Many people who’ve never built a home before are surprised to learn that the process for financing a custom home is different from a traditional mortgage. Construction loans have unique procedures and terms. Many of our clients have built with construction loans; this process has become quite every day for us. Understanding what is involved in securing your custom home-build financing will empower you to begin the journey.
How Do You Borrow Money to Build a House?
Your loan to purchase the lot to build your house is separate from the loan you will secure to build it. The terms for land loans are often different than those for purchasing lots with homes already built. Interest rates are often slightly higher, and the loan requires a larger down payment. Further, not every lender offers land loans. They are increasingly common, but it is essential to check with your bank and any prospective lender to ensure they offer this type of loan.
This is the loan you need to purchase the building materials and pay your team. Construction loans have more stringent terms for qualifying than a traditional mortgage. Construction loans are either construction-only loans, where you (or your new mortgage company) pay the balance at the end or construction-to-permanent loan, which converts to a mortgage with terms you’ve already locked in when you secured your financing. While this is convenient and absolves you of a second set of closing costs, it often carries a higher interest rate than a traditional mortgage.
After your home is complete, your construction loan either automatically converts to a mortgage, or you must secure a new mortgage that bundles your lot and construction loan. You will have far more options for lenders for your end loan, as many banks that do not offer construction loans will buy your mortgage now that the risks associated with construction have been eliminated.
Qualifying for a Construction Loan
It is harder to get a loan to build a house than to secure a mortgage for an existing one. The requirements for a construction loan. That’s because there’s more risk for a bank to assume during the construction of a new home than on an existing home. Some projects don’t make it to completion, cost more than expected, or don’t finish on time. Ensure this doesn’t happen to you by working with a reputable builder and financing team.
You will need a much higher credit score than a conventional loan's requirements to qualify for a construction loan. We have seen some applicants qualify with a credit score slightly below 700, but a credit score of 720 or above is usually a pre-requisite for a construction loan.
Your interest rate for your construction loan will be slightly higher than the prevailing mortgage rate at any given moment.
You will need to put down around 20-25% of the total estimated cost of your project to secure a construction loan. You will need enough to pay for the first draw for your project so that your lender’s risk doesn’t begin until your project is underway.
What You Need to Know About Construction Loans
A construction loan is disbursed from the lender directly to the builder in stages throughout your project. You may draw when you pour the foundation, next for framing, again when the drywall goes up, and so on.
Pay Only Interest
Unlike conventional mortgages, you aren’t attempting to reduce your balance until the project is over. You don’t pay the principal of your loan until your end loan. You also don’t pay interest on the entire lump sum of your final project. You pay interest only on the portion of your construction loan you have already drawn.
Your lender will coordinate 4-6 inspections to ensure your project is on schedule. You can often expect a visit from your inspector before the next draw is scheduled on your loan.
It’s easy to understand how an appraisal works to provide a valuation for an existing home. Your proposed construction project must also undergo an appraisal process. Your appraiser uses your builder’s plans to either estimate how much this home will cost to build or estimate how much this home will be worth once built, depending on the model they are using. Your home must be worth more than it costs to build in order to be approved for a construction loan to build it.
Tips for a Smooth Construction Loan Process
Shop Around - Talk to several lenders to compare terms and options.
Consider Your Options - Your construction loan is a balloon loan that must be repaid when the project is over. You will need to shop, secure, and purchase a conventional loan to repay the loan or choose a construction-to-permanent loan that converts to a traditional mortgage after construction.
Use Your Builder as a Resource -Your builder likely knows which lenders have worked well for their past clients. They may know about lenders with attractive terms or options you hadn’t considered.
Secure Financing Early - If you plan to build a custom home with a construction loan, secure your financing early in the process. Get pre-approved during the design process to make your layout and material selections with your actual budget in mind.
Ready to satisfy a life-long dream that culminates in a custom home? We can’t wait to build your dream home. Let’s connect about your Lake Oconee custom construction today.