Building a dream home from the ground up is a common goal for a lot of people. But, with an ambition to build a home in that way comes the need to secure financing. And when it comes to financing, the smoother the process is, the better. So, what are the basics when you’re thinking of getting a home construction loan?
Home financing expert Jonah Trenton of RefinanceMortgageRates.org is here to talk about the ins and outs of securing a home construction loan to help you to get a start, and to build your knowledge to help you reduce the stress of that process while you’re at it.
Financing new home construction is typically more complicated than getting a conventional mortgage on an existing home for many homeowners like you. Not all lenders will offer you a home construction loan program. As such, some owner-builders use home equity lines or current home refinancing to help pay for the construction costs associated with building a new home.
Unfortunately, mortgage rates for home equity lines and home equity loans often make these second mortgages expensive. Additionally, these financing options seldom cover the complete cost of building a new home. So, if you’re thinking about building a home from the ground up, the following information may be vital to your success.
Types of Construction Loans and Terms
Securing a home construction loan, while more involved than a conventional mortgage, ensures that you have enough funding to cover building costs. Each lender offers different terms, interest rates, and loan programs for new home construction, although most construction loans fall into two categories:
1. All-in-one loans, also called rollover construction loans or construction-to-permanent loans, start with a construction loan to fund the build, then convert to a conventional mortgage upon completion of the home.
2. Construction-only loans, which only fund building the home and must be paid in full upon completion.
Typically, lenders offer construction loans with terms under twelve months, at a higher interest rate than a conventional mortgage. As an owner-builder, you then have the option of locking in an interest rate range for the term of the loan. Alternatively, you can opt for a floating interest rate that changes over the term of the loan, based on prime interest rates.
Some lenders also offer the option of locking a rate, while providing a float down option should interest rates drop within a specific period after closing on the loan. Funds are dispersed in draws, or a percentage of the full loan amount, based on the completion of certain stages of construction.
Qualifying for construction loans
To qualify for a construction loan, you will submit many of the same documents and verifications as with a conventional mortgage:
- Verification of income and assets
- a credit history report
- home appraisal
These documents are necessary for a home construction loan, just as these documents would be required for a conventional mortgage. The primary difference being that with a construction loan, you must submit home plans and other documentation for an estimated appraisal by the lender. Your chosen lender may also request a potential construction budget, complete with material lists and estimates from a builder or subcontractors.
Getting construction loans
While each lender and each market is different, the process for obtaining a construction loan is typically the same. The following time line of events is only an example, but provides insight into how a potential homeowner like you can get a construction loan.
- Select a home plan and potential construction site
- Get estimates from more than one builder as to cost, construction time line, and required draws
- Locate lenders that offer construction loans
- Review each loan program, including interest rates, terms and end loan options
- Select specific loan program and terms, then apply with chosen lender
- Submit income and asset verification, as well as home plans and estimates
- If applying for construction-only loan, seek out mortgage lenders for permanent home loan upon completion of the home
You can make the process even simpler by evaluating the potential construction site in comparison with other homes in the area, then choosing your home plans accordingly. Owning the land before applying for a construction loan can also increase the likelihood of getting your construction loan approved.
Information to gather before applying
Before applying for a home construction loan, you will need specific key pieces of information. The following checklist is an example of the documents and other information you’ll need to gather before you start shopping for a construction loan.
- Income records for the previous three years
- Land deeds or sales contracts for the construction site
- Bank statements, including 401(k), investment portfolios, savings, checking and other liquid asset records
- Credit history report to review for any inaccuracies prior to making a loan application
- Home plans, including any modifications
- Estimated construction budget including permit and professional fees, as well as labor and material costs
In short, getting a new home construction loan requires more steps and more documentation than a traditional mortgage. Additionally, lenders offering construction loans are not as numerous as those lenders offering conventional mortgages. Potential owner-builders will find the process more involved, but equally more rewarding once construction is complete.
RefinanceMortgageRates.org, a consumer oriented organization compiled of industry professionals with a mission to educate and inform readers in a tumultuous real estate and mortgage climate. They seek to increase knowledge of a complex market to consumers like you to help you make better decisions about home loans.