What is a Construction Loan?

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Are you thinking of building your own home? You’ll need construction loans in Colorado to do it and it’s different than your traditional mortgage. Lenders have a lot more at stake when you build a home than when you buy an existing home (or a cookie-cutter home from a builder).

I have many years of experience helping homebuyers secure attractive financing for their home construction needs. Check out what construction loans look like and how you qualify.

Understanding the Construction Loan in Colorado

Construction loans are temporary loans (short-term loans). You borrow the funds to build the home, and then you must convert it to a permanent loan (standard mortgage).

Construction loans pay contractors to buy materials and build the home. Lenders pay contractors in installments based on the agreed-upon schedule and satisfactory inspections proving the work is done.

After construction is complete, you do one of two things – pay the construction loan off in full (rare) or convert it to a permanent mortgage.

Construction loans may include some or all of the following costs:

• Cost to buy the land, materials, and labor
• Cost of plans and city permits
• Costs to close the loan(s)
• Reserves in case something unexpected occurs during building
• Reserves to cover the interest costs owed during the building process

During the ‘construction phase,’ you only make interest payments on the amount disbursed. This enables you to afford your housing payments for the house you currently live while construction continues on your home. You may include the interest costs in your loan amount, drawing from the loan to pay the interest or pay the fees yourself.

Qualifying for a Construction Loan

Qualifying for a construction loan in Colorado is a little trickier because there’s no collateral. If you don’t make your payments there’s nothing for lenders to take back. Because of this, you must meet the underwriting requirements. Each lender differs, but in general, expect:

• A credit score requirement of at least 680, sometimes higher
• Max debt-to-income ratio allowances of 43 – 45%
• At least 20 – 30% down payment
• Stable income and employment
• Proof you can afford the interest payments plus payments for your current housing

In addition, you must discuss how you’ll pay off the balance of the construction loan once the building is complete. If you’ll convert it to permanent financing and it’s not a single close loan, you’ll need to provide the lender with details on how you’ll secure financing before they’ll approve construction financing.

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