It seems that there’s really no good information online about how construction loans are calculated, or at least not that I’ve found. But it’s really important to figure out ahead of time for planning and saving. I’ve read that a lot of people are surprised when they apply for a construction loan due to not understanding how much is actually required for the down payment and how it’s calculated. I’ve spoken to a couple of different banks and they all pretty much are calculated the same way – it’s just that different banks will loan different Loan-To-Value (LTV) amounts.

Here’s the basics for how construction loans are calculated:

Step 1: Add up the following: current/appraised land value + builder’s contract + anything you’ve already paid for the house/land (architectural plans, site design, permits) + construction closing costs

Step 2: The bank will loan you the lesser of the two amounts: 1) the appraised value after your house is built, or 2) a percentage of the cost to build. The percentage of the cost to build (LTV) can vary based on each bank, but I’ve found that 80% LTV is average.

Step 3: Take the loan amount from Step 2 and subtract any remaining balance you may have to pay-off your lot loan. This is now the funds available to use towards your builder’s contract price.

Step 4: Take your builder’s contract price that you’ve gotten from your builder and subtract the amount from Step 3. The difference between those two is the amount that you need to bring to close the loan – your down payment.

Step 5: That’s not all that you need to save though in order to build home. You also need to save up for all of those expenses that goes into the home building process prior to breaking ground (closing costs, architect/engineering fees, site design, and permits prior to closing). Add all of those things plus the down payment calculated in Step 4 and that’s the TOTAL amount that you need to save in order to build a home.

I’m sure this is a little hard to follow, and if you’re anything like me, you’ll want to see this in excel to be able to play around with different costs/values. The attached spreadsheet does just that. This of course is based on our loan and house values. It shows the calculation I did for HomeStreet Bank. I worked with Adam Stoecker at HomeStreet Bank and he said that for our house, they would ideally not loan more than 80% of the value assumed, but they do have the ability to loan higher if needed. The attached calculation is pretty basic but does a good job at showing how much we need to save in order to build (click on the link to get the excel file).

 Example Downpayment Calculation

The banks also want to make sure that you have a reserve of 6 months of your future house payment liquid. They basically want to ensure that you’re not spending every last dime you have to build your home.

So, just exactly how are you supposed to save so much? Well, of course you can use your savings, and whatever profit you have from selling your current home (if any). But I was surprised to find out that one of the banks we looked into (Washington Federal) only requires that 5% of the down payment actually comes from your own funds. So, if you have some wealthy relatives, or a hefty 401k plan and would like to take a loan for the other 95%, you can do that. But if you’re like us – we’re going to fund our down payment the good ol’ fashioned way – saving!