Building a home from scratch is a significant undertaking in time, patience and finances. And, unless your bank account can support the costs associated with building your dream home, you will need to secure a construction loan. In most cases, a construction loan is a short-term loan to the consumer to build their home. Borrowers should be prepared to put down 20 percent on a construction loan.
Funds are not distributed to the homeowner in a lump sum, but as “draws” for a period of typically 6-9 months (no more than 12 months) as the home construction progresses. The homeowner uses the draws to pay the builder.But before a lender will approve a loan, the bank will review a builders license and references in order to determine if the contractor can be hired. An inexperienced or unreliable contractor can turn a consumer’s dream home into a nightmare by not finishing a build or mismanaging a budget.
Banks have to be careful today and minimize their risk and protect the borrower, Before any draws on the loan are made, banks typically send inspectors to the site to evaluate the construction progress.
What kind of loan is right for you? Even though it may seem obvious, this question does not always have a clear answer and the subject often is misunderstood by potential borrowers. It’s important to understand that these loans have unique characteristics and the lending options that are available for you will depend on factors like your personal situation, the type of property you are buying, your level of preparation and your timing for building a home.
NEW HOME CONSTRUCTION LOAN
If you have (or soon will have) all your ducks in a row – you’ve found your lot, finalized your house plans and are working with a builder – then a construction loan likely is what you’re ready for. construction loans usually are more difficult to obtain and will include less favorable financing terms when compared to a standard home mortgage. Be prepared to be faced with a larger amount of paperwork, additional transaction costs, a sizable down payment, a very short-term loan period and the possibility of higher interest rates (although monthly payments can be interest only during the construction phase). You likely will spend more of your time getting a construction loan processed and approved
CONSTRUCTION TO PERMANENT LOAN
Fortunately, the most common option today is the Construction-to-Permanent Loan (also called a “Single Closing” or “All-in-One” construction loan) that allows a borrower to have one loan, one closing and the construction loan simply converts to a long-term, permanent mortgage after the construction is completed.
Funds from a construction loan can help you build a home either on a lot you already own, or it can help finance the purchase of a new lot that you want to buy and then build on. If you already own your lot, your equity in the property can be included as part of the collateral for the construction loan. If you bought the land with a lot loan, then the construction loan typically would be used to payoff and refinance that first loan. If you are buying a lot with the construction loan you will coordinate the closing for the purchase of the lot with the construction loan closing.