How Construction Loans Work When Building a New Home

Written by Andy Stauffer

February 21

mortgage and construction loans

When it comes to getting financing for a home, most people understand basic mortgages because they’re so simple and almost everyone has one. However, construction loans can be a little confusing for someone who has never built a new home before. In the years I’ve been helping people get construction loans to build homes, I’ve learned a lot about how it works, and wanted to share some insight that might help de-mystify the process, and hopefully, encourage you to pursue getting a construction loan to have a new home built yourself. I hope you find this information helpful!

How Construction Loans Work: The Basics

I’ll start by separating construction loans from what I’d call “traditional” loans. A traditional home loan is a mortgage on an existing home, that generally lasts for 30-years at a fixed rate where the borrower makes principal and interest payments for the life of the loan. These mortgages can be obtained through a conventional lender or through special programs like those run by the FHA (Federal Housing Administration) and the VA (Veterans Administration).

In contrast, a construction loan is underwritten to last for only the length of time it takes to construct the home (about 12 months on average), and you are essentially given a line of credit up to a specified limit, and you submit “draw requests” to your lender, and only pay interest as you go. For example, if you have a $400,000 construction loan, you won’t have to start paying anything on it until your builder submits a draw request (perhaps something like $25,000 to start) and then you’ll only pay the interest on the $25,000.

Construction Loans Are Like A Big Credit Card

The best way to think about a construction loan is to compare it to a giant credit card that only lasts until the home is built. At that point, you then get a mortgage for the house you’ve built, which will pay off the balance of your construction loan. There are no prepayment penalties with a construction loan so you can pay off the balance whenever you like, either when it comes due or before then (if you have the means). So in a way, a construction loan has a balloon payment at the end, but your mortgage will pay this loan off.

Interest rates are also calculated differently: with a traditional loan, the lender will sell your loan to investors in the bond market, but with a construction loan, we refer to them as portfolio loans (which means we keep them on our books). We have the freedom to negotiate the right interest rate based on several factors. It’s not like an auto loan where you walk into the bank and look at the rate sheet on the wall that shows today’s interest rate (which could change tomorrow). I have the ability to look at “the big picture” and determine a rate based on many factors, including your credit, financial history, income and project equity.

You Need Both A Construction Loan And A Mortgage

Eventually, after our construction loan has funded your home’s construction, you will need to get a mortgage for the home which will pay off the construction loan. Something people ask me all the time is “do I have to get a mortgage from the same company that provided my construction?” and I’m happy to answer “No.” You have complete freedom in choosing your mortgage company. I finance people for construction loans all the time where I then hand them over another company to do the permanent mortgage.

Conforming vs. Non-Conforming Loans

I think it’s helpful for people to know the difference between “conforming” and “non-conforming” loans. A conforming loan is a mortgage for less than $417,000, while a loan larger than that is a non-conforming (sometimes called “jumbo”) loan. There are differences in the qualification guidelines on these loans. There are a bazillion mortgage companies that can approve you for a conforming loan: finding a lender for a jumbo loan can sometimes be more challenging because the rules are stricter.

One-Step vs Two-Step Construction Loans

There are two different ways to get financed for building a home: A) one-step loans (sometimes called “simple close” loans) and B) two-step loans. Both loans are great products, but it depends on the type of home you’re building. Here are the differences:

One Step Loans: with a one-step construction loan, you are selecting the same lender for both the construction loan and the mortgage, and you fill out all the paperwork for both loans at the same time and when you close on one a one-step loan, you are in effect closing on the construction loan and the permanent loan. I used to do lots of these loans years ago and found that they can be the greatest loan in the world IF you’re absolutely certain on what your home will cost when it’s done, and the exact amount of time it will take to build. For example, a tract home builder that builds 200 homes a year can easily work with a one-step loan when he’s building a floor plan he’s used fifty times in the past. However, when building a custom home where you may not be absolutely sure what the exact price will be, or how long the building process will take, this choice may not be a very good fit.

If you have a one-step loan and later decide “Oh wait, I want to add another bedroom to the third floor,” you’re going to have to pay cash for it right then and there because there’s no wiggle room to increase the loan. Also, as I mentioned, the time line is very important on a one-step loan: if you expect the home to take only 8 months to build (for example), and then construction is delayed for some reason to 9 or 10 months, you’ve got major issues.

Two Step Loans: with a two-step loan, you’re splitting up the construction loan and the mortgage, where you finish building your house and then close on the mortgage when it’s built. This is a much better fit for people building a custom home. You have more flexibility with the final cost of the home and the time line for building. I tell people all the time to expect that changes are going to happen: you’re going to be building your house and you’ll realize halfway through that you want another feature or want to change something. You need the flexibility to be able to make those decisions as they happen.

With a two-step loan, you can make changes (within reason) to the scope of the home and add change orders and you’ll still be able to close on the mortgage. Also, since the clock is not running like on the one-step close, you can take a bit longer to finish building the house. I always give people plenty of time to get their homes built. Delays occur, whether it’s due to bad weather or other unforeseen circumstances. With a two-step, will have the flexibility of extending the construction loan.

