Construction Loans: Appliances Included Or Not?

Construction loans are a financial tool that helps borrowers build their dream homes. They are typically short-term, higher-interest loans that cover the costs of building a residential property from scratch or making major renovations to an existing one. The loan amount is based on the budget and building schedule presented to the lender, who will also consider the borrower's financial standing and credit history. While the inclusion of appliances in a construction loan may vary, permanent fixtures like appliances and landscaping can be included in the loan amount.

Construction loans and appliances

Construction loans are a financial tool that helps future homeowners build their dream homes. They are typically short-term, high-interest loans that provide the funds required to build a residential property. The loan amount is based on the budget and building schedule presented to the lender during the application process.

When it comes to appliances, it is important to note that construction loans may cover them in certain cases. Some construction loans, especially renovation loans, offer programs that help finance appliances that improve a home's energy efficiency. In ground-up construction, appliances may be included in the price of the completed home and subsequently, in the loan amount.

However, it is worth noting that not all construction loans include appliances. Some lenders may consider appliances as home furnishings, which are generally not covered by construction loans. It is crucial to discuss with your lender what will be included in your loan-to-value calculation. Some construction loans include a contingency reserve to cover unexpected costs or upgrades, and appliances may fall into this category.

The inclusion of appliances in a construction loan can vary depending on the lender and the specific loan program. It is always advisable to consult with your lender and carefully review the loan terms to understand what is covered and what is not.

Additionally, it is important to be mindful of the challenges in the construction industry, such as material shortages and timeline issues, which can impact the availability and cost of appliances during the building process.

Construction loan types

Construction loans can be used to build your dream home, but they come with complexities. Construction loans are typically short-term, higher-interest loans that provide the funds required to build a residential property. They are usually disbursed in stages as the work progresses, and you are only required to pay interest on the money that has been drawn.

There are several types of construction loans available to borrowers, designed to suit different financial needs and projects. Here are some of the most common types:

Construction-to-Permanent Loan

The construction-to-permanent loan (also known as a C2P loan) is a two-in-one financing option. During the construction phase, the borrower only pays interest on the loan, and the funds are disbursed in stages to cover building costs. Once the house is complete and the borrower moves in, the loan is converted into a traditional mortgage, with a loan term of 15 to 30 years. This option has the benefit of only requiring one set of closing costs, reducing overall expenses.

Construction-Only Loan

A construction-only loan provides the funds necessary to complete the building of a home. However, the borrower is responsible for either paying the loan in full at maturity (usually within a year) or obtaining a mortgage to secure permanent financing. This option can be costlier than a construction-to-permanent loan as it involves two separate loan transactions and two sets of closing costs.

Renovation Loan

Renovation loans are suited for those upgrading an existing home rather than building a new one. They offer flexibility and autonomy to borrowers, who can use the funds as needed to finance renovations such as structural repairs, room additions, or cosmetic upgrades. Renovation loans typically have lower down payment requirements than construction loans.

FHA Construction-to-Permanent Loan

An FHA construction-to-permanent loan has less stringent approval standards, making it a good option for borrowers who might not qualify for a conventional loan.

VA Construction Loan

A VA construction loan is available for eligible veterans and functions similarly to the FHA construction-to-permanent loan.

It is important to note that construction loans have a specific set of rules and requirements, such as full disclosure of building documents, plans, and budget. The interest rates tend to be higher than traditional mortgages due to the increased risk for the lender.

Construction loan requirements

Construction loans can help you build your dream home, but they come with certain requirements that you must meet to qualify for the loan. These requirements vary depending on the type of construction loan and the lender. Here are the key requirements you need to be aware of:

Credit Score

Most lenders require a minimum credit score of 620 or higher to approve a construction loan. This may vary depending on the lender, and some loans have different minimum requirements. For example, a Home Equity Loan from Rocket Mortgage requires a minimum FICO score of 680, 700, or 740, depending on the tier.

Down Payment

Construction loans typically require a down payment of at least 20% to 25% of the loan amount. This is because the lender bears a higher risk in the absence of physical collateral, as is the case with traditional mortgages on existing homes.

