Building a new home is certainly stressful but getting a construction loan shouldn’t be that difficult if you understand how the process works.
One of the biggest questions I hear from potential customers is how to we finance a new construction project. How do we get a construction loan? Are there different types of construction loans?
There are two ways a builder will typically require you to pay for your new home. Obviously there are as many ways to finance a construction project as there are ways to buy a new home. But these two scenarios are the most common that I see in my daily job.
Deposit and Full Payment/Closing When Construction is Finished – In this scenario the builder will require you to furnish a large deposit prior to construction. When the house is finished you’ll have a single closing similar to buying any house where you’ll pay the remaining balanced owed on the house. In this situation you would most likely get a typical mortgage just like buying an existing home.
Deposit and Progress Payments As Work is Rendered – This is the most common situation that a builder will require. This scenario has many variations so I’ll keep it as simple as possible. Again the builder will require a substantial deposit prior to construction. You will also be required to provide a letter of credit in both of these situations proving your ability to pay. For this option you’ll need to get a construction loan.
Typically a construction loan will have a single closing at the beginning where you’ll sign for the entire loan amount. At milestones in the construction process your builder will send you an invoice or requisition for work performed to date. The bank will release the funds for the work done after an inspection by an appraiser. You’ll then start paying interest only for the portion of money paid. This process continues until the project is finished, at that time the loan will typically convert to either a fixed loan or a variable rate loan much like a normal mortgage.
In order to obtain a construction loan the bank will require you to submit a set of plans and information about your builder. That information is used to get an appraisal on the new property. The one frustrating thing that some customers are seeing with the down market is low appraisals compared to construction costs. Currently material prices are a all time highs while real estate values are plummeting. What that means is you’re paying a premium to build new right now compared to buying an existing home.
As I said earlier there are many different types of construction loans. There are construction loans that allow you to borrow money for the new home even if you haven’t sold your existing home yet. There are construction loans that allow you to pay for the land in one closing and the house with a 2nd closing. Some people choose to take a 2nd mortgage on their existing home to pay for a 2nd home. There are many options available to you to build your new home, you just need to start the process as soon as you know you’ll be building a new home to prevent delays.