The way mortgages work is relatively straightforward: you pick a house you like, you borrow money from the mortgage lender, you buy the house and you pay your mortgage loan (with interest) on a monthly basis.
Construction loans work differently. The nature of the loan is the same, but the purpose of obtaining it is different. Let’s see what construction loans are and how they work.
Table of Contents
What is a Construction Loan?
A construction loan is handed out to bear the construction cost of a house. Where a mortgage loan is given to buy an already existing place, a construction loan is given to build a property and everything needed with it. Such as a garage, patio, basic building structure etc.
A construction loan is a short-term loan, used to buy land or build your own property. These could also be granted for the renovation of an existing property, but it depends on the kind of loan you’re given. During the construction phase of the loan, you only make interest- only payments, or no payments at all based on your outstanding loan balance.
Since these are short-term loans, they end within the first year of borrowing. The interest rate is higher than that of a traditional loan so it’s better to pay it off and end it early.
What are the requirements for a Construction Loan?
Just like any other loan, there are certain requirements that a borrower must fulfil in order to obtain a construction loan.
Credit Score: A credit score is something you obtain over time, this is like a measurement metric that ensures lenders that you’ve had a good loan repayment history so you’re less likely to default on the loan. For construction loans, the credit requirement is at least 680 score points. If your score is higher than this, you can expect flexible terms and conditions of the policy.
Debt-to-income Ratio: Another measurement metric that most lenders use is the debt-to-income ratio, which tells how much income you have and how much debt you already pay against that income. To qualify for the construction loan, the ratio should be less than 45%.
Cash Reserves: Lenders usually require you to pay a downpayment of 20%-30% on the original loan, so they will also require you to have enough cash reserves not only for a downpayment, but also to repay the loan back.
Lates Documents: With every requirement, the borrower is required to send in the latest documents of their tax history, bank statement, insurance payments, sources of income etc. Make sure everything is up-to-date so that you have a better chance of getting the loan.
How to get a Construction Loan with no money down?
It is possible to get a construction loan if you have no money down if you can cover the purchase price. You can also look for grants or down payment financing of 100%, this way the borrower also doesn’t need to pay the insurance cost and additional fees.
With the right amount of strategy, the borrower can be qualified for a loan even if they have no money down, for this you will have to take expert advice or hire a real estate agent that can guide you through the process and make it a win for you.
However, it still depends on every case whether your case is strong enough to qualify. Be prepared for disappointments, but also make sure you have a contingency plan in action like the option of going to another lender if possible.
5 Percent Down Construction Loan
A construction loan with only a 5% downpayment looks like a dream, but it is not applicable in most situations. When a loan is applied for, the lender scrutinizes the application and notifies them if the applicant qualifies.
For qualified applicants, a minimum down payment of 5% is required if the purchase price is under $510,400 (certain programs may allow for a minimum down payment as low as 3%). With a 5% down payment, you will have a single permanent loan with mortgage insurance at 95%.
Construction Loan Calculator
Jumping in the market looking for a lender and a construction loan isn’t a smart decision unless you’ve done all the research you need. And part of that research is having a close estimate of the finances you will spend.
For this, there are a couple of Construction Loan Calculators online that help you get a figure. They ask for quick questions like whether you’re looking to purchase or refinance the property, how much is it going to cost, then comes the loan information such as the interest rate and duration of the loan etc.
Is it hard to get a Construction Loan?
This is rather a relative term, because if you’re a high-risk borrower or someone with a very low income, it is definitely hard to get a construction loan. Since construction loans are short-term loans and are flexible in nature, they usually have a high interest rate and ask for a credit score of at least 680 points. In such a case it could be hard in getting a loan.
If you’re someone who needs it and are sure enough to pay it back on time, the lender can see through you. This makes it so much easier for you to qualify for a construction loan, or any loan for that matter.
It depends on how much money you need and whether you will be able to pay it back including interest. Even though a short term loan, the interest rate can spike up your monthly payment making it super hard for you to pay back. So make sure you know what you’re getting yourself into.
It is advisable to shop around for more options and lenders because the cost of insurance and lenders may vary. For you to find the best one, you need to search the market and filter the lenders that best suit your needs.