The final phase of our process is when we’ll meet with you to discuss financial funding arrangements and review accounting procedures. We believe in total transparency. You will never be surprised when it comes to the financial details of your new home construction. You’ll see how your money is spent in real-time and a third-party accountant signs off on any spending each week to ensure oversight.
Financing the build of a custom home is different than a classic bank mortgage to buy an existing home. With a typical mortgage, the buyer purchases an existing home and the land on which it was built. If you’ve purchased a home in the past, you know that a classic mortgage is typically straightforward regardless of the loan type you may choose. A construction loan is the type of loan you will need to build your custom home on a piece of property that you own or are buying.
Financing Steps for Construction Loans
The three main transactions in custom home building are the lot purchase, the construction of the home itself, and the mortgage. For custom home construction, you will secure separate financing for each although various lenders may package certain types of loans together.
Generally, the first step is to secure a loan to purchase your home site. Second, building the new home is financed through a construction loan which is structured to release periodic disbursements to pay for the various phases of construction as the house is being built. Lastly, a mortgage will be secured for the completed home.
Step 1: Unimproved Property Loan
Unless you already own a piece of land outright or if you plan on paying cash for the property, the first type of loan you will need to secure is an unimproved property loan, available from a variety of financial institutions. The price of land and the interest rate varies depending on the value and location of the lot. As with most other loans, the size of your down payment will affect the terms of your unimproved property loan.
The closer to an urban area, the more expensive the land is likely to be. Consider various factors when searching for a lot including how close it is to a city, the potential value in the coming years, and local laws on land use and zoning. You will need to close on the lot before construction can begin.
To qualify for an unimproved property loan, the lender will ask some specific questions, like how much you can provide as a down payment, your annual earnings, the total cost (principal and interest) of the loan, its duration, and your financial history. A higher down payment may be required than for a traditional mortgage loan.
Step 2: Construction Loan
If your plan is to finance your custom home build, you will need to secure a construction loan. Construction loans are specialized and aren’t available at every bank. A reputable custom home builder will guide you through the process and may be able to help you secure the loan.
Construction loans are usually 12-18 months in duration depending on the size of the build and may require a down payment of 20% to 30% of the total loan.
The Different Types of Construction Loans
A construction-to-permanent loan, also known as a single-close loan, is a loan used to finance the cost of purchasing the lot, building a custom home, and later serves as the mortgage on the home once construction is complete. This type of loan is good for borrowers who want to build a custom home on a lot of their choosing and use a custom builder of their choice.
A standalone construction loan is a short-term loan that is secured to fund the construction of a custom-built home. Once the construction is complete, the loan must either be paid in full, or you must apply for a mortgage. The lender that provides the financing for construction but not the mortgage will likely want evidence of pre-approval of the permanent mortgage prior to approving a construction loan.
Step 3: Mortgage-Based Loans for New Construction
Once the construction of your new home is complete, you will need a mortgage, a permanent loan, for the completed home. If you took out a construction-to-permanent loan, it won’t be necessary to pay another set of closing costs. Mortgage-based permanent loans are the typical loan that most people use to buy a home.
Difference between a Traditional Mortgage and a New Home Construction Loan
A traditional mortgage will provide long-term financing for a home that already exists. The home is used as collateral to secure the loan. The loan period can be up to 30 years and the borrower will make payments towards the principal and interest for the entire length of the loan. It’s a best practice to shop around for a mortgage. There may be differences in rates and some mortgage providers charges higher upfront fees than others.
A new home construction loan, however, doesn’t have an existing home to use as collateral. This type of loan is a short-term loan for the time it takes to construct the home. Without a completed home the financial institution can use as collateral, most lenders require the homeowner to put in the required 20%-30% equity in the beginning before the loan proceeds are utilized. The custom home builder that you choose will need to be approved by the financial institution handling your construction loan. The builder must prove creditworthiness and have a history of completed homes.
Once the loan is secured, construction can begin. Funds from your lending bank are disbursed as needed by the builder instead of being granted all at once. This way, the customer only pays interest on the loan proceeds as they are disbursed rather than the full amount of the loan. Disbursements are called draws and the lender will ask an inspector to verify that various milestones have been met before the next draw is approved. Total Quality Home Builders will ensure that milestones are met and that all subcontractors and suppliers have been paid.
Securing financing prior to building a custom home provides the security of knowing there will be funds available throughout the entire construction process. As with any loan, you and your bank are taking on risk so be sure to partner with a reputable builder. Total Quality Home Builders will help you through the process of obtaining the best financing possible for your dream home.
