A home construction loan is a type of mortgage that allows the borrower to build his own home, as opposed to buying a fully built residence. This is an option used by borrowers who are looking for a more custom residence than is available on the market. The borrower has more control of the look and feel of the residence and can choose every single detail of the home if desired. In order to obtain financing or a mortgage, the borrower must pay a down payment to the lender.
A loan-to-value, or LTV, ratio is a percentage used by lenders to determine how much of the home’s value is tied to debt. To find this ratio, the lender divides the total amount of debt on the home into the appraised value of the home. This is the first major indicator of the amount of down payment needed. For Fannie Mae and Freddie Mac home construction loans, a LTV of 95 percent or less is required. This means that the borrower must have a minimum down payment of five percent in order to procure the loan. The down payment must come in the form of funds, as Freddie Mac and Fannie Mae do not consider equity to be a down payment.
The second determining factor in the amount of down payment needed is the borrower’s debt-to-income (DTI) ratio. The DTI is the percentage of the total monthly debt payments of the borrower (including the new monthly payment) versus the total monthly pre-tax income of the borrower. In most cases, the lender will require that the borrower have less than a 35 percent DTI in order to approve the loan, although some will approve the loan with a 43 percent DTI. Even if the borrower has enough funds to pay a full 20 percent down, the lender will not approve the loan if the debt-to-income ratio is too high.
Other factors involved in determining your down payment and ultimate approval include income and employment history, credit score and credit report. A credit score below 680 may preclude a borrower from getting a home construction loan. To raise your credit score, check your report for errors, pay off any outstanding judgments, liens or collections, and pay down credit card balances to less than 30 percent of the credit limit.
If the thought of a 20-percent down payment seems unreachable, make small goals to help save up the needed funds. Cut out extra spending, such as high cable bills, cell phone plans, and expensive meals out. Look at the big picture of building and make it a priority for as long as needed; stay focused on what you need in order to pay your down payment.
- "Construction to Permanent Financing: Single Closing Transactions;" eFannieMae.com; January 2012
- "Underwriting Requirements Guideline;" United Guaranty; May 14, 2012
- Freddie Mac: Freddie Mac Home Possible Mortgages
- InCharge Debt Solutions: How to Calculate Debt-To-Income Ratio
- Ask a Lender: What Are Construction Loans?
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