Designing your very own dream home from the ground up is an exciting project. But unlike purchasing a move-in-ready home, new construction has its own type of financing, called a construction loan. One of the key things you should know before you apply for a construction loan is the construction loan down payment. Whether you’re looking to construct a cozy cottage or a custom luxury estate, knowing how down payments work can ease any surprises and deliberations about where money is headed, and give you more control over what’s really going on.
What Is a Construction Loan?
A construction loan is a short-term, high-interest loan that pays for the cost of building a home. They generally have a term of 12 to 18 months and are put in place to pay for, say, the purchase of land, the cost of labor, the cost of materials, and permits. After construction, borrowers can choose suboptimal mortgage products and then the construction loan is converted into a traditional mortgage, a process called a construction-to-permanent loan.
Because new construction takes longer it also introduces risk such as delays, cost overruns or even abandonment therefore lenders require a larger down payment for new construction than they do for existing construction.
What Is the Construction Loan Down Payment?
Down payments on construction loans generally range from 20% to 30% of the loan amount. If, for instance, your custom home will ultimately cost $400,000, you could have to make an upfront payment of between $80,000 and $120,000. This is significantly higher than the often-recommended 3% to 5% down payment that you’d need to pay with a conventional mortgage.
It depends on a number of things, such as:
- Your credit score
- Income and debt-to-income ratio
- The total construction budget
- The lender’s policies
- The location of the property
Lenders want to see a big down payment in order to guarantee that you’re serious about the project and have both the resources to finish what you start.
Why Do Lenders Require a Higher Down Payment?
Unlike standard home loans where the property you’re purchasing already exists and can therefore be used as collateral, loans for construction are issued based on an edifice that doesn’t exist. This makes it a riskier bet for lenders. A substantial down payment:
- Reduces the lender’s risk in case the borrower defaults.
- Demonstrates borrower commitment to the project.
- Covers early construction expenses such as land purchase, permits, and site preparation.
Can You Reduce the Down Payment?
However, there are a few options to avoid a down payment, or at least cut it down; depending on your circumstances and the loan you choose to take.
1. VA Construction Loans:
If you’re a veteran or an active-duty service member, you may be eligible for a VA construction loan. Supported by U.S. Department of Veterans Affairs, VA loans provide zero-down payment options, allowing home building to become more affordable for those who have served the country. Not all lenders will do this, but those who offer VA construction loan have experience with veterans and streamline the process including costs upfront.
2. FHA Construction Loans:
These are aimed at borrowers with subpar credit scores and enable lower down payments as low as 3.5 percent in some instances. But FHA loans have more costly and stringent loan limits and home condition standards, and also carry mandatory mortgage insurance.
3. Lender Incentives:
In markets with strong growth prospects, some local banks or credit unions may offer promotional construction loans with low down payments.
Preparing for Your Construction Loan
To increase your chances of receiving favorable loan terms (including a lower down payment), you should:
- Check your credit score and correct any errors on your report.
- Reduce existing debts to improve your debt-to-income ratio.
- Prepare a detailed construction plan with cost estimates, timelines, and blueprints.
- Select a reputable builder, as many lenders require you to work with a licensed, insured contractor.
How Can I Find the Best Custom Home Builders Near Me?
And finding a builder is as important as securing financing. A good builder will not only deliver your vision, but will also keep the project on schedule, under budget, and make it easier to satisfy your lender’s requirements.
Begin by googling local companies, requesting referrals, and looking at reviews. Speak to several builders, and inquire about previous jobs, licensing, insurance, and warranties. While in this search you may also run into VA approved builders if you’re applying for a VA loan.
When you’re asking, “How can I find the best custom home builders near me?” seek out agents who are experienced with the kind of home you’re seeking and who know the permitting and zoning laws in your area.
Best Home Builders in Texas
Texas is among the best states for new home construction due to its land availability and comparatively low costs. If you’re building in the Lone Star State, here are some of the top home builders in Texas: Perry Homes, Avant Construction, Highland Homes and Vintage Luxury Builders. These are builders who have a reputation for quality work, great customer service, and customizable floor plans. One way to make the loan process go more smoothly is to work with an experienced local builder that knows the local climate, soil and building codes.
Final Thoughts
The construction loan down payment is a little more challenging to understand than advance payment. Frontend costs may be higher than a regular mortgage, but with proper budgeting and research such costs can be limited and you could qualify for a program to reduce or eliminate the need for a hefty down payment.
Every decision from selecting reputable builders to locating the right lender are all part of the mix that determines whether your project is a success. If you’re a vet, there are also more perks when picking up skills from VA construction loan lenders specializing in no-money-down programs. And whether you’re in Texas or somewhere else, go the extra mile to find the best home builders because the team is the basis of turning your dream home to a reality.