If you’re a builder, then you know that construction loans can be hard to come by. Banks and other lenders often see the risk of lending money for unfinished work as too high. This can make it difficult for builders to get started on their projects. Fortunately, there are many ways to finance your building needs.
In this article, we’ll discuss the benefits of spec construction loans, why they may be right for you, and how they work.
What are Spec Construction Loans?
Construction loans are a type of loan that requires the home buyer to contribute some money towards the building project. This differs from a conventional mortgage, which covers 100% of your purchase amount and will be paid off after you sell or refinance your new home. A construction loan only provides funds for part of the project, which is usually around 80–90%. This means that builders have to fund most aspects of their projects on their own until it’s complete.
What’s more, buyers often get into contracts with builders prior to actually having an approved loan in place. In this scenario, it may seem impossible to get financing through traditional lenders once progress begins being made on-site, even though all other terms have been agreed upon. That’s where spec construction loans come into play.
How Do Construction Spec Loans Work?
Before you can get a construction loan, the lender will need to fund an appraisal. This ensures that your new home’s value is high enough to secure the amount of money they’ll be lending out. This is especially important if you don’t have equity in place yet for your project. It also plays a role even when buyers do bring their own funds (known as skin-in-the-game). If builders are working on projects with high values and limited skin-in-the-game, lenders may require appraisals just to confirm that there’s sufficient value in place before issuing loans. Spec construction loans allow homeowners to begin building right away without needing additional approvals after the initial assessment.
What Are the Different Types of Construction Loans?
While there are many different types of construction loans, they typically fall into one of the following categories:
Bridge loans provide short-term financing during a period when your builder is waiting on their permanent loan to close. This might happen if you’re working with an out-of-state lender or if you don’t have equity in place for your project yet.
Construction Only Loans:
These are the most common types that builders work with because it allows them to get started right away without needing funds from buyers. However, these types of spec home loans should only be used when other forms of financial assistance, such as grants and gifts, can cover at least 20% of building costs.
What are the Average Construction Loan Rates?
Rates tend to be much higher for construction loans than traditional home mortgages. Lenders often consider construction loans more high-risk than traditional loans. Most spec builders will work with interest rates between 12–18%, depending on the project’s value and their own credit scores. Furthermore, some borrowers may also have to pay origination fees (which can range from 0–15%) in addition to monthly mortgage insurance premiums (which can run anywhere from $30 – $150 per month).
What are the Basic Requirements for Spec Construction Loans?
In order to secure a spec construction loan, borrowers must meet the following eligibility requirements:
Good to Excellent Credit Score:
Even though most loans are high-risk, lenders still want to see an excellent credit score (680+) in order for you to qualify.
Minimum Down Payment of 20%:
Lenders don’t require buyers with spec construction loans to bring their own funds into the project. They do need at least a minimum down payment of 20%. It brings some equity into your new home and also serves as collateral for any missed payments or defaults on your loan terms.
Proof of Suitable Income:
Just like a traditional mortgage, spec builders must prove their income in order to qualify. They’ll need enough money to secure future payments on the loan as well as cover any additional costs that may arise from delays or defects during construction. In most cases, this means showing at least six months of employment history and current pay stubs for self-employed borrowers (proof of business affairs will be needed instead).
A Low Debt-to-Income Ratio (DBI):
Even though most spec builders don’t have to show any skin-in-the-game, they still need a low debt-to-income ratio (DBI). Lenders want their borrowers to be able to cover monthly expenses even if they aren’t working on the project. As such, your DBI should typically fall below 45% and 30% for self-employed.
Construction Project Approval:
After a builder has been approved for a loan amount, they must then submit their construction plans to the lender. Most lenders will only approve projects that have been designed by an architect. It is also important the project is pre-approved for building permits from local authorities.
General Contractor or Builder Approval:
Lenders also like to approve the individual or company that you plan on hiring (known as your general contractor) before writing up a construction loan. They want to make sure this person will be able to do their job properly, follow through with deadlines and budgets, pay subcontractors for work completed, etc.
How to Choose the Right Construction Loan Lender
If you’ve decided to use a construction loan lender, there are some aspects you’ll need to be aware of in choosing the right provider.
In fact, you should ask these questions before choosing a lender:
- What kinds of construction loans do you offer?
- What interest rates are available?
- Are there any closing fees to worry about?
- Could I use my land’s equity as a down payment?
Ready to Take Out a Construction Loan?
As you can see, spec construction loans are ideal for all kinds of home building projects. If you want to learn more about the construction spec loans we offer, contact us today to speak to a member of our team.