Components of a Construction Loan Budget

When you build your own home or make home improvements and renovations, you may need a home construction loan to pay for everything. So, what is the everything that makes up a construction loan budget? Some elements of the budget are obvious: the hard costs and soft costs of construction. Hard costs cover the labor and materials used to bring your project to life, and the soft costs pay for the planning, design and permits.

That is everything, right? Wrong. Closing costs also make up your construction loan budget. The closing costs consist of loan origination fees, title insurance, lender fees, closing agent fees, insurance and recording fees. Surely this everything, right? Nope. Interest reserve is next.

The interest reserve is an amount normally equal to 60 to 70 percent of the annual simple interest of the loan amount. Construction loans are usually interest-only loans, meaning that during the life of the construction loan, you are required to pay only the interest due on disbursed funds. Let's say that, three months into construction, you run short of money because of some other emergency. Having an interest reserve ensures that you have enough money to pay the interest due during the life of the loan.

For other emergencies, there is the contingency reserve. If the price of concrete shoots up right before you are ready to pour the foundation, the contingency reserve gives you a little breathing room in your construction budget. A normal amount for the contingency reserve is five percent of the hard costs of the project. The lot value of your property is included in the construction loan budget.

If you have owned the property for less than one year, this is equal to the acquisition price. Otherwise, this is equal to the current value of the lot. Is that everything? Almost. Inspection fees represent the last element of a construction loan budget. Without inspection fees, a project can grind to a halt, and most lenders insist on periodic inspections of a project as part of the loan agreement. All of these items, hard and soft costs, closing costs, interest and contingency reserves, lot acquisition and inspection fees make up the everything of a construction loan budget.