If you are tired of searching for dream home and have decided to build it instead, you might need a construction loan. Similar to a traditional mortgage, a construction loan can be the avenue of funding to make your dream home become a reality. However, it is different from a tradition mortgage in many ways and applying for one can often be a daunting task. In this article we want to walk you through some tips for getting approved for a construction loan.
Credit and Debt
Simply put, these are two of the biggest factors considered when getting approved for a construction loan. Because the asset being funded, in this case the unfinished home, does not exist at the time of applying, the requirements are stricter when compared to a traditional mortgage.
Before applying for a construction loan, you need to have a complete understanding of your current credit situation. Manual credit reports are able to be ordered from the three bureaus: Experian, Equifax, and Transunion. However, there are several free options available for credit monitoring. Use these services to first see what your credit situation looks like.
By looking at these reports frequently, you are able to understand the effects different actions have on your credit. Plus, you have the ability to discover and contest any errors which may be on your report, such as a misreported late payment. Reporting these errors and having them removed will have a great impact on your score.
Tips for improving your credit, which will in turn help in getting approved for a construction loan, include:
- Minimize late payments as much as possible.
- Pay off credit card balances on time and in full.
- Pay off Debt.
That last tip brings us to the next major factor in getting approved for a home construction loan, and that is your debt-to-income ratio. Your debt-to-income ratio is figured by taking your total monthly debt payments and dividing it by your total gross monthly income. The larger the ratio, the less likely you are to be approved for a construction loan.
To get your debt-to-income ratio lower, there’s essentially two steps you can take:
- Pay off as much debt as possible or,
- Bring in more income.
Arguably, the most likely of those two to happen in a short amount of time is you pay off some debt. This can include items like your current auto loans, credit cards, medical bills, etc. the more debt you can eliminate before applying for a construction loan the better. Most lenders will not approve a construction loan if the ratio is greater than 40%.
Start Saving Now
As soon as you begin to consider getting a construction loan, you need to start a savings plan, if you have not already. Depending on the type of construction loan you will be applying for, the down payment required could be extensive, sometimes up to 20% or more of the funded amount. The reason for this goes back to the risky nature of these loans.
Additionally, if you are concerned about getting approved for a construction loan, a larger down payment would go a long way to showing the lender how serious you are, as well as your readiness to take on this loan.
Set a monthly budget
In truth, this is the area where many potential borrowers fail in, in turn hindering their chances of getting approved for a construction loan. Set a strict monthly budget and stick to it. In that budget set a savings goal for the month to ensure your savings timeline it met. And here is the biggest tip on a budget; stick to it.
Don’t cheat on the budget you set forth. Sometimes this means reigning in yourself from purchasing that new gadget or attire. Keep the focus on saving as much money as possible, and paying off as much as possible, before applying for a construction loan.
Pick the right builder
One tip for getting approved for a construction loan many borrowers overlook has nothing to do with the borrower and everything to do with the builder. Your potential construction loan lender will scrutinize your builder almost as much as they will you. While they will not look at the builder’s finances or anything of that nature, they will:
- Ensure the builder has the proper insurance and licenses to complete the work.
- Make sure the builder has proven experience building a home from the ground up.
- Verify the builder consistently meets construction goals and timelines.
Finding the right builder is important, so before applying for a construction loan, speak with your lender concerning your builder of choice. If you pick us as your lender, we’ll even work with your builder to make sure they provide the needed documentation to get you approved for a construction loan as quickly as possible.
Collect the needed documents prior to applying
One of the parts of applying for a construction loan, or any loan for that matter, many potential borrowers dread is the amount of paperwork and documents required. While we try and make it as seamless and stress-free as possible, it is the nature of the beast. Therefore, one of the best tips for getting approved for a construction loan is to have as much of the paperwork ready before applying. This paperwork, like many mortgage loans, includes:
- Recent tax returns
- Income records
- Employment status and verification
- Bank Statements
For a construction loan, there are a few other documents you will need. These are:
- Builder Contract
- Building plans and design
- Builder’s budget and specification sheet
Getting approved for a loan can be a long process, depending on the lender. Through our years of experience, we’ve been able to develop processes which get your construction loan approved and funded as quickly as possible. If you’re ready to get started, or have further questions, don’t hesitate to reach out. We have experts ready and willing to answer all of your questions.