How to Get a Construction Loan (US)
Identify the two types of construction loans., Decide which loan type is right for you., Contact regional banks and credit unions., Find out the requirements for applying., Shop around., Confirm the lender is experienced in construction loans...
Step-by-Step Guide
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Step 1: Identify the two types of construction loans.
Before shopping for loans, understand the two types of construction loans on the marketplace:
Construction only loans.
These loans are short-term loans that last for a year or so.
They usually have adjustable rates that rise or fall with the prime rate.
At the end of the term, you must pay off the entire loan.
This means refinancing into a more conventional loan that can be for up to 30 years.Construction-to-permanent loans.
This is an all-in-one option that you can use to buy land and complete your home.
You then work with the lender to transition to a permanent loan after construction is completed. -
Step 2: Decide which loan type is right for you.
Each type of construction loan has positives and negatives.
Consider the following when deciding which to pursue:
The application process is easier for an all-in-one construction-to-permanent loan.
You apply only once.
By contrast, you’ll need to apply twice to get a construction loan and then another permanent loan to pay off the construction loan.
You’ll save several thousand dollars in closing costs with a construction-to-permanent loan.However, your interest rate might be higher with an all-in-one loan.
By the time you finish construction, interest rates could have fallen dramatically.
Unfortunately, you could be locked into a higher rate with your construction-to-permanent loan.
Generally, you also have fewer options with an all-in-one loan.
If you get a construction only loan, then you can find a permanent loan from any lender you choose, which might provide more options. , Construction loans are a small part of the market for home loans.
They are also higher risk, so not all lenders offer them.
You should first approach regional banks and credit unions.
Ideally, you should approach an institution that you already have a strong lender relationship with.For example, if you’ve taken loans with a bank before, approach them again. , Each bank will have its own requirements, which you should research before applying.
For example, banks often require the following:
A qualified builder.
This person is typically a licensed general contractor with a solid reputation for building homes.
By hiring a qualified builder, you show the bank that the loan is a good risk.You can find a builder by contacting your local chapter of the National Association of Home Builders.Specifications.
Banks will want you to provide floor plans and information on the materials used.
Down payment.
Lenders will typically require 20-25% as a down payment.
Appraisal.
You need to have your specifications appraised.
The appraiser will find comparable properties based on the information you provide. , Most banks offer loans but not choices.
One way to get different choices is to shop at every bank and credit union in town.
When you call or visit, ask for the construction loan department.
If the bank doesn’t offer construction loans, then move on to the next bank.
Alternately, you can hire a construction loan broker to shop around for you.
This might be a good option if you are too busy.
Brokers can get loans at wholesale rates and can often get clients good deals.
They can also explain your options to you and answer any questions you might have.
You can find a construction loan broker by getting a referral from your local Chamber of Commerce or by searching online., You’ll want a lender who has handled construction loans before.
When you meet with a loan officer, ask the following questions to check whether they have the necessary experience:
How long have they been doing construction loans? What is the loan-to-cost ratio (LTC) required for construction loans? The range is usually 5-20%.
Which is better: a voucher or draw disbursement system? Have the loan officer explain each to you.
Does the bank require an interest reserve account? A contingency account? An experienced loan officer should be able to answer these questions easily. , You’ll need good credit to get a construction loan.
Pull a free copy of your credit report and review it for errors.
If you find any, then dispute them with the credit bureau that has the wrong information.
Check for the following:accounts listed that don’t belong to you accounts incorrectly listed as in default or in collections the wrong balance listed the wrong credit limit listed accounts that should have fallen off your credit report , You might not qualify for a construction loan, which means you shouldn’t rush out and buy land.
Instead, call the lender and ask if they can pre-qualify you.
This process takes only a few minutes.
You provide information about your income, assets, and debts, which the lender uses to decide the amount you can borrow.Pre-qualification is not approval, which requires a much more in-depth analysis of your credit worthiness and finances.
Nevertheless, pre-qualification can provide you with some idea of what you can borrow. , Construction loans are difficult to get because you don’t have a finished home to act as collateral for the loan.
Accordingly, the lender will want to closely monitor the progress of construction.