Debt-to-Income Ratio

Lenders will also consider your debt-to-income (DTI) ratio, which compares your recurring monthly debts to your gross monthly income. A lower DTI ratio is generally favourable, and some loans have specific requirements, such as a DTI of 50% or below for a Home Equity Loan from Rocket Mortgage.

Builder and Construction Plan

The lender will need to approve both your builder and your construction plan. They will verify the builder's licensing, qualifications, insurance, and professional reputation. As for the construction plan, the lender will want to see a signed contract, blueprints, a line-item budget, and a payment schedule. A realistic timetable and detailed information about materials and work are also important.

Documentation

You will need to provide various documents, including income verification, tax returns, bank statements, and property details if you are using land as collateral. Homeowners insurance with builder's risk coverage may also be required. Additionally, you will need to submit all necessary building documents, such as building plans, contractor invoices, permits, and expected milestones.

Other Considerations

It is important to discuss the inclusion of permanent fixtures, such as appliances, with your lender, as these may be covered within the loan. Construction loans may also include a contingency reserve to cover unexpected costs. You should also be prepared for possible delays or timeline issues due to material shortages and other factors.

Construction loan interest rates

Construction loans are short-term loans with higher interest rates compared to traditional mortgages. The interest rates for these loans are determined by the lenders and are influenced by various factors, including the borrower's financial position, location, and the Loan-to-Value (LTV) ratio.

The borrower's financial position, including their credit score and financial history, can impact the interest rate offered on a construction loan. Borrowers with lower credit scores may be subject to higher interest rates due to the increased risk for the lender. A strong financial track record, on the other hand, can improve creditworthiness and lead to lower interest rates.

The location of the property also plays a role in determining the loan interest rate. Some areas may have higher interest rates due to local real estate market conditions and the value of properties in that region.

The LTV ratio is another critical factor in setting interest rates. The LTV ratio is the loan amount divided by the appraised value of the property. A lower LTV ratio generally results in a lower interest rate because the risk for the lender is reduced.

It is important to carefully consider your financial situation and shop around for the best interest rates when applying for a construction loan. Different lenders may offer varying rates, and some banks may provide special rates for existing customers. Additionally, a float-down feature offered by some lenders allows borrowers to take advantage of lower market rates upon receiving their Certificate of Occupancy and Appraisal.

Construction loan alternatives

Construction loans are a common option for financing custom homes, but they may not be the right fit for everyone. Here are some alternatives to traditional construction loans:

Personal Savings and Investments

Using personal savings and investments is one of the most common ways for homeowners to build a custom home without a construction loan. This method allows individuals to fund their home-building project without incurring debt or interest payments and provides complete ownership and control over the home. Any surplus funds can be reinvested in the property or used for other financial goals.

Home Equity Loans or Lines of Credit

Homeowners who have built up equity in their existing properties can tap into this equity to fund the construction of their new home. Home equity loans allow a lump-sum withdrawal, while a home equity line of credit (HELOC) provides a revolving credit line throughout the construction process. This option offers favourable interest rates and potential tax benefits on interest payments.

Cash

Paying for a new home in cash upfront eliminates the need for a construction loan and provides financial freedom, avoiding interest payments and streamlining the home-building process. However, it is essential to consider the implications of using cash and its potential impact on other financial goals.

FHA-backed One-Time Close Construction Loan

For those with low credit scores, an FHA-backed one-time close construction loan might be an option. This loan is insured by the Federal Housing Authority and can be obtained through a chosen mortgage lender. It finances the entire project, from purchasing the land to paying the builder and materials. Once construction is complete, the loan automatically becomes a permanent mortgage.

VA Construction Loan

If you are a current or former member of the US military, you may be eligible for a Department of Veterans Affairs (VA) construction loan. This option requires no down payment, but there are additional steps to register your builder and plans with the VA, and the property must be your primary residence.

USDA Construction Loan

For those in eligible rural areas, a construction loan through the US Department of Agriculture (USDA) is an option, especially for those with low incomes. This loan has a minimum credit score requirement of 640, and there is no down payment required.

Frequently asked questions