Find the Best Construction Loan for Building Your Home and Save Thousands of Dollars

Construction Loan Funded New Home

If you’re planning to build a house, getting the best construction loan may not seem as exciting as designing your home.  However, construction loans set the foundation for your financial future, and it is critical for you to find the best construction loan for your situation.

Options abound in the world of construction loans. The information we’ve compiled for you below can help you avoid the intimidation and confusion that is common when trying to find the best construction loan.

When do I need a construction loan?

You need a construction loan when you are building a home on a lot and to not wish to pay cash during the building process.

What are the benefits of a construction loan?

The benefit of having a construction loan is that you will have a partner (your lender) that will inspect the home & structure as it is being built to ensure that you are getting what you are paying for.  This can be especially helpful if you are unfamiliar with the home building process.

Construction loan checks generally include :

  • An up-front appraisal, to make sure what you are building is worth what the bank is lending you
  • An appraisal at completion, to make sure things are worth what they were anticipated to be
  • Inspections at every draw (a draw is a withdrawal your contractor makes) to ensure that you got what is being paid for
  • A deadline for your project, for instance: building must be finished by X date or there are penalties or repercussions
    • The deadlines can be a positive or negative aspect of a construction loan, as they could result in a penalty to you if your contractor does not meet the deadline.  It may be worthwhile to include penalties in the contract with your general contractor if they do not complete the home by the time your construction loan closes/converts.

Where can I get a construction loan?

You can get a construction loan from some of the places you might get a traditional mortgage loan, like credit unions, banks and mortgage brokers.

Warning: Do not just talk to “your bank” or “your credit union” or somebody “someone” recommended.  Check around to at least 5 or so different places in your area using the guidelines we provide below.

Choosing your lending partner for your construction loan wisely can save you a lot of money and a lot of headache later on.

Where can I get the best construction loan?

Best Construction Loan from a Credit UnionIt depends on what fits your situation best, and what’s available in your area.  However, in general, I would order the options like this:

  1. Credit Unions (Search for some in your area)
    • Tend to have the lowest fees and lowest rates
    • Generally are run locally, allowing for more flexibility, help and understanding through the process
    • Mostly do not sell loans to another party
    • Historically, have been hard to join; now are mostly as easy to join as banks
    • Tend to have exceptional customer service, and are run by their members
  2. Mortgage Brokers (Search for NMLS professionals in your area)
    • Look at a wide range of options to find the one that is best for you
    • May have access to some unique products that may align well with your project
    • Sometimes are run locally
  3. Banks (Search for FDIC banks in your area)
    • Tend to have the highest fees and rates
    • Generally to be run elsewhere, have more rigid rules and less help for you through the process
    • May sell your loan to another party
    • Are known for poor customer service

What types of construction loans can I choose from and how can I choose the best construction loan for me?

Options abound when it comes to construction loans.  Getting a standard home loan is fairly straightforward.  With construction loans, many lenders handle things differently.  Therefore, it’s important to interview each one of your options, consider the differences between your options and what might be the best construction loan for your situation.

Before you proceed, make sure you have a rough idea how much money you would like to borrow, and what type of long-term financing (30-year fixed, 15-year fixed, ARM, etc) you are interested in.  Once you know that, proceed and get ready to interview your lenders.

Basic Characteristics

The following are the basic attributes of  a construction loan that you will need to consider:Best Construction Loan Interest Rate

  • One Time or Two Time Close
    • One Time Close – Take care of all of the closing details at once.  Usually avoids some fees of closing twice, but you should compare the numbers on both options.
    • Two Time Close – Close on your construction loan, and then later close on the long-term mortgage loan.
  • What type of long(er) term mortgage loan does the construction loan convert into
    • Fixed Rate – Fixed interest rate through the life of the mortgage loan.  Most people will want this, unless you know you are going to move before an ARM loan would adjust.
    • ARM (Adjustable Rate Mortgage) – Variable interest rate through the life of the mortgage loan.  This makes it hard to predict costs going forward and should not be used unless there are special circumstances.
    • Other
  • Interest Rate for construction loan:
    • What is the rate?
    • Is it variable or fixed?
    • When can it be locked in?
  • Interest Rate for long(er) term mortgage loan:
    • What is the rate?
    • Is it variable or fixed?
    • When can it be locked in?
      • At initiation of construction loan
        • With float down at conversion
        • Without float down at conversion
      • At conversion of construction loan
      • Some construction loans allow you to lock in the interest rate for your long-term mortgage loan when you close on the construction loan; some do not, and force you to take the “market” rate when your loan converts.  Generally, locking up-front will have a slightly higher interest rate, as there is more risk to the lender.  If interest rates are going up, then locking in up front could be worthwhile.  If you’re not sure, or anticipate they will drop, then waiting to lock in your rate later could be beneficial.
  • Term of Construction Loan
    • Typically 6, 9 or 12 months – Choose longer than you think.  Problems arise during construction.
  • Average Payments during Construction Loan Phase
  • Payment during Long Term Mortgage Loan
  • Term of Long Term Mortgage Loan
    • 30-year Fixed
    • 15-year Fixed
    • 5 or 10 year ARM
  • Origination & Other Fees at initiation of construction loan
    • Origination fee
    • Appraisal
    • Title fees
    • Title insurance
    • Credit report
    • Inspections
    • Recording fee
    • Flood certificate
    • Other
  • Origination & Other Fees at conversion to long-term mortgage loan
    • Origination fee
    • Underwriting fee
    • Escrow for taxes and insurance
    • Title/closing fees
    • Title insurance
    • Recording fee
    • Appraisal
    • Tax service fee
    • Endorsements
    • Other

How should I interview lenders about their construction loan offerings?