You should put together a timetable of construction and include it in your construction contract.Talk with your builder about what you want.
They can help you come up with a realistic estimate of how long each stage will take. , You’ll need to give the bank a construction contract when you apply.A construction contract is a written agreement between the borrower and the builder for services to be provided by the builder.
You should have a lawyer review the contract before signing.
A valid construction contract should include the following:identity of the parties to the contract, including contact information scope of the builder’s work, such as obtaining permits, furnishing equipment and labor, etc. timing, such as when construction will begin, end, and the schedule of work in between reasons extensions of time may be granted payment: when, where, and how how plans can be changed warranties to fix defects in the home and what the builder will do to fix them how you will resolve disputes, such as mediation or arbitration signatures of the borrower and builder , Your builder might or might not have all of the insurance that you need.
You should check ahead of time.
If they don’t, then you’ll need to purchase insurance before applying for your loan.
Consider the following:
Builder’s risk insurance.
This insurance covers your home while under construction, and protects against vandalism or theft of tools, equipment, and materials.
Policies generally last nine months to a year and can be renewed.
If your builder has this insurance, then get a copy of their certificate of insurance.
Liability coverage.
Someone might get injured during construction, in which case you’ll want coverage.
Ask your builder if they have general liability coverage.
You should also have a homeowner’s policy.
Generally, most people get $300,000 of liability coverage through their homeowner’s policy. , You’ll need to submit many documents when you apply for your construction loan.
Accordingly, you should gather them ahead of time.
Ask your lender what you will need, but generally you should get the following:copy of the deed to the land HUD-1 Settlement Statement (if necessary) contract for the land if you aren’t yet the owner construction contract builder information (name, contact information, and federal tax ID number) plans and specifications for the home certificate of liability insurance for the builder builder’s risk/homeowner’s policy building permit if builder wants disbursement at closing , The approval process generally takes a little longer for a construction loan than a typical mortgage.
Your lender will review your credit history, income, debts, assets, and appraisal before granting approval.After you submit your loan, the lender should provide you with disclosures that will guide you through the loan process.
Make sure to get all required documents to the bank at least 48 hours before your scheduled closing. , After approval, you’ll get a bank draft schedule, which follows the stages of construction.
You’ll request funds from the bank, and the bank will have someone check on the progress of the construction before releasing the money.You should review this schedule carefully.
It should also explain what documentation you need to submit to the lender in order to get a disbursement., A construction loan isn’t a typical home mortgage.
As you review your documents, you might not understand some items listed.
Talk to the loan officer if you have questions.
One thing you might not understand is the “interest reserve.” Generally, you will not make payments on the loan while your home is being built.
Instead, you will make an interest payment on the funds disbursed.This money will come out of the interest reserve, which is a sum of money set aside for these payments.Construction loans also add contingency funds in case of cost overruns.
Usually, the bank adds 5-10% of the loan balance.
If you don’t use these funds, they won’t be added to your mortgage. , You should ask whether the interest rate will float for the length of the construction or whether you can lock in the rate upfront.
Also, if you have a construction-to-permanent loan, then you should ask whether you can lock in the rates now for the permanent mortgage.
If rates are trending upwards, you should consider locking.
Before locking, check whether you will be charged a fee, which will reduce the amount you will save by locking in.
However, if rates are moving down, you should consider letting the interest rate float. , If you got a construction only loan, then you will have two closings—one on the construction loan and then a second closing after you finish construction and get a permanent loan to pay off your construction loan.
With a construction-to-permanent loan, however, you have only one closing., Once your home is built, you can shop for a mortgage.
You will have to apply and be approved for it.
If you got a permanent-to-construction loan, then you’ll need to convert it.
Your lender will want to see the following before the conversion takes place:certificate of occupancy from the builder final title update from a title insurance company 100% complete inspection report completion and acceptance letter signed by the builder and you final lien waiver or affidavit signed by your builder homeowner’s insurance policy with the first year’s premium already paid -
Step 3: Contact regional banks and credit unions.
-
Step 4: Find out the requirements for applying.
-
Step 5: Shop around.
-
Step 6: Confirm the lender is experienced in construction loans.
