Things to Know About New Construction Loans

Are you planning on building a home and getting a construction loan? Building your own home is a dream for many, but it can quickly become an expensive and complicated process. If you need financing to build your new home, a construction mortgage will be your best option.

These aren't the same as a more traditional mortgage and have some different requirements. Let's take a look at the details of getting a construction loan. There is a lot to know about new construction loans before diving in headfirst. Besides what you'll learn here, Maximum Real Estate Exposure has an excellent resource for more education on this type of mortgage.

How a Home Construction Loan is Different

A construction mortgage differs from the traditional home mortgage, as it is a shorter-term loan. While the lender would typically use the value of the home as collateral, but with a construction loan, this isn't an option.

This means the lender is taking on a larger risk when providing this type of lending. This leads to higher interest rates for the borrower to compensate the lender for the additional risks.

The bank needs more information than normal from the borrower to approve the loan. They need to see the builder's contract and their schedule of construction, along with bank statements and tax returns normally required with a traditional mortgage. You will also need to include budgeting for construction items and a clear timeline of the work. The length of the construction mortgage will be dependent on the expected completion date.

The lender will look at the information provided to evaluate if it seems reasonable. They may also check the builder's financial details and if the costs predicted by the builder are a good assessment of the likely project expenses.

If the builder has underestimated the costs of construction, this can lead to an increase in the build time as well as the need for additional funds. This could leave the borrower needing to find an extra source of funds if they don't have spare cash to deal with cost overruns.

If the lender approves the loan, the money will be made available as per the schedule of construction. They will normally have someone check the progress of the project, as the money is provided.

The Costs Covered by Construction Loans

The loan should pay for the building materials and cost of construction. Other costs associated with the build, like finishing costs, additional labor, landscaping, and permits can also be paid for from the loan.

Everything related to the construction of the home is allowed to be paid for from the funds provided by the lender. However, you can't pay for things which are removable, like home furnishings, for example.

New Home Construction Loan Types

There are a few different construction loans available depending on your situation. Here are the types of construction loans you are likely to run into in your search for a mortgage.

Construction Only Loan

A loan that only covers the costs of building the home means that you will need to either get a mortgage when the home is built or pay off the loan in full. This loan will allow funds to be made available as they are needed during construction, and the borrower will normally only be expected to pay the interest on this money.

This type of loan can be a more expensive option if you are going to require a mortgage once the home has been completed.

Construction to Permanent Loans

This type of loan allows you to cover the cost of construction, then converting to a permanent mortgage. This option has a couple of advantages. It means that you won't need to apply for a mortgage once the home is constructed and there will be fewer fees to pay in closing.

The construction to a permanent loan is the most common way people finance the construction of a new home build.

Owner-Builder Loans

If you are going to construct the home yourself, some lenders offer suitable loans. It brings additional risks for the lender, however, and they may only approve a loan if the borrower is a licensed builder or contractor. If you happen to be in the construction industry this may be a type of construction loan worth exploring.

Renovation Loans

A loan for renovation work on a home can be easier to secure, as it is likely to be for a smaller amount. The lender might not require as much information about the project and the schedule involved. As the loan required is smaller, the loan can be unsecured or using the equity in your home if the amount needed is larger. Renovation loans are quite common for those who are looking to add an addition to their property.

Finding the Right Home Construction Loan for You

Before you look for a lender willing to provide the funds for your new home, you need to have had the plans drawn up and agree on a contract with a builder. This information will be required to qualify for a loan.

Your financial situation is also going to be important when applying. You need to have a stable source of income, good credit history, low levels of debt, and be able to provide a large down payment. Some people don't realize this but you can also get a down payment gift from a family member when you are taking out a construction loan as well. Maybe you plan on building an inlaw as part of your project? Your parents could certainly be contributors to the project if they have the desire to do so.

Final Thoughts on Procuring a New Construction Loan

When you have everything in place, you can begin to search for lenders. You may find it easier to look for specialist lenders as this isn't a standard mortgage. Local credit unions or smaller banks could also be an option. Getting a new construction loan is something that takes a bit more homework than a standard mortgage. There are far fewer lenders that give this kind of financing.

It may be prudent to work with a mortgage broker who has some experience dealing with construction mortgages. They will be able to seek out the lenders in your area who are providing this type of specialized financing.

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