Updated
May 09, 2023 If you’ve been searching for your dream home and realized you aren’t going to find it unless you build it yourself, you’re probably going to need to get a home construction loan. Home construction loans differ from traditional mortgages because you can borrow for a house that’s not yet finished.
This guide will help you understand what home construction loans are, how they work, and which lenders you should consider.
In this guide:
- What Is a Construction Loan and How Does it Work?
- Types of Construction Loans
- How to Get a Home Construction Loan
- Where to Find Construction Loans
What is a Construction Loan and How Does it Work?
Typically, when you acquire a new home, the house is finished and can be appraised to determine its value. You can then take out a mortgage loan to pay for the real estate—and any closing costs—when you close.
But if no physical structure exists yet, you’ll need a different kind of loan—a home construction loan.
Construction loans work differently from traditional mortgages and home improvement loans. Instead of borrowing the entire loan amount all at once, you borrow just enough to pay the builders as they construct the house. You typically make interest-only payments on these loans during the building process, and once the home is finished, your loan either converts to a traditional mortgage, or you pay it off with a new loan.
>>Read more: What types of properties can you use a mortgage on?
Types of Construction Loans
There are a few different construction loan programs to choose from, which we will explain below.
Construction-to-Permanent Loans
When you get a construction-to-permanent loan, you take out one loan to finance the building process. Then, when the home has been completely constructed, the loan converts to a permanent mortgage.
The biggest benefit of this type of construction loan is that you only have to apply to one lender and close on a single loan. However, the lender takes on more of a risk by promising to convert to a mortgage once the home is finished, so you’ll usually pay a higher interest rate on this type of loan.
Construction-Only Loans
As the name suggests, these are loans that finance the construction process only. When your home is complete, you will have to take out a mortgage to pay off the construction loan.
The benefit here is that you can shop around among the best mortgage lenders to find the best mortgage rates. Construction-only loans also allow for smaller down payments.
But if choose this type of loan, you’ll have to complete two separate loan transactions and pay two separate fees.
There’s also the risk that you may not be able to qualify for a loan at the end of the process. That would mean you couldn’t pay off the construction loan quickly, and could even risk losing the home.
All-in-all, construction-only loans should only be considered by experienced home builders with good credit who have a high level of confidence that they’ll be able to qualify for a mortgage after construction. If you’re a first-time homebuyer, or if you’ve never managed construction project like this, a construction-to-permanent loan might be a better option.
Owner-Builder Loans
Owner-builder loans are a specific type of construction loan you’d need to apply for if you planned to build your own house or be your own general contractor instead of working with a builder.
Building your own home or acting as your own general contractor can help reduce the cost of building a new home. However, owner-builder loans can be very difficult to qualify for. That’s because many lenders are not confident that owners will be able to build a high-quality house that is worth as much as the owner is borrowing.
As with construction-only loans, only experienced home builders should consider owner-builder loans.
Renovation Loans
Renovation loans are loans you take out to improve an existing home. They can be guaranteed by the value of the existing home, so they may be easier to qualify for. However, if you are building a home from the ground up, this will not be an option for you.
End Loans
End loans go hand-in-hand with construction loans. You will need to take an end-loan to pay off your construction loan when the home is complete. You can shop around with different lenders to find an end loan.
Your ability to obtain an end loan to pay off your construction loan will vary depending on how much the finished home appraises for as well as other factors, such as your credit and income.
If your house isn’t worth as much as it cost to build, you may not be able to qualify for an end loan without bringing cash to the table.
How to Get a Home Construction Loan
You can obtain home construction loans from a variety of different lenders, including online-only lenders, brick-and-mortar banks, and even from credit unions. Most lenders, including local banks and credit unions, do allow you to apply online.
You will need to meet certain criteria to qualify for a home construction loan. This includes:
- A minimum credit score of 680 to be considered by most lenders
- Income sufficient to show you can repay your debt
- A debt-to-income ratio of 43% or less (36% with some lenders)
- A down payment of at least 20% to 25%, depending on the lender
Some lenders also require cash reserves equal to a certain percentage of the construction cost.
Information You’ll Need to Apply
You need to be prepared to provide a lot of financial information when you are applying for a construction loan—just as when you are applying for any type of mortgage. Some of the information you’ll need includes:
- Detailed blueprints and specifications for the home
- Tax returns and/or pay stubs showing proof of income
- Bank and investment account statements showing proof of assets
The bank will also obtain a copy of your credit report to determine if you have a good enough credit score to qualify for a construction loan.
Where to Find Construction Loans
It is very important you specifically use a construction loan, rather than a personal loan or any other loan type, when building a home.
Construction loans are released by the bank on a specific schedule of draws after the construction has been inspected to ensure that it is progressing properly. You cannot get this type of protection from other loans, such as a personal loans.
The best thing to do is to talk with your builder to find out which lenders your builder has a relationship with. You can also check with local banks in your area that offer construction loans, or you can work with a mortgage broker to find a construction loan that you qualify for.
Here are a couple of major national banks that offer construction loans.
Citizens Bank
Citizens Bank offers home construction loans. You can get started with an online application online or contact a dedicated loan officer to assist you in navigating the process. Learn more about Citizens Bank construction loans here.
BB&T Bank
BB&T also provides home construction loans. These are short-term, interest-only loans that you refinance when you complete the construction process.
BB&T mortgage professionals will work with you to determine whether you meet qualifying requirements for construction loans and what your rates would be if you decide to take out a loan.
Learn more about BB&T Bank construction loans here.
Bottom Line: The Right Construction Loan Can Help You Build Your Dream Home
Construction loans give you the chance to build your dream home. Just be sure to shop around and compare rates to find the best construction loan, and make sure you understand the difference between construction loan types so you can find the loan that’s right for you.
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