Finance

Home Construction Loans

Everything you need to know about home construction loans

Home Construction Loans: Finding the perfect home is challenging. It doesn’t matter if you intend to live there or rent it out. However, it can be very convenient to purchase a home already built. Although you may have ideas about how things should look, all the properties available need to match them. You may have a dream about designing your home from the finest details to its final form. It is possible only through renovations or construction.

Home construction loans are available to borrowers who wish to build the perfect home for themselves or as an investment.

These are some of the problems you may find yourself. A construction loan is a solution. However, home construction loans are different from residential mortgages. These loans can be more complex and have additional requirements.

This article will explain everything you need about residential construction loans and how to qualify. You can compare it with other residential loans by reading about these unusual mortgage loans for all types.

What is a loan for home construction?

A construction loan is a short-term residential loan that provides funds for the construction and renovation of borrowers’ homes. As the project progresses, funds will be in stages. The loan typically lasts one year. During this time, you will need to finish the project and get the certificate of occupancy.

Because the property isn’t yet available, this type of loan has a higher risk than residential mortgages. Construction mortgages may have a higher interest rate to compensate for this risk. After the property has been, most borrowers refinance their original loans with a long-term residential mortgage.

Read More: Alternatives To Construction Loans

What types of residential properties can finance?

You can use the proceeds of a residential construction loan to construct or renovate a single-family residence, townhouse, two-family property (duplex or triplex), or renovate condominium units.

Multifamily properties with 5 or more units fall under the category of properties and can use commercial loans. A commercial construction loan is required if you want to renovate or build one. Here’s all you need to know about commercial construction loans.

Which occupancy types are eligible for financing?

There may be restrictions on acceptable occupancy types depending on the lender. Lenders may not lend to owner-occupied properties or investment properties. Some lenders are more flexible and can accept both occupancy types, but creative lenders are usually more flexible. These creative loan programs will be the focus of this article.

First, let’s define what is owner-occupied or investment property.

Owner-occupied

It refers to real property that the owner can use as their primary or secondary residence. Owner-occupied construction loans are available to borrowers looking to build a home or vacation home in a beautiful or tranquil location.

Invest

The investment category includes residential properties you intend to rent or sell to third parties. These properties, unlike owner-occupied ones, are designed to generate income.

Your experience as an investor in real estate will also play a role in determining the type of construction loan that is right for you. Many creative loans are available, regardless of your experience as a builder or investor.

What is the process of residential construction loans?

A detailed construction plan, timeline, and budget must submit as part of your application.

Interest rates

Construction mortgages have higher interest rates than other residential loans. It is because this type of loan finances properties that aren’t yet available, unlike other mortgages.

If you default on your mortgage payments, your lender may foreclose on the property. For construction loans, however, lenders might only foreclose on vacant land or a partially-finished structure. It is considered a higher-risk situation by lenders.

Variable interest rates for construction loans are also available. These fluctuate depending on the prime rate.

Timetable

A home construction loan’s short timeline is one of its fundamental characteristics. Some lenders will allow construction to last from 9 to 12 months. Extensions are possible if needed.

The proposed construction timetable will determine the duration of the loan. To help lenders properly evaluate the loan application, borrowers need to submit a realistic construction timeline, a detailed plan, and realistic budgetary requirements.

Schedule

The lender will send a drawn plan to the borrower once the application has been completed. The draw schedule should include a detailed payment plan detailing the project. It should also contain information about when funds will apply to contractors or builders and what requirements must be before each draw is released. Will ensure that the construction proceeds as planned and that the funds are for their intended purpose.

A draw could come after the house. If this milestone has, the lender will only release funds for the project’s next stage.

A third-party inspector will also visit the site during various phases of the project to verify the progress. You can expect between five and seven inspections before the project is complete.

Because these loans typically have interest-only payments, draws are essential to determine your monthly dues. Even though construction is ongoing, you only have to pay interest on funds drawn up to date.

Repayment

Borrowers may apply for a construction-to-permanent loan wherein the loan is automatically converted to a permanent, long-term mortgage once the construction is completed and is ready to be occupied.

Another option is to obtain a loan to finance construction and the second loan in the form of a permanent mortgage. This repayment option requires approvals and two loan applications.

These two options are in more detail below.

What is a home construction loan?

The loan proceeds may pay for the construction of the property, as well as the costs of land and labor and other costs, such as permit fees, architectural and engineering fees, and permit fees.

A construction loan typically does not cover home furnishings. However, A few home construction loans also include a contingency fund that provides a cushion if the borrower needs to change or upgrade some details.

