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

Taking on a construction project to build your dream home can be an exciting yet daunting process One of the biggest financial considerations is determining how much money you’ll need upfront to qualify for a construction loan Construction loans have steeper down payment requirements than traditional mortgages, so it’s important to understand what lenders typically look for.

Typical Down Payment Requirements

Most lenders require a down payment of at least 20% for a construction loan This down payment is based on the total cost of your construction project, including both the cost of the land and the cost of building the home.

For example, if you purchase land for $100,000 and your construction costs are estimated to be $400,000, your total project cost is $500,000. With a 20% down payment requirement, you would need to put down $100,000 upfront before being approved for a construction loan.

The 20% down payment gives lenders assurance that you have enough skin in the game. If you were to default on the loan, the lender could likely recoup their costs through selling the partially completed home and land. Lower down payments leave lenders at greater risk, so it’s uncommon to find construction loans with less than 20% down.

What Impacts Down Payment Requirements

While 20% is standard, your specific down payment requirement may vary slightly based on other factors:

• Credit score – Borrowers with higher credit scores may qualify for lower down payments around 15%. Those with poorer credit may need as much as 30% down or more.

• Loan type – FHA and VA construction loans can sometimes be obtained for as little as 3.5% and zero percent down, respectively. USDA construction loans also offer zero down options in eligible rural areas.

• Relationship with lender – If you have an extensive relationship with a local bank or credit union, they may be willing to reduce the down payment requirement for construction loans.

• Appraised value – If the completed home is expected to appraise for significantly more than construction costs, some lenders may accept less than 20% down.

• Loan-to-value (LTV) ratios – Most lenders cap construction loans at 80% LTV. So if construction costs rise, you may need to increase your down payment maintain 80% LTV.

Down Payment Sources

Where will such a large down payment come from? Here are some common sources borrowers tap for construction loan down payments:

• Savings – Ideally you’ll have built up sufficient cash savings to cover at least 20% of project costs. Regular contributions to retirement accounts and other investments can help grow your down payment fund over time.

• Proceeds from selling a home – If you’re moving from an existing home, the profits from its sale can directly fund your new home’s down payment.

• Personal loans – Unsecured personal loans or loans secured against other assets can provide an alternative source of down payment funds. However, take care not to over-leverage your finances.

• Retirement funds – Withdrawals from IRAs or 401(k)s can be used, but should be considered carefully due to taxes and penalties.

• Gifts – Receiving gift funds from relatives is usually allowed. Lenders will just need gift letters confirming that the money doesn’t need to be repaid.

• Land equity – If you already own the construction lot, its appraised value can act as part of your down payment.

Lowering Your Down Payment Needs

If you’re short on funds for the full 20% down, there are some options to reduce the amount needed:

• Look into FHA, VA and USDA construction loans as mentioned above

• Seek out lenders willing to go as low as 10-15% down for those with excellent credit

• Pay for pre-construction costs like architectural plans out of pocket rather than financing them

• Ask the seller to provide seller financing on the land purchase to reduce your financed amount

• See if family members can cosign on the construction loan to supplement your collateral

• Make a larger down payment after construction is complete when refinancing into a mortgage

Weighing the Pros and Cons

Putting down 20% or more has its advantages and disadvantages:

Pros

• Improves chances of approval and gets you better loan terms

• Lowers your interest rate, saving money over the life of the loan

• Avoids paying mortgage insurance (required for loans with less than 20% down)

• Builds immediate equity in the home upon completion

Cons

• Requires substantial cash savings most buyers don’t have

• Ties up money that could be invested elsewhere for higher returns

• Can limit funds available for construction contingencies

• Makes it harder to qualify for financing if costs exceed estimates

Key Takeaways

Construction loans allow you to customize and build your dream home from the ground up. But make no mistake about it – the down payment requirements are steep compared to buying an existing house with a standard mortgage. Be prepared to put at least 20% down in most cases, and have Plans B and C available in case your down payment falls short. With proper planning and budgeting, you can make your vision of a custom-built home become reality.