Taking on a construction loan to build your dream home can be an exciting yet daunting process. With so many factors to consider, one of the most important questions is “how much construction loan can I afford?”. Determining your budget and loan capacity is crucial before embarking on a build project
In this article, we’ll walk through the key steps to figure out your affordable construction loan amount. We’ll also look at useful online calculators that can provide estimates and help assess financing options. Read on to learn how to determine how much you can borrow for your new home construction.
Why Construction Loans Differ from Mortgages
Construction loans and mortgages share some similarities but also have important differences. Both allow you to finance real estate, but their purposes and structures vary:
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Purpose: Mortgages finance existing properties, while construction loans fund building a new home from the ground up.
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Loan Terms Construction loans are short-term, usually 6-12 months. Mortgages are long-term, like 15-30 years
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Interest Rates: Construction loans tend to have higher and adjustable rates based on the prime rate. Mortgages often have fixed rates.
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Payments: Construction loans involve interest-only payments during the building phase. Mortgages have principal and interest payments.
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Collateral: Construction loans are considered riskier since there is no existing home as collateral. Lenders have stricter requirements.
These key differences make determining loan affordability for a construction project more complex. This is where using a construction loan calculator can help
Estimate Your Affordable Loan Amount
Figuring out how much construction loan you can afford involves assessing your financial situation, the project costs, and your down payment funds. Follow these steps:
1. Check Your Credit Score
As construction loans are riskier for lenders, your credit score plays a bigger role in approval and loan rates compared to mortgages. Those with higher scores get better terms. Before applying, check your credit reports and focus on improving your score. Aim for at least a 680 FICO score.
2. Review Your Debt-to-Income Ratio
Lenders analyze your current debt obligations against your income to determine the maximum loan you can afford. Total your monthly debts like car loans and credit cards. Divide this by your gross monthly income to get your DTI ratio. Many lenders require DTIs of 35-43% or less for approval. Pay down debts to lower your ratio.
3. Calculate Total Project Costs
Add up all the expenses to build your home. This includes:
- Land purchase or financing costs
- Construction fees
- Materials and labor
- Design, permits, and fees
- Contingency reserve funds
Create a detailed budget with your contractor to estimate accurate costs. Expect costs to be 10-20% higher than a mortgage for an equivalent home.
4. Factor in Your Down Payment
Down payments on construction loans are usually higher than mortgages, from 15-25% of total costs. The more you put down, the better the loan terms will be. Determine your available savings and gifts from family.
5. Use a Construction Loan Calculator
With information gathered on your credit, income, project budget, and down payment, you can now use an online calculator. Enter these figures to estimate your affordable loan amount and potential monthly payments.
The MortgageCalculator.org Construction Loan Calculator and Casaplorer Construction Loan Calculator allow you to review different down payments and rates. Compare loan scenarios to find your optimal financing.
Assessing Affordability Beyond the Calculator
While construction loan calculators provide estimates, also consider these extra affordability factors:
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Loan fees – Calculate 1-3% of the loan amount for origination, underwriting, processing and other lender fees.
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Permit and inspection costs – Budget $1,000 to $5,000 depending on project complexity.
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Utilities during construction – Estimate $300 per month for water, electric and other utility costs.
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Bridge financing – If your current home sells before the new one is done, plan for short-term housing.
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Loan conversion costs – For a construction-only loan, account for refinancing into permanent financing.
Adding a 10-15% buffer above the calculator estimates helps account for these extra costs and financial cushions.
Choosing the Right Loan Amount
Determining how much construction loan you can afford takes research and number crunching. While exciting to build your ideal home, take a conservative approach with financing.
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Only borrow what you need, not the maximum approved. Each $10,000 adds $50-$100 to monthly payments.
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Have a stable income and emergency fund for unexpected overages.
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Get quotes from multiple lenders and compare all fees carefully.
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Consider starting smaller. Add-ons can come later once your mortgage begins.
With prudent planning using loan calculators and a methodical budget, you can make your new home construction project a success without overextending your financing. Enjoy the process and the pride of building your dream house from the ground up!
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.
What are Real Estate Construction Loans?
Before delving into the specifics of loan types and how they might work for you, there are some commonalities shared by all real estate construction loans, including:
- banks – while mortgage companies might be most common with securing a conventional mortgage, they tend to shy away from the complexity and risk of real estate construction loans. Banks are where you need to concentrate your efforts seeking this kind of financing, most often, as well as some government programs;
- land – usually, the property on which you will be building is included in the real estate construction loan. It is not required though. If you own property already, you actually may be able to leverage it as collateral, and get better terms for your construction loan;
- plans – you will need to provide detailed plans and timetables to qualify for this type of financing. Expect much more scrutiny, supervision and direct activity with your lender;
- FICO – as a real estate construction loan is often lacking a home as collateral, the borrower’s FICO score is much more important than it might be in other financing.
Most often, construction loans are short-term loans (one year or less) that turn into a longer, more conventional mortgage when building is complete. The larger part is usually 15 or 30 years.
With a construction loan secured, you will receive installment payments for that first year of building. They are on a predetermined draw schedule to cover the costs of building. You will make interest-only payments during the building period, typically based on a variable rate.
Expect your lender to check-in every time before disbursing draw-period funds, to make sure the project is adhering to the schedule pre-approved by you, the builder and the lender. Everything works off schedules and milestones that you had clearly set out to the lender to secure financing.
How the loan works more specifically depends on the type on loan you secure, and who you secure it with.
Use A Construction Loan To Build A House?
FAQ
How to calculate a construction loan payment?
What is an example of a construction loan estimate?
What is the debt ratio for a construction loan?
What is the minimum FICO score for a construction loan?
How much money do you need for a construction loan?
You should have enough income to cover payments on your current debts and the new construction loan. Lenders typically require a DTI ratio no higher than 45% for construction loans. Down payment of at least 20%. Borrowers typically need a down payment of at least 20% for a construction loan, but this can vary by lender.
What is a construction loan calculator?
A **construction loan calculator** is a helpful tool for estimating and evaluating various financial aspects related to your construction project.
How do I calculate construction loan payments?
A simple interest calculator is used to calculate Construction Loan Payments, but the method depends on the the type of the loan. How much construction loan can I get? Qualifying for a specific loan amount depends on the LTV and LTC of the specific program, borrower’s credit profile and income as well as documentation level.
How can construction companies estimate the cost of new construction loans?
Construction companies can swiftly estimate the cost of new construction loans or refinancing options. This tool enables precise budgeting, helping companies ensure they are financially prepared for their construction projects. With this calculator, you can gain insights into your loan terms and monthly payments.