Qualification and Down Payments

We look at the same basic criteria when approving people for a construction loan, with a few differences. Unlike the VA loans or some FHA loans where you might be able to get 100% financing and even have nothing down, the maximum LTV (loan-to-value) ratio we generally work with is about 80%. Meaning, if your house is going to have a total price of $650,000, you’re going to need to bring $130,000 cash to the table, or at least have that much in equity somewhere. If you happen to have owned your lot for an extended period of time, we can consider the appraised value of the lot as a contribution toward your equity requirement.

You May (Or May Not) Need To Sell Your Current Home First

One popular question I get is “Do I need to sell my current home before I get a loan to build a new home?” and my answer is always “it depends.” If you’re seeking a construction loan for, let’s say, a $500,000 home and a $250,000 lot, that means you’re looking for $750,000 total. So if you already live in a home that’s paid off, there are no challenges there at all. But if you currently live in a home with a mortgage and owe $250,000 on it, the question is: can you be approved for a total debt load of $1,000,000? As the mortgage guy, I have to make sure that you’re not taking on too much with your debt-to-income ratio.

Some people will sell their current home and rent a house while they’re getting their new home built. Others will be able to live in their current home while building, and they’ll sell that house after the new one is completed. So most of the time, the question is simply whether you sell your current home before or after the new home is built. From my perspective, all a lender really needs to know is “Can the customer make payments on all the loans they take out?”. Everyone’s financial situation is different, so just remember it’s all about whether you can handle the total amount of debt you acquire.

5 Common Misconceptions and Mistakes

There are a few things that a lot of people don’t quite understand when it comes to construction loans, and a few mistakes I see frequently. Here are just a few:

#1) You don’t need to already have land!

Great news: some folks think they already need to own their lot in order to get a loan to build their home, but that’s just not the case! I frequently write construction loans for people that include both the house and the land: it’s all part of the cost of building a house. If you have your land already, that’s great, but you certainly don’t need to.

#2) Don’t think “I’ve been approved, so the bank will take care of me no matter what.

Sometimes people will get approved for a construction loan, which they get excited about, and in their excitement while designing their home, they forget that they’ve been approved up to a certain limit. For example, I once worked with some clients who we had approved for a construction loan up to $400k, and then they went merrily about designing their home with a builder. I didn’t hear from them for a few months and started wondering what happened, and they eventually came back to me with a totally different set of plans and a different builder, and the total price on that home was about $800k. Apparently, in the process, they forgot to tell me that they’d fired their old builder, and hired a new one, and made all kinds of changes in their home’s design and the scope grew out of control. I wasn’t able to get them financed for the new home because it had doubled in price!

#3) Don’t go on a spending spree after getting qualified.

This is especially important if you have a two-step loan: sometimes people think “I’m qualified for a huge loan!” and they go out and buy a new car. …which can be a big problem, because it changes the ratio of their income and debt, which means if their qualifying ratios were close when obtaining their construction loan, they might not get approved for the mortgage that is needed when the construction loan matures. Don’t make this mistake!

#4) Don’t forget to pay your other bills!

This one may seem extremely obvious, but things happen sometimes that make a bigger impact than you might expect. I once had a client who was halfway through having his house built, and he somehow forgot one payment on his current home’s mortgage. He rectified it relatively quickly, but enough time had passed that his lender reported his late payment to the credit bureaus and when the construction process was completed, he couldn’t get financed for a mortgage because his credit score had dropped so significantly. Even though he had a very large income and had plenty of equity in the deal, his credit rating dropped too sharply for us to get him the mortgage. In his case, I was able to help him by extending his construction loan so he could keep the house long enough for his credit score to bounce back, but it was a major hassle and I can’t always count on the ability to do that. The truth is that mortgage companies really don’t care what “the story” is on why you’re late on a payment—if you go on vacation and forget to pay your mortgage, your credit score is toast.

#5) Make sure you have a contingency for unexpected or unplanned expenses.

I always warn my clients that there will be extra expenses when building a home, and you need to have a way to pay for them. Sometimes these expenses are for issues and problems that come up, like finding rocks when excavating. I remember one client recently that was building near the Broadmoor Bluffs and everything was looking fine until the excavation started, when an enormous boulder the size of a large car was found below the surface. They had to use dynamite to blast it out, and that added about $15,000 to the total cost of the project.

Other times, even if you don’t find surprises when excavating, you may have good reasons for adding to the project’s cost: you may change your mind on some allowance items and would want to get an upgraded flooring material, or you may want to finish more rooms in the basement than you initially planned. Perhaps you come up with good ideas or find some appliances or finishes that are more than you budgeted: not having the money to purchase these items can suck the fun out of building your home. You wouldn’t want to have to say “no” to things just because you didn’t budget for them.

So changes can be either positive things or negative things, but they still need to be paid for, so you want to make sure you have some extra money set aside. Some contracts are written with a contingency built into the budget, or sometimes you may just want to set aside some cash in a savings account.

Final Thoughts: Choosing The Right Contractor

One of the most important things I tell people is to choose your general contractor wisely. That, and don’t attempt to build your own home! One of the worst mistakes you can make is to serve the role of being your own contractor. In my experience, this is the most consistent source of problems: I’ve seen everything from major time delays in the construction process, to cost overruns, to the inability to get subcontractors to the show up on the job site, to issues with the building department regarding proper inspection and code procedures, and more. You definitely want to hire a builder, and make sure it’s a reputable builder.

