How Much Down Do You Need for a Construction Loan?

Taking out a construction loan to build your dream home can be an exciting prospect. With a construction loan, you can create a custom home tailored exactly to your needs and preferences. However, construction loans also require more money upfront compared to a traditional mortgage. So how much of a down payment do you need to get approved for a construction loan?

Typical Down Payment Requirements

Most lenders will require a down payment between 20-25% of the total construction costs for a construction loan. This means if you want to build a $400,000 home, you may need to put down between $80,000 to $100,000 to get approved.

The reason lenders require such a substantial down payment is that construction loans are riskier than traditional mortgages. With a regular mortgage, the home serves as collateral for the loan. But with a construction loan, there is no completed home as security. Requiring a large down payment helps offset some of the lender’s risk.

Some specific down payment requirements from major lenders include

• Wells Fargo – At least 25% down
• Bank of America – 20-25% down
• Chase – 25% down
• Local banks and credit unions – Typically 20-25% down

So in most cases, you can expect to put down at least 20% and potentially more depending on the lender. Coming up with such a large down payment can be a challenge for some borrowers

Putting Less Money Down

While 20-25% is the standard, there are some scenarios where you may be able to get a construction loan with less money down:

• VA and USDA loans: Veterans and service members may qualify for a no-down payment VA construction loan. Low-income borrowers in rural areas can get a USDA construction loan with no down payment.

• Using land as a down payment: If you already own the land you want to build on, some lenders may let you use a portion of the land value toward the down payment requirements.

• Premier Bank – 10% down: Premier Bank offers construction-to-permanent loans with only 10% down for qualified borrowers. This is much lower than the industry standard.

• Renovation loans: If you’re doing a major renovation rather than building new, renovation loans typically only require 5-15% down.

• FHA loans: FHA allows down payments as low as 3.5%, however FHA construction loans are hard to find and limited.

As you can see, there are scenarios where you may put down less than 20%, but you will likely pay a higher interest rate or fees to offset the increased risk to the lender. Carefully compare options to find the best fit for your financial situation.

Using Equity You Have in Land

If you already own the property you want to build on, the equity you hold could potentially count toward the down payment on a construction loan.

For example, if you have a $100,000 piece of land paid off and want to build a $300,000 home, the lender may let you put the $100,000 land value toward the 20% down payment. This essentially uses the equity you have built up in the land instead of bringing new cash to the table.

However, lenders will want to carefully assess the land value to ensure it appraises for at least the amount you claim. They will also look at factors like if there are any loans or liens currently on the property.

But in the right situation where you have significant equity, utilizing it can help reduce the new cash you need to bring to the closing table.

Why Such a Large Down Payment is Required

It’s understandable to be surprised or overwhelmed by the 20-25% down payment requirements for a construction loan. This is much higher than the typical 5-20% down payment needed for a regular mortgage.

Lenders require such a substantial down payment for a few key reasons:

1. Construction loans are riskier

With a regular mortgage, the house itself acts as collateral that the lender can foreclose on if you default. But with a construction loan, the home is not yet built, so there is no backing asset. This makes it riskier for lenders. Requiring a large down payment helps offset some of this risk.

2. Unpredictable costs

The construction process is filled with potential cost overruns and delays. A large down payment gives you extra cash reserves to cover unforeseen expenses. This protects the lender if the budget goes off track.

3. Secondary funding not guaranteed

Even if the construction loan will convert to a mortgage, the lender isn’t guaranteed you’ll qualify for the permanent financing. A substantial down payment shows you can cover a large portion of costs yourself if needed.

4. Slows pre-sales incentives

Some speculative builders try to get construction loans for homes they plan to sell before completion. A large down payment requirement deters this.

Tips for Saving up for a Down Payment

Since construction loan down payments tend to be large, it’s important to save and plan ahead if you hope to build. Here are some tips for amassing your down payment:

• Start saving early – Set up automatic transfers to ensure you sock away money each month into your construction savings fund. Time is on your side.

• Reduce spending – Cut back discretionary purchases and look for ways to trim your monthly budget. Small sacrifices add up.

• Earn extra income – Take on a side gig or find ways to make extra money that can all be directed toward your construction savings.

• Choose the right location – Property in a lower cost area will require less down payment than an expensive plot of land. Location matters.

• Invest lump sums – Put any windfalls, bonuses, tax refunds or gifted cash directly into your construction down payment fund.

• Check down payment assistance programs – Some nonprofit groups offer down payment assistance, particularly for lower-income buyers.

With diligent saving, budgeting, and planning, you can accumulate the sizable down payment often required to start your dream construction project. Don’t get discouraged!

Weighing the Pros and Cons

While construction loans allow you to build your perfect custom home, the steep down payment requirements can deter some buyers. If you’re exploring construction loans, carefully weigh the pros and cons:

Pros

• Create your dream home custom designed for your needs
• Potentially higher home value by building new
• Exact floor plan and layout you want
• Brand new systems, construction, and finishes

Cons

• 20-25% down payment can be difficult to save
• Higher interest rates than traditional mortgages
• Construction delays and cost overruns are common
• No existing home to fall back on if plans fall through

As you can see, construction loans allow immense customization freedom but also require more cash upfront. Look at your current financial situation and weigh if building new is the right choice over purchasing an existing home.

Partnering With the Right Lender

While the down payment amount is one of the biggest obstacles with construction loans, having an experienced lender can make the process smoother. Be sure to shop around and ask lenders:

• How much down payment do you require?
• Can I use land equity toward the down payment?
• What happens if construction goes over budget?
• Do you offer construction-to-perm loans?

Finding a lender well-versed in construction lending will help you understand requirements and have more financing options. They can guide you through the complex process.

The Bottom Line

Saving up 20-25% of construction costs for a down payment is certainly challenging. But with diligent preparation, utilizing equity you hold, finding flexible lenders, and weighing pros and cons, a construction loan may still be feasible. Do your homework to see if building makes sense for your financial situation. With proper planning, you can make your dream home a reality.