1. Pay down debt:
A lower debt-to-income ratio is ideal for getting a great rate on a construction loan. If you are planning on acquiring this loan in the future, take steps now to reduce your overall debt load to produce a better ratio for loan officers to consider. Calculating your debt-to-income ratio is fairly easy. Just divide the total debt payments you make each month by how much money you bring in during the same period. Multiply this fraction by 100 to get a percentage. Financial managers advise keeping a debt-to-income ratio at, or below, 35%. For a more in-depth look at ways you can strategically pay down debt, check out the SCCU Guide to Financial Freedom
2. Check your credit score: Knowing your credit score
ahead of time can help save you headaches after applying. If you notice errors on your credit report, you can file a dispute with the credit bureau to have these removed. Since derogatory marks negatively impact your credit score, eliminating any mistakes prior to applying for a loan is critical.
3. Increase credit limits:
While this may seem counterintuitive, requesting a raise to your current credit limits can actually increase your credit score. When you've had a good history of on-time payments, your credit issuer may be willing to increase the amount of credit they'll extend. Raising your credit limit can also lower your credit card utilization ratio and create a two-pronged approach to increasing your credit score. Combine these benefits with a low-interest credit card
like those offered by your credit union, and you can create a great opportunity to build a solid credit history.
A low-interest environment is ideal for borrowers and rates today are competitive. By using a credit union, you can generally obtain lower-interest construction home loans.
Checking out SCCU's construction loan page
gets you a quick overview of the current rates offered. For construction loan details and a personalized rate quote, contact us
or request a loan consultation
with an SCCU Express Mortgage Originator.
What Are the Requirements for Construction Loans?
Now that we know how home construction loans work, let's take a step back to understand the requirements for approval. The process for construction loans is generally more involved than a traditional mortgage since the loan has an underlying asset that either doesn't yet exist or is in the process of being renovated.
With construction loans, the lender will still have many of the same standards as a traditional mortgage application, such as requiring a detailed work history, bank statements, income verification, and other necessary information and documentation. In addition, the lender also assumes the role of a quasi-construction manager, requiring the review and approval of the builder or contractor and for the building plans, a project budget, and a timeline for completion.
Getting approved for a construction loan may depend on a number of factors, such as:
● Having a very good to excellent credit score.
Your credit score is a general representation of your credit risk, which is how likely it is that you'll be able to pay your debts on time each month. According to consumer credit reporting agency Equifax
, a "Very Good" credit rating is between 740 to 799, with "Excellent" being 800 to 850. A "Good" rating (670 to 739) may still get approved, depending on other factors.
● Having enough income to pay the debt.
When it comes down to applying, you'll need to be able to demonstrate you have enough income to keep up with payments. A sound financial management theory known as the 28/36 rule states that you should spend 28% or less of your gross monthly income on housing and 36% or less on the total debt payments made each month.
● Maintaining a low debt-to-income ratio.
As discussed above, construction loan lenders are looking for a healthy debt-to-income ratio. A low ratio translates into a borrower generally having more liquid funds available to make loan payments each month.
● The ability to put at least 20% down.
Remember that construction loans will typically require a down payment of at least 20%, with many programs requiring more than this. There are variations to this rule, but putting down less than 20% may result in higher interest rates and may also subject the loan to mortgage insurance premiums.
● Having a good home construction project schedule and budget.
Since construction loans are riskier for lenders than traditional mortgages, they need to see the plans in place are provided by professionals with a solid track record for success. Make sure you select a qualified contractor that is both licensed and experienced, as well as able to provide all the necessary documentation to keep the project on-time and on-budget. Among other things, you'll most likely need copies of their current licensure, work history, and insurance certificates (often naming the lender as an additional insured). In many cases, lenders maintain lists of “approved builders.” You may want to ensure that your builder is on your chosen lender’s list, or can meet the qualifications to be added.
● Organizing your paperwork.
Your lender will want to see as much detail as possible when reviewing your loan application. After you've found a licensed, insured, and experienced general contractor, providing other pertinent documents will help your lender evaluate your application more quickly. Have documents such as these on hand and ready: a land deed, blueprints, budget, draw schedule, contracts, and more. As you start the process, make sure to maintain good records to present all of the information to your lender in an easily transferable manner.
Knowing your lender's requirements before you start is a good way to ensure you're working towards checking off all the boxes needed to approve the loan. To facilitate this, you can schedule a loan consultation
to get a better understanding of everything required.
Getting a Construction Loan as a First-Time Homebuyer
Reading this far may have you worried if you're a first-time homebuyer. Will you qualify for a construction loan if this is your first home? The good news is that even if this is your first home, you can still qualify for a home construction loan.
Just like with any mortgage application, first-time homebuyers can qualify for a loan based on factors such as creditworthiness, debt-to-income ratio, a history of on-time bill payments, etc. Making sure to present the best picture possible is key.
If your credit score is somewhat low, take steps before applying to bolster your score. If you have a lot of debt, work to pay this down. Also, it's a good idea to go ahead and start a savings fund for the down payment and other costs. Proactively planning for the requirements of a construction loan will leave you far better prepared when you're ready to apply.
Choosing a Home Construction Loan Lender
Remember that not all construction loan lenders are created equal. The loan officer at the lender has a lot to do with the successful (and headache-free) completion of your construction loan. Making sure to do your part also plays an important role in successfully preparing for a home construction loan application, but doing some due diligence on your lender is recommended as well.
Make sure to compare various lenders' home construction loan rates and general terms. Also, pay close attention to the down payment requirements and closing costs. In general, credit unions are able to offer lower rates and lower fees than banks because of how the institutions are structured. You'll also want to make sure that the lender(s) you're looking at offer the type of construction loan needed in your unique situation.
Just within the four types of construction loans we presented above, there are many different programs, each with its own requirements. Experience matters in construction loans, and your lender will play a large role in how successful the project is.
Home Construction Loans vs. Traditional Mortgages
When you purchase an existing home, you'll go through a conventional mortgage process. Most conventional mortgages are termed at 30 years, with 15-year terms that may offer lower interest rates. However, as we've seen with a new construction or major home renovation, a traditional mortgage is not best suited for this application, and a home construction loan will most likely have all of the features you need.
A few of the major differences between traditional mortgages and construction loans include:
● Traditional mortgages can require as little as 3.5% down. Construction loans generally start at 20% down and go up from there.
● Because of the risk involved, a construction loan's interest rate tends to be higher than a conventional mortgage. Construction loans also usually have more requirements that need to be met in order to qualify.
● Construction loans need a qualified contractor to submit budgets, timelines, contracts, and more in order to be considered by a loan officer. Adding a third-party (outside of yourself and your lender) simply adds an additional layer of risk. You'll need to make sure you've vetted your contractor and that they are familiar with the process and have a track record of successfully delivering on home construction projects and lender requirements.
● The construction phase of these loans typically have much shorter terms, depending on how long the build is scheduled to last. The most common term for a construction phase is one year or less. Comparatively, the most common conventional mortgage has a 30-year term.
● Construction loans are often interest-only based on the draw schedule. The end of the construction phase may trigger the need to pay the balance in full. A construction-to-permanent loan allows borrowers to convert their construction loan into a standard mortgage at the end of the building process.
Construction home loans are incredibly useful for many different scenarios when building a new home or renovating an existing property. Knowing the pros and cons of traditional mortgages versus construction loans, and when each is appropriate, can help you decide which avenue to pursue in your new home search.
Additional Loan Types for Home Remodels & Repairs
While home construction loans are great for building new homes or major remodeling projects, they aren't always the best loan type based on your particular situation. If you're looking to finance a smaller home repair or renovation, you may consider a home equity loan (fixed second mortgage, home equity line of credit, a personal loan
, or even a low-interest credit card
These options are generally considered shorter-term solutions and are useful when a quick repair/renovation is needed. Our onsite loan underwriters make it easy to get a decision quickly no matter what type of financing is needed.
Applying for a Home Construction Loan
Getting a home construction loan can be exciting, but feel daunting at the same time. At SCCU, we're here to make the process of building or renovating your dream home
as easy as possible.
If you need help with understanding where you are in the process, applying for a construction loan, or any other aspects of our program, check out our Construction Loan page
for additional resources.