I’ve worked with Andy Stauffer for a few years, and when his clients come in to see me to get their construction loans, they obviously love working with Andy (and who wouldn’t?). I tell people that picking a builder is like getting married: you’re going to be living with someone for nine months to a year (on average) and you better get along with whoever that person is. Trust is something that’s very important, and you build trust over time, but you need to make sure right away that you enjoy your relationship with your builder from the beginning. I’ve seen some builder/client relationships that are downright adversarial, and that is just no way to build a home.

If you’re looking at building a home in Colorado Springs with Stauffer & Sons, you can contact them here. When the time is right, I’ll be happy to talk with you about your options for a construction loan. Also, If you recently lost your home in the Waldo Canyon or Black Forest fire, Kirkpatrick Bank has special financing options for you. Just contact me for more information. I hope you’ve found this helpful. Good luck building!

Disclaimer: the views, opinions, and positions expressed on this blog post do not necessarily reflect the views or opinions of Stauffer & Sons Construction and are not intended as legal or professional advice. All information deemed reliable but not guaranteed. For more information, please review our website terms of use.


  1. Tyler

    Thank you so much, very Informative!

  2. Lindsay

    This is great information! Thank you!!

    • Ron Stauffer

      Thanks for the comment, Lindsay. We’re glad you found it helpful!

  3. usmsbow

    Very well-written and clear. Helped out a lot- thanks!

  4. beau

    My biggest question: is it based on total construction cost or what the finished home and land is worth?

    • Ron Stauffer

      Good question, Beau. Your construction loan (which later converts to a permanent mortgage) will be for the amount of the contract with your builder. i.e. what the home is “worth” really has no bearing on your loan, other than that you’ll need an appraisal before closing to ensure that the home appraises at or above the contract price. So if your contract to build is $500,000, then that’s the amount your loan would be for. If it appraises at $550,000, that’s just a bonus.

  5. DeSpence

    This is a great article; thank you! We are looking at land and building a home on it, but we keep getting the impression that we have to buy land separately. Glad to know we don’t have to! Also, we have approval through a VA lender. Does that all kick in once the house is built and we want to roll everything into one, or…? The VA stuff doesn’t seem to apply to land OR construction loans, just the overall mortgage side of things.

    • Ron Stauffer

      Hi DeSpence, I’m glad you found it helpful! You would have to ask a mortgage expert to confirm, but as I understand it, yes, the VA loan only kicks in on the permanent mortgage that comes into play after the home is built. Feel free to call Kirkpatrick Bank at the number listed above—if you tell them you found them though our website, they’ll be happy to help you, even if you don’t live in Colorado or don’t end up hiring them. 🙂 Good luck! -Ron

  6. Jimmy

    Thank you for the straight forward information. You are not on here just trying to get clients. This information is for everyone that is considering building a home. Thank you for taking the time to do this!!!

    • Ron Stauffer

      You’re welcome, Jimmy. I hope you’ve found it helpful!

  7. Douglas Rawan

    This is very helpful information mainly for those who are seeking construction loan for new house.

    • Ron Stauffer

      I’m glad you found it helpful, Douglas. Thanks for commenting.

  8. DA

    Thank you for the info! What if the builder decides to stop work after making some draws? how does the bank handle something like this? What will the new owners be faced with?

  9. Ron Stauffer

    Hmm… that can be a tough situation. Sometimes a home builder becomes unable to complete a project or goes bankrupt in the middle of building a home. Is this a situation you’re in right now? If so, the first thing I’d recommend is contacting your mortgage lender to see what their process is, then call an attorney to see what your rights are (regardless of what the bank says).

    Then there are a few other questions that need to be cleared up. First, at what stage of construction is the home? Second, is the amount of money drawn commensurate with the level of completion, or is there a disparity? (i.e. has the builder been paid for 75% of the job but only completed 60%, etc.)?

    Ultimately, if the building contractor can’t or won’t complete the job, you can sue him/her. The bank probably will as well, since they’ve got an ownership interest in it.

    Fortunately for us, we’ve never been sued by a client, and we’ve never just “stopped” in the middle of building a home before. We have, however, had to do “rescue” jobs before where people have called us with a half-completed home and asked us to finish it.

    I’m not sure what you mean by “new owners,” as well. Are you saying you’d sell the house half-completed?

    • DA


      I am pre approved for a new home construction loan in Florida, and I do have a GC lined up. I am just preparing for the worst case scenario. I have checked the builders’ credentials and haven’t found anything negative. I guess it will be a matter of trust.

  10. Ron Stauffer

    Phew! That’s good news. You’re right, building a home is definitely a relationship built on trust.

    There are two things you can do to ensure that you’ve picked a good builder in this regard:

    1) Talk to your mortgage lender. See if they’ve worked with the builder before. Most lenders have a pre-screening process for builders, and it’s a really good sign if your lender has worked with the builder before. For example, Kirkpatrick Bank has funded more than 20 of our homes in the past 2-3 years, so that obviously shows that they trust us with their money, in a way. Hopefully your lender has the same kind of trust with your builder.

