The Ultimate Cheat Sheet on Home Construction Loans

How to get home construction loans to build your custom home:

A down payment of at least 5-10% of the total value of your building project will be required. If your building project (land and house) is projected to be $300,000 you will need a minimum down payment of $15,000 to $30,000.

Owner Builder Loans can be an exception to the above down payment requirements. Owner builder loans often require nothing down because banks assume the homeowners will have a minimum of 10% equity in the project by virtue of the owner-builder participation.

The total monthly loan amount extended to you will be in the range of 50% of your gross monthly income.

This amount varies. There are some financial institutions that may go as high as 65%, and there are others that will use numbers lower than fifty percent. Fifty 50% represents a debt to income ratio. This means that the bank will allocate 50% of your gross monthly income to pay your housing costs, including principal, interest, standard fees, PMI, taxes, and homeowners insurance.

For example, if you earn $5000 per month gross, the maximum amount allocated to pay your monthly housing costs would be $2500 per month. If one assumes a 6% interest rate and a 30-year mortgage that translates into a total loan amount of $333,000 assuming $2000 per month in payment of principal and interest and $500 per month for taxes, insurance, standard fees, etc.

However, any monthly revolving debt must first be subtracted from your gross monthly income before applying the 50% ratio.

Extending the above example, if you had a car payment of $350/month, student loans of $125/month and credit card bills of $75/month, the calculation to determine how much you can borrow goes like this: ($5000 – ($350+$125+$75))= $4450 X 50% = $2225.

If you currently have a mortgage and plan on selling that property by the time you close your new loan, this monthly payment is not included. However, if you were planning on keeping this property and renting it, then the monthly payment amount on this property would be included in the debt in the above calculation.

An exception to this might be made if you have a history of being able to rent the property, and this income offsets the monthly payment you make. However, if you are currently living on the property, it will be difficult to show a history of rental income from it, and your financial institution will probably include this debt in its calculation. Furthermore, if the bank does accept rental income as an offset, it will only allow 70-75% of the monthly rental as an offset, not the full 100%.

The mortgage industry has changed a lot in the past decade.

Historically most financial institutions used a 28/38% ratio to calculate the loan amount for which you qualified. Today’s more flexible guidelines you can borrow much more money. This change has both positive and negative implications. The ability to borrow more and buy a bigger or better house is certainly a positive one. However, the negative that consumers need to consider is the debt load under which they can put themselves. In other words, just because the bank will loan you up to 60% of your gross monthly income, that doesn’t mean that you can afford to pay this amount.

Most people who are building homes will be interested in something called construction to permanent loan. This is a loan that is specifically tailored to the home building process. It is two separate loans fused into one.

The first part is the construction loan, used during the building of your house; it works like a credit line. Once you are approved for a specific amount, you write checks against that account as you buy your lot and then as you begin to pay the builder. The payments you make are interest-only payments during the construction phase based upon the outstanding balance.

The second part of the loan is the permanent loan, which is put into place once the construction of your new home has been completed. This is a standard 30 or 15 year fixed or an adjustable-rate mortgage.

Construction to permanent loans (CTP) will save you time and money because they require only a single closing. When selecting a mortgage product, make certain the lending institution you are considering offers a true construction to a permanent loan with a single close and a single set of closing costs.

There are financial institutions that will provide a construction loan followed by a permanent loan– but will put you through two closings and charge two sets of closing costs. Simply put, there is no need to go through this, or more importantly, pay for this, so make sure you know what you are getting when you shop for your “construction to permanent” loan product.

Wikipedia link to Home Construction Loans