Build Your Own House

Construction Loan Requirements

Summary: New home construction loans have certain requirements that change from time to time and are different for each mortgage lender. The higher your credit score and down payment the better your chances are for an approval.

The more money you have into any construction project increases your equity and lowers the risk of you defaulting on your loan or not finishing building the new home or major remodeling project.

And, the lower your total debts in relationship to your total income, called a debt to income ratio or DTI, the more a mortgage lender or construction lender will be willing to lend you money and again, often at a lower interest rate.

Also, construction loans are now limited to a maximum of 75% of the "subject to completion" appraised value of your project. This is considered a low loan-to-value loan (LTV). I mentioned earlier that your construction lender would be obtaining such an appraisal as part of the loan application process.

It would be wise to have obtained such an appraisal yourself early in the planning stages.

The end loan, or permanent mortgage application, is always part of the construction loan application process, regardless of whether or not you obtain a one-time close or two-time close construction loan.

There are a number of end loan programs available today. You can find everything from 30- and 15-year fixed (very traditional) to adjustable rates tied to various markets. There are even private money lenders willing to lend money for new home construction loans. More choices in mortgage lending are good for you as a borrower!

Own Two Homes?

By the way, even in a sluggish market, houses do sell sooner or later, but if you already have a home and you fear it won’t sell before your new one is ready, go ahead and sell it first and live in an apartment while building your new home. Also, you may not qualify for a construction loan with an existing house payment.

Talk to a construction mortgage lender. Some lenders do not count the debt from your current housing against your borrowing power. Try and find one of those.

Financing charges will vary with lenders but will be estimated in advance for you. They will probably total about 1 to 3 percent of the mortgage amount. They may have to be paid when you close your construction loan, or they may be deducted from the total construction loan amount.

How Much Extra Cash Needed?

You will need some extra cash. Call it interim (short-term) working capital. Some expenses will occur before your lender makes the first disbursement of construction money, and you will need a few thousand dollars to bridge that gap for such things as paying subs, fees, and permits. If you have cash available, fine. If not, you may want to borrow from a commercial bank or take a second mortgage on your existing home or get a bridge loan.

Excluding the cost of the land and the 1 to 3 percent in financing charges I discussed, you shouldn't need more than an additional 5 percent of the cost of the house for interim operating expenses. This money is needed only until the house is finished or you get a draw for reimbursement. When the lender disburses all the money in the form of the permanent loan, the need for your operating cash will disappear and you can put it back where you got it.

Mortgage lenders and home construction lenders will have different opinions on many of your particular financing needs, and you need to shop around and spend some time talking to them. They will help you tremendously in putting your financial budget together. In this aspect, they are like subcontractors. Each of them will also explain their policies on construction draws, inspections, construction loan interest payments, points, credit reports, qualifications, and interest rates.

Carl Heldmann (Previous Page)