. You will usually have two sets of closing (and associated costs) with this loan type – at the beginning, and then again as you refinance the larger mortgage. The interest rate is variable during the build period and becomes fixed for the mortgage part of it. The payments made during the build are interest-only, and then you settle your balance as you roll the principal into your 30-year, fixed-rate mortgage.
- Construction-to-permanent loans: a more common type of real estate loan, this one will combine the two loans (build, mortgage) into one 30-year loan at a fixed rate. This loan type will usually require more of the borrower, in terms of down payments and credit scores. The clear benefit it has over the other, is the single set of closing costs to get the full loan amount, and an ability to fix the interest rate earlier.
One benefit of the stand-alone loan is for people who already own a property and may be looking to sell it when their build is completed. The stand-alone would allow this borrower to put more money down once they sell their existing home – which they could not do with the other loan type.
The stand-alone could also help people who have less money up-front to get into their property, because they could use the finished home as collateral to secure a better rate for the mortgage.
Another strategy is to look to the government for any existing programs that might be applicable to your situation.
The US Department of Housing and Urban Development (HUD) uses FHA loans to help more buyers find homes. Boasting low down payments and closing costs with easy credit qualifying, these loans can bring opportunity to a wider range of applicants. These traits hold true in FHA real estate construction loans.
FHA construction loans are construction-to-permanent, meaning only one closing. Key benefits of this loan, compared to one you would secure at a bank, include:
- A higher DTI (debt-to-income) level may be allowed;
- Reduced down payments, even as low as 3.5%;
- Federally-insured program with specific advisors and resources.
An FHA construction loan will have a few more stipulations as well, such as land ownership involved in the deal. If you owned the land for more than six months, you cannot qualify for this loan.
Your city will also need to provide a certificate of occupancy following a detailed inspection of the property after the building period. 60 days after this is issued, your loan begins amortizing.
US military veterans might have additional options to consider. Though the VA does not itself offer any loans, some qualified VA lenders will offer VA construction loans.
The good news is that qualifying for them uses the same criteria as any VA home loan. The challenge, however, is in finding a VA lender who offers them: they are often considered too risky, so they are not common in the marketplace.
Once you do find a VA construction loan provider, you are going to need to adhere to a very strict set of guidelines and rules about the property and the finished building to meet VA regulations and property requirements. They take an average of 45-60 days to close, which is a long time for any type of mortgage.
The benefits of the VA construction loan, which is a construction-to-permanent type, include:
- Potentially getting into the loan with low, or even zero money down;
- Gentle credit requirements;
- No PMI (private mortgage insurance) and low interest rates.
The real challenge in securing a VA construction loan, is finding a lender and a builder who are both comfortable with the deal. The risks, extra paperwork and delays involved make these loans more of a true rarity in the current marketplace…but veterans can certainly benefit from the extra efforts made to find and secure them.
If building your own home is a dream held, you should be happy that there are loan programs designed specifically to help you achieve that goal.
You should expect to put in some extra footwork to find a lender offering your loan, as well as saving for a larger down payment typically required. You’ll want to be building your credit score too, as it will play a larger role in your qualification.
If you are not a licensed contractor yourself, you will want to find a builder to work with who understands your funding needs. You will need plans and schedules to submit for funding, and you will have multiple checkpoints during construction to keep everything on-track.
You will receive money during the draw period, during which you are paying only interest on your loan. Following the build, you will have a 15- or 30-year mortgage at a fixed rate and pay either one or two sets of closing costs to get there, depending on your loan type.
As you can see, despite their complexity, construction real estate loans do provide opportunity and potential for many prospective homebuyers. While they may not be as popular and common as other types of mortgages, they can certainly be the key in helping you achieve your own dream home.
Understanding Real Estate Construction Loans
To build a new house is a dream shared by many Americans. Many people might never act on it, while many others certainly will: finding ways to save and plan, and one day build the home they always wanted.
The good news is that if you are looking for help in achieving a similar dream, there are programs and loans that are ready to help you. The complication is that real estate construction loans are more complicated than a normal loan, so you have to do a little more legwork.
This article will help you to understand some of the basics about new construction real estate loans so that you can one day also claim your own part of the American dream.
When Do I Make Payments On a Construction Loan (IN DETAIL)
FAQ
How to calculate interest on a construction loan?
How to calculate down payment on a construction loan?
What is the interest rate reserve on a construction loan?
Why do lenders allow interest to accrue on construction loans?
How do I calculate a construction loan payment?
Regardless of whether the construction loan is a stand-alone or a construction-to-permanent type, there are two ways to calculate the payment amount due: The Accurate Construction Loan Calculator is easily capable of handling either payment calculation and creating an amortization schedule.
What is a construction loan calculator?
Our construction loan calculator helps you estimate the financials of your construction project. It can determine your monthly payments during your home construction project, and the monthly mortgage payments after the construction is done. It can also estimate the FHA, USDA, and VA construction loans. How Do You Calculate a Construction Loan?
How do you calculate interest on a home loan?
A good approximation will be to: Take 70% of the loan amount. Use this calculator to figure out monthly payments. Multiply the result by 12 to get the total approximate interest. Take the full amount of the loan. Use this calculator to figure out your monthly payments. Multiply by the term of the loan.
What is the accurate construction loan calculator?
The Accurate Construction Loan Calculator is easily capable of handling either payment calculation and creating an amortization schedule. This calculator is also capable of handling either home construction loans or commercial construction loans equally as well. Below are the step-by-step instructions.