Build Your Home With a Construction Loan

Find the right construction loan for your home

What Are Construction Loans?

What is a home construction loan? How does a construction loan work? These are two common questions for anyone who is considering building a home instead of buying one. As its name indicates, it is a construction loan extended to a homebuilder or homeowner for the purpose of constructing a new home.

Construction loans are riskier propositions for lenders. If the borrower defaults before the new home is completed, there is nothing tangible for the lender to sell to recoup its loss. That is why construction loans are typically more difficult to qualify for than a home mortgage, and also may have less favorable loan terms, such as higher interest rates.

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Credit Score

Minimum 680, and 750 for jumbo construction loans

Down Payment

Typically 20% to 25%

Eligibility

Equity in land or an existing home can help

Find the Right Construction Loan Type for You

Construction loans can be classified in various types based on their purpose or the lenders that provide the loan type you’re looking for.

Based on the financing structure

All-In-One Construction-to-Permanent Loan

The idea behind a construction-to-permanent loan is to simplify the process of constructing a new home. With construction-to-permanent financing, you can finance the construction of the home and your mortgage, all with one loan. This can save you money in closing costs, as you would otherwise need to take out separate loans — one for constructing the home, and one for long-term permanent financing, with two sets of closing costs instead of one. This loan type is often called all-in-one construction-to-permanent loan.

Standalone Construction Loan

With a standalone loan, the borrower takes out a short-term construction loan, which then must be converted to a long-term mortgage with a separate loan. This results in two closings — one for the standalone mortgage loan, and one for the long-term mortgage — which typically results in higher costs for the borrower.

Standalone construction loans can be used for:
  • Construction completion
  • Lot and construction
  • Ground-up construction (already own land)

Based on the loan program and the lenders that provide it

Conventional Loans

Conventional construction loans are offered by banks, credit unions and mortgage lenders that conform to the standards of the two government-sponsored enterprises: Fannie Mae and Freddie Mac.

Government-Backed Loans

Government-backed construction loans are funded by banks, credit unions or other mortgage lenders. Because they are backed by federal agencies, lenders are able to lend to borrowers with riskier credit profiles. In the case of construction loans, two main agencies are in play: The Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA).

Hard Money Loans

Hard money loans are funded by private lenders that sometimes will fund loans that banks or credit unions won’t touch. Hard money lenders place more emphasis on the value of the property than the credit or other qualifications of the borrower; the tradeoff is that they’re usually more expensive. They also are often short-term loans, and can be used to pay for construction. It may then be possible to refinance into a conventional, long-term mortgage.

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How to Get a Construction Loan With No Money Down

How much down payment is needed for a construction loan — and can you get one for no money down? For many construction loans, lenders require a minimum 20 percent down payment. Some options do exist, however, for people looking for a zero-down construction loan — or at least one lower than the standard requirement of 20 percent to 25 percent.

If you are a member of the military, guard or reserves, a veteran or a spouse of a member, you may be eligible for a VA construction loan. These loans are guaranteed by the U.S. Department of Veterans Affairs. Because the federal government only guarantees the loans and does not fund them, however, it can be difficult to find a lender who will approve a zero-down VA construction loan.

If you are not able to find a zero-down construction loan, consider a low-down payment option. The Federal Housing Administration (FHA) insures construction loans that require only 3.5 percent down.

FHA Construction Loans

The Federal Housing Administration (FHA) offers construction loans with 3.5 percent down payments and relaxed credit requirements.

FHA Construction-to-Permanent Mortgage

The FHA’s construction-to-permanent mortgage finances the cost of construction and a long-term mortgage in one loan, with one closing fee. The FHA will place the funds for construction in escrow and release them as needed.

FHA 203k Loan

These loans are typically used for repairs. There are two versions: a streamlined one to pay for repairs and upgrades, and a standard version for larger projects, which can include purchasing a run-down home and completely rebuilding it.

Requirements for Construction Loans

Are you wondering how to get a construction loan? The first step is ensuring you meet the basic requirements. Lenders consider several factors when deciding whether to fund a home construction loan.

Credit Score

What credit score is needed for a construction loan? Generally speaking, you’ll need a score of at least 680 to qualify for a construction loan. For more expensive projects, you should have a score of at least 700. If your construction loan exceeds the maximum conforming loan ($424,100 in 2017), you will probably need a score of 750, which is considered excellent credit.

Down Payment

Typically, lenders require a 20 percent or 25 percent down payment for construction loans. Some options exist for lower down payments, specifically construction loans backed by the FHA and VA, which offer 3.5 percent and zero percent down loans, respectively.

Equity

Construction loans are riskier for lenders, because if something goes wrong during construction, there isn’t a finished house they can sell to recoup their loss. If you already have equity in something that you can offer as collateral — such as a plot of land or equity in an existing home — it may help your chances of getting approved or help you secure a lower interest rate.

How to Get a Construction Loan with Bad Credit

If it’s not possible to improve your credit score, try the following tips.

  • Make a larger down payment.
  • Offer collateral, like equity in the lot.
  • Try a credit union or regional bank.

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How Much Does It Cost to Build a House?

If you’ve just begun toying with the idea of building a house, you may be asking yourself, “How much money do I need to build a house?”

The answer to that question depends on several factors, including the cost of the land upon which the home will be built, the size of the home, and what amenities and features will be included in the home. The area the house will be built in also influences the ultimate cost of building the home.

Another factor that can influence the cost of building a house is whether it will be built from a pre-existing floor plan, or whether the homeowners hire an architect to design a custom floorplan. Building a custom home with a custom floorplan costs more money than using a pre-existing design.

The cost-per-foot to build a new home could range from $100 to $200 per square foot on the cheaper end to $200 to $400 for higher-end custom homes.

Using Construction Loans for Home Renovations

Home improvement loans are used to pay for home repairs or renovations — in some cases, they can even be used to rebuild a house from the foundation up.

The Federal Housing Administration offers two loan programs geared toward renovations. These include the FHA 203k one-time close loan, which can be used both to purchase the residence and to pay for necessary repairs.

The FHA also offers Title I home and property improvement loans, which can be used in conjunction with 203k loans.

Is Land Included in a Construction Loan?

If you still need to purchase land for your new home, you may be asking yourself, “Is land included in a construction loan?” Typically, land is not rolled into a construction loan — you’ll likely need to either purchase land with cash or take out a loan for the land only. The good news is that once you’ve secured the lot, you can use the equity in the land toward a construction loan.

Getting a loan to purchase land is trickier than getting a loan to purchase a home. Raw land — i.e., land without improvements such as buildings or hookups for utilities or sewers — is more difficult to finance than improved land purchased with the intention of immediately constructing a house upon it.

The U.S. Department of Agriculture (USDA) offers a program for purchasing land called a USDA Section 502 loan. With this loan, low-income borrowers can purchase land in rural areas with the purpose of improving the land to build a house on it.

Another possibility, if you’re willing to go with a manufactured home rather than a newly constructed one, is a U.S. Department of Housing and Urban Development (HUD) Manufactured Home and Lot Combination loan. These loans can be used to purchase both a lot and a manufactured home. The program covers loans as high as $92,904 for both the manufactured home and lot.

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