If you planto build your own home, you will either need a lot of money upfront or a construction loan. Buildingyour own home means the builder isn’t fronting the money to build the home, as they would with a cookie cutter home. When a builder is creating a subdivision, they have the capital to afford the upfront costs of building the home. They then sell the home to you upon completion, which is when you need the mortgage.
If you build your own home, you are the one that provides the financing to get the home built. Because you are asking for financing on a structure that isn’t built yet, finding financing may be a little tougher.
Keep reading to see what requirements you must meet in order to get a construction loan.
Find a Qualified Builder
If you expect a lender to give you money to build a home, you will need to provide them with proof that you have a qualified builder. You can just hire any old builder to do the job. You need one that has a history of successfully building homes.
In other words, you can’t be the general contractor. If you want a lender to take your quest to build a home seriously, you need to find a general contractor that does this for a living. This means don’t go and hire the local handyman in your neighborhood. Instead, hire someone that has a reputation of building quality homes in the area. The lender will need ample proof of the builder’s track record before they will give your loan a second thought.
Provide as Many Details as Possible
The lender needs to know everything there is to know about the home you plan to build. Your builder (if he is experienced) should put together enough documentation that will satisfy your lender. Experienced builders know that lenders want to see professional floor plans, proof of the type of materials that will be used, and the specifications of every area of the home. There’s no such thing as providing too much detail about the home as far as the lender is concerned.
Have Plenty of Cash Handy
Unlike completed homes where you can often get 100% financing or find loans that require small down payments, you’ll have to make a large down payment on a construction loan. Lenders want to know that you have enough skin in the game that you will keep making your payments. It’s understandable since lenders take a big risk in providing funds on a home that doesn’t even exist yet. You could easily walk away from the project since it’s not a home you are abandoning just yet.
How much cash you will need will vary by lender. At the very least, plan on putting down 20% of the cost of the home. Some lenders may require as much as 30% or 40% depending on the area and the cost of the home, though.
In addition to the down payment, you may need cash reserves. This is money you have sitting in a reserve account, such as a checking, savings, CD, or invested in bonds. Essentially, any money you have tied up in an account that you can liquidate on the spot will count. Lenders usually require that you have enough money to cover at least 6 months of payments on the construction loan.
Make Sure You Have a High Credit Score
Your credit score is another important factor in the construction loan process. Because it’s such a risky loan, lenders typically want to see high credit scores. They want to know that you have a history of paying your bills on time. They also want to know that you don’t have a history of bankruptcies, foreclosures, or collections.
There isn’t a minimum credit score that you need in order to qualify for the construction loan, as it will vary by lender. This isn’t a program provided by Fannie Mae or the FHA – it’s usually a loan provided by a portfolio lender that will keep the loan on their own books. This means each lender may require a different credit score.
Watch Your Debt Ratio
Again, because each lender has their own requirements, your debt ratio requirements may vary. On average, you can expect lenders to want a total debt ratio between 35% – 41%. The lower your debt ratio is, the higher your likelihood of getting approved.
A low debt ratio lets a lender know that you aren’t overtaxing yourself financially each month. If it’s going to be a struggle to make the mortgage payment, your chances of default become much higher. This causes lenders to become wary of your ability to pay the loan. This causes them to either deny your loan application or give you a higher interest rate and closing costs to make up for the risk.
Owning the Land is a Benefit
Lenders like to see borrowers that own the land they are going to build the home on before they build. By own the land, we mean own it free and clear – not own it with a land loan on it. Because land doesn’t appreciate and you can’t live on land without a home built on it, there isn’t much collateral that the lender can hold onto. This causes them to view your loan as risky.
If you already own the land, though, your chances of paying your mortgage to build the home on time are much higher. You already have cash invested in the home, just in a different way – you own the land. If you walk away from the home now, you walk away from the money you already invested to buy the land.
Construction loans are harder to come by than standard mortgages for cookie-cutter homes. The lender puts themselves at risk, so the more benefits you can provide a lender the better off your chances of approval. Don’t get discouraged if the first lender you apply with turns you down. Instead, keep shopping until you find a lender that has requirements that you can meet. In the meantime, the more you increase your qualifications, the better your chances of getting approved become.