-
Step 7: Check your credit history.
-
Step 8: Get pre-qualified before buying land.
-
Step 9: Create a timetable for construction.
-
Step 10: Enter into a construction contract.
-
Step 11: Get the necessary insurance.
-
Step 12: Gather required documents.
-
Step 13: Submit your application.
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Step 14: Receive your schedule of draws.
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Step 15: Understand the loan.
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Step 16: Choose whether to lock in your interest rate.
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Step 17: Close on your loan.
-
Step 18: Pay off your construction loan.
Detailed Guide
Before shopping for loans, understand the two types of construction loans on the marketplace:
Construction only loans.
These loans are short-term loans that last for a year or so.
They usually have adjustable rates that rise or fall with the prime rate.
At the end of the term, you must pay off the entire loan.
This means refinancing into a more conventional loan that can be for up to 30 years.Construction-to-permanent loans.
This is an all-in-one option that you can use to buy land and complete your home.
You then work with the lender to transition to a permanent loan after construction is completed.
Each type of construction loan has positives and negatives.
Consider the following when deciding which to pursue:
The application process is easier for an all-in-one construction-to-permanent loan.
You apply only once.
By contrast, you’ll need to apply twice to get a construction loan and then another permanent loan to pay off the construction loan.
You’ll save several thousand dollars in closing costs with a construction-to-permanent loan.However, your interest rate might be higher with an all-in-one loan.
By the time you finish construction, interest rates could have fallen dramatically.
Unfortunately, you could be locked into a higher rate with your construction-to-permanent loan.
Generally, you also have fewer options with an all-in-one loan.
If you get a construction only loan, then you can find a permanent loan from any lender you choose, which might provide more options. , Construction loans are a small part of the market for home loans.
They are also higher risk, so not all lenders offer them.
You should first approach regional banks and credit unions.
Ideally, you should approach an institution that you already have a strong lender relationship with.For example, if you’ve taken loans with a bank before, approach them again. , Each bank will have its own requirements, which you should research before applying.
For example, banks often require the following:
A qualified builder.
This person is typically a licensed general contractor with a solid reputation for building homes.
By hiring a qualified builder, you show the bank that the loan is a good risk.You can find a builder by contacting your local chapter of the National Association of Home Builders.Specifications.
Banks will want you to provide floor plans and information on the materials used.
Down payment.
Lenders will typically require 20-25% as a down payment.
Appraisal.
You need to have your specifications appraised.
The appraiser will find comparable properties based on the information you provide. , Most banks offer loans but not choices.
One way to get different choices is to shop at every bank and credit union in town.
When you call or visit, ask for the construction loan department.
If the bank doesn’t offer construction loans, then move on to the next bank.
Alternately, you can hire a construction loan broker to shop around for you.
This might be a good option if you are too busy.
Brokers can get loans at wholesale rates and can often get clients good deals.
They can also explain your options to you and answer any questions you might have.
You can find a construction loan broker by getting a referral from your local Chamber of Commerce or by searching online., You’ll want a lender who has handled construction loans before.
When you meet with a loan officer, ask the following questions to check whether they have the necessary experience:
How long have they been doing construction loans? What is the loan-to-cost ratio (LTC) required for construction loans? The range is usually 5-20%.
Which is better: a voucher or draw disbursement system? Have the loan officer explain each to you.
Does the bank require an interest reserve account? A contingency account? An experienced loan officer should be able to answer these questions easily. , You’ll need good credit to get a construction loan.
Pull a free copy of your credit report and review it for errors.
If you find any, then dispute them with the credit bureau that has the wrong information.
Check for the following:accounts listed that don’t belong to you accounts incorrectly listed as in default or in collections the wrong balance listed the wrong credit limit listed accounts that should have fallen off your credit report , You might not qualify for a construction loan, which means you shouldn’t rush out and buy land.
Instead, call the lender and ask if they can pre-qualify you.
This process takes only a few minutes.
You provide information about your income, assets, and debts, which the lender uses to decide the amount you can borrow.Pre-qualification is not approval, which requires a much more in-depth analysis of your credit worthiness and finances.