Construction Loan InterviewFirst, start by asking lenders all of the “basic” questions above.  Then, if you feel like this lender might be able to meet your needs at a reasonable cost, follow-up with these detailed questions:

  • How do your construction loans work? (open-ended question, let them give you an overview)
  • Do you credit any of the fees from the construction loan toward the permanent loan?
  • Can equity in land be used for down payment?
  • What are the down payment requirements for the construction loan?
  • What are the down payment requirements for the permanent loan?
  • Is any reserve required for the construction loan?
    • Some loans may require a reserve amount, over and beyond the amount of money you are contracted to sell for
  • If there is a reserve, what can the reserve be used for, and who can use it?
  • What type of loan products can a construction loan roll over into?
  • When can I lock my rate for the permanent loan?
  • When can I lock my rate for the construction loan?
  • What fees are there for locking my rate?
  • Are there options to float down the rate of my permanent loan?
  • Is the second loan available at market rates, or are there raised rates to do it being a refinance of the construction loan?
  • What payments are required during construction – do interest costs roll into the loan, or are they paid, or do I have an option?
  • Can I have a good faith estimate of the fees for both the construction and permanent loan?
  • What happens if construction goes longer than expected?  Will the rate no longer be locked?  Are there penalties?
  • Who services the construction and long-term loans?
    • You might want to consider favoring companies that service their own loans, if you are concerned about having lousy customer service in case your loan is sold.
  • What number of days does it take to close on the loan?
  • Is the construction loan rate locked upfront or floating during the construction loan period?
  • Is the rate during the construction loan the same rate when the loan converts into the mortgage period?
  • What happens when building cost comes in lower than my loan amount?
  • Will you work with my contractor? (If you have one picked out)  What contractors have been good to work with (If you haven’t picked one out)
  • What types of things do you require my contractor to do in order to proceed with the loan?
  • How often do you service construction loans in my area?
  • When my contractor makes a draw, how long does it take for you to process his draw requests?
  • Do you feel like you have the best construction loan product available?  If so, why?

Processing Interview Results & Deciding on the Best Construction Loan

Once you’ve interviewed several credit unions and banks in your area, it’s time to narrow down to a few different choices to compare.

First, eliminate all of the choices that have a payment amount in the construction or long-term mortgage loan that exceed 25% of your monthly take-home pay.

Second, eliminate all of the choices that do not offer the long-term financing that you desire.  For example, you may not want an ARM loan, but may find that over half of the lenders you interview offer only ARM loans.  Discard those lenders from consideration.

Third, eliminate any remaining choices that you don’t feel comfortable with, based on their answers to any of the questions above.

It is dangerous to look at just a particular aspect of a Construction-to-Long-Term Mortgage Loan and try to decide off of that; look at the total cost with all fees and interest rates included.

Best Construction Loan Calculator SpreadsheetWith those that are left, use our Construction Loan Comparison Calculator Spreadsheet to compare the total cost of all of your options.   We have a Google Sheets version that you can copy into your Google Drive Account and edit with your information, and Microsoft Excel (xlsx) version, which will work on LibreOffice, OpenOffice or Mac OS Pages.
Once you have your top choices in the spreadsheet, consider the following:

  • Among your options, which are the lowest overall cost, yet are an achievable (25% or less of take-home pay) payment amount?
  • Do the options that allow me to lock in now cost only marginally more than loans that would lock later, assuming similar interest rates?  If so, prefer loans that let you lock now, to take away uncertainty later!

Do you need help figuring it all out?

If you need someone to consult with as you go through the process of finding the best construction loan, contact us or leave a comment below with your questions!

Congratulations! You Just Picked the Best Construction Loan

As you probably realize by now, you’ve saved yourself thousands of dollars and untold amounts of hassle by educating yourself and picking the best construction loan.  Now, enjoy the building process!

Here are a couple resources that we recommend for people building new homes:

What Your Contractor Can't Tell YouWhat Your Contractor Can’t Tell You” by Amy Johnston – Excellent book detailing the construction process, including how to avoid many pitfalls during the home design and construction process.

How to Build Your Dream Home Without Getting Nailed!How To Build Your Dream Home Without Getting Nailed!” by The Chubby Builder – Everything you need to know to make building the home of your dreams the pleasant and profitable adventure it should be.

Armchair BuilderArmchair Builder – Many resources geared towards people building their own home, but also very useful when working with a contractor.

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1 Comment

  • Thank you for all this great information about construction loans! I really like your point that after we interview all loan locations, look at the numbers and cut anyone that exceeds 25% of our monthly take-home pay. My husband and I are looking for construction loans and want to make the best decision possible, so thanks for the tips.