Building your home can help you realize a dream, as opposed to moving into someone else’s ideal home. However, that requires understanding how construction, loans work and recognizing that they’re much different than traditional home loans.
Two Types of Construction Loans
When learning about construction loans, it’s important to recognize that they’re subdivided into two types. Which one you choose depends on your unique situation and on what you believe will offer you the greatest benefit for your money. This is a decision you will have to make, as you shop around for low down payment construction loans Madison WI and search for the lender with the best deal.
Stand-Alone Construction Loans
A stand-alone construction loan actually requires you to take out two separate loans. The first loan is to pay for the construction of the home. Once construction is complete and you take possession of the home, the second loan is a traditional mortgage and is used to pay off the construction debt. This is the better option for people who already own one home. They can make smaller payments on the construction loan. After they sell the first home, they’ll have the money to cover the down payment on the second loan and make regular mortgage payments.
There are a few disadvantages to the stand-alone construction loan. First, you can’t choose a fixed interest rate, which means you may end up paying more interest than you expect. Additionally, this requires you to pay closing costs and administrative fees on two loans.
Here, you take out the loan to pay for the construction and begin paying on the interest as soon as construction begins. Once the construction phase is complete, the outstanding balance on that first loan is converted to a traditional mortgage and you begin making your normal monthly payments. Since this is the same loan, you only pay one set of fees and closing costs.
Here, as well, you have to accept the variable interest rate. Once the loan is converted to a regular mortgage, you can choose the option of a fixed rate and you also have the option of choosing your term. Your down payment is usually 20% of the expected mortgage.
Qualifying for a Construction Loan
Regardless of the type of loan you choose, qualifying for financing is still going to be a complex process. Just like a traditional mortgage, lenders will look at your credit score, debt to income ratio, and your repayment plan. They will also take your down payment amount into consideration.
In looking at your debt to income ratio, lenders expect you to pay 45% of your income or less on debts. If you’re paying out more than that, try to change the ratio, either by increasing your income or reducing your debts. For the purposes of a construction loan, you’ll also be expected to maintain a 680-credit score or better.
In looking at your down payment, most construction loan lenders require between 20% to 30% of the loan value. However, it’s a good idea to shop around, because some lenders are more lenient in regards to the down payment. They will also look at your repayment plan, following the completion of the construction phase. Specifically, they will want to know if you plan to repay the loan amount in full or if you will need a second loan to cover the construction loan. If you’re selling a home, you may not need the second loan.
There are many options, when it comes to financing a new construction. Which loan product you choose depends upon your situation and how you envision paying for the home. No matter which loan type you select, be sure to shop around for the best offers, because every lender offers its own incentives.