    2) Get a list of previous clients from the builder if you can. The more recent, the better. Contact them and ask them about the builder’s communication skills, the level of responsiveness, etc. It’s a warning sign if you hear things like “Well, it took him a long time to return our calls,” or “there were long stretches of time where no work was being done on the house.” Those are the kinds of things you want to avoid, so if you can talk to previous clients who tell you that the builder keeps in constant contact and that the project was completed on time, that’s a sign that you’re probably hiring a reputable contractor who will complete your home and give you an enjoyable building experience.

    • DA

      The good news is that my bank is doing an extensive check on the builder. Financials, previous builds, etc. Hopefully he checks out OK because I do like the final price were able to come to.

      • Ron Stauffer

        That’s good news. I hope it all works out for you!

  11. Taylor

    This is a great article! We are currently looking into buying some land and building a home on it, but are still early in the process. We currently own our home and I was curious – with the two step loan process, would we be making payments on that loan during the building process? Or do you start paying upon completion? Thank you in advance!!

    • Ron Stauffer

      Hi Taylor, the first loan is the construction loan, and you only make payments on that as you draw from it. Using Terry’s example, above, if your construction loan is for $400k but you’ve only made one draw from it for $25k, you’ll only pay on the current balance, which is $25k. Does that help?

  12. Dave Cooper

    Hey Ron, I am hoping to be a first time homeowner in the near future, but have a question. I have plans/prints for a home and have a builders quote of $220,000, how much am I looking to pay (each month?) on the interest from the builders draw amount…say it’s $25,000? I’m not really understanding that part. In the article above there is a reference about paying interest on the $25k draw amount….but the builder will have to make several other draws in order to reach the quote of $220,000. I’m sorry if this is a ‘strange’ question, but I’m not sure how it works. It seems like I would have to pay off the initial $25k before another draw could be made, correct?

    • Ron Stauffer

      Hi Dave, you’d want to talk to your lender to get specifics (since loan terms and policies can be different between banks), but here’s my best shot at answering your question.

      Let’s say you’re building a hypothetical home that costs $220,000 and the total build will take nine months. Your builder takes a draw at groundbreaking, then at three months, six months, then at completion. Let’s also say that each draw is for the exact same amount: $55,000 per draw.

      In this scenario, at day one, the builder draws $55,000 from your loan, so you being paying monthly interest on the $55,000 principal. You do this each month until the fourth month when the builder draws another $55,000, and your new balance becomes $110,000. Now you’re paying the interest on $110,000 instead of $55,000. This process repeats, and your monthly payments increase after each draw, until the home is complete, at which point the builder takes the final draw, and your balance is now the $220,000. At this point, you apply for a standard home mortgage, which pays off the construction loan.

      Does that make sense?

      • Dave Cooper

        Thanks for the reply Ron, that most definitely has shed light on my question. We’ve paid $1000 for the completed plans, found a builder, have a written quote… to get 2 credit cards utilization below 25% ( to help with ratio), then find a lender who wants to make some money for their investors… for 30 years.

        I appreciate your time and this article.

        • Ron Stauffer

          That’s great, Dave! Best of luck to you on the building project!

  13. Joyce Martin

    Thanks for sharing the great information .

  14. Barry Campbell

    Great information. I have one question. My builder normally doesn’t require a construction loan but because of the upgrades I want, he is requesting I get a construction loan. My question is – can I get a loan for just the cost of the upgrades? And would a builder normally be ok with that?

    • Ron Stauffer

      Hi Barry, your situation is one I’m not familiar with but I think you’d have to talk to your lender for the answer. I’d imagine that they’d just offer you some sort of personal loan instead, since a construction loan is not really designed for what you’re describing. As far as the builder’s perspective, we really have no preference as long as the bill gets paid. 🙂

  15. Krishna kundu

    Can I get a construction loan to demolish my present home and build new home on the property?

  16. Chris Shirley

    This was very helpful and I learned a lot!!! Thank you so much!!

  17. Ron Stauffer

    Hi Krishna, I’m sure you could, if your lender were willing. I don’t know of any reason why not, as long as the numbers make sense. (i.e. the appraised value of the final home and property justify the additional cost of demolishing the original home).

  18. Tim Gabrhel

    What’s the standard requirement for construction to begin upon receiving a construction loan? Have a lot eyed up, but not looking to “move” for another 2-3 years. This means a potential of not starting construction for 1.5-2.5 years (assuming the loan began today). Advice? Ideally being able to roll the lot into the overall loan & not purchase separately, at least not yet. The desire here is to lock in the land before it’s taken.

    • Ron Stauffer

      Hi Tim, I think it’s a smaller window than you’re looking for: you’d probably need to get started building within 90 days or so. So if you’re over a year out, it’s not worth getting the loan yet. You could, of course, get “prequalified” and see what your options might be when the time comes, and I highly encourage you to do this. Many times, people start making plans based on what they want and they don’t know what they can afford (which is putting the cart before the horse).

      If you want to “lock up” land that’s available now, you could go get a loan just to buy the land and start paying on that now. When it’s time to build, you could have either the construction loan or the mortgage roll in the cost of the land when you start building. It all depends on the lender you use and your personal financial situation though, so check with the lender you think you want to use first. I hope that helps!

  19. TimeFlow

    Hi Ron,

    Did have a two question. Great article btw. Wife and I who are first time homeowners are building and this helped us a lot.

