If you are planning to build your own home this year, you will probably need a new home construction loan. This article will highlight the critical parts of construction loans so that you can make an informed decision on how to finance new home construction loans.
- Talk to Experienced Construction Mortgage Lenders in Your Area.
- Learn about FHA Construction and Fix & Flip Loans from Private Money
- Shop and Compare Residential Construction Loan Programs and Interest Rates with No Application Fees.
Overview of Home Construction Financing and Home Building Loans
Unless you can pay cash for your home building project, you will need a construction loan to pay for large portions of the labor and materials. A home construction loan also can be used to buy land for your house to sit on, too.
Home construction loans are more complex than a regular mortgage loan; you are borrowing funds for a short time to construct a building that does not exist yet. A construction loan or fix and flip home loan is basically a line of credit similar to a credit card. But in this case, a bank controls when money is borrowed and paid to your contractor.
A home construction loan requires bank approval for both you and the builder. The bank has to check that you can afford the loan and will have enough money to finish the project. The contractor must show he has the financial ability and skills to get the house constructed on time and under budget.
What Are the Two Types of House Construction Loans and Lines?
There are two types of construction loans: one time close loans, and two time close loans.
In all of these loans, money is distributed by the lender according to a draw schedule that was set up in advance. For example, so much money will be disbursed when the foundation is done, and so much when the framing is done. The idea here is to only pay for work that has been finished, minus holding costs. The latter is typically 10% of the total project amount. This will be held back until everything is finished on the property and it is occupied.
During construction, the payments are interest only. They start out small as you will only pay on the funds that are handed out to the contractor.
When construction is finished, you will make a large balloon payment for all that is owed. On some construction loans, there will be no payments due until the house is finished.
Fees for construction loans are higher than a regular mortgage; the risks are greater for the construction loan lender because the building is not complete. Also, the bank must carefully manage fund disbursement. This takes more work than funding a regular mortgage. See my recent article that highlights the similarities and differences between a construction loan and HELOC.
About One-Time Construction Loans
These are the most popular for home buyers. But they can be hard to find in some parts of the US. They are also referred to as construction to permanent loans. These will wrap your construction costs into the mortgage so that you have one home building loan.
These are good home improvement loans if you have a very good idea on what the project is going to cost.
A one-time construction loan has a single approval process and one closing. This makes the project simpler and reduces your closing costs. Within the one time construction loan, there are several different options.
Some lenders may charge a higher rate for the construction loan than permanent mortgage financing. The borrower can usually select from several mortgages, such as a 30-year fixed loan, FHA construction loan, fix and flip financing or several ARMs.
Some banks may allow you to lock in a fixed rate loan with a float down variable. This would let you get the lower rate if construction loan rates fall. This costs you of course. If the construction takes more than a year, you may have to pay more.
Here are some considerations for one time close loans:
- You pay only one set of closing costs.
- You get approved for both the construction and mortgage at the same time
- Permanent financing has several options
- FHA 203K Loan for house construction
- If you go over budget, you might need to take out another loan and pay closing costs again.
- Permanent construction loan rates may be higher than with a two time close loan.
About a Two -Time Close Home Construction Mortgage
This type of loan is really two loans. You get a short term loan for construction, and another loan for the long term mortgage when the project is done. So, you are refinancing the building when it is done. You will need to get approval and pay closing costs again when it is done.
During construction, you only have to pay interest on the funds that are disbursed. The payments are small at first but will rise with time.
The bank usually will add a contingency fee of up to 10% on the loan in case costs go over. This happens often with home construction. It is always best to qualify for as much money as you can. That way, you have a cash reserve to tap if you need it.
You have two loan settlements with a two time close loan, so closing costs are higher. But you often can get a better interest rate on your permanent mortgage.
Considerations for this Type of House Construction Loan:
- More flexibility to modify your plans and boost loan amount.
- Mortgage rates may be lower than the one time close loans.
- You can shop around for a permanent mortgage.
- You have to be approved two times.
- You face financial risk if your circumstances changed before you apply for a permanent mortgage
- If you do not get approved for your mortgage, you could be foreclosed up.
Something to Remember with Home Construction Mortgage Loans
Both types of construction loans can work well for your construction project. Which one is best for you will depend upon your personal finances and the type of project. Getting a one close loan is often less risky, and is the type of loan we see more often.