Nevertheless, pre-qualification can provide you with some idea of what you can borrow. , Construction loans are difficult to get because you don’t have a finished home to act as collateral for the loan.
Accordingly, the lender will want to closely monitor the progress of construction.
You should put together a timetable of construction and include it in your construction contract.Talk with your builder about what you want.
They can help you come up with a realistic estimate of how long each stage will take. , You’ll need to give the bank a construction contract when you apply.A construction contract is a written agreement between the borrower and the builder for services to be provided by the builder.
You should have a lawyer review the contract before signing.
A valid construction contract should include the following:identity of the parties to the contract, including contact information scope of the builder’s work, such as obtaining permits, furnishing equipment and labor, etc. timing, such as when construction will begin, end, and the schedule of work in between reasons extensions of time may be granted payment: when, where, and how how plans can be changed warranties to fix defects in the home and what the builder will do to fix them how you will resolve disputes, such as mediation or arbitration signatures of the borrower and builder , Your builder might or might not have all of the insurance that you need.
You should check ahead of time.
If they don’t, then you’ll need to purchase insurance before applying for your loan.
Consider the following:
Builder’s risk insurance.
This insurance covers your home while under construction, and protects against vandalism or theft of tools, equipment, and materials.
Policies generally last nine months to a year and can be renewed.
If your builder has this insurance, then get a copy of their certificate of insurance.
Liability coverage.
Someone might get injured during construction, in which case you’ll want coverage.
Ask your builder if they have general liability coverage.
You should also have a homeowner’s policy.
Generally, most people get $300,000 of liability coverage through their homeowner’s policy. , You’ll need to submit many documents when you apply for your construction loan.
Accordingly, you should gather them ahead of time.
Ask your lender what you will need, but generally you should get the following:copy of the deed to the land HUD-1 Settlement Statement (if necessary) contract for the land if you aren’t yet the owner construction contract builder information (name, contact information, and federal tax ID number) plans and specifications for the home certificate of liability insurance for the builder builder’s risk/homeowner’s policy building permit if builder wants disbursement at closing , The approval process generally takes a little longer for a construction loan than a typical mortgage.
Your lender will review your credit history, income, debts, assets, and appraisal before granting approval.After you submit your loan, the lender should provide you with disclosures that will guide you through the loan process.
Make sure to get all required documents to the bank at least 48 hours before your scheduled closing. , After approval, you’ll get a bank draft schedule, which follows the stages of construction.
You’ll request funds from the bank, and the bank will have someone check on the progress of the construction before releasing the money.You should review this schedule carefully.
It should also explain what documentation you need to submit to the lender in order to get a disbursement., A construction loan isn’t a typical home mortgage.
As you review your documents, you might not understand some items listed.
Talk to the loan officer if you have questions.
One thing you might not understand is the “interest reserve.” Generally, you will not make payments on the loan while your home is being built.
Instead, you will make an interest payment on the funds disbursed.This money will come out of the interest reserve, which is a sum of money set aside for these payments.Construction loans also add contingency funds in case of cost overruns.
Usually, the bank adds 5-10% of the loan balance.
If you don’t use these funds, they won’t be added to your mortgage. , You should ask whether the interest rate will float for the length of the construction or whether you can lock in the rate upfront.
Also, if you have a construction-to-permanent loan, then you should ask whether you can lock in the rates now for the permanent mortgage.
If rates are trending upwards, you should consider locking.
Before locking, check whether you will be charged a fee, which will reduce the amount you will save by locking in.
However, if rates are moving down, you should consider letting the interest rate float. , If you got a construction only loan, then you will have two closings—one on the construction loan and then a second closing after you finish construction and get a permanent loan to pay off your construction loan.
With a construction-to-permanent loan, however, you have only one closing., Once your home is built, you can shop for a mortgage.
You will have to apply and be approved for it.
If you got a permanent-to-construction loan, then you’ll need to convert it.
Your lender will want to see the following before the conversion takes place:certificate of occupancy from the builder final title update from a title insurance company 100% complete inspection report completion and acceptance letter signed by the builder and you final lien waiver or affidavit signed by your builder homeowner’s insurance policy with the first year’s premium already paid
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Catherine Shaw
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