    1) So I won’t know till we close in the next week, but I maybe made the mistake of buying a vehicle. I drive to work, and my lease was up on the car. I returned it, and purchased a vehicle with a monthly expense about only $18 more a month. I know it depends on the bank, but would they look at the purchase as something worrysome? Also would a car with a lease payment for only 3-4 months left be included when thy included me? If so, my DTI ratio went up about .2%. Didnt know if they would include leasing payments though.

    2) So I accidently opened a department store credit card (it is not a visa or mastercard, just a department store credit card). I THOUGHT it was just an account for them but turns out I was totally wrong. Would it be better to close it or just leave it? It has nothing on the credit card (and they only gave us about $1800 to spend). Didn’t know if banks would be worried if we opened and closed on that fast.


    • Ron Stauffer

      Good questions! I can only give my opinion from what I’ve observed, so you’d obviously want to ask your lender for details on your situation. First, I doubt your car situation will affect things much since, as you mentioned, it’s such a minuscule difference in cost. Second, I don’t think the department store credit card will hurt you if you don’t use it. It might even help, if you have that much more available credit that you haven’t used. I hope that helps, and good luck in your first time buying experience!

      • TimeFlow

        Thanks Ron. Everything worked out great with the bank. Now to just get the builders moving haha.

  20. Stephen

    Thank you, very informative! My question is, can I get a Pre qualified New Construction loan with a contingency to sell my current home first.

  21. Ron Stauffer

    Stephen, this is a very common question. The answer, at least from some lenders is: you have to sell your current home first, OR be able to qualify for having two mortgages. Some people can, and some can’t. A lot of times, the people we’re building for sold their house already and they sign a one year lease on a rental during the building phase. Others, who move here from out of state, live in an RV on their property while we’re building for them. So it’s ultimately up to your debt-to-income ratio, as well as the lending guidelines for your particular lender. Some people can definitely afford to have a second home while they’re still living in and paying on their first home, and some can’t. (We work with wealthier folks from time to time, where we’re building their 2nd, or 3rd, or even 4th home, so in their case, it’s not a problem). I hope that helps!

  22. Kellye

    What would be the best type of loan for my husband and I to build a home? We would like to borrow $277,304, 80% of the total cost of the actual/estimated appraisal. We can pay the 20% ourselves and we have a 750+ credit score. We want to sell our house and apply that to our loan. We will not sell our house until we move into the new one. What type of loan will allow us to do this?

    • Ron Stauffer

      Hi Kellye, it sounds like you just need a standard old construction loan with a mortgage at the end of it. Nothing sounds unique about your case, other than wanting to stay in your house until you’re done building: you’ll have to be approved for the ability to pay both loans at the same time. If you can pay them, you should be fine. Good luck!

  23. Carol

    So I own my land that I paid $62,000. The cost to build my new is $240,000. I also have $75,000-80,000 cash to put down. How can I figure what my new mortgage is going to be? I can’t find anything on the web about this. And anything I do find is so hard to understand.

    • Ron Stauffer

      Hi Carol, the answer you’re looking for is: it depends. It’s highly dependent on your lender. Some lenders will allow you to use the equity in your land *up to* a certain limit, either in dollars or percentages. I spoke to a lender a few weeks ago about this question. They told me that the way *they* calculate it is: they’ll loan up to 90% of the total cost of land and house. Meaning, if you build a $1MM house on a $200k lot, the total amount they’ll lend you is $1,080,000, meaning you’ll have to bring $120,000 to the table. But, let’s say you already paid cash for the the $200k lot, so you’re already ahead, since what they’ll loan you is slightly more than what you need, since you only need $1MM (in this scenario). Does that help? Ultimately, I guess my point is that the lender you pick will determine what your loan amount is, how much they’ll lend you, what you have to put down, and what your payment will be. So I’d make sure to pick a good lender first, then they can help determine the answers to your specific scenario.

  24. Confused

    Thank you so much! I’m wondering about the bit about serving as your own contractor – what if you are a general contractor? My husband & I are debating building instead of buying – he is a general contractor, he’s been in construction for over 20 years & has had his contractors license for over 10. Will that affect the loan?

    • Ron Stauffer

      Fair question. We’re obviously biased, but I can tell you this: of all the lenders I’ve spoken to about this, they’ve all told me the same thing. They’ve all said “We *can* underwrite a home built by the homeowner, but we highly discourage people from doing so.” So ask the particular lender you want to work with what their criteria are. It may work out just fine, and the financing may be very simple, but each case is different.

      • Michelle Johnson-Wright

        My husband and I are looking for a construction to perm loan. We own the land already,have 215,000 in grant money to use towards building our Sandy-damaged home and looking for a construction loan for 60-70k to cover the rest of completing our home. Can you explain once construction is complete and we switch to a conventional mortgage and the appraisal process? Our newly constructed home should appraise for 265,000-285,000 ? The market in Atlantic County is not great so what is the worse case scenario and how to overcome this. Sorry we are brand new to this.

