Understanding Construction Loan Requirements
Construction loans are one of the many loan products we make available to our members at Truliant Federal Credit Union. Here are some helpful tips to consider and be aware of as you begin your journey.
1. Credit Score and Income Minimums
With any type of loan, you’ll want your credit to be in tip-top shape. Construction loans and mortgages, especially, require good credit to get approved, so make sure to review your credit report many months before you’re in the market and work to increase your score. Pay down debt, get debt-to-income as low as possible and make sure there are no errors on your report. Additionally, don’t make any large purchases in the months before you’re going to apply for a construction loan.Most lenders typically want a minimal credit score of 680 for the loan to be considered, some want the score to be 720 or better.
2. Income
With a solid history of good credit and a promising credit score, your income is another aspect lenders take into consideration. All lenders will ask for financial verification documents to confirm you’re situated financially to repay the loan. A low debt-to-income ratio is another positive on your behalf.
3. Down Payment
Generally, lenders want the borrower to cover between 20% and 25% of the construction project's costs with their down payment.
4. Creating a Detailed Plan for Your Construction Project
Lenders like to see that the borrower has carefully planned out their construction project before borrowing funds. Many financial institutions offering construction loans will want to see plans and specifications of the house.
Take the time to compile your blue book before you start looking for financing for your construction project. The more prepared and organized you are when you apply, the better you'll look in the eyes of the lender.
5. Selecting a Builder You'll Work With on Your Project
You should already have a builder lined up to work with on your project before you apply for financing. You should make sure that your builder is licensed and insured residential builder.If you need help finding a builder, the National Association of Home Builders local association’s directory could help.
It will most likely be harder to acquire financing for your project if you're using an amateur builder or if you're trying to carry out construction work yourself. It's important to put a lot of thought into who you select as the builder for your envisioned construction project.
6. Getting an Appraisal Amount for the Envisioned Project
You need more than just financial projections and detailed building plans when you apply for a construction loan. You also need to have an appraisal performed. This appraisal will detail what the value of both the building structure and land the structure is on will be once the project is complete.
If a home is being built on the property, your appraisal will be an estimation of the future value of your home. The lender might want to have their own appraisal performed on your project when you apply for your construction loan and you might want to have a personal appraisal performed before you apply for a construction loan, too. This will allow you to get an idea of what the results of your construction project should be worth.
7. Construction Loan Rates
Very few lenders offer a guaranteed rate construction loan. Some have products with an option to pay a fee to “lock” the rate during the construction phase, and some lenders products are set up to do that automatically at the end of the construction phase. Other lenders may have a product that requires a second closing and rate and the term may be re-negotiated for the permanent financing.
Understanding all your options, and the variables involved with construction loan rates and requirements can be beneficial.
FAQs
To get a construction loan, you'll need a low debt-to-income ratio and proof of sufficient income to repay the loan. You also generally need a credit score of at least 680. Make a down payment. You need to make a down payment when you apply for the loan, just as you do with most mortgages.
Is a construction loan harder to get than a mortgage? ›
The approval process for a construction loan can be more rigorous than with a conventional mortgage loan. For both types of loans, a lender will likely consider factors like the borrower's credit score, debt-to-income (DTI) ratio, and down payment.
What does your credit score have to be to get a construction loan? ›
Credit Score and Income Minimums
Additionally, don't make any large purchases in the months before you're going to apply for a construction loan. Most lenders typically want a minimal credit score of 680 for the loan to be considered, some want the score to be 720 or better.
What are the disadvantages of a construction loan? ›
Cons
- Extensive loan documentation requirements.
- Interest rates that are higher than with conventional loans.
- Interest-only payments during the construction phase.
- Substantial down payment requirements.
Debt-to-income ratio: 45% or lower. Down payment: Minimum 20% for a construction-to-permanent or construction-only loan, although some lenders require more. For a renovation loan, you can probably put down much less. For example, if you get an FHA 203(k) loan, you'll only need a 3.5% down payment.
Is it difficult to get a loan to build a house? ›
Applying for a construction loan can be a complex process. You'll need to prove that your home-building project is real, viable, and relatively low-risk for the lender. For most construction loan applications, you'll need to provide the lender with a project timetable and a realistic budget.
What is an example of a construction loan estimate? ›
The lender will loan you a percentage of the appraised value of the home. So, for instance, if the home is appraised to be worth $500,000, they will loan you $500,000 x (95% as an example) = $475,000. The down payment will be your construction costs less the loan amount.
Can an FHA loan be used to build a house? ›
The FHA construction-to-permanent loan allows you to build a home from scratch. You can use it to buy land, finance construction costs and cover lender fees. This loan combines the features of a short-term construction loan with a standard, long-term FHA loan.
How hard is it to get a credit builder loan? ›
Credit-builder loans are easier to qualify for than a traditional loan, especially for people with poor or no credit histories. If you make regular on-time monthly payments, credit-builder loans are a good opportunity to improve your credit scores.
Can you build a fourplex with an FHA loan? ›
Under the traditional FHA mortgage program, clients can purchase a home with up to 4 units. The advantage of this is that borrowers can get favorable terms such as a low down payment and they may receive lower interest rates than they would with the typical multifamily loan.
Loans and other accounts are considered part of those assets. That means your account will most likely be sold to another institution, which will then take over and manage it just like your previous lender did. In most cases, these accounts or assets are packaged and sold to the same lender.
Why are construction loan rates higher? ›
Yes, interest rates for commercial construction loans are typically higher than traditional commercial loans. This is due to the higher risk associated with construction projects, such as delays, budget overruns, and potential market changes during the construction period.
Is a construction loan the same as a renovation loan? ›
Remember, while extensive renovations might be needed, a construction loan is typically only necessary if you're building a home from the ground up, acquiring land included. Conversely, renovation loans are suitable for existing structures even if significant repairs are required.
How do payments work while you are building a house? ›
During the construction-loan phase, you're only responsible for interest payments on the money drawn, as it's drawn. After the conversion, you start making payments that cover interest and the principal — as you would with any mortgage.
What is too high for income to debt ratio? ›
Key takeaways. Debt-to-income ratio is your monthly debt obligations compared to your gross monthly income (before taxes), expressed as a percentage. A good debt-to-income ratio is less than or equal to 36%. Any debt-to-income ratio above 43% is considered to be too much debt.
What is the debt yield on a construction loan? ›
Debt Yield = Net Operating Income / Loan Amount
For example, consider the purchase of a property with $300,000 NOI and a loan of $3 million. In this example, the debt yield is 10 percent ($300,000 / $3,000,000 = 10%).
Why are construction loans risky for lenders? ›
If the budget is improperly managed, funds can run out before the end of the project. This scenario is risky for every party, but particularly so for the lender.
How does interest work on a construction loan? ›
Pay Interest Only During Construction: With a construction loan, your monthly interest payments are calculated and applied based only on what construction funds you draw each month. This offers substantial relief over the alternative, which would be paying interest on the entire loan amount every month.
Is it cheaper to buy or build a house? ›
Overall, it's cheaper to build a home than to buy one in California, with 13 out of the 20 counties saving you money if you decide to build your house from scratch. Budget-wise, building is more favorable in Southern California whereas Central California caters best to those interested in buying.
