What Is a Home Construction Loan?

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A construction loan, as the name suggests, is a short term loan that people usually take to finance the construction of their new home. Such a loan is usually offered by the lending companies for a set term (12 to 18 months) to help the client in building his/her home. Once the construction process is complete, the borrower needs to get a new loan to pay off the construction loan. This new loan is sometimes called “end loan”.

Qualifying for a Construction Loan

Lenders are usually reluctant to offer a construction loan for various reasons. One major reason behind lenders’ hesitance is that they are lending money for something in which more than 90 percent depends on third party, the builder. Both the lender and the client sign the loan agreement based on an assumption that the building that is yet to be constructed will have certain value when it is complete. However, if things go wrong – for instance if the contractor does a poor job, or the value of property falls due to some external factors – then the property would not worth as much as the loan, and it would be considered as bad investment on the part of lender.

In a bid to protect themselves from any unforeseen tricky situation, the lenders usually impose strict requirements for qualification of a construction loan.

A Qualified Builder Must Be Involved

The banks and private lenders usually ask their clients to hire services of a qualified builder before applying for the loan.

Provide the lender with Detailed Specifications

The lenders also ask the clients to come up with a comprehensive construction plan, including everything from foundation to ceiling heights to type of material that they want to use in the home.

Have the Home Value Estimated by an Appraiser

It may sound a bit weird to appraise something that really does not exist, but the lenders want their clients to have an appraiser assess the value of the land where the house will be constructed as well the design of the house. These calculations are then compared to other similar houses in the community and an appraised value is thus determined.

Make a Large Down Payment

Down payment for construction loan is usually higher than conventional loans. 20% is the minimum percentage you will be required to put down to get a construction loan. Some banks and lenders require 25 to 30% as down payment. This is to make sure that you are serious about the project and would not walk off if things go wrong. This also protects the lender in case the end product does not turn out to be worth as much as the loan.

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