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Construction loans differ from traditional mortgages by funding your dream home's construction from the ground up. These short-term loans have interest rates about 1% higher than conventional mortgages. Lenders require stricter qualifications that include a credit score of at least 680 and a 20% down payment.
The construction phase typically spans 12 months and requires interest-only payments while your home takes shape. Michigan's construction loan process needs careful planning and preparation. We will walk you through everything in applying for a construction loan in this piece.
You will learn what lenders look for and how they release funds as your project moves forward.
Understanding what a construction loan covers
A construction loan can help you build your dream custom home in Michigan. These specialized loans are different from standard home financing options and come with unique features tailored to the home-building process.
What a construction loan is and how it works
A construction loan helps cover the costs to build a new home. The loan typically lasts 12 to 24 months and provides funding throughout construction before it converts to a permanent mortgage.
The most unique aspect of construction loans lies in fund distribution. The lender releases money in a series of "draws" as your project moves forward. Each draw matches completed construction milestones like foundation work, framing, or utility installation. Lenders need to inspect and verify that each phase meets quality standards before releasing more funds.
Your payments start small and grow over time. You only pay interest on the amount drawn, not the full loan amount. The payments increase gradually as more funds go into the building process.
What costs are included and excluded
Construction loans cover a detailed range of building-related expenses:
- Land purchase
- Labor costs
- Building materials
- Permits and inspections
- Site preparation
- Landscaping and hardscaping
- Porches, decks, and garages
The loans don't cover everything. Design costs and architectural services need completion and payment before loan approval. You must handle these expenses on your own before applying.
The news gets better if you own your lot already. Your property's equity might serve as part or all of your down payment. Lenders use a current appraisal to determine your equity value once you've owned the property for six months or more.
How it differs from a regular mortgage
Construction loans are fundamentally different from traditional mortgages. These loans use your building plans and future home as security rather than an existing structure. The higher risk leads to interest rates about 1% higher than conventional mortgage rates.
The approval process requires more scrutiny. Lenders will review your builder credentials, construction plans, and project timeline along with credit scores and income verification. They need to know your project can succeed and stay within budget.
Regular mortgages run 15-30 years, but construction loans stay short-term by design. Once construction ends, you either pay the balance in full or convert it to a permanent mortgage through a "construction-to-permanent" loan.
Steps to apply for a construction loan in Michigan
Getting a construction loan in Michigan needs proper planning and preparation. Let me walk you through the steps that will help you get financing for your dream home project.
Start with pre-qualification and credit review
Your first move should be reaching out to lenders to get pre-qualified for a construction loan. This step gives you a clear picture of how much you can borrow based on your finances. You'll need to show recent pay stubs, W-2s, federal tax returns from the last two years and your asset account statements.
Michigan lenders usually want to see good to excellent credit scores—670 or higher works best. Your future house payment should stay within 28% of your monthly gross income. The total debt should not go beyond 44%.
Choose a licensed builder and get a signed contract
After pre-qualification, pick an experienced, licensed builder who has built a solid reputation. Take time to read online reviews, check their credentials, and see examples of their previous work. A detailed, signed construction contract becomes vital once you've picked your builder.
The contract should have:
- Total construction costs (including land if applicable)
- Specific start and completion dates
- Detailed scope of work
- Fixed-rate terms
Submit your construction plan and budget
Your next step focuses on getting all documentation ready for your lender. You need to submit detailed building plans, specifications, and a line-item budget from your contractor.
Lenders want to see these detailed cost estimates to check if the projected expenses make sense. The package should also include a realistic construction timeline that shows major project milestones.
Secure homeowners insurance with builder's risk
Proper insurance coverage must be in place before loan approval. Lenders need you to have a prepaid homeowners insurance policy that includes builder's risk coverage, even though you won't live in the home during construction.
This special insurance keeps you protected against fire, wind, theft, or vandalism during construction. Your policy should cover buildings under construction, materials, supplies, and provide liability protection.
What lenders look for during approval
Getting a construction loan approved takes more work than regular mortgages. Lenders take extra steps to check several factors that help them reduce risk in these complex deals.
Minimum credit score and income expectations
Michigan lenders focus on strong credit histories for construction loan applications. You'll need a credit score of at least 680, though many prefer 720 or higher. These higher numbers reflect the extra risk that comes with construction projects.
Your debt-to-income (DTI) ratio plays a vital role alongside credit scores. Lenders want your future housing payment to stay under 28% of your monthly gross income. Your total debt should remain below 44%. This setup will give a clear picture of your financial strength to handle both building costs and daily expenses.