From lender to lender, the contingency requirements vary. A lender might require 5-10% contingency funds to fund its construction mortgages. is based on the total cost of the project and the land’s value. The borrower can waive this contingency if additional reserves are documented (typically around 10%) after the downpayment. It is to ensure that the project is within the budget.

There are many types of residential construction loans.

Construction-to-permanent loan

This type of loan is known as the one-time closesingle close, or all-in-one close. After the project’s completion, it converts your construction loan into a long-term one. This type of loan is for borrowers who are unable or unwilling to pay the balloon payment by the maturity date or believe they will lose their creditworthiness in the future.

Construction-to-permanent loans come with several advantages in the form of:

  • Convenience. Borrowers don’t need to submit separate applications or seek approval from another party to convert the construction loan into a long-term loan. It Lets borrowers concentrate on furnishing their homes and renting them instead of dealing with paperwork and delays.
  • Closing cost: After approval of the construction loan, the loan includes a one-time close. The loan will automatically convert to a permanent mortgage, and no additional closings are required. It saves the borrower from having to pay exact closing costs.
  • Easy repayment: This loan comes with flexible repayment terms. Borrowers only have to pay interest for the construction duration, typically one year. The balloon payment at maturity and converted into a traditional mortgage.
  • Secured Interest Rate: This type of loan may allow you to lock in the maximum rate for the loan term. It would protect you from fluctuations in market interest rates.

Alternative lenders have construction-to-permanent loan programs designed for borrowers who want to maximize these advantages. FHA and VA may offer construction loans.

Construction-only loan

This type of loan is also known as two-close or two-time-close because, unlike construction-to-permanent loans, it requires borrowers to re-apply and re-qualify for a permanent mortgage or end loan once the construction.

Borrowers who take out a construction-only loan are exposed to additional risks as they have to pay the balloon payment at the end of the term. If their financial situation has deteriorated between the construction start and completion, borrowers may have difficulty securing another loan. They will need to pay two sets of closing costs, which can amount to thousands of dollars. They might even be charged higher interest rates for their permanent residential loan depending on market conditions.

A construction-only loan is better for borrowers who anticipate receiving a large sum of money in the next year or who have their cash flow, credit score, and DTI improving. They may be able to afford the balloon payment and qualify for a permanent loan with lower terms.

Renovation loan

Borrowers can purchase and renovate a fixer-upper for fix-and-flip or fix-and-rent.

A renovation loan is a unique type of home construction loan. It does not require that the borrower build the property. Instead, the borrower can renovate or improve their current dwellings or rent a fixed-upper for rental or flipping. Renovation loans are prevalent in areas with no vacant land or older housing stock.

These loans are more flexible than traditional construction loans. These loans can use for many purposes.

  • Renovations for Owner-Owned Homes: Renovation Projects for Second and Owner-Owned Homes;
  • Fix and Flip: requires the purchase of a fixer-upper, renovations to the property, and then a profit-making flip.
  • Fix and Rent: The same idea as fix-and-flip, but instead of selling it immediately, the borrower leases it out to third parties to generate rental income.
  • Cash-out refinances: Using this option, the borrower can take out a new mortgage to pay off their existing mortgage balance and use the cash proceeds for renovations. This option can be very beneficial, especially when the mortgage rate is low.

All of these options are available to borrowers. They can either hire a general contractor or act as their contractor if the project is their own.

Each lender will have its terms and conditions for renovation loans. You may be eligible for the following:

  • A loan amount of up to 5M
  • 80% to 15% loan-to-value ratios (LTV);
  • A repayment term of 12 Months;
  • 75% Advance is available for fix-and-flip and fix-and-rent.

Owner-builder construction loan

It is either a construction-to-permanent or construction-only loan, as described above. But there’s a twist: the borrowers are the builders.

Lenders that offer owner-builder construction loans let borrowers act as their builders only if the license is available.

End of loan

The end loan is a regular mortgage, as the house secures it. It is the second component of a construction-only loan. Borrowers who are interested in ending loans must complete another closing.

End loans are beneficial because not all lenders offer construction-to-permanent loans. The requirements for end loans are similar to conventional mortgage loans. It is especially true for borrowers with low credit scores or high debt-to-income ratios (DTI).

These unorthodox mortgage loans are for you if you fall into this category. Some loan programs can be tailored to your needs and meet your requirements, regardless of your particular situation.

Residential construction loan parameters

There is no standard loan term. Your creditworthiness and the construction project details will determine the terms you receive.

To give you an idea about what to expect, we have listed some loan requirements and parameters:

The amount of the loan

Construction loans offer different loan amounts depending on the type of construction or renovation you are planning. Borrowers can get up to a $5M loan to finance their investment properties or construction projects. Although the minimum loan amount at $500,000 per case, exceptions can be made.

