Getting an interest only construction loan to build or renovate your dream home can be an exciting yet daunting process. Using an interest only construction loan calculator is a great way to estimate your potential loan payments during the construction phase as well as your payments once the loan converts to a traditional mortgage. This allows you to determine if the project fits within your budget before moving forward.
In this article, we’ll explain what an interest only construction loan is, the benefits of using a calculator, and walk through the key steps to use one effectively
What is an Interest Only Construction Loan?
An interest only construction loan is a short term loan used to finance the building of a new home or renovations on an existing property. During the construction phase, which typically lasts 6-12 months, the borrower only pays the interest on the loan each month. This allows more cash flow during construction since you aren’t paying down the principal.
Once construction is complete, the loan converts to a traditional 15-30 year fixed rate mortgage. At that point, your monthly payments will include both interest and principal, like a typical home loan.
Interest only construction loans carry more risk for lenders, so borrowers usually need excellent credit scores and sufficient income and assets to qualify. Rates may be slightly higher as well. But they can be a great option for financing major home building projects.
Benefits of Using a Construction Loan Calculator
Calculating your payments manually on an interest only construction loan can be tricky. This is where using an online calculator tool comes in handy. Here are some of the major benefits:
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Estimate your interest only payments – The calculator will factor in your loan amount, construction loan rate and term to determine your estimated monthly interest only payments. This shows what you can expect to pay during the construction phase.
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See payment impact when loan converts – Once construction is done, the calculator will show what your new monthly mortgage payment will be after converting to a fixed rate loan. This lets you see how the payments change.
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Adjust variables to fit your scenario – You can tweak the loan amounts, rates, terms and other variables to model different loan scenarios. This allows you to find the best option for your financial situation.
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Detailed amortization schedule – Many calculators generate a detailed payment schedule that shows the breakdown of interest vs principal each month once the loan converts. This helps with budgeting.
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Easy to use and adjust – The calculator does all the hard math for you. You simply plug in the numbers and can go back and adjust inputs quickly to compare different options.
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Visualize your costs – Some calculators include graphs that visually depict your payments and loan balances over time. This can further help you understand the impact of an interest only construction loan.
How to Use a Construction Loan Calculator in 5 Steps
Using an interest only construction loan calculator is straightforward. Just follow these five steps:
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Enter your projected construction costs – This includes land purchase price plus all costs to build or renovate the home. This will be the amount you need financed.
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Input your down payment amount – The down payment reduces the loan amount required. Most lenders require 20-25% down for construction loans.
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Select construction loan term – Typical terms are 6, 9 or 12 months. The term impacts your interest only payments.
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Enter estimated construction loan interest rate – Rates are variable during construction but the calculator needs an estimated rate. Research current rates to make an informed estimate.
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Input mortgage loan details – Once construction is complete, provide mortgage amount, rate and term (e.g 15 or 30 years fixed) so the calculator can determine your post-construction monthly payments.
Once all inputs are entered, the calculator will output your estimated monthly costs for both phases of the loan. You can tweak the variables to model different scenarios.
Here’s an example to demonstrate:
- Construction Costs: $300,000
- Down Payment: $60,000 (20%)
- Construction Loan Amount: $240,000
- Construction Loan Term: 12 months
- Estimated Interest Rate: 7%
- Mortgage Amount: $240,000
- Mortgage Term: 30 years fixed
- Mortgage Rate: 5%
For this scenario, the calculator estimates your interest only payments would be around $1,400 per month during the 12 month construction phase. Once converted to the 30 year fixed rate mortgage, your principal and interest payment would be approximately $1,265 per month.
Running through different versions helps you determine the loan structure and payments that work best for your budget and financial goals.
Finding a Construction Loan Calculator
Now that you know how to use an interest only construction loan calculator, where do you find a good one? Here are some options:
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Bank websites – Many large banks like Bank of America offer free online calculator tools.
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Mortgage websites – Top mortgage sites like NerdWallet and LendingTree also provide calculators.
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Specialty calculators – Sites like Mortgage Calculator offer a dedicated construction loan calculator with helpful features.
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Google search – Search for “construction loan calculator” to find many free options to choose from.
I recommend trying a few different calculators to find the one you like best. Look for in-depth features, an easy interface, ability to export the full amortization schedule, and mobile accessibility. Taking a few minutes to find the right calculator will make estimating your construction loan a breeze.
Next Steps After Using the Calculator
Once you’ve modeled some scenarios and have estimates on potential construction loan payments, here are some next steps:
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Evaluate if the payments fit your budget – Make sure your income and expenses allow room for the construction phase interest payments as well as the post-construction mortgage payments.
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Research construction loan requirements – Interest only construction loans have stricter qualifying guidelines. Understand what’s required for your credit score, down payment, and financial reserves.
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Talk to a lender – Have preliminary discussions with lenders that offer construction loans. They can help tailor options to your scenario and provide quotes on actual rates.
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Discuss timelines with contractors – To determine loan term needs, talk to your potential contractors about estimated construction timelines if building new.
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Refine plan as needed – Keep fine tuning your numbers and exploring alternatives if payments exceed your target budget.
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Submit your loan application – Once satisfied with the estimates, proceed with formally applying for the construction loan and down payment assistance programs if applicable.
The interest only construction loan calculator is the first step to understanding your financing options for your home building or renovation project. Taking the time to model out your payments will give you greater confidence in moving forward and achieving your dream home.
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.