        • Ron Stauffer

          Hi Michelle, I missed this part of your question earlier. The answer is: it depends on whether you start with the construction loan, then apply for a mortgage (a “perm” is what bankers call it), or if you have a “one-step” or “single-close” loan. Every lender is different, so you’d have to ask them how they work. I’d imagine that with most two-step loans, you close on the perm as soon as the house is built. Whether that happens the day you get the C.O. (certificate of occupancy) or before then, I’m not sure. But with a one-step loan, the whole thing just happens according to a schedule. …and the appraisal is done at the beginning, so you don’t have to get an appraisal after the house is built. One thing I’d caution you against is hoping that your home appraises for more once it’s built than what you spent on it. I’m not saying you’re doing this… I’m just saying don’t count on earning any instant equity between the time you break ground and the time you move in. That may or may not happen, but it’s highly dependent on the market.

  25. Lilianne Sanchez

    We bought a lot for $89,900 and We paid $19,000 now the lot appraisal is around $115,000, We would like to build a house, and for We already have the plans and for construction will cost around $210,000, do I need a down payment for getting a loan and what is the percentage, thanks so much if you have the answer,

    • Ron Stauffer

      Hi Lilianne, you’d have to ask your lender what their specific policy is. Most lenders do allow the equity you have in the land itself to be considered as part of the “down payment,” but they all calculate it differently. Find a good lender you think you want a construction loan with and see what their policy is. Good luck!

  26. Dawn D

    I own a home in a ‘hood in Denver that is experiencing many scrapes and rebuilds. The house is in bad shape (was a foreclosure), but would still sell for another 50% of what I owe on it, and I want to scrape and build. I know the new home would be worth close to twice what I would owe after the build, based on my research and what I want to do. I live there now. How should I proceed?

    • Ron Stauffer

      Hi Dawn, that’s a great question, but unfortunately, we have no experience with “scrape and builds” in Denver, so I don’t know. I’m sure your lender has an opinion though, so try asking them what their policy is. You could probably do that with a refinance somehow, but it would probably be a very specific lender in Denver with experience with your market and those types of builds.

  27. Jackson

    Thanks for the info! Very informative and helpful! I do have one question though. If you don’t have money for contingencies could it be taken out of the loan/budget. For example, if you have a $275,000 loan but the projected cost is $250,000 could it come out of the remaining balance? Not to mention whatever down payment is applied.

    • Ron Stauffer

      Hi Jackson, that’s a great question. It depends on what exactly the issue is. We build in a contingency in our contract for some things, such as mistakes we might make (maybe we guess wrong on the total cost of grading the driveway), or market changes occur that we didn’t expect (a hurricane hits Florida, which causes the price of lumber across the USA to skyrocket, for example). But there are scenarios where the total build cost could increase and the homeowner pays for it. One scenario we see in Colorado sometimes is outlined in our “rock clause” — this is where the excavator starts digging and finds out there are huge boulders under the dirt that will require blasting (with dynamite) to remove. There’s no way we can protect against this since it’s always an unknown until we start digging. In most cases, the client has to pay for this out of pocket since the odds are the lender won’t agree to include that in the loan after it’s been underwritten. So I hate to sound indecisive, but the answer is really “it depends.” Sometimes people do end up spending extra out of pocket due to issues like this, but if you’re building, say, an $800k house and you go over $10k on the excavation due to blasting, that’s really not so bad. So we always tell people to have some extra in the bank, just in case. Does that help?

      • Jackson

        If I’m understanding correctly…contingencies can be built into the contract between myself, GC and bank (what they approve) and anything else would have to be paid up front if there were any problems. If so, yes this helps. Thanks alot

        • Ron Stauffer

          Yes. We always build in a contingency as part of the budget for every home we build, and every lender we’ve worked with likes this, and they actually require it. Almost everything fits into the contingency *except* for the “rock clause” I mentioned. That’s really the only exclusion, at least with our contract. Just about everything else would come out of the contingency in the contract at no extra cost to the client.

  28. Becky

    Thank you for the article. My question is, if I have taken out a line of credit with the current equity in my home to purchase a lot, may I then use the lot as principal for my construction to perm loan?

    • Ron Stauffer

      Becky, I think it would entirely depend on the lender since they all have different rules. If you can qualify with your debt-to-income ratio though, you probably could. Meaning, if you’re able to maintain all that debt (construction loan + line of credit + existing mortgage) then you may be able to do what you’re asking. Ask your lender though, as they have their own ways of calculation what counts as a “down payment” and what doesn’t.

  29. Ruben

    Hi i was wondering if i would be able to get a loan and build the house my self?

    • Ron Stauffer

      Hi Ruben, some lenders may allow you to do this. Some won’t. I spoke with a construction lender a while back and asked about this, and his response was “Ron, the two biggest lending disasters in my entire career were from people building their own homes. I really, really don’t like approving those.” As you can see, it scares banks… but again, you may be able to, depending on who your lender is.

  30. Will

    Very informative. All my questions were answered.

  31. Chris

    I am ETSing out of the Army and have a contract for someone to make mortgage and HOA payments for my current town home until the home is sold to a third party by them. When it comes to a construction loan, is it more often than not a must to have to put money down or make payments before the home is finished? My wife and I really want to build our next place but are a little intimidated about the process. We will have mortgage and hoa bills until Oct. 1 next year but if we can start building soon that would be great…because that means we won’t be homeless for however long it takes to build a house once we move back to our home state.

