If you need to borrow money to buy a home that's already on the market, you can usually depend on a mortgage to help.
But what happens if you need a loan for a house that only exists in your mind? That's where construction loans come in.
These home loans can be used to do everything from buying the land and paying for construction and labor to covering the costs of permits and other fees.
What is a construction loan?
A construction loan is a short-term loan that covers the cost of building a new home, including land, contractor labor, materials and permits.
Typically, the home must be completed within six months to two years, according to the Consumer Financial Protection Bureau. This differs from traditional mortgages, which are long-term loans repaid over 10 to 30 years.
Construction loans can be riskier for lenders since you don't have an existing home to use as collateral, so they usually have higher interest rates.
In most cases, you only pay interest until the build is complete, then begin making payments on the principal, as well.
How to apply for a construction loan
Not every mortgage lender offers construction loans, so it's crucial to research lenders before applying.
When you do apply, you'll have to submit the same financial information you would for any other loan, including documentation of your income, assets and debts.
Requirements for construction loans vary, but lenders typically want to see:
- Credit score: 680
- Down payment: 20% to 25%
- Debt-to-income ratio: 45% or less
Lenders will likely also want to review detailed plans for the property, including the blueprints and budget, as well as credentials for any architect, builders or contractors involved.
You'll also need an appraisal to determine the value of the land and the finished building.
If the loan is approved, you'll be given a portion of the money to start the build. An appraiser or inspector will be on-site at specific benchmarks to assess the progress and authorize more funding as construction continues.
Once the build is complete, you'll repay the loan or convert it into a mortgage.
Types of construction loans
Here are a few of the most common construction loan types.
Construction-to-permanent loan (C2P)
A construction-to-permanent loan funds the building of a new home from the ground up. During construction, you are typically only expected to pay interest — once the build is done, however, it converts into a traditional mortgage (usually with a term of 15 or 30 years) and you begin making monthly payments on both the principal and interest.
One benefit of this kind of loan is that there's only one application and one set of closing costs.
TD Bank is a solid contender for construction-to-perm loans, which can be used for primary residences or second homes.
TD Bank Mortgage
Types of mortgages
Conventional, VA, FHA, jumbo, construction-to-permanent, physician loans, TD Right Step, TD Home Access, refinancing, home equity loans, HELOCs
Terms
Up to 30 years
Minimum credit score
620 for conventional, 500 for FHA
Minimum down payment
0% for VA loan, 3% for TD Right Step Mortgage®, TD Home Access Mortgage®, FNMA HomeReady®, 3.5% for FHA loan, 20% for jumbo
Availability
TD Bank offers home loans in 15 East Coast states and Washington, D.C.
Terms apply.
Pros
- Mortgages with 3% down and no PMI
- $10,000 lender credit
- Specialized mortgages for physicians
- Offers HELOC and home equity loans
Cons
- Higher-than-average rates
- Doesn't offer USDA loans
- Not available in all states
Flagstar Bank also offers construction loans for primary and secondary homes, with 9- to 12-month construction terms and mortgage terms of between 8 and 30 years.
- Provides grants of up to $15,000 for first-time homebuyers, making it a great option for those who may not have much saved up for a down payment or closing costs.
- Destination Home Mortgage allows qualified buyers to put 0% down, a rare no-down-payment loan option geared towards first-time homebuyers.
- Possible to close in as few as 15 days, meaning you'll get the keys to your new home in less than half the time it usually takes.
- Rates tend to be higher than industry average
- Home equity loans only available in nine states
Construction-only loan
A construction-only loan doesn't convert into a regular mortgage when the build is complete: You make interest payments during the construction period and, once it's over, pay the principal back in one lump sum.
This option avoids the complexities of rolling your construction loan into a mortgage but it requires you to have a large sum of money on hand at the end of the project.
End loan
One alternative to paying off a construction-only loan out of pocket is applying for a separate mortgage to repay the initial funding. This involves two applications, however, as well as two sets of closing costs — which can add to your overhead considerably.
This second mortgage is known as an "end loan." Typically, a borrower would only take out an end loan if they wanted to work with a specific lender that didn't offer a construction-to-permanent loan.
Ally Bank is a good option for an end loan since it doesn't charge lender fees, which can significantly increase the home loan cost.
Ally Home
Annual Percentage Rate (APR)
Apply online for personalized rates; fixed-rate and adjustable-rate mortgages included
Types of loans
Conventional loans, HomeReady loan and Jumbo loans
Terms
15 – 30 years
Credit needed
620
Minimum down payment
3% if moving forward with a HomeReady loan
Terms apply.
Owner-builder loan
An owner-builder loan is a construction-to-permanent or construction-only loan in which the borrower also serves as the builder.
This is not a simple DIY project: Lenders typically only approve owner-builder loans if the borrower is a licensed contractor.
Renovation loan
A renovation loan isn't intended for a new build: It's for borrowers buying a home that needs serious renovations or upgrades, like overhauling the kitchen or adding a new bathroom.
With a renovation loan, project costs are rolled into the overall home loan, so you only apply once and only pay one set of closing costs.
Rate offers renovation loans, including Fannie Mae-backed HomeStyle Renovation Loans, which can help you buy a fixer-upper or fix up your existing home.
Rate
Annual Percentage Rate (APR)
Apply online for rates.
Types of loans
Conventional, FHA loan, VA loan, jumbo loan, physician loan, refinancing, HELOC, reverse mortgage
Terms
15-year and 30-year terms for fixed-rate mortgages; adjustable-rate mortgages have 5-year, 7-year or 10-year introductory periods
Credit needed
620 for conventional, 580 for FHA loans
Minimum down payment
3.5% with FHA loan
Construction loan: Pros and cons
- Allow homebuyers to build the home of their dreams
- Can convert into a traditional mortgage after construction is finished
- Often only requires interest payments during build
- Can finance home renovations on a fixer-upper
- Higher interest rates because of increased risk
- Typically has shorter term than traditional mortgage
- A larger down payment is required
- Funds are only disbursed in stages
Construction loan FAQs
What is a construction loan?
A construction loan is a short-term loan used to build a new home from the ground up or to renovate a fixer-upper. The construction timeline is usually limited to 24 months or less, with the lender releasing funds in phases as work continues. Commonly, only interest payments are made during construction but, once it's done, you'll need to either roll the balance into a mortgage with the same lender, pay it off in a lump sum or take out a new loan with a different lender to pay off the initial amount.
Is it hard to get a construction loan?
Because there is no existing home to use as collateral, it's usually harder to be approved for a construction loan than for a traditional mortgage — and interest rates are higher. You typically need a down payment of at least 20%, with a lot less flexibility on your credit score. And because you need to submit plans and get workers vetted, the process usually takes longer.
What if construction isn't completed on time?
In most cases, you'll need to submit a written request to your lender to extend the term of your construction loan. You'll have to explain why the project has been delayed, present schematics and photos of its current status and propose a new completion date. You may need to get your loan re-approved and pay additional fees or even agree to an adjusted interest rate.
When do you start paying on a construction loan?
In most cases, you only need to pay interest payments during the construction process. Once the build is complete, you'll either have to start making monthly payments on the principal and interest (for a construction-to-permanent loan) or pay off the balance in one lump sum (in a construction-only loan).
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