Time and time again we are asked what the typical steps in qualifying for a construction loan are. As such, we have written this article to shed light on the loan qualification process and have included all of the pertinent steps from beginning to end:
Income Verification
You will need to verify your income by providing copies of the last 2-3 years tax returns as well as copies of recent paystubs and your most recent W-2. If you are self-employed, the qualification process will be more difficult as self-employed applicants are typically more likely to default on their loan obligations. The income verification will demonstrate to the lender that you will be able to pay back the construction loan.
Credit Score Check
The lender will pull your credit reports from the three major credit reporting agencies; Experian, Equifax and TransUnion. We highly recommend that you pull your own credit reports ahead of applying for a construction loan. This way if there are any mistakes you will be able to fix them ahead of time instead of having to explain the mistake to your lender. Typically, a minimum credit score of 700 is required for a loan amount over $417,000. If your loan amount is less than this amount a credit score of 680 may be acceptable.
Debt to Income Ratio
There are two main kinds of Debt to Income Ratio (DTI for short) and they are usually expressed as a pair using the notation x/y (i.e. – 28/36).
The first DTI, known as the front ratio, indicates the percentage of income that goes toward housing costs, which for renters is the rent amount and for homeowners is a combination of the mortgage Principal, private mortgage Insurance, property Taxes and mortgage Interest, also known as PITI.
The second DTI, known as the back ratio, is the percentage of income that goes towards paying all recurring debt payments including but not limited to: PITI, car loan payments, recurring credit card payments, student loans, child support, alimony, etc.
The lower that your DTI numbers are, the more likely that you are to qualify for a construction loan.
Down Payment
You will need to have a required down payment, which is usually at least 20 percent of the total costs of construction. This is typically required prior to commencement of construction. If you already own the land on which you are building you may use this as equity towards the down payment. Plans, permit fees and any site work you performed may also be considered as a part of your down payment.
Cash Reserves
Most construction loan lenders will require 6 months of PITI (mortgage principal, mortgage interest, property taxes and insurance) as reserves. Typically, two months has to be cash and the other four months can be a combination of assets such as stocks, 401k, etc.
Hire the Right Contractor
The lender will have to approve the general contractor that you will be using to construct your home. Therefore, make sure that they are reputable and that you have checked all of their references. Each lender typically has a list of pre-approved architects and builders so be sure to ask them for this in order to expedite your approval process.
Hire the Right Architect
Make sure that they can design the house with your goals in mind while staying within your budge. The lender will retain an estimator to ensure that the proposed design can be constructed within the budgeted amount.
Obtain Approval of the Construction Loan
Once all of your proposals are in for the actual cost of construction, the lender will then proceed with issuance of the construction loan so long as you are within the proposed budget. The construction loan is then finalized once a certificate of occupancy is issued and the lender confirms the appraised value meets or exceeds the original estimated value of the house and property after construction.
Congratulations
If you have read this entire article you are know on your way to knowing the proper steps that you must follow to be approved for a home construction loan.