Would you like to build your dream home – but don’t have the capital you need to purchase the land or fund the construction? Then you can still accomplish your goals by taking out a construction loan.
What Is a Construction Loan?
A construction loan provides short-term financing to purchase the land, materials, labor and permits requisite for residential construction.
The initial term for a construction loan is typically no longer than one year. The project must be completed before the term expires. Once the project is finished, it is normal for the borrower to convert their construction loan into a conventional mortgage.
What Is Required for a Construction Loan?
The requirements for a construction loan may vary based on the lender providing it. That said, construction loan applicants are usually required to have proof of income, a low debt-to-income (DTI) ratio, and a credit score of at least 680. It is also normal for a lender to require 20% down payment for the cost of the project.
In addition to proving they are financially qualified, construction loan applicants are typically required to demonstrate they have everything in place to actually complete the project. This includes showing they have already partnered with a licensed and reputable professional home builder. The lender may request a list of the builder’s recent projects, as well as their profit and loss report.
The lender will also request a thorough description of the construction plan. This document, which is often referred to as a “blue book,” typically includes details such as the project’s timeline, subcontractors, and labor and material costs, as well as its proposed floor plan, ceiling height, and other physical attributes. The blue book gives the lender a complete overview of the work they are financing.
Finally, the lender will require an appraiser to calculate the market value of the home once its construction has been completed. Note that this step precedes groundbreaking; it is an estimation of the finished home’s market value, albeit an accurate one.
Do you intend to build your home yourself, without hiring a general contractor? Then the financing you want is called an owner-builder construction loan.
How Do You Apply for a Construction Loan?
Do you believe you meet all the requirements for a construction loan? Then your next steps are straightforward.
- Select your builder. A reputable general contractor is likely already familiar with the construction loan application process, and can provide any insight you might need to prepare for what’s ahead.
- Assemble your paperwork. Gather your tax returns, W-2 forms, bank statements, and any other documents which demonstrate your income (and by extension your ability to repay the loan).
- Select your lender. As with any other loan, you want to shop around for the lender that will give you the best terms available. Make sure you know what the current average APR is before locking yourself into a 15- or 30-year mortgage.
- Begin the approval process. Once you have chosen your builder and lender, it’s time to formally apply for your construction loan. If everything goes according to plan, you’ll be able to break ground soon!
- Purchase homeowners insurance. You will not occupy your home while it is being built. Even so, your lender will most likely require you to purchase homeowners insurance that includes builder’s risk coverage.
Are you interested in taking out a construction loan in Central, Northeast or Northwest Minnesota? Then Community First Bank is the local lender you can trust to fund the project seamlessly. We welcome you to contact us or stop by one of our locations in Menahga or Sebeka, MN today!