Finding your dream home can take time to find where to begin! Many home buyers find houses that meet some of their needs but not all. That means you could buy a home that makes you happy. The average American home costs about $400,000, that’s a lot of money to spend on something you don’t love.
However, securing financing for a custom-built home differs from purchasing an existing property. In the realm of new home construction, it’s not a singular, fixed price tag that you must manage. Instead, it entails a sequence of costs, often substantial ones, dispersed across an extended timeframe.
You can build your own if you don’t want to settle for less. This allows you to design a home tailored to your wants and desires. Plus, there are no concerns about a home that was lived in by someone else. First, you need to get a construction loan to finance your new home.
How to get a Home Construction Loan
A construction loan is a short-term financing option that covers the costs of building a new home. A construction loan differs from a mortgage and is a specialty financing type. After the home is finished, you need to take out a mortgage to pay for it.
Home Construction Loan Requirements
To secure a home construction loan, you typically need to meet the following criteria:
Solid Credit Score: A robust credit score is essential. While conventional loans may require a score around 700, some lenders may offer flexibility. FHA, VA, and USDA loans may have lower credit score requirements.
Substantial Down Payment: The down payment varies by loan type. Conventional mortgages might allow a 5% down payment, but construction loans often demand at least a 20% upfront payment. Inquire with your lender about the possibility of obtaining a construction loan with no money down. In most cases, FHA loans start with a 3.5% down payment, and USDA and VA loans might not require any down payment.
Reputable Licensed Builder: Lenders scrutinize the builder’s reputation to ensure they can fulfill financial obligations and complete the construction project. This evaluation involves the builder presenting professional licenses, proof of insurance, and references from vendors indicating a reliable payment history. The lender also assesses the builder’s credit rating and financial stability.
The criteria for a construction loan are generally more stringent compared to a traditional mortgage due to the absence of collateral since the house is yet to be built, inherent in traditional mortgage arrangements.
There are several forms of construction loans to review before making a decision:
Construction Only
This is a short-term construction loan that lasts about a year. It only covers the construction costs. Many large lenders do not offer construction-only loans because of the higher risk. They can be harder to qualify for, and the rate will be higher. If you choose a construction-only loan, you will have to pay more loan fees when applying for a mortgage.
Construction-To-Permanent
This loan pays construction costs and switches to a regular mortgage when the job is complete. You only make interest payments during the construction phase.
These loans are usually more expensive than mortgages. So, if you choose this option, check several lenders before making a decision. You could find a lender that offers better terms than another.
Renovation
This is an FHA 203k loan that can be used to renovate your home. It is insured by FHA and lets you buy and rehab your home with one monthly payment. You also can qualify for this type of loan through Fannie Mae and Freddie Mac lenders. If you have enough equity in your home, you may qualify for a second mortgage to finance home improvements.
Owner-Builder
Some home builders want to be their own contractor and some lenders offer owner-builder loans. The owner-builder loans require you to show skill and expertise in homebuilding.
End Loan
This is a regular mortgage loan that you can get after the home is built. You can get an end loan if the construction is complete.
What Are Rates on Home Construction Loans?
Interest rates for construction loans are typically higher than those for conventional mortgages. This difference is attributed to the increased risk undertaken by the lender, as funds are disbursed before there is an actual asset to secure the loan. In the event of a default, the lender faces the challenge of repossessing a construction site rather than a finished home, which is less desirable.
Due to this elevated risk, construction loan interest rates are generally higher compared to the rates associated with traditional mortgages. The rationale behind this discrepancy is to compensate for the heightened uncertainties and potential complications involved in financing a property that is still in the construction phase.
Interest rates for construction loans can either be fixed or variable, with the latter meaning they fluctuate based on the connected index. Variable loans often begin with lower rates compared to fixed loans but have the potential to increase or decrease on a monthly basis in accordance with prevailing market rates.
Takeaway on the Home Construction Loan Process
Embarking on the journey of constructing a home from the ground up is a significant undertaking. Hence, the selection of the right mortgage banker holds paramount importance. The RefiGuide will connect you with seasoned bankers possess the expertise to assist you in navigating the intricacies of the new home construction loan process, ensuring that you can bring to life the home you have envisioned.
Prior to proceeding with a home construction loan application, it’s advisable to review discuss your plans with loan officer that specializes in home construction lending and a financial advisor. This step ensures that your focus is in the right direction, increasing the likelihood of securing a favorable interest rate and successful investment. Nevertheless, borrowers need to conduct thorough research to ensure alignment with all terms stipulated by a lender and to determine that the selected loan is the most suitable for their specific needs. Now that you know the types of home construction loans, you will know what to look for when talking to your home lender.
About RefiGuide.org
Bryan Dornan is a financial journalist and currently serves as Chief Editor of RefiGuide.org. Bryan has worked as a mortgage loan officer in the industry for over 20 years and has a wealth of experience in providing mortgage clients with the highest level of service in the industry. Bryan's continual focus is to promote affordable home-ownership to consumers like you across the United States. He also writes for RealtyTimes, Patch, Buzzfeed, Medium and other national publications. Find him on Twitter, Muckrack, Linkedin and ActiveRain.
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