How Much Down Do You Need for a Construction Loan?

Getting a construction loan to build your dream home can be an exciting yet daunting process. One of the first things you’ll need to figure out is how much money you need to put down. While requirements vary by lender here’s what you need to know about down payments for construction loans.

Typical Down Payment Requirements

Most lenders will require a down payment between 20-25% of the total construction costs for a construction loan. Here are a few reasons why down payments tend to be higher:

• Construction loans are riskier for lenders since the home is not yet built. Requiring a larger down payment helps offset some of this risk.

• The lot or land generally is not adequate collateral on its own. A significant down payment shows the borrower has “skin in the game”.

• Construction loans eventually convert to a traditional mortgage Lenders want to ensure borrowers have enough equity in the home

While 20-25% is typical, some lenders may offer construction loans with as little as 10% down. Government-backed loans like VA and USDA loans can also have lower down payment options.

Factors That Influence Down Payment Amounts

Several factors determine how much you’ll need to put down for a construction loan:

• Credit score – Borrowers with higher credit scores can generally qualify for lower down payments. Those with scores below 620 may need as much as 30% down.

• Loan program – FHA loans only require 3.5% down. VA loans can go as low as 0% down for eligible borrowers.

• Land value – If you already own the land, its appraised value can count toward your down payment.

• Additional collateral – Some lenders may accept other assets as collateral to reduce cash down payment requirements.

• Builder reputation – Established relationships between lenders and reputable builders can sometimes open up easier loan terms.

• Loan-to-value (LTV) ratios – Most lenders cap construction loan LTVs at 80%. Better terms may be available at lower LTVs.

While mortgage lenders look for 20% down or more on traditional home loans, construction lenders clearly expect even larger down payments. Making a substantial down payment is key to getting approved.

What Goes Into the Down Payment?

The down payment includes both the cash you need to close and funds held in reserve. Here are the two main components of a construction loan down payment:

1. Initial Cash to Close

• Down payment on land purchase (if you don’t already own the lot)
• Closing costs including origination fees, appraisal, etc.
• Upfront permit and utility installation fees

2. Cash Reserves

• Contingency fund for budget overages
• Interest reserve to cover loan payments during construction
• Working capital to cover delays or increased costs

Lenders want to see you have cash set aside for unexpected expenses. They also want reassurance you can continue making payments if the project gets extended.

Can You Use Land as a Down Payment?

If you already own the land or lot you plan to build on, the appraised land value can count toward your down payment. Here are two options for using land equity:

Take out a construction loan for building costs only – In this case, your land down payment may only need to be 10-20% of construction costs, minus the land value.

Include land purchase in total loan amount – You can wrap land acquisition and build costs into one construction loan. Your down payment is based on the combined amount.

Using land equity can help you come up with a larger down payment to qualify for better loan terms. An appraisal is required to confirm the property’s current market value.

Minimum Down Payment Options

While 20-25% is standard, you may be able to find construction loans with smaller down payments:

• FHA loans – Only 3.5% down required plus closing costs. Credit scores of at least 580 required.

• VA loans – No down payment for eligible veterans/military members. Must have 620+ credit score.

• USDA loans – No down payment required for properties in designated rural areas. Credit scores of 640+ needed.

• Renovation loans – Some lenders offer 5-10% down on renovation loans for existing homes.

• In-house lenders – Large national builders often have their own financing with lower down payments.

The tradeoff is higher interest rates and monthly payments compared to larger down payments. Or you may need to meet stricter credit score or income requirements.

While they are less common, homebuilders and specialized lenders can sometimes work with down payments as low as 5-10%. Qualifying standards are higher, but it opens doors for buyers with limited funds.

Tips for Saving up for Your Down Payment

Here are some tips to help you save up cash for a down payment on a construction loan:

• Start saving early – Set aside funds well in advance of applying for a construction loan.

• Reduce spending – Cut discretionary purchases and budgets for things like dining out or vacations.

• Increase income – Take on a side gig or seasonal job to bring in extra money.

• Choose lot/plan wisely – Opt for a more modest lot and efficient floorplan to reduce overall costs.

• Take advantage of programs – Look into down payment assistance grants and partner with builders offering low down payment options.

• Use other assets – Ask lenders if you can use stocks, bonds, or a 401K loan instead of cash reserves.

• Get family gifts – See if you’re able to use gifts from family toward your down payment under lender guidelines.

While it takes discipline, coming up with a 20% down payment is possible with some preparation. Developing a savings strategy early on can help you reach your down payment goals.

Weighing the Pros and Cons of Different Down Payments

Putting down 20% or more has advantages like better rates, loan approval odds, and equity. But smaller down payments can also make sense for some. Consider the key trade-offs:

Pros of 20% or more down:

• Better rates and loan terms
• Increased chance of approval
• Less interest paid over loan term
• Added equity and ownership

Pros of 10% down or less:

• Purchase ability with limited funds
• More cash reserves after closing
• Smaller impact on savings
• Potentially easier to qualify

Cons of 20% or more down:

• Requires substantial cash savings
• Potentially depletes investment accounts
• Less cash reserves after closing
• More upfront costs

Cons of 10% down or less:

• Higher interest rates and fees
• Less equity and ownership
• More interest paid over loan term
• Potentially harder to qualify

Look at your unique situation to determine if putting 10-20% down makes the most financial sense or if a lower amount better aligns with your resources and goals.

Partnering With the Right Lender

While down payment requirements will vary, partnering with the right lender can help you identify the most viable construction loan options given your finances. Here are some tips for finding the best lender:

• Ask local builders for lender recommendations
• Review customer satisfaction on lender review sites
• Compare interest rates and fee structures
• Ask about down payment flexibility
• See if they offer in-house financing
• Opt for lenders experienced with construction loans

Connecting with referral partners that understand the unique aspects of construction lending can help you gain access to programs with lower down payment requirements.

The Bottom Line

Saving up around 20% of total construction costs for a down payment gives you the best shot at approval. But some homeowners secure loans with less than 10% down through special programs or niche lenders. Evaluate all your options, choose an experienced lender, and save as much as possible in preparation – this will put you in a strong position to get approved and build your dream home.