What type of loan is best for building a house?
A construction loan provides money for building a house. These loans tend to have shorter terms and higher interest rates than traditional mortgages. With a construction loan, instead of releasing all the money at once, the lender pays the builder or contractor in installments as the home is built. When the home is finished, the construction loan is either paid off or turned into a permanent mortgage.
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Types of construction loans
There are a few types of home construction loans. Which will work best for you depends on your needs. Bear in mind that just because a lender offers construction loans does not necessarily mean they offer all types — you'll need to zero in on lenders that have the style of loan you want.
Construction-to-permanent loans. Also called a "single-close" construction loan, this loan becomes a regular mortgage when the home is complete. During construction, you might only have to make interest payments, which can help keep costs lower while you live somewhere else. Because this loan combines a construction loan with a traditional mortgage, you only need to shop for a loan and pay closing costs once.
Construction-only loan. Loans that only pay for construction are also known as "two-close" loans, because you'll need two different loans. The construction loan is paid off when building is finished. Unless you have enough cash to buy the completed home, you'll need to find a traditional mortgage while the home is being built. These loans usually cost more overall because with two closings, you'll pay many of the closing costs and fees twice.
Renovation construction loans. Renovation loans combine the cost of fixing up a home with the mortgage. These are different from construction loans, because you're fixing an existing house, not building a new one. The total amount you can borrow is based on how much the home will be worth after the renovation. Renovation loan options include Freddie Mac CHOICERenovation loans and FHA 203(k) loans.
If you are buying a newly-built home that's already finished, you don't need a construction loan. Since you're not paying for the building process, a regular mortgage will work. The only difference is that you might have to pay a builder's deposit. That earnest money is separate from your down payment. Construction loans vs. renovation loans
Construction loans and renovation loans aren't quite the same thing, though they often get lumped together. The key difference is whether there's a house there that's a starting point. Some lenders will allow you to use a renovation loan for a full teardown, because technically you're renovating an existing home. Is a construction loan harder to get than a mortgage?
Getting approved for a construction loan is usually harder than getting a traditional mortgage because there's no finished house to use as security. You'll need solid finances and possibly a large down payment.
If you are buying a home from a developer rather than a builder you've hired, the developer may offer you financing or a loan through a lender they work with. Using the developer's lender may make the process easier, but it's a good idea to compare different construction loans to see if you can find a better deal.
Sometimes, developers will offer incentives if you work with their lender. But if you'd get a lower interest rate from another mortgage lender, that may be a better deal.
What is the lowest down payment for a construction loan?
Mortgage lenders often require 20% down payments on construction loans. That amount can change depending on how much you borrow, the type of loan and your finances. In some cases, a lender could even ask for a down payment higher than 20%.
What is a good credit score for a construction loan?
The credit score required for a construction loan depends on the loan type. Some lenders may require a credit score of 700 or higher for a conventional construction loan, while government-backed loans usually have lower requirements.
Even though government agencies have minimum credit scores for their loans, lenders can set their own standards. For example, the Federal Housing Administration allows credit scores as low as 500 for FHA 203(k) loans, but some lenders may ask for a higher score.
How to apply for a construction loan
Getting a construction loan involves a few extra steps compared to a regular mortgage. Here's what to expect.
1. Find a builder
To get a construction loan, you'll need to work with a reputable builder. When you apply for a construction loan, the lender will check the builder's license, credit, references and more. The builder also has to provide construction information like blueprints, a budget and a construction schedule.
If you plan to build the home yourself, you may need a special type of construction loan called an owner-builder or self-build loan. These loans aren't for casual DIYers: Lenders will require proof of your ability, including a license and construction experience.
2. Compare construction loan lenders
Look for a lender that offers the type of loan you need, competitive interest rates and terms that fit your budget and timeline.
Applying for preapproval with different lenders can help you see how much you could qualify to borrow and what interest rate you might get. In addition to the usual paperwork — like pay stubs and tax returns — you'll probably need to provide information like building plans and your builder's references. 3. Get homeowners insurance
Even though your home isn't built yet, you'll need homeowners insurance. Most lenders require a policy with builder's risk insurance, which covers the materials and structure during construction. Once you've got these pieces in place and feel confident about your choice of lender, you'll be ready to apply for a construction loan.
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