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

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.

If you’re looking to build a new home from the ground up or renovate an existing property, a construction loan can provide the financing you need to make your dream home a reality. One key question when applying for a construction loan is how much down payment you’ll need to put down.

Construction loans typically require a higher down payment than conventional mortgages on existing homes There are a few reasons for this

Higher Risk for Lenders

Construction loans are riskier for lenders because there’s no existing home as collateral if the borrower defaults. With a traditional mortgage, the lender can foreclose on the home if payments stop. But with a construction loan, all the lender has is an empty lot or partially built home. Requiring a larger down payment helps offset this risk.

Funds to Start Construction

The down payment provides the capital needed to purchase the land and start the initial construction Lenders want to see borrowers have skin in the game before providing the rest of the construction loan funds,

Weed Out Less Qualified Borrowers

A higher down payment requirement helps ensure only qualified borrowers with the financial means to successfully complete the project will get approved. Individuals who can’t come up with the down payment likely aren’t in a good position to take on a construction project.

So what’s considered a typical down payment for a construction loan? Here’s an overview of common requirements:

Minimum Down Payments for Construction Loans

  • 20-25% – Many lenders require a minimum down payment of 20-25% of the total construction cost. This covers the land purchase and a portion of building expenses.

  • 10-15% – Some lenders may offer construction loans with around 10-15% down for borrowers who meet stringent credit and income requirements. This is less common.

  • 3.5% – FHA construction loans allow down payments as low as 3.5%. However, borrowers must meet FHA credit and income standards.

  • 0% – VA and USDA construction loans are available with 0% down for those who qualify. Credit score minimums still apply.

While it’s possible to get a construction loan with less than 20% down from certain lenders, you’ll often pay a higher interest rate. And you’ll need excellent credit.

Factors That Impact the Down Payment Amount

While minimum downs range from 20-25% typically, your specific down payment depends on several factors:

  • Credit score – Borrowers with higher scores can qualify for lower down payments. Those with scores below 680 will likely need larger down payments.

  • Debt-to-income ratio – Your total monthly debt payments divided by gross monthly income. The lower your DTI, the better chance of a lower down payment.

  • Loan-to-value ratio – The size of your loan versus the completed home’s value. Aim for an LTV of 80% or lower.

  • Cost of construction – Down payments are a percentage of total building costs. More expensive projects require larger down payments.

  • Type of construction – Custom new construction often requires larger down payments than spec home building.

  • Builder reputation – Borrowers with an experienced, reputable builder may qualify for lower down payments. Lenders are less risky.

  • Additional collateral – Providing additional collateral like a secondary home or investments can lower down payment needs.

Down Payment Sources for Construction Loans

Where will the down payment funds come from? Here are some options construction loan borrowers commonly use:

  • Savings – Personal savings, such as from checking or savings accounts, are the number one source for down payments. Lenders like to see you’re using your own cash.

  • Proceeds from selling a home – If you’re moving, the money from selling your current house can fund the down payment.

  • Investments – Cashing out stocks, bonds, mutual funds, or real estate investments. Retirement accounts can also be used in some cases.

  • Gift funds – Receiving a financial gift from a family member is an acceptable source of down payment funds. Lenders will want a gift letter.

  • Home equity line of credit – Borrowers with existing home equity can tap it for the down payment via a HELOC.

Down Payment Assistance Programs

There are also many national, state, and local down payment assistance programs available for qualifying buyers. These programs provide grants, forgivable loans, or low or zero interest loans to cover all or part of the construction loan down payment.

Common providers include state housing finance agencies, the Federal Home Loan Bank, USDA, and non-profits like Habitat for Humanity. Your lender should explain available options when you apply.

Weighing the Pros and Cons of Construction Loan Down Payments

Coming up with a 20% or higher down payment isn’t easy. But larger down payments for construction loans also come with benefits:

Pros

  • Get better loan terms and interest rates
  • Improve chances of approval
  • Reduce monthly payments
  • Build equity faster by borrowing less

Cons

  • Harder to save for higher down payments
  • Down payment funds could be invested elsewhere
  • Takes longer to build savings to required level

Evaluate your finances, credit, construction plans, and time horizon when deciding how much to put down. Know that paying 20% down or more upfront is the most prudent option to get approved and ensure your project stays on budget.

Partnering With the Right Construction Lender

Finding the right construction loan for your project means partnering with a lender that understands your down payment situation. Be sure to get pre-approved before making an offer on land or starting any renovations. This shows sellers and contractors you’re serious. Pre-approval also locks in the rate and terms.

Here are some top lenders known for their construction loan down payment options:

  • Regions Bank – Offers construction loans with 5% down for qualified buyers.

  • Guaranteed Rate – Has construction loan programs with 10% down payment options.

  • Academy Mortgage – Pre-approvals as low as 3% down for credit-worthy borrowers.

  • First Horizon Bank – Features a construction product with 10% down payment.

  • TD Bank – Provides construction financing with 15% down in some markets.

Research multiple lenders to find one that can accommodate your down payment capacity. This takes some legwork, but maximizes your chances of approval.

The Bottom Line

Construction loan down payments are higher than conventional mortgages. But options exist even if you can’t make a 20% down payment. Explore specialized loan programs, down payment assistance, and lenders willing to work with your situation. This allows you to start building your dream home sooner.

How are new construction home loans paid?

When you obtain a new construction loan, you will be responsible for only paying interest until construction is complete. The bank tracks of disbursed funds when a specific portion of the home is completed. These loans are real estate secured but tend to have a higher interest rate due to being short-term.

You can save money on your new construction loan by making sure construction happens on time. If, for some reason, you get to the end of the short-term loan period before construction is complete, you will have to extend your current construction loan. If the construction lender approves, your construction loan either is extended or increased – for a cost.

Assuming your builder stays on schedule, and everything goes to plan, you’ll need to go to a lender and take out a standard mortgage loan when construction is complete. The new mortgage will be used to pay off your new construction loan balance. This will require you to pay closing costs , which will vary depending on the program and lender.

  • Buyer needs to obtain a new construction loan before construction work begins.
  • These loans are short-term and have a higher interest rate.
  • The buyer will obtain a standard mortgage when construction is complete.
  • The buyer will pay closing costs for both the construction loan and mortgage that they obtain later.

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?

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.

How does a construction loan payment work?

Pay Interest Only During Construction: With a construction loan, your monthly interest payments are calculated and applied based only on what construction funds you draw each month. This offers substantial relief over the alternative, which would be paying interest on the entire loan amount every month.

How to calculate a construction loan?

The lender will loan you a percentage of the appraised value of the home. So, for instance, if the home is appraised to be worth $500,000, they will loan you $500,000 x (95% as an example) = $475,000. The down payment will be your construction costs less the loan amount.

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.

What is a low down payment on a construction loan?

Down payments vary depending on the particular loan program. For example, their VA construction loan can be as low as 0% down, and their FHA loan can be as low as 3.5% down. Compared to most construction lenders requiring 20% down, Nationwide can offer these low down payment programs at low rates in a combined loan in all 50 states.

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?

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.

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