You’re ready to own your dream home. For some, new construction is the best way to achieve the ideal house, one that is customized to meet all your needs. If you have tried finding the perfect home and nothing seems to fit quite right, a new build is the opportunity to tick all the boxes. Build from the ground up, planning for what you need and want most in your home.
Sold on the idea of building your dream home? Now all you need is affordable financing. New construction loans lay the foundation for financing your dream home build. Keep reading to learn what types of loans are available, how to secure financing, and how to get the best deal on loans.
What Is a Construction Loan?
A construction loan is a type of financing available to fund major renovations or build a custom home designed to meet your specifications. Construction loans can be obtained through lenders (such as a credit union or bank) by an individual or real estate developer looking to build a custom house. They can be used for building residential or commercial properties.
Construction loans are typically short-term, about a year, which are then rolled over into a mortgage loan.
Types of Construction Loans Available
For the purposes of this article, we’ll focus primarily on construction loans used by homeowners to build custom residential properties. The two primary loan types available are:
One-Time-Close Loans
An all-in-one loan rolls the construction loan and mortgage on the completed home into a single loan. These types of loans can simplify the process of building a custom home and may reduce closing costs. However, they can be less flexible, as the construction amount is locked in, and if you go over budget, you may have to take out a second loan.
Two-Time-Close Loans
The more common loan type available is the two-time-close loan. This is essentially two separate loans: the construction loan and the mortgage on the completed build. One loan funds the construction of a custom home, while the other loan finances the mortgage on the completed project.
Once the construction is complete, you can roll your loan into a conventional fixed-rate mortgage or an adjustable-rate mortgage (ARM).
These types of loans are usually preferred by lenders and homeowners alike because they offer more flexibility and lower mortgage rates. If you need to modify the design or increase the budget, you are free to do so. You can also shop around for better rates when it comes to permanent financing.
How To Finance Your Dream Home, a Step-By-Step Guide
Follow these steps to qualify for a construction loan and build your dream home:
- Plan ahead: Look at your finances, establish a budget, and start saving. Getting your finances in order ahead of time can ensure faster approval times and better rates.
- Do your research: Find a builder who can deliver the results you want and who is qualified to work with the lender you choose.
- Shop around for the right lender: Look for a lender who best fits your construction project needs and offers great rates and expert support.
- Apply for your construction loan: Make sure to gather all necessary specs, plans, surveys, and permits. Reach out to your builder for their proposed disbursement schedule.
- Begin building: Your lender will inspect the property as needed, and funds will be dispersed to the builder according to the disbursement schedule. Loan payments are interest-only during construction.
- Convert to permanent financing: Once your project is complete, your loan is converted into permanent financing. Your lender will send an appraiser for final inspection, and your loan will convert to an amortized loan based on the original closing documents. Make sure to provide a certificate of occupancy, final survey, and homeowner’s insurance policy. Take time to review amortization documents and understand your mortgage payment schedule.
- Begin repayment
Lenders understand construction loans can be overwhelming and have construction loan experts available to help you every step of the way. Talk to an expert and get rapid support when you need it most.
Other Key Considerations When Applying for a Loan
Construction loans are not collateralized, which means they tend to have tougher eligibility requirements and higher interest rates than traditional mortgages. Since these types of loans are riskier for lenders (i.e., the house doesn’t exist yet and cannot be seized by a lender if a borrower defaults on the loan), you may need to meet stricter loan qualifications.
To increase your chances of approval, aim to get your finances in order before applying. A good credit score and low debt-to-income (DTI) ratio is key. You may also be required to put a minimum of 20 percent of the build estimate down to qualify for a construction loan.
Loan approval is also conditional to your construction details. You will have to provide proof of a licensed contractor qualified to work with your lender, as well as the following documentation:
- Full specs and blueprