If you have looked for your dream home but can’t find it, you could think about building a new home. Building your own home requires a new home construction loan, and new home construction requirements for mortgages differ than for existing properties. Learn all about new home construction loans in this article and reach out to RefiGuide today to qualify and ask questions.
As you gear up to finance on your construction projects this year, understanding the current home construction loan rates and their expected trends is crucial. Whether you’re new to the construction field or a seasoned developer, gaining insights into the 2024 new home construction loan requirements can significantly impact your plans.
What Are New Home Construction Loans?
New home mortgage loans are those that fund the construction of a residential home, also known as a stick-built home.
The new home builder loan also finances the purchase of the land the new home sits on.
The most common new home construction loans is a short-term loan and a construction to permanent loan.
A short-term loan only funds the construction of the property and is usually a year in length.
A construction to permanent loan converts into a regular mortgage when the construction is complete.
Homebuyers who get a standalone construction loan usually apply for a regular mortgage to pay off the construction loan when the home is done.
Construction loans are usually used to pay for building costs, including the land, labor, building materials, and permits.
How a New Home Construction Loan Works
The first time period on your construction loan is usually a year or less. This is when the home is built. Construction loans are on a strict timeline, so the lender will need to know your building timeline, detailed building plans, and a budget. Based on what you provide, the lender will provide funds from the loan during building phases. Usually, the funds are sent directly to your builder.
Difference Between a Construction Loan and Regular Mortgage
There are several key differences between construction mortgages and regular mortgages:
- How the funds are delivered: Unlike a traditional home loan with lump sum proceeds, the lender pays construction loan money in installments as the building progresses. The construction loan draws usually happen when building milestones are reached, such as when the foundation or framing is done. Compare a HELOC vs construction loan to learn more.
- When the loan is repaid: With a regular mortgage, you begin paying the principal and interest immediately. With your new home construction loan, the lender usually only wants interest while the building is underway. You also are only required to pay interest on money that is been delivered to the builder.
- Amount of inspections: As the home is constructed, the lender will have an appraiser or inspector check in often. They will verify if the home has reached a certain point so that funds can be delivered to the builder. These are called draws. Generally, four to six inspections are conducted during the build phase.
- More stringent requirements: A construction loan usually has more rigorous requirements, including having adequate financial stability and possibly a larger down payment. You also usually need a 680 credit score or higher to get a new home construction loan.
- Different interest rates: Construction loan interest rates are usually higher than regular mortgage interest rate. There is usually no collateral for the fixer upper loan, so there is a higher risk.
What Are the New Home Loan Mortgage Rates Currently?
Most traditional mortgages have fixed rates, unless you get an adjustable-rate mortgage. On the other hand, construction loans typically have variable rates. The rate will probably change based on the prime rate. So, the monthly payments for the new home loan may change.
Construction loans usually have higher rates because the loan isn’t backed by a finished home. The lender cannot take the home if you don’t pay, so they usually see a construction loan as a bigger risk. Many lenders charge about 1% higher for a construction loan than a regular mortgage.
What Credit Score Do You Need for a New Home Construction Loan?
Generally, a credit score of 620 is the minimum requirement to qualify for a new home construction loan from most mortgage companies. Of course having a credit score above 720 can help secure the most attractive mortgage rates. Along with a high credit score, demonstrating financial stability can significantly enhance a borrower’s chances during the loan approval process.
Below-Average Credit: To meet FHA construction loan requirements, you need a minimum credit score of 580. However, some private mortgage lenders may provide construction loans to those with credit scores as low as 500, provided they make a down payment of at least 10 percent. The debt-to-income (DTI) ratio should not exceed 43 percent, although there are exceptions. The required down payment is 3.5 percent for those with a credit score of 580 or higher, and at least 10 percent for those with scores between 500 and 579.
New Construction Home Loan Types
There are two major types of new construction home loans:
Construction To Permanent Construction Loans
With this loan, you borrow cash to pay for constructing the home. After the house is finished and you move in, the loan is made into a regular mortgage. So, the loan has become a traditional home loan, which is usually 15 or 30 years long. You can choose a fixed or adjustable rate.
Construction Only Construction Loan
This type of construction loan gives you the money to build the house. But you are responsible for paying off the construction loan when the home is completed. You can settle your debt by paying it off in cash or getting a mortgage.
Construction only loans may cost you more than a construction to permanent loan. This is especially the case if you need a mortgage to pay off the construction loan. This is because there will be two closings to fund and two fee sets. Closing costs are usually 2% to 5% of the loan, so you may pay closing fees twice with a construction only loan.
Also, bear in mind that your financial situation could change during building. What if you have your hours cut or lose your job before the home is done? This is why many people prefer to get a construction to permanent loan. However, there are scenarios where getting a construction only loan is a good choice. RefiGuide lending experts will review your situation and make our best recommendation to meet your new construction loan needs.
What About Renovation Loans?
A related subject to construction loans is home renovation loans. You may have a home that you own but you want to fix it up. The best, lowest interest option is usually a home equity line or credit or home equity loan. These are second mortgages that allow you to pull some of your equity out in cash.
Another potential option is a cash-out refinance, but this is best for someone with a first mortgage rate that is higher than market rates. In 2024, 2nd-mortgage rates have not changed a lot, and are still well above 6%. If you have a lower rate than that, it is often preferred to get a second mortgage for home renovation needs.
Can I Get a FHA Construction Loan for a New Home?
An FHA construction loan is a government-supported mortgage that aids borrowers in financing the construction of a new home or significant renovations to an existing one. Insured by the Federal Housing Administration, these home construction loans provide protection to mortgage lenders against defaults, thereby facilitating financing for borrowers who may have lower credit scores or smaller down payments.
New Home Loan Mortgage Requirements
These are the typical new home mortgage requirements, but they can vary by lender:
- Financial stability: You need a low debt-to-income (DTI) ratio and enough documented income to get a new construction loan. A 680 credit score is usually required. These factors show that you are financially stable and will pay back the loan.
- Down payment: You have to make a loan down payment, just like a traditional home loan. The size of the down payment depends on the lender and how much you want to borrow. A 20% down payment is common.
- Construction plan: You need an experienced builder and plan to get a construction loan. So, have the construction company and their architect devise a detailed construction plan.
- Home appraisal: Whether you obtain a construction only loan or a construction to permanent loan, the lender wants to see that the home will be worth what you say. Your appraiser will review your construction plan blueprints, what the land is worth, and more. Note that the home is collateral for the mortgage if you do a construction to permanent loan.
Summary on New Home Construction Loans
Before finalizing your budget and construction plans, it’s essential to get prequalified or preapproved by an experienced home construction lender. This pre-qualification step will help determine your borrowing capacity and the lender’s limits on how much you can borrow.
Obtaining a construction loan to build a new home is a common choice for people who can’t find the home they want. There are more stringent requirements than for regular loans, and the approval and funding processes are more complex. Contact RefiGuide today to get connected to top mortgage lenders offering attractive new construction loans that best meet your needs.
About RefiGuide
Bryan Dornan is a financial journalist and currently serves as Chief Editor of RefiGuide.org. Bryan has founded several mortgage and marketing companies and has worked as a loan officer and mortgage broker in the industry for over 25 years and has a wealth of experience in providing mortgage clients with the highest level of service in the industry. Bryan's continual focus is to promote affordable home-ownership to consumers like you across the United States. He also writes for RealtyTimes, Patch, Buzzfeed, Medium and other national publications. Find him on Twitter, Muckrack, and Linkedin
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