Are you planning to build a new home on a plot of land that you already own? Few people have enough cash on-hand to be able to finance the entire construction cost on their own. For most people, a construction loan will be required in order to make that dream come true.
There are two most common types of loans for those building a new home: a construction loan and a construction to permanent mortgage. Let’s discuss the differences between the two loan products.
Construction Loan
A construction loan, just as the name implies, is a loan to finance the costs involved with constructing a dwelling on your lot. This type of loan allows you to make draws against a pre-determined loan amount to pay the builder as construction on the new home progresses. This type of loan carries relatively short term with a balloon payment that must be paid in full upon maturity – typically within 6 months – 2 years of the loan origination. Most people will then take out a traditional mortgage to pay off the construction loan.
Advantages of a construction-only loan include increased flexibility in loan terms that allow you to customize the loan for your specific needs. Also, you will only pay the interest that accrues on the amount you have drawn during the life of the loan. This means you are not paying on loan costs if your project is delayed for any appreciable amount of time. This can also be beneficial since much of the cost of a new home is incurred towards the latter stages of home construction when “big ticket items” such as cabinets, flooring and appliances are added to the home.
This kind of loan also comes with some disadvantages including higher variable interest rates than a standard mortgage as well as incurring its own set of closing costs. Lenders also demand higher qualifying standards such as higher credit scores, down payments and reserves.
Construction-to-Permanent Mortgage
This type of loan also provides the builder with cash draws that allow for construction costs to be paid as needed during the construction period. However, when the home is complete are ready for occupancy, this loan converts to a traditional mortgage, with available fixed rates that are comparable to other mortgage products. This allows the homeowner peace of mind that the long-term interest rate is locked in at the start of construction, as well as offering the advantage of a single close, incurring only one set of closing costs.
You will not make a full mortgage payment until the home is complete, therefore you are only paying interest on the drawn amount while the home is under construction. You can also include the price of the land on which your home is being built in the loan amount which contributes to your overall down payment on the completed home, if you already own the land.
This type of loan is not without its downsides, namely that your loan amount is fixed and if you change your mind and opt for higher-end finishes (or maybe decide to finish the basement) then your loan will need to be modified and submitted back to the underwriting process.
Regardless of which type of loan you plan to use, be aware that there are a few additional requirements that these loans carry that you would not find with a standard home mortgage. First and foremost, your lender will want to know all the details about the home you are planning to build. This includes approved blueprints, site appraisals, builder licensing and so forth. You may be required to pay for a second appraisal once the home is completed to ensure the final value meets the lender’s requirements.
You should also plan to have stricter pre-approval guidelines like a credit score of at least 700 and sufficient cash reserves above and beyond the down payment to prove that you will be able to make the monthly mortgage payment even in the event of unforeseen financial stress.
Regardless of which way you decide to go, the experts at CloseYour Mortgage are here to make the process as pain-free as possible. Reach out today and let us help you make your dream home a reality.