How to Get a Construction Loan
A construction loan is really a “combination loan” — think of a construction loan as two loans in one. The first part of your construction loan is just that, a short-term loan for home construction costs. That first short-term loan is usually replaced automatically by a traditional long-term home loan once the construction is complete.
Building a custom home is going to require a construction loan. The high cost of home building combined with a built-in three percent inflation rate (and the unknown factor — cost overruns) means that even the very wealthy take out construction loans when building a new home. Wondering how to get a construction loan?
Find out how much money you’re qualified to borrow
The first step in getting a construction loan is determining how much cash you are able to borrow from your lender. This means completing a standard residential loan application at your bank or other lender. Why do this? For one thing, filling out this application will require you to gather all the papers you’ll need for your future loan application. A second benefit is that you’ll get a ballpark estimate of how much you can borrow. This estimate is the first step toward selecting a site and starting the process of building your home.
How much money you can borrow will be different from person to person. Your credit score, payment histories with debtors, down payment, the type of loan product you’ll be applying for, and the market conditions in your part of the country. Because everyone’s history is different, there’s no way of knowing how much money you’ll be able to borrow unless you go through a pre-qualification process.
Get your paperwork together
Your lender will provide you with a loan packet containing all the forms you’ll need. Every lender has a different set of papers, but your packet will probably include:
- one “application checklist” to help keep your loan application organized
- one “residential loan application” form
- one “description of materials” form
- one “construction cost breakdown”
When you are putting together these forms, make sure you follow the checklist and loan application instructions to the letter. Make a copy of the “description of materials” form and the cost breakdown for future reference. It wouldn’t hurt to make copies of all of these forms while you’re at it.
Information you’ll need
As you start to shop around at banks and financial institutions for your home construction loan, you’ll need different pieces of information, like bank records, proof of income, etc. The requirements vary from lender to lender, but the following list of items to have around when applying for a loan should keep you covered:
- As much documentation for your home building project as you can come up with
- A complete set of drawings and blueprints
- A detailed description of materials
- A construction cost breakdown sheet
- Your employer’s address and phone number, and certain employment details (length of employment, monthly income, tax returns and balance sheets for the past two years, etc)
- Your personal financial information — account numbers, balances, addresses and phone numbers of your banks and lenders
- Any deeds or copies of money agreements to prove ownership of property.
A good loan officer should be there to help you find all these pieces of information — remember, the lender wants your business so he or she can make money. Use your loan officer as much as you can, they’re in place to assist you.
You can walk into any bank in your town and find a loan product — but most banks don’t offer much in the way of choice. The only way to find variety in construction loan products is to shop around at dozens of different banks and financial institutions.
You can call up any local bank and ask for a loan officer — if the bank is large enough they may even have a specific construction loan officer you can speak with. If you can’t get in touch with a larger bank, you may have trouble securing a construction loan.
Your best alternative, after calling around to banks and getting a few nibbles, is to speak with a loan broker that specializes in construction loans. These brokers have relationships with banks all over the country who are willing to make construction loans. Think of the broker as your representative. Yes, your loan broker is basically a middle-man, but you should think of this kind of loan helper as a retail worker. They buy loans wholesale and sell them to you retail. For many people, using a construction loan broker is the only way to find a competitive construction loan.
Questions to ask a potential lender
How long has your bank been making construction loans?
What is the loan to cost ratio required for a construction loans with your company (This number can range anywhere from 5 to 20%, so it is important to know.)
Does your bank require a contingency or an interest reserve account?
Is there a prepayment penalty?
What is the processing time for this loan?
Final steps for a construction loan
Once you’ve submitted your loan application, there are a few things left to do before construction can begin.
The first step is known as the builder’s package and construction contract. A builder’s package includes your builder’s references and credit information, a cost breakdown, a materials list and the construction contract itself. That contract is a written agreement between the borrower and the builder that outlines the scope of their business together.
Last but not least, you’ll need to acquire the proper insurance policies for building a home. The bank will require that construction insurance, liability insurance, and workmen’s compensation insurance are secured before the construction job can begin.