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Construction Loan

Construction Loan Guide Step 2: How to Get a Construction Loan

    Building a new home is exciting. However, finding a construction loan is not. In fact, most people find it draining. So to keep you from loosing your mind and to give you extra time to pick out the right floor tile, we've put together the construction loan information you need. If you are unfamiliar with construction loans, you may want to read Step One of our Construction Loan Guide Construction Loan Basics first. It will help you better understand the following information.

How to Apply for a Construction Loan

    When you get a construction loan, you will need to apply for both the long-term mortgage and the short-term construction loan (Clough 7). Normally you will have to apply for the long-term mortgage first. That way your construction loan lender will know that once the construction is done you will be able to repay your loan. When you apply for your construction loan, you will need to provide your lender with the plans and specifications of your new home (Lank 347). Your lender will review your plans to make sure your house will be constructed well. They do not want to give you a loan only to have their collateral fall apart a year later.
    Remember that when you apply for a construction loan, just like any other loan, your lender will look at your credit history. Your credit score will determine what interest rate and how big of a construction loan you qualify for. It would be smart to look at your credit score before applying for a construction loan. That way you will know how much money and what type of interest rate you can expect to receive.

Being Approved for a Construction Loan

    In order to be approved for a construction loan, you must be approved for a mortgage and have your builder approved. In order to prove that you have a mortgage, you will need a commitment letter (Reed 164). The commitment letter tells your construction loan lender that your mortgage lender will pay off the construction loan.
Without that letter it will be very hard for you to get a construction loan.
    In addition to having a commitment letter, you will also need to have your builder approved. Your construction loan lender will look at your builder's net worth, credit rating and references from three other construction loan lenders (Reed 164). It may seem odd that your builder will need to be approved, but to a lender they are just protecting their investment. They want to know that your house is well built and the quality of your house depends on your contractor.  Therefore, they need to know that you builder will do a good job.  

Construction Loan Types

    When you look at construction loans, you will be able to choose between two types: a one-time or a two-time close. A one-time close means you get your construction loan and mortgage loan at the same time; whereas, a two-time close means you do not get your mortgage loan until the construction is finished (Reed 167). When you get a one-time close construction loan, your interest rates will be locked in before the construction will begin.  However, when you get a two-close construction loan, only your construction loan interest rate will be locked in before construction begins. Your mortgage interest rate will not be determined until construction has finished. Therefore, it is smart to get a two-close construction loan if you think rates will go down before your construction will be over. But if you think interest rates will increase, it is best to lock in your interest rate with a one-time close construction loan (Reed 167).

How Much Money Do You Need

    When building a new home you will need to budget for the hard costs, which are your land, materials and labor; your soft costs, which are your closing fees; and your hold-back fund, which is used to cover all of the unexpected costs (Reed 164). You will find that when building a new home many unexpected costs will spring up, from deciding to change your kitchen cabinets to having a foundation problem. In order to be prepared for those unexpected costs, you will need that hold-back fund. When deciding how much to put in that fund, budget about 5 to 10 percent of the total of your hard and soft costs (Reed 165).  For example, if your hard costs are $180,000 and your soft costs are $20,000, then you should budget between $10,000 and $20,000 for your hold-back fund.  Therefore, the total amount of money you would need is $210,000 or $220,000.

How Much Money Should You Expect to Get

    Most lenders will only give a construction loan totaling 75% to 80% of the estimated construction costs (Clough 7). Therefore, if you plan on building a home that will cost $400,000 to build, you should only expect to get a construction loan for $300,000 to $320,000. You must be able to afford paying for the other 20% to 25% of the construction costs.  That means you would have to pay between $100,000 and $80,000.

The Rest of Our Construction Loan Guide:


Clough, Richard H., and Sears, Glenn A. Construction Contracting Sixth Edition. New York: John Wiley & Sons, Inc., 1994.

Lank, Edith. Modern Real Estate Practice in New York. Chicago: Dearborn Real Estate Education, 2003.

Reed, David. Mortgage 101: Quick Answers to Over 250 Critical Questions About Your Home Loan. New York: American Management Association, 2005.