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Construction loans differ from typical home loans. With a traditional home loan, you make a down payment, take possession of the home, and then make a payment to the lender each month. With a construction loan, you are asking the bank to estimate the value of something that does not yet exist—and then lend you money for it. A lot can happen during the typical 12-month construction process—from the expected construction delays and cost overruns to the unexpected—like a change in your employment situation or your builder going out of business. The risk to the bank is much greater, so it exercises greater caution in loan decisions.
A construction loan is really a reimbursement process. The bank does not advance construction funds; it will only pay for construction items that are complete. Each month you must submit a draw request along with supporting documentation to prove that building is progressing. The bank reviews the documentation, a third-party inspector visits the building site, and only then will the bank issue a reimbursement payment for the construction phases that are complete.
There are three major elements to qualify for a construction loan: the construction budget, including all the costs associated with building a new home; the appraisal value, or the estimated value of the new home when completed; and finally, the construction loan amount, including land equity and your down payment. Your personal financial qualifications determine this amount.
You need to set your project budget before you begin seeking a builder or settling on a house plan. You do this by pre-qualifying, a fairly simple step in the mortgage process. Pre-qualifying can be done in person or over the phone and is provided as a free service by most banks and mortgage companies.
Lenders want you to have more equity in the new home construction project, greater down payments, or land equity. Construction lenders want to see full documentation and asset-based qualifications. Your employment, credit scores, debt-to-income ratio, and other qualifications will be reviewed. With a maximum debt-to-income ratio of 38 percent, including both the payment on your current home and future loan payments, many homeowners will have to sell their current home in order to qualify for a construction loan.
Some of our best selling plans
Your plans and specifications, like those for the Best Sellers shown in the collage above, will need to be reviewed by an independent appraiser who will calculate the value of your building lot and completed home and compare it to recently sold and comparable homes in the area. The construction lender must verify that the completed home value will conform to the local market.
If you're hesitating to buy a house plan because you're not sure how big or small of a construction loan you're going to need, consider purchasing a Cost to Build Report for one or more home plans that you're interested in. This is a good way to get a much better understanding of the costs involved with a particular house design. You can purchase a Cost to Build Report from any house plan product page--just look for the blue Calculate Cost to Build button on the right side of the page. You can also take a look at our Cost to Build Frequently Asked Questions Page.