Why a Construction Loan
When the houses on the market don’t measure up to what you’re looking for in a home, building your own can be a great option. With a new construction, you can design your own unique space that’s perfectly suited to your wants and needs.
However, building something completely new is a more complex process than simply finding a home you like and buying it. On top of financing, some borrowers underestimate the stress of making all the decisions during building. Not only are there countless design details like what countertops, flooring, and even doorknobs you want, but you also have to communicate with the bank and builders, deal with cost overages, and work within a limited time frame.
While we can’t say if you should go with brass, silver, or gold cabinet handles, we can help make the financing process pain-free.
Understanding a Construction Loan
Many people don’t realize that getting financing for a new construction requires two loans: first the construction loan, and then the mortgage for the completed house. A construction loan is for nine months, and once the house is completed, you work out permanent financing (i.e., a 30-year fixed loan at x%).
Having two loans means double the closing costs, which includes the origination fee, appraisal, title work, etc. However, on the permanent loan, we do reduce some of those fees because some of the work is done with the initial construction loan.
For instance, the origination fee is 50 percent of the normal charge the second time around. If completion is within 12 months of construction, we may not have to do a full appraisal and can do a completion certification at a reduced rate. Those things help make the process a little easier for borrowers.
Down payment requirements for construction loans are also different from other home loans. We typically lend up to 80 percent of the appraised value on a construction loan, whereas on a purchase of an existing home, we can lend up to 100 percent on some loan types.
The down payment for a construction loan can be difficult for some borrowers unless they have equity in the property they are building on or cash in hand. They can also build up “sweat” equity by building the house themselves and saving on labor costs.
How to Know If You’re a Good Candidate for a Loan
When you apply for a loan, the most important things we’ll look at are credit and debt-to-income ratio. It also helps if you have money in savings because it’s likely you’ll need to put some of your own funds into completion.
It makes it easier if a borrower has either been gifted the land or bought it several years before and paid it off or down quite a bit to build up equity. This can essentially be your down payment instead of cash. Keep in mind that job changes or big financial changes like starting a business during construction are not a good idea, as these can cause problems with the final loan.
If, after reading this, you think you’re in good shape, you can start on getting a loan!
Taking Those First Steps
The first step is submitting an application for a Fast Mortgage Quote so we can check on credit and your debt-to-income ratio. At the application stage or soon after, we will request bids, plans, or estimates for the new home and from the contractors involved. You can’t plan for everything (and borrowers will often make changes during construction), but we try to limit complications by getting all this information ahead of time.
Once you submit an application, you can look at acquiring the land if you do not already own it, and then start on the house plans, bids, and estimates from contractors. Do thorough research and get several bids to be sure you are getting what you expect at an appropriate price. Be sure to find a builder you not only trust, but can also communicate with well.
A good relationship can save you from serious problems popping up in the middle of construction. You want to be on the same page with your builder from before you break ground. Construction is generally a nine-month process and a large investment for the borrower. There are frequently cost overages, and everyone needs to be prepared for if and when something comes in higher than expected.
As your loan is approved and construction begins, keep a realistic time frame in mind. Some customers tell us they’ll be done with the house in five months, and it ends up taking an entire year. Finishing a house in even six months is extremely rare. The majority go the full nine months, and most have a to be extended a little. Things come up with builders, weather impacts timelines, and surprises can happen to anyone, so be prepared for setbacks.
Whether you decide on a new construction or you find a perfect home on the market, we want to help make the process as smooth as possible. Please reach out to one of our lenders or visit our Mortgage Resources Page if you have any other home buying questions. We’re here to help!