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Few properties meet a buyer’s needs when looking for suitable houses, which is why construction loans present a unique possibility to construct your own dream home or modify an existing one.
If you’re interested in customizing your home, you may wonder what the necessities for a construction loan are.
Construction loan requirements must be followed closely before a lender is willing to issue funds.
What Is A Construction Loan?
Whether you’ve already bought the home of your dreams or wish to build your own from the ground up, construction loans cover just the short-term costs of building or remodeling a house.
Construction loans typically come with high interest rates and are only intended to cover the build process.
After the building process is complete, construction loans convert to a mortgage loans until the home is paid off.
How Does a Construction Loan Work?
In contrast to a 30-year mortgage, a construction loan is usually just for 12 to 18 months, covering the construction period or the land itself, and is based on the project’s completion.
While mortgage loans have varying criteria based on the lender, a construction loan is regarded as more difficult to qualify for and has a higher interest rate than a standard loan.
Lenders see construction loans as high-risk because, unlike regular mortgages, which have a home as collateral if you default on your payments, construction loans have none.
Construction loans may also be structured as a draft or a draw schedule, depending on the project’s stage of development and the milestones, such as when the foundation is laid out and framing begins.
Additionally, the lender often employs an appraiser and inspector to keep tabs on the construction project’s progress throughout each stage of the loan’s life.
A draw occurs on the draft or draw schedule when approved by the appraiser and the lender makes additional payments to the contractor, as shown on the schedule.
Types of Construction Loans
Like all loans, construction loans come in a variety of shapes and sizes, but they typically cover the following:
- Contractors
- Cost of the land
- Any building materials
- Permits needed by local communities
You may be wondering what kind of construction loan is best for you, depending on your plans for a property.
Construction loans that allow you to turn a temporary loan into a permanent one upon completion are called construction to permanent loans.
Construction loans only cover the basic costs of the building, and to complete it you need to take out another loan or convert it to a permanent loan.
Renovation loans and construction loans for owners are two other types of construction loans to consider.
A renovation loan can only be used to renovate a house that you currently own or intend to buy.
Meanwhile, a home construction loan is a form of permanent loan where the owner builds his house without the help of a company or contractors, which also reduces the possibility of being accepted by lenders.
Finally, while a construction loan is used to build a home, the final loan is owed to the homeowner only after construction is complete.
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What are the requirements for a construction loan?
So what are the requirements for a construction loan?
There are many other things to consider when applying for a construction loan, such as partnering with a builder and securing approval from local communities, as well as a construction timeframe with comprehensive plans and a proper budget.
Since construction loans have many risks, borrowers must meet several additional criteria before being approved for this loan.
Good credit
Lack of collateral makes construction loans riskier, so borrowers must have a credit score of at least 680, with some lenders asking for as high as 720.
Before applying for a construction loan, check your credit score and make the necessary improvements.
Sufficient income to cover payments
In addition, you must demonstrate sufficient income to pay the construction loan, your next mortgage loan, any personal debt you have, and your normal living expenses.
Your lender will request financial documents to verify your income and assets.
A Low Debt-to-Income Ratio
Having a low debt-to-income (DTI) ratio is critical when applying for a construction loan, as lenders look to see whether you have the income to cover prior debts as well as the loan.
To increase your chances of approval, your DTI needs to be under 45%.
A Sizeable Down Payment
Lenders need a 20% down payment for this high-risk loan, although a bigger down payment increases your chances of being approved.
The bigger the down payment on a construction loan, the better your chances of being approved by a lender. Approval of the construction project and budget
Lenders prefer as much detail as possible for a construction loan. To increase your chances of approval, include information such as:
Work is on property
Comprehensive home designs and plans
Realistic budgets
A potential design or drawing plan with clear milestones
Reference Source: Total Mortgage