    • Ron Stauffer

      Hi Chris, I don’t think I’ve heard of your exact situation before, but I’ll bet you can find an experienced mortgage lender that has. Especially if you contact a lender in Colorado Springs or somewhere else that has a significant military presence. Most lenders will want you to wait before they issuing a construction loan, since they don’t ever want the home they’re funding to be contingent on another home selling. …the last thing banks want is half a house they’re responsible to finish or sell. I know it doesn’t sound fun, but I’ll bet most lenders would say you have to sell your townhouse first. I’d never discourage you from asking around though, so give it a shot and see what they say!

  32. Pete

    I would like to hear more discussion about appraisals for home constructions with fewer than 3 bedrooms. What about 1 bedroom construction? I’m someone who wants to build a stepping stone house. By the at mean, a 1 bedroom house to start where the plans include expansion projects to undertake in the future. Bank’s seem to have problems appraising 1 bedroom homes.

    • Ron Stauffer

      Hi Pete. You’d want to talk to an actual appraiser for that, I think. I’ve never heard of a bank loaning on a one bedroom home, most likely because that type of home would fill such a unique niche that it would be hard to re-sell. Banks that lend on construction are all about making sure their investment is safe, and they don’t like to lend on things outside what the market demands. Having said that, I’ve been keeping my eye on the Tiny House movement, and I think the more people start to buy into that concept, the more comfortable lenders will get with offering financing for very small homes. That remains to be seen, but I’m sure we’ll see changes like that down the road.

  33. Jeff Stockwell

    Thanks for the great Info, my question is we own our lot we paid 170k for and the build cost will be 690 but the appraisal when done is only 730k, that’s 130k over appraisal, is this common or should we shop for a different builder

    • Ron Stauffer

      Hi Jeff, I doubt your builder is gouging you, so I think the difference in the home you want and the appraisal you’re getting is that you’re building something too large. My point being I don’t think you could get the same home for $130k less by hiring a different builder. Usually it’s a matter of scope. If you can make the home smaller (less square footage), you can probably hit your mark.

  34. Melissa Hamilton

    Hi Ron,

    Not sure if you’re still following this post, but I do have a question. If I own the land outright does that bring up the LTV of the home to potentially lower my down payment needed for the construction loan?

    • Ron Stauffer

      Hi Melissa, I sure do—I respond to every question. 🙂 Yes, most lenders will consider the equity you have in your land as part of (or all of) the down payment for the house. We’ve had clients who have done this several times. Check with your specific lender to see what they say: some lenders will let you do that but only up to a certain amount (i.e. 10% or 20% or some other specific percentage of the total cost to build). So if you own, say, a $100k piece of land outright, you may be able to use that to secure a $500k construction loan with no money down, but it depends on each lender’s policy. I hope that helps!

  35. Ron Stauffer

    Hi Ashley, I hope I understand your question correctly: you’re asking about how the appraisal affects the construction loan, right? There are some times when an appraisal comes in lower than the actual cost to build, and in that case, yes, if the lender won’t lend the full amount it costs to build, you’ll have to pay the difference out of pocket. It’s good for people that want to build a custom home to have extra cash in the bank for just this scenario. Generally though, our home appraisals match the contract cost of the house. The challenge is if the home you want is considered unusual or an outlier.” Meaning, if every home in your neighborhood has four bedrooms, but you want nine bedrooms…or if they’re all traditional homes on one level, and you want a three-story monolithic dome made of concrete, you may have trouble getting the appraisal you want. In that case, you’d have to pay cash for the whole thing. If you’re getting a loan, it should generally conform to the neighborhood’s size and quality standards. I hope that helps.

  36. Annie

    Ron – I’m about to finance a lot and the construction loan together. My question is – when does the seller of the lot actually get paid? Do they get paid via a “draw” early on? Or do they get paid after all the construction is completed and the house closes? That doesn’t seem to make sense to me, because what happens to the lot seller if mid construction the builder disappears or something?

    • Ron Stauffer

      Hi Annie, I can’t say with 100% confidence since our company is never involved in the “selling” side of the transaction. I’m sure it’s like any other real estate transaction though, where the seller gets paid with one check at closing.

  37. lovingmyhair

    This was very helpful

  38. Dephanie

    Hi Ron so after the home is built how soon after will my loan officer convert my construction to a permanent loan ? is there a written guide for them to do it in a timely manner?

    • Ron Stauffer

      Hi Dephanie, it depends on your own lending scenario. For example, many of the clients we’ve built homes for use Kirkpatrick Bank for their construction loan, and then use another bank for their permanent loan (mortgage). So it’s always different for each family. The idea is that you’d get the home built, and then go get a mortgage to pay off your construction loan. (Unless it’s a one-step construction loan, which funds both the construction loan and the mortgage, according to a schedule set by the bank). Does that help?

      • Dephanie

        Do you know what is the time frame for the conversation?

        • Ron Stauffer

          I’m not sure I understand the question, but most of the construction loans our clients have used have a nine month to 12 month term. Is that helpful?