5 Ways to Raise Your Home Value with a Construction Loan
If you own a home and want to increase its value, a good way to do so is to get a construction loan or a home renovation loan. For those who have the income and credit to qualify, increasing your home value with a renovation can really be quite easy.
As you consider which renovations to do to increase your home’s value, it is important to know that the cost of the renovation or construction may not always pay off in an equal amount of increased home value. That said, there are some home renovations that will nearly always bring more value than others.
It may not sound like much, but one of the biggest pay offs for home improvements today is a new, attractive front door. Experts say that a new front door will give you 96% return on investment in many cases. It does need to be the right front door of course; as with all home renovations, you should remember that you do not want to spend too much on a home improvement compared to the value of the home.
If your home is worth $250,000, you will not see your money back by putting in a $10,000 front door. But a nice, attractive $1000 door should pay off when it comes time to sell or pull out cash.
Experts note when you get the renovation or construction loan, replacing some of the older elements of the home, such as windows, siding and doors, usually will pay off better in increased home value than a large remodel, such as an addition.
That said, some real estate agents argue that an updated bathroom and kitchen will still pay off when it comes time to sell. A recent report noted that kitchen renovation projects usually return more on investment than a bathroom. A minor kitchen remodel was recently found by US News and World Report to return approximately 83% of the money invested.
Doing the kitchen often makes sense because people tend to overestimate what a kitchen remodel costs. A typical dated kitchen might make the buyer think that $50,000 is needed. But a minor upgrade to a kitchen – new cabinet doors, appliances, counters, sink, paint and hardware, can often be done for $20,000 or less. Smart and cost conscious shoppers can often make a kitchen look like new with much less than you think.
It is important to not overdo it on the kitchen, and on any major construction or remodel. If you have a $100,000 home and you spend $60,000 on the kitchen, there is little chance you will see that money back, even though you will certainly enjoy your newly luxurious kitchen.
Experts recommend that you spend approximately 25% of the value of the home for a new kitchen, and 12-15% for a renovated bathroom.
When thinking about the style of the renovation, experts warn home owners away from ‘improvements’ that are vastly different than the style of the rest of the home. If the new kitchen does not match the style of the rest of the house, it may even detract value.
Converting part of the attic into a bedroom is another renovation that your construction loan could make very worthwhile. Experts state that this type of addition can lead to an 84% return on investment. Turning the attic into a usable space is very profitable in many parts of the country; it can be even more attractive in the areas of the country where there are no basements.
Another popular option that is not very expensive is to convert existing windows into French doors that go to the backyard. It makes rooms feel larger and gives one somewhere to go. It just makes the home feel bigger.
New siding, windows and insulation may not be as sexy in terms of renovations, but it still can return a lot of money when the time comes to sell the home.
Other improvements to the home that add value include:
- Adding a wood deck: 87.4%
- Garage door replacement: 82.7%
- Attic bedroom: 84%
Taking out a home construction loan or a renovation loan to do home improvements makes a lot of sense if you spend the money wisely. The biggest thing to keep in mind is to not spend too much money on any one major improvement compared to what the home is worth.
As mentioned earlier, a $50,000 kitchen upgrade on a $100,000 house is not worth the investment, no matter how much you personally enjoy the kitchen. But a $20,000 new kitchen on a $100,000 home makes sense when you sell the home.
If you keep in mind the useful tips we offered above on home improvements that are worth the cost, you will be able to increase the value of your home and make it that much more enjoyable for you and your family.
Everything You Need to Know About Home Construction Loans
When you want to buy your own home, you have two basic choices: Buying an existing home or building your own. Most people who build their own home use a construction loan to get the work done. Home construction loan rates remain near record lows, so the timing may still be right for you. If you are considering a home construction loan, please use this article as a guide throughout the process.
Overview of Construction Loans
There are two major types of home construction loans:
- Construction to permanent loan: You borrow funds to pay for the construction. When you finally move into your home, the lender switches the loan balance into a regular mortgage.
- Stand-alone construction loan: The first loan pays for construction. When you are ready to move in, you get a mortgage loan to pay off the debt of the home building loan.
Construction to Permanent Loans
A construction to permanent loan has the advantage of featuring only one closing. This will reduce your fees and closing costs over having a separate construction loan and mortgage loan.
