How to Get a Construction Loan to Build a Home

The number of existing homes for sale is at a more than 20-year low nationwide, according to the National Association of Realtors. Home buyers — including first-time buyers — are looking at other options that include building a house.

Here’s how to get started if you decide to get a construction loan and build a home.

» MORE: Should you buy, build or renovate?

Finding a construction loan lender

“It all starts with your ability to be financed and what kind of budget can you establish from there,” says Dan Moralez, regional vice president for Northpointe Bank in Holland, Michigan. “You don’t want to be sold something by somebody and then the next thing you find out is that you don’t qualify.”

But not every mortgage banker or broker offers construction loans.

“Most mortgage people will go their whole career without ever doing one,” says Jerry Thomas, a mortgage loan officer in Farmington Hills, Michigan. “Another big group of (lenders) will do one and then swear they’ll never do another one again.”

To find a construction lender, ask for referrals from friends and family. Builders often have lenders they recommend, and if you're buying within a new development, it's likely the builder will suggest a "preferred lender."

» MORE: Best construction mortgage lenders

Locking in the land

Getting a place to build a house is a major part of the homebuilding process.

“You don’t have to own the lot free and clear,” Moralez says. However, any equity you have in the land can be applied toward a down payment and closing costs.

Moralez says he has clients who want to “lock in a piece of dirt” so they can build on it in a year or so. Unfortunately, he says, the number of lenders who finance vacant land is significantly smaller than the number of lenders who will do a construction loan.

Buyers who are planning to finance the cost of the land and home construction simultaneously will need to keep this in mind when searching for a lender.

» MORE: Compare current mortgage rates

Qualifying for a construction loan

It’s harder to get approved for a construction loan than for a typical purchase mortgage, Moralez and Thomas say. That’s because the bank is taking extra risk during the building phase, since there isn’t an asset to secure the mortgage.

Typical down payments are around 20%. Federal Housing Administration, Veterans Affairs and U.S. Department of Agriculture mortgage programs back construction loans and can allow some credit leniency, sometimes along with lower down payments.

"If you can put 20% down and you have a 720 credit score or better, you know you're pretty much going to qualify for everybody's program," Thomas says.

» MORE: Best lenders for FHA loans

Want to build it yourself?

“More and more often, we’re saying no,” Moralez says. “Most lenders will not do a self-build project.” He says the few exceptions go to borrowers with relevant trade experience.

Moralez says borrowers who think they can save money contracting out the work themselves may be in for a disappointment. With the housing industry facing a shortage of skilled labor, you’ll likely pay more for workers than a high-volume contractor would.

Also, construction loans for a do-it-yourself project typically require higher credit scores and larger down payments. Terms and qualifications vary by lender.

» MORE: Get your free credit score

Staying within a budget

Cost overruns are the biggest danger you could face when building a home, Moralez says. A builder's bid sets cost allowances for lighting fixtures, flooring, countertops and other major features. An upgrade here or there can bust the budget, and you’ll have to make up the difference in cash, he says.

Research the costs of the materials upfront to help prevent significant and expensive modifications along the way.