How Construction Loans Work

My wife & I are under contract to buy land in Winter Park so we can build a house. I spent the whole day getting financial documents over to the lender & learned how construction loans work throughout the process.

Down Payment Options

After searching different lenders, we found most land financing options to require either 20%, 30%, or 50% down payment. We chose the 20% option as I don't want to tie up a ton of cash in this kind of market. At the same time, I do believe in the Winter Park market over the long term, therefore, I'm willing to invest cash now while people are willing to sell highly coveted property.

The Risk Of Buying In This Market

Sure, we'll likely experience a downturn in the near future if history repeats itself (like it always has in the past), but I'm confident in the Winter Park market 10, 20, and 30 years from now. I know I'll be happy I purchased property in this market over the long term. With the big push to remote work allowing people to now live wherever they choose, Colorado ski towns have a lot of upside.

Why I Believe In This Investment

Owning a coworking space in Winter Park, I've seen firsthand the amount of people who are choosing to move here full time. They're all dual income families who are primarily working in tech related industries, with two multiple six figure incomes. If the trends continue towards remote work, I believe we'll only experience more and more of these types of people flooding Colorado mountain towns due to the amount of lifestyle activities we have to offer. Not to mention clean air, water, and lots of sunshine. Investing money to build a house now will pay off in the future at a 2-3x multiple.

The Loan Structure

On to how the loan works...

Let's use the numbers below as an example.

Land cost - 200k

Down payment required by lender - 20% (40k)

Loan amount - $160,000

We'll put the 40k down and purchase the land.

Upon closing on the land, we'll work with the lender to get the construction loan. We'll submit the plans and style of house we plan to build. An appraiser will appraiser & RE agent will help to appraise the estimated future value of the home with the lender.

The lender will lend 90% LTV (loan to value), meaning we can borrow 90% of what the home's future value appraises for.

For this example, let's say the home appraises at $1,000,000.

We'll technically be able to borrow up to $900k to build the house.

How The Payments Work

The new construction loan will consume the original land loan once the construction process starts. And one of the best parts is no further down payment is required when construction starts. The original down payment amount of $40k is the only upfront capital required.

So, let's take the $900k approved amount from above. (It's not going to cost this much to build just so you know. I'm using this as the example. I'm planning to do a lot of the work myself, so I'll be saving a ton of this money.)

The question you're probably wondering is, "Do we have to pay a mortage amount on the $900k immediately?"

The answer is no. Thank God.

This is the next best part of the equation. We will only be making interest only payments on the accrued amount. So before construction starts, this will be an interest only payment on $160k.

Once we begin construction, we'll pay the General Contractor upon completion of each phase of work. And the amount paid to the contractor will be tacked on to our loan.

For example, let's say the foundation costs $20k. After completion of the foundation, we'll be paying interest on $180k

Let's say framing costs another $30k. At this point, we'll be paying interest only payments on $210k.

And so on it goes until completion of construction.

The Timeline

We have 12 months to complete construction unless negotiated up front. She gave this away without me asking, so I'm going to ask for at least 18 months to be safe. Especially since we live in a harsh winter climate.

Refinancing Upon Completion

Once construction is completed, we can either keep the loan on the adjustable rate mortgage terms. Or, we can refinance to a 30 year conventional mortgage at a fixed interest rate. We'll make this decision based on the current state of the market at this point in time.

And there you have it folks, construction loans in a nutshell.