During the construction of your home, you will pay only interest on the balance of the construction. Your interest rate is variable during the construction process. It will move up and down based upon the prime rate. So, if the Fed raises or decreases the short-term interest rates, your rate will change.
The home construction lender will convert your construction loan into a permanent home loan after the contractor has finished all construction. The mortgage you get is the same as any mortgage. You can select either a fixed or adjustable rate, and can choose a term of 15 or 30 years.
Some home construction lenders let you lock in a maximum rate at the start of the construction phase. Usually, lenders require a 20% down minimum payment for the permanent loan. Always verify the current home construction loan rates before making a commitment.
Stand-Alone Construction Loan
A stand-alone construction loan can be a good fit if it lets you put less money down. This can be a major asset if you already own your home and you do not have enough cash for a large down payment. You will have more cash available after you sell your house, though. You can stay in your current home while your new one is being built.
This sort of loan does have disadvantages. First, you must pay two closing costs and two sets of fees. First, you have to pay for the construction loan, and second, the permanent mortgage.
Also, you cannot lock in a rate when you get a land loan and then a stand-alone construction loan. If rates go up doing the construction phase, you may have to pay more on your permanent loan.
Last, if your finances change during construction, you may find that you cannot get approved for the loan for the home you just built. Check with mortgage lenders to see 2018 construction loan rates today.
How Home Construction Loans Work?
Building a new home to your specifications could sound like your ultimate dream. But building a home from scratch can be complex. This is especially true if you need to take out a loan to pay for the home.
Below is a good overview of how home construction loans work.
What Is a Home Building Loan?
A construction loan is a short term loan that pays for the construction of your home. As the work goes along, the lender pays out the money in parcels.
Construction loans are often short term with a maximum length of one year. They have variable rates that go up and down with the prime rate. The rates on this type of home building loan are higher than rates for long term mortgage loans. To get approval, the lender needs to see your construction timetable, plans and a budget.
Once the loan has been approved, the borrower is put on a draw schedule that follows the construction stages of the project. You usually will need to make interest payments only during the construction process. As funds are needed, the lender normally sends an inspector to check on the project’s progress.
Major Types of Home Construction Loans
The first type of construction loan is construction to permanent. This is where you borrow money to pay for the construction costs of building the home. Once the house has been complete and you are ready to move in, the loan is converted to a standard 30 year or 15-year permanent mortgage.
This is essentially a two in one loan, so you have only one set of closing costs to pay. This reduces your out of pocket costs.
During construction, you only pay interest on the balance; you do not have to pay down principal yet. Usually, you will have an interest rate that varies during the construction phase, so your payment and rate can go up and down.
Once your loan is a permanent mortgage, with a term of 15 or 30 years, you will make payments that cover interest and principal. At that time, you can decide for a fixed or variable rate mortgage.
The other type of construction loan is a construction only loan. This is where you take out two different loans. One is just for the construction of the home, which usually takes a year or less. When you move in, you take out a new loan to pay off the construction.
With the construction only loan, you do not need as big of a down payment. This can be a good choice for the person who already owns a home and is building their next home. You could have limited cash available right now, but once your current home is sold, you will have more cash to pay the mortgage on the newly completed house.
But construction only loans can be expensive. Because you have to do two separate transactions, you need to pay two sets of fees. If your financial situation gets worse, such as if you lose your employment, you may not qualify for the mortgage to move into your home.
How to Apply for a Home Construction Loan in 2019
Qualifying for this loan is usually more difficult than qualifying for a regular mortgage. With a regular mortgage, your home is collateral for the loan. If you do not make your payments, the bank will take the home. With a home construction loan, the bank cannot seize a home that is not built, so the loan is a larger risk.
To offset this risk, the home construction lender usually has tougher requirements. To qualify for this loan, you will need good to excellent credit, a stable income, low debt to income ratio, and at least a down payment of 20%.
Your lender will want a lot of information about the lot, planned size of the house, materials that are being used, and the names of the contractors doing the work. Working with an experienced and licensed contractor will make this process easier.
Remember that building a home usually comes with costs that were not expected, so you have to show the bank that you have the savings to afford any additional costs that crop up.
References: Construction Loans Explained. (n.d.). Retrieved from http://www.bankrate.com/finance/mortgages/construction-loans-explained.aspx