Four Ways to Finance Building a Home

Updated: Nov. 16, 2023

A traditional construction loan is not your only option when financing your from-the-ground-up dream home, beach house or woodsy cabin.

If you’re tossing around the idea of building a home, to live in full time or use as your family’s regular vacation spot, you’re probably also wondering about the best way to finance the project. Is a traditional construction loan, with a high interest rate and a hefty down payment, the only way to go?

Not at all! While a construction loan is certainly a reasonable choice in many situations, there are other ways to foot the bill. Here are four alternative ways to finance the construction of your dream abode, in case you don’t want a construction loan or don’t meet the qualifications.

Hard Money Loans

Rather than your income, credit score and the amount of cash you have on hand for a down payment, a hard money loan is all about assets, says Denver mortgage broker Chris Roberts. With this type of loan, the real estate you are purchasing serves as collateral. If you default, the land/structure goes to the lender.

“The lender is comfortable lending you the money because they know that if something happens, (the property) will cover it,” Roberts says. This option, Roberts says, is particularly appealing to retirees, who often have minimal income but plenty of other financial resources. If you own no significant assets, you are not going to qualify for a hard money loan, Roberts says.

And don’t head to your bank for a hard money loan. They are only available through private lenders, usually business entities but sometimes individuals. Also, be aware that interest rates on hard money loans are high and repayment terms short.

“Hard money loans are probably the highest (rates) … out there,” says Roberts. “We see them from seven percent to as high as 10 percent.”

Another downside: You usually can’t just use the money willy-nilly. Expenses generally must be pre-approved, and funds are transferred directly from the lender to vendor, supplier, contractor, etc.

On the plus side, hard money loans offer a quick turnaround. “You can get a hard money loan approved in five days, and they cut you a check right away,” Roberts says.

FHA One-Time Close Construction Loans

OK, but what if you have no assets, let alone decent credit? This doesn’t necessarily mean a loan to finance the building of your bungalow is off the table. It’s possible you’ll qualify for an FHA-backed one-time close construction loan, which is a loan insured by the Federal Housing Authority. You apply for and obtain these loans through the mortgage lender of your choice.

Similar to a traditional construction loan, an FHA-backed one-time close construction loan allows you to finance the entire project, from purchasing the land to paying the builder, buying materials and covering your lender’s fees. When construction wraps up and you move in, the loan automatically becomes your permanent mortgage, hence the term “one-time close.”

The main difference between this loan and conventional construction loans? Folks with less-than-stellar credit (a score below 600) can get one. You’ll also need a minimum down payment of 3.5 percent and an acceptable debt-to-income ratio.

Recipients are also automatically on the hook for private mortgage insurance (PMI). With non-FHA loans, the need for PMI depends on your down payment.

VA Construction Loans

If you are currently serving in the U.S. military or are a military veteran, you may be eligible for a Department of Veterans Affairs (VA) construction loan.

Getting a VA construction loan does require you to jump through a few hoops. You’ll have to submit forms your builder fills out specifying all your plans, along with your blueprints, to the VA. Your builder is also required to register with the VA. And everyone involved has to follow procedures regarding appraisals, funding, warranties and more.

Despite the extra steps involved, the plus side is you won’t need to come up with a down payment, which could be appealing if you want to build your home but haven’t had an opportunity to save. It’s important to note that with a VA loan, the home build has to be your primary residence. So if you want to use it to build that cabin in the woods, you’re out of luck.

USDA Construction Loans

Would-be home builders with low incomes may be eligible to apply for a construction loan through the U.S. Department of Agriculture (USDA), as long as the property is in an eligible rural area. (No, you don’t have to farm the land you purchase. In fact, income-producing farms are not permitted.)

Like FHA construction loans, these loans are one-time close. And like VA construction loans, they have numerous requirements attached, including credit score (640 is the minimum), who can build your house and certain administrative details. However, you can get a USDA construction loan with no money down, and interest rates are low.

Final Thoughts

The loan process can be confusing because lenders offer different types of loans. If you are seeking an FHA, VA or USDA loan, you can apply through a mortgage broker. Some banks and credit unions service these loans as well.