Over a million new homes break ground each month in the United States. The housing market has slowed in recent months, but some economists say demand is still unmet.
You might be thinking about a custom-built solution. Many builders put up homes quickly and with less durable materials. Their designs may leave something to be desired.
The big problem is financing. How can you convince a lender to finance something that doesn’t even exist yet?
You need a different type of loan. In this guide, we’ll walk through the steps for how to get a construction loan. With this information, you’ll be able to convince almost any lender to back your dream home.
How Construction Loans Work
If you’re hearing about a construction loan for the first time, you probably have a few questions. How do construction loans work? Are they like mortgages or lines of credit?
There are actually a couple of different types of construction loans. The first is the standalone construction loan.
A standalone construction loan is much like a line of credit. You’ll apply to the lender, and they’ll transfer the funds to you in installments, called draws, as you need them. Each installment pays for a particular task like framing the house.
You’ll then make interest-only payments during construction.
This is a short-term financial solution. It’s designed to cover the construction of your house and nothing more. When construction ends, you have to pay the loan off.
A construction-to-permanent loan is a bit different. At the end of construction, this loan type converts into a standard mortgage. This is helpful if you won’t have the funds to pay off a standalone loan.
Which Type Do You Need?
There are advantages and disadvantages to both construction loan options. A C2P loan means you only pay one set of closing costs. It also helps you lock in at interest rates.
C2P loans might be the right choice if you’ll need to shop for a mortgage anyway.
A standalone loan lets you shop around for better terms for your mortgage. It’s a good option if you have a lot of cash or another home to sell.
The Construction Loan Process
Getting a construction loan is a touch more complex than getting another type of loan such as a personal loan. There’s good reason for this. Since your home doesn’t exist yet, the lender wants some guarantees.
You can expect a rigorous approval process for a building loan. The lender will want to inspect your land and your architectural plans. They’ll want to see timelines.
They’ll also review your chosen builder. On top of all that, the lender will conduct the usual audit of your finances. They’ll want to see credit scores and more.
More reviews take place during the building process as well. The lender will likely check in with the builder before each scheduled draw. They’ll want to know if the project is proceeding according to schedule and if all is going to plan.
When to Apply
You’ll get your documents in order before you apply for construction loan financing. The first steps are putting your credit in order and collecting financial documents.
If you have poor or bad credit, some lenders may not consider you. Other lenders will extend a loan, but they may want to charge higher interest rates.
Once you’ve gathered your documents, you’ll apply for pre-approval. This step happens before you choose a builder or buy a property.
You’ll apply for the construction loan once you have a builder and a blueprint. Remember, the lender wants to see all the plans. If you don’t have a blueprint or a builder, it’s not time to apply yet.
Before you buy a property or find a builder, gather up your financial documents and research lenders. You’ll need to know how much you can get in a loan before you start making plans.
You’ll need to do some research on lenders. Many financial institutions don’t finance new construction projects. You’ll have to find out which banks and credit unions will fund your project.
Don’t forget to look beyond traditional lenders as well. There are many alternative lenders who may be more willing to finance you. Some of them may even specialize in construction loans.
You may qualify for government-backed loan programs as well. If you’re a veteran, you can talk to Veteran Affairs. The Federal Housing Administration and USDA also offer loans.
Once you’ve found some lenders you like, you’ll gather up your documentation. You’ll want to include:
- Statements about annual income
- Daily expenses
- Information about assets, like a 401k
- Statements about existing debt and debt payments
- Your financial history
- Your credit score
The financial review is important for lenders, since they want to know you’ll be able to repay the loan. This information should allow them to estimate how much loan they’d be willing to give you.
Plans Are Part of How to Get a Construction Loan
Once you have pre-approval, you’ll have a rough idea of how much financing you can access. It’s time to talk to some builders and see how they’ll help you bring your dream home to life.
Always do careful research on builders. Some builders have stellar reputations, while others do not. Many things can go wrong during construction, so ask about the builder’s experience.
How do they handle unexpected tasks or delays? What are their management processes like? Can they give you examples of projects they’ve completed successfully and on-time?
You’ll also want to ask the builder to draw up plans. Ask them about the materials they’d use. Create a timeline for the project.
Any lender you apply to will want to see your detailed plans, even if you’ve been pre-approved. Working with the builder will help you craft plans that fit your vision and address the lender’s concerns.
Apply for the Loan
Now you’ll actually fill in the lender’s application and submit it, just like with a personal loan. Even if you have pre-approval, you may need to submit your financial documents again.
The lender will review your plans and your builder. They’ll also take the time to reassess your financial documents.
A lender will scrutinize a builder. They will ask for third-party references. They will also ask about the builder’s bill-payment history.
A lender will likely want to see some completed projects as well. Their goal is to make sure the builder won’t leave the project half-finished.
Here, you should be on the same page as the lender. You want to pick a good builder who will complete the project to specifications. You should have asked the builder some of the same questions the lender will.
The lender will not approve or reject your home plans. Instead, they’ll call in an appraiser. This person will review plans and comparable projects to decide the home value.
You may want to apply to a few different lenders. Remember to space out your applications, since lenders will query your credit history. Many queries at the same time can cause a temporary dip in your credit score.
Some lenders will require you to have a down payment for a construction loan. Others may not ask you for one. It’s never a bad idea to put some money down if you can.
Some lenders may ask for a larger down payment, particularly if they consider your application risky. If you’re particularly qualified, they may waive the down payment altogether.
A larger down payment usually increases the lender’s confidence. They may offer you a lower interest rate or more favorable terms if you can put more down.
If you can’t put any money down, the lender may see you as a risk. They may charge more interest or add extra fees.
A larger down payment also helps you. The more you can put down, the less your loan amount will be. This means the payments will be more manageable for you.
Read the Fine Print
The final step in getting a construction loan is looking over the contract once you’ve been offered a loan. Make sure you review and understand all the terms.
The loan agreement will include:
- The amount of the loan
- Interest rate and APR
- Extra fees charged by the lender
- The repayment schedule
- Penalties, such as failure to pay or early payment
If you’re not sure about the terms, ask someone to help you review them. You want to be sure you’re getting the best possible deal as you make your dream home a reality.
Build on Your Dreams
The process for how to get a construction loan may seem complex. With luck, this guide has made it much simpler for you. You can now begin applying for construction loans to finance your dream home.
A construction loan might be the right choice for your project. There are also many other types of loans. Check out our blog for more information on them, so you can be sure you’ve got the right loan for your needs.
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