The construction lender will consider two key ratios when determining the loan amount: (1) the loan-to-value ratio (LTV) and (2) the loan-cost ratio (LTC).

LTV is the ratio of the loan amount to the house’s expected market value. LTV is the sum of the construction cost and the loan amount.

Lenders typically allow lenders to approve LTV of 70-75% and LTC of 85-90%, respectively.

Deposit payment

As with all loans, you must prepare for a downpayment and pay it off on the closing date. The lender, the loan amount, qualifications, and the program you are applying to will all affect the down payment.

Home construction loans require a larger down payment than other residential loans to cover the risk associated with this type of mortgage. Some programs require a minimum of 30% down payment.

Credit score

To assess your creditworthiness, lenders will need to see your credit score. Construction loans have inherent risks, so most lenders require credit scores in the 700s. Lenders have additional assurance that the property is, in fact, available.

Debt-to-income ratio (DTI)

DTI is the sum of your monthly payments and your monthly gross income. Lenders use this parameter to determine how likely you are to be able to manage your monthly payments if you receive a loan for home construction.

Banks consider borrowers with low DTI less risky because they have lower monthly incomes and can pay more mortgages. A high DTI, on the other hand, indicates that the borrower might have too many debts and not enough income after all their current obligations. Lenders have different requirements for DTI. It is best to speak with your lender to discuss other options.

Citizenship

Traditional lenders may limit construction loans to U.S. residents. Alternative lenders may be a better option if you are not a U.S. citizen or a foreign national who wants to finance your residence in the U.S. They are flexible and can accept applications from non-U.S. citizens, unlike traditional lenders.

Plan for construction

A detailed plan detailing your goals and objectives for the loan’s life span is essential to qualify for a construction loan. This plan should be prepared in collaboration with your contractor or builder and must reflect your personal preferences. Lenders will be more confident about your ability to repay, and this will help you build trust with them.

Appraisal

Lenders need to determine if the property’s expected value will suffice to secure the construction loan. The house will be used as collateral. The lender will ask a third-party appraiser to provide two valuations of the property: (1) the current value and (2) the value after completion or after renovation (ARV).

What are the main factors when applying for a residential construction loan?

Although it may seem like the process for getting a construction loan is similar to any other mortgage, this is often not the case. Construction loans are more complicated and can take more planning and time.

Here are some guidelines to help you get a loan for construction.

Expert and licensed builder

Although this may seem simple, your builder must have the knowledge and license necessary to complete the tasks successfully. Remember that lenders prefer to work with builders and companies with a proven track record.

Your builder should be qualified and licensed.

Ask your family, friends, and colleagues for recommendations to help you find a qualified builder. These people can give you firsthand accounts of how your construction went and their feelings about the final result.

You can also visit the directory of the National Association of Home Builders if your friends or family cannot recommend any builders. 

After finding a builder/company you feel is a good match, do your homework and research thoroughly. Compare carefully. Your builder will literally and metaphorically have the final say in your home. So take the time to research the options.

Additional documents

To be able to apply for a loan, you will need to meet specific documentary requirements. For the primary level, you may require proof of income, pay slips, tax returns, and bank statements.

These items are also required when applying for a loan construction.

  • Contract with your builder
  • Specific budgetary requirements
  • Timetable details
  • Detail project plan
  • Builder’s business permits, insurance, and credentials. Contact number.

Timeline

Your timeline for completing your application should be as precise and reasonable as possible. It should also take into consideration any delays. Although it may be difficult to predict the causes of delays, such as natural catastrophes, your builder should be able to give you a better idea based on existing conditions.

Due to the pandemic, low-interest rates, and many people deciding to improve their housing situation, there was a shortage of lumber, aluminum, steel, and electrical materials. Although this bottleneck will improve by 2022, you should still talk to your builder about it to ensure there are no significant delays in the construction of your house.

Home Insurance

Although it may seem counterintuitive, homeowners insurance should be purchased even if the house is still under construction. Lenders require that you insure your home as soon as possible during construction for any event (fire, accident or theft, etc.).

How to find the best home-construction loans

Construction loans are more complicated than residential loans. Each lender has its requirements and procedures. Loan terms can vary. Additional documents related to the construction project will be in addition to the standard requirements.

It is easy to become overwhelmed when comparing and searching for the right product. You can do it with others. Mortgage brokers can make it easier to concentrate on the most important thing- building your home.

For general inquiries:
* Email: [email protected]
* Phone: +1 (571) 544-6600

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