Tax returns, pay stubs, and bank statements help verify your income. Lenders will review these papers to make sure you can manage loan payments during and after construction.
Down payment requirements and land ownership
You'll need bigger down payments for construction loans compared to standard mortgages. Most Michigan lenders ask for 20-25% of the total project cost upfront. Some banks might take 10% down in special cases.
Owning your land already can boost your position substantially. You can often use your property's equity toward the down payment. This setup cuts your out-of-pocket costs and shows your steadfast dedication to the project.
Loan-to-value ratios change with property size.
Properties up to 20 acres qualify for 90% financing. Land between 20-40 acres might only get 80% maximum LTV.
Why a detailed construction plan matters
A solid construction plan helps secure loan approval. You'll need detailed blueprints, specifications, cost estimates, and building timelines before the bank looks at your application.
These documents show you can finish the project on budget and on time. Lenders also check your builder's reputation, finances, and past work. Picking an experienced contractor with a soaring win record makes your project more appealing.
The bank must approve any changes to your building plans, so getting the original plan right matters. This careful oversight protects your investment and the lender's money throughout construction.
What to expect during the loan process
The construction loan process is substantially different from traditional mortgages, especially when you have to manage and disburse funds. You need to understand these differences to prepare for the process ahead.
How funds are released in stages
Construction loans operate on a unique draw schedule, which releases funds in phases instead of a lump sum. Your lender distributes money based on completed construction milestones as your project moves forward.
Money gets disbursed after completing foundation work, framing, roofing, interior finishing, and final completion.
Your builder must submit documentation that outlines completed work with supporting evidence for each draw request. The lender releases funds within 2-3 business days after approval. You'll only pay interest on the amount drawn—not the entire loan amount—throughout construction.
The role of inspections and appraisals
Quality checkpoints come in the form of inspections throughout your building process. Your lender schedules an inspection before each disbursement to verify work quality and compliance with approved plans. These inspections protect your interests and the lender's investment.
Construction loan appraisals use an "As-Completed" approach based on your building plans, specifications, and construction budget. This determines your property's future value once completed according to plan. The appraiser looks at comparable recently-sold properties in your area to establish value.
When and how the loan converts to a mortgage
Your loan converts to a permanent mortgage once construction completes, usually within 6-12 months. The conversion requires several steps: construction completion, final inspection, occupancy certificate, and mortgage paperwork finalization.
The permanent mortgage works like a traditional home loan with regular principal and interest payments. You can choose your preferred term (15-30 years) and rate type (fixed or adjustable) during this transition. Construction-to-permanent loans convert automatically, which saves you from paying multiple closing costs.
Build With Confidence: Construction Loan Help from Clear Rate Mortgage
A construction loan can help build your dream home, but it requires expert guidance and a strong plan. These loans are stricter than traditional mortgages but offer benefits tailored to your building journey.
Success starts with preparation—good credit, a solid down payment, and well-detailed plans are your foundation. Working with a trusted builder and staying in close contact with your lender ensures smooth fund releases and keeps the project on track.
Construction loans offer interest-only payments while building and can convert to a permanent mortgage later. While the process may seem complex, understanding the basics can make homeownership more achievable.
Clear Rate Mortgage simplifies the path forward. Our team explains Michigan construction loan options, payment steps, and helps you choose a structure that suits your goals.
Prequalify now! and let Clear Rate Mortgage support your dream from the ground up.
FAQs
1. What happens if construction is delayed on a construction loan?
If your construction timeline extends, you may need to request a loan extension from your lender. Lenders will evaluate the cause of the delay and might charge additional fees depending on the situation.
2. Can you change builders after getting a construction loan?
Switching builders after approval requires lender consent and updated documentation. The new builder must meet the lender’s qualifications and submit revised plans and contracts.
3. Is it possible to refinance a construction loan before completion?
Yes, refinancing is possible but can be complex and depends on the current progress of your project. You'll need lender approval, a new appraisal, and updated financial verification.
4. Are there penalties for early repayment of a construction loan?
Most construction loans do not include prepayment penalties, but it's best to confirm with your lender. Paying early may reduce interest costs during the build phase.
5. Does a construction loan cover unexpected costs during the build?
Unexpected costs are not always included unless you budget for a contingency upfront. If overages occur, you may need to cover the difference out of pocket or request a loan increase.
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