Sara Routhier, Managing Editor of Features and Outreach, has professional experience as an educator, SEO specialist, and content marketer. She has over five years of experience in the insurance industry. As a researcher, data nerd, writer, and editor she strives to curate educational, enlightening articles that provide you with the must-know facts and best-kept secrets within the overwhelming worl...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Sep 18, 2012

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The ability to design a home literally from the ground up is a dream shared by many people. It’s possible to take out a home loan in order to construct a house. In fact, while they’re technically mortgage loans, these are sometimes called construction loans. A construction loan can fund the entire building process and then become a traditional home loan after the completion of the house.

In order to obtain a home loan with the purpose of building a house, a borrower will first have to find a willing lender. As with all forms of financing, different lenders have different requirements and qualifications that must be met before they will agree to lend money to an applicant.

Lenders typically examine the credit history of an applicant. They do this in order to identify any past incidents of missed payments and defaults, which helps them gauge whether a borrower is worth lending money to. In order to ascertain whether a borrower can even make monthly payments, lenders will also view the debt-to-income (DTI) ratio of applicants.

Normally if an applicant borrower was approved at this point they would receive the funds to purchase a home. However, if borrower wishes to build a home the process is different.

Since a home will be constructed, the lender or bank will send a real estate appraiser to view the lot and building plans for the home. This is so the bank or lender to ensure that the value of the finished home will meet or exceed the amount of money that the lender wishes to borrow.

The borrower will then present the lender a construction estimate along with the construction contractor’s information. Most lenders have to evaluate the construction company prior to approving the construction of a home.

After being presented with the necessary construction information, a lender may require that a borrower purchase a Builder’s Risk insurance policy that will protect the investment in the home’s construction. A Builder’s Risk insurance plan covers damaged or stolen materials and will cover possible replacement costs during the construction of a home.

Before construction can begin, the lender may also require that a payment plan be created. This will ensure that the construction company or contractor is paid in installments as more of the home is completed. Regular invoices may need to be submitted to the lender. Depending on individual policies, some lenders will give payments directly to the home builder. Others will give payments to the borrower who then would be responsible to pay the home builder themselves.

Once a home is completed a bank representative will inspect the home. If everything checks out, the construction loan will be converted into a regular home loan. Although at the beginning of the process a bank may require a down payment for a home loan towards the construction of a house, some lenders will agree to use purchased land for the home as a down payment.