  39. Shesh

    My husband and I are in the process right now of buying a piece of land in Oklahoma. We have financing for the land and will be making monthly payments on it. we are getting a travel trailer and living on the land for an unknown time frame.
    A friend advised when he had his home built. it went as so.
    1. his builder shows him a plan, lot, and they agree on both, and he pays ernest money and they start the construction
    2. when construction was over (friend has lending company) and builder and friend go to closing and all is done in closing with a mortgage.
    What I am wondering is if my husband and would be able to do a deal like this with our land. would the builder have to buy the land from us ( and we might not get to stay on land) and start the construction and then when it is all done everything gets financed into a mortgage?

    • Ron Stauffer

      I can’t seem to understand the scenario you’re talking about with your friends, but here’s what we do: we build the home, and that’s it. We never, ever, own the land, buy the land, sell the land, etc. The homeowners will buy the land, then hire us to build the home, and they get financed for it, then we build it, and walk away. I don’t know if that helps you, but that’s our process. Many other builders do actually own land and sell it to the buyers, but we don’t, so I’m afraid I can’t help with explaining exactly how they do that. I hope that’s at least slightly helpful.

  40. Kelly Shunnarah

    Thank you, I learned a lot

  41. Kina Liversedge

    Love your article! I have a couple questions. We are currently living in a manufactured home on an acre of land that we are currently purchasing by way of owner financing through a broker. How will that figure into a new construction loan? Also, we get our water through a shared well. Will that cause any problems that you could think of?

    • Ron Stauffer

      Hi Kina, it all depends on your lender. I hate to be so vague, but there are so many rules about the size lot you have, the area you live in, the water rights you might have, the kind of home you live in (whether it’s a HUD approved manufacture home or not), the value of the house and land, etc. So I’d say contact a lender and give them very specific info about your particular scenario and they should be able to answer all those questions for you.

  42. Tee

    In the situation where the man whose credit score dropped, if he had not been able to get the extension, what would have happened to him? Would he just have lost the home? Would a foreclosure be placed on his credit? How does that work exactly because I may be in that same situation right now.

    • Ron Stauffer

      Great question, Tee: I don’t know. I think in theory, the bank would have just taken ownership of the home and would have tried to sell it. …but he really had them over a barrel, since I’m sure that’s a LOT more work for the bank than just getting him into a mortgage. If that had happened to him, his best choice would be to go shopping and find another lender, I think, and ask them if they can lend to him knowing his extenuating circumstance.

  43. Chuck Johnson

    Good reading material. I’m sure nothing has changed much in 3 years… Has it?

    • Ron Stauffer

      Chuck, I think rates have changed, but that’s probably about it.

  44. L17

    great read! If we put down 20% on the construction loan and we will be getting a second fixed mortgage when the build is done do we put down another 20% or large deposit on the home to avoid PMI? Or is the original 20% sufficient?


    • Ron Stauffer

      Fair question. Don’t forget, though, that the mortgage (“perm loan”) replaces and pays off the construction loan. So the 20% you’ll put down (if that’s what your lender requires) will apply to the mortgage, not the construction loan. But again, check with your lender to see their specific rules and policies.

  45. Candace Nichole Shea

    Just to be clear, If we get a construction loan of $380,000 we meed to bring $76,000 cash to closing. After the home is built, say it only cost $250,000, do we then only get a mortgage loan for the $250,000 amount, excluding the $76,000 down payment. Do we have to do all the inspections with the appraisal, and closing costs for the mortgage loan?

    • Ron Stauffer

      Hi Candace: I’m not sure I understand the scenario. If you have a construction loan of $380k and also bring $76k to the table, that’s $456k. So why would you get a loan for that much if the home only costs $250k?

      • Candace Nichole Shea

        I’m sorry let me rephrase; once the construction is done, we only have to get a mortgage loan on the amount that is not paid off during construction, not on the homes worth.

        • Ron Stauffer

          Candace, that’s correct. Actually the “worth” of the home never comes into the equation. All that matters is the amount borrowed. If you build a home that costs you $500k but appraises for $1 million after it’s built, that’s equity in your pocket. 🙂

  46. JoAnne Jenkins

    We bought land a few years ago, with plans to build a house in the future. An opportunity came up for us to get a road built on the land for about half the cost it would normally be, so we built a road on it. (and since it took longer than a big road construction company, we were able to pay for it over time as it was built.)
    Now when we talked to a bank about a construction loan so we can start a house next year, we were told they couldn’t give us a loan because we built a road on the land. What? Why would that make it so we can’t get the loan?

    • Ron Stauffer

      Hi JoAnne, I think you should get another bank or talk to another lender. There have been some circumstances we’ve seen where issues like this arise, though, usually when something is done poorly. Great example: a couple came to us wanting to build a house on a property they bought. However, they had a dirt road put in, and it was done so poorly that it was a huge liability—they essentially carved up the side of a hill so much that if it was going to rain, it would have diverted almost all the water from their lot directly onto some homes below them. It was a major, major mistake, and we told them we couldn’t work with them because they were likely going to get sued when it rained. They ended up not building at all, and essentially lost the $110k they spent on the land. It was a shame for everyone involved, but that’s what happened. There wasn’t a bank around who would finance them due to the liability. So having said that, if you’re sitting on some land that now has a road that’s made your lot dangerous or liable for flooding another person’s property, that makes sense. But if not, you can just shop around to find a different lender that will work with you. I hope that helps.

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