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As with any loan, you’ll need to meet a certain set of requirements to obtain a construction loan. On first glance, getting approval for a new construction loan may seem similar to the process of obtaining a mortgage, but getting approved to break ground on a new property is a bit more complicated. Requirements vary by lender, and by the type of construction loan a borrower is applying for.
How Do New Construction Loans Work?
Usually, construction loans have variable rates that move up and down with the prime rate. Beyond that, construction loan rates are often higher than traditional loan rates. Consider this: with a traditional mortgage, your home is collateral—if you default on your payments, the lender can seize your home. However, with a construction loan, the lender doesn’t have that option available, so these loans are considered to be more risky for the lender.
Since construction loans are used with projects that have a short timetable and are dependent on the completion of the project, you have to provide the prospective lender with a construction timeline as well as detailed plans and a realistic budget.
Depending on the type of construction loan, the borrower might be able to convert the construction loan to a traditional mortgage once the home is built. This is known as a construction-to-permanent loan. If the loan is solely for the construction phase, the borrower might be required to get a separate mortgage designed to pay off the construction loan.
New Construction Loan Requirements
If you are seeking a new construction loan, the usual requirements are as follows:
Begin with a Plan
For a lender to approve a loan for new home construction, you will need to create and present a detailed plan for the property, so that the lender has an idea of what you intend to do with it and when. Your plan for the property ultimately determines the type of loan you will need. It may take some time before you can start construction on the new property, in which case you likely would need a separate Lot Loan to purchase the land; however, if you are ready to begin building right away, you can take out a construction loan.
Make Sure You Have Established Credit
Construction loans tend to be riskier for lenders when compared with home loans because there is no finished structure to use as collateral. Obviously, your credit record is not the only criteria that lenders will observe to determine whether they will approve the loan, however, they will certainly examine it very carefully. Therefore, you should check your reports to look for any inaccuracies, as well as paying down your existing debts to the greatest extent possible.
Debt to Income Ratio
Your debt-to-income ratio (DTI) should be 43% or lower. A higher ratio may be allowed if you otherwise have strong finances.
Consider the Down Payment
Your down payment will inevitably vary based on the loan type. While you would be able to put 5% down on a conventional mortgage, construction loans tend to require at least 20-25% upfront. Be sure to ask your lender how to get a construction loan with no money down. Down payments for FHA Loans start at around 3.5%.
You Need a Repayment Plan
Construction loans usually require no payments or interest-only payments during the construction phase. You’ll make fully amortizing principal and interest payments once construction is complete.
Hire an Experienced & Licensed Builder
Your lender will want to verify that the builder is experienced enough to pay suppliers and complete the construction project. The vetting process requires your builder to provide professional licenses, proof of insurance and references detailing payment history. The lender will also often review the builder’s credit rating and financial standing.
If you’re curious about acquiring a construction loan, here are some of the basic steps of the process:
- Get pre-approved with a construction loan lender.
- Find and sign a contract with a reputable builder. Be sure that the contract has a loan contingency— that way you can exit the contract if you can’t finalize your construction loan.
- Submit your builder contract and the typical underwriting documents to your chosen lender for approval. If you already own the land you will be building on, submit a copy of the deed, survey, and settlement statement (if you bought the land recently).
- Get a subject to completion appraisal for your proposed property.
- Get final approval and close on your construction loan.
Following these steps, construction can begin. Your lender will pay your builder through a series of disbursements and retains the rights to inspect each phase of work. Once the construction phase has been completed, your construction loan will be modified to a permanent loan or you will need to obtain long-term financing.
RCN Capital | New Construction Loans
Here at RCN Capital, we offer a 12-24 month term program with rates starting at 7.99%.
RCN Capital lends to real estate professionals, commercial contractors, developers & small business owners throughout the country. Whether you are looking to fix & flip properties or hold properties for rental income, RCN has flexible options that are suited to your needs. If you are an investor looking to finance a new construction, RCN Capital has competitive loan options available. Connect with us today to discuss your next new construction loan deal.