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

Getting a construction loan to build your dream home can be an exciting process. However, it also requires more planning and budgeting compared to purchasing an existing house. One of the key things you need to figure out is how much money you need for a down payment when getting a construction loan. Here are some tips on determining the down payment amount and getting approved for construction financing.

Typical Down Payment Requirements

Most lenders require a higher down payment for a construction loan than a conventional mortgage This helps mitigate the risk associated with financing a home that hasn’t been built yet

• The typical down payment for a construction loan is 20-25% of the total project costs.
• Some lenders like Premier Bank may offer construction loans with a 10% down payment.
• The down payment usually covers the cost of the land purchase and some of the construction costs.

For example, if your total project budget is $500,000, you may need to provide a down payment between $100,000 – $125,000. Having a larger down payment shows the lender you are financially committed to the project.

Using Land as Down Payment

If you already own the land where you want to build the house, you may be able to use the land value as part of your down payment. The lender will assess the equity you have built up in the land to determine if it can count towards the down payment.

• The land value must cover at least 10-25% of total construction costs to potentially qualify.
• An appraisal will determine the current market value of the land.
• You’ll need to show clear title and sufficient equity in the land.

For instance, if the land is worth $100000 and your build budget is $400000, the land equity could cover 25% of the costs. This means you may not need to provide any additional down payment.

Lower Down Payment Options

While 20-25% is standard, there are a few options that allow lower down payments on construction loans:

• FHA construction loans only need 3.5% down with a minimum credit score of 580.
• VA loans are available with 0% down payment for veterans and military members.
• USDA loans offer 0% down loans for building in rural locations.

These programs have maximum loan limits and eligibility requirements. For example, VA loans require a Certificate of Eligibility showing your service status. USDA loans have income caps based on location.

Factors That Impact Your Down Payment

Here are some key factors lenders consider when determining down payment requirements:

• Credit score – Borrowers with higher credit scores may qualify for lower down payments. Scores below 620 can expect to put down 25% or more.

• Debt-to-income ratio – Your total monthly debts divided by gross monthly income should be below 43% to qualify. Lower ratios allow smaller down payments.

• Construction costs – The higher the total construction costs, the larger down payment you may need to qualify. Expensive homes often require 25%.

• Loan program – Conventional loans have higher down payments than government-backed options like FHA, VA and USDA construction loans.

• Builder reputation – Loan terms may vary based on the experience and credibility of the home builder.

Tips for Saving for Your Down Payment

Here are some tips to help you save up for the construction loan down payment:

• Start setting aside money as soon as you decide to build to give yourself plenty of time.

• Create a separate savings account or use a high yield online savings account to earn interest.

• Reduce monthly costs and stick to a detailed budget to maximize savings.

• Use windfalls like tax refunds, bonuses, or gift money to grow your down payment fund.

• Take advantage of down payment assistance programs if you qualify. These provide grants to first-time homebuyers.

• If needed, trim down costs in the construction plans to require a smaller down payment amount.

Weigh Pros and Cons Before Borrowing

While tempting, you may want to avoid borrowing from retirement accounts or taking on new debt to come up with the down payment.

Consider the pros and cons:

Pros

• Allows you to build home even if you haven’t saved enough yet

Cons

• Causes you to accrue more interest costs
• Potential for fines and taxes on retirement account withdrawals
• Puts you in risky financial position

Only borrow funds if you can pay it back quickly. High-interest credit card debt makes it harder to qualify for a mortgage. An alternative is to delay construction until you have saved more.

Work with Your Lender to Determine Down Payment

The down payment for a construction loan varies significantly based on your financial profile and the details of your project. As you create your new home plans and budget, consult frequently with potential lenders.

Ask them to help you determine:

• The minimum down payment required
• If land can be used as down payment
• Options for lowering the down payment like government programs
• Steps you can take to improve your rate and down payment amount

This allows you to set realistic savings goals and account for the down payment in your overall budget. With proper planning, you can build the home of your dreams.