How to Get a Construction Loan

Secure the financial backing you need to build your dream home

By Kaye Morris

Photo by iStockphoto.com

Many people desire a home that is different from the mass subdivisions, or they want a home location on acreage rather than a lot. In order to build the home of your dreams on the location of your choice, you need a construction loan. Applying for a construction loan is a much more involved process than applying for a regular home mortgage, but with the right information, you can easily put together a construction loan application package.

• What You Need to Know
• You need to know your credit score and a good estimate of what your construction project will cost. You may also have to secure proof that your project will be insured before you are approved.

Step 1:

Check your credit. Errors often appear on credit reports. Take steps to remove any errors before applying for a construction loan. Do not change jobs or apply for other loans during the time you are applying for or closing on a construction loan.

Step 2:

Prepare a personal financial statement. A personal financial statement lists all of your assets and debts. The lender needs to establish that you are capable of paying for your current debt as well as the interest payments on a construction loan. Many lending institutions require you to own the land you intend to build on or refinance the land cost into your construction loan to give the lender security in your loan.

Step 3:

Get written estimates for all construction costs. If you are hiring a builder for the construction, he can supply the written estimate of construction costs. If you plan to manage the construction and subcontract the work, get estimates from the subcontractors. If you plan to do any or all of the work yourself, get estimates from building suppliers for the cost of materials.

Step 4:

Prepare a construction budget. A construction budget consists of all the costs derived from the estimates assembled into one document that outlines the costs by type such as foundation, flooring, brick and lumber. The construction budget also includes a detailed time-line for the completion of the home.

Step 5:

Complete the construction loan application and submit your personal financial statement and construction budget to the lender. Talk to the lender about construction loan options. Construction loans usually come in two types: construction only loans and construction to permanent loans. Construction only loans fund the cost of the construction, and the entire amount of the loan is due and payable upon completion of the construction. Construction to permanent loans fund the construction costs and convert the funded amount to a permanent mortgage loan.

Step 6:

Secure a commitment for a builder's risk insurance policy. Until you break ground, you don't really need this insurance, but a bank wants to make sure that you will purchase a builder's risk policy to protect their financial interest as well as yours. Most insurance agencies that sell homeowner's insurance will issue a builder's risk policy but some may not if you are building the home yourself.

Step 7:

Establish a payment agreement with your lender that involves a transfer of funds to your account as you incur expenses. Getting approved may hinge upon your agreement to this process.

• Tips & Warnings
• Shop around. Construction loans are "in house" loans, and different lenders may have very different rates and requirements.
• Demonstrate to the bank how you can make interest payments, if required, on the construction loan while making your household payments.
• Don't roll a construction loan into a mortgage until the building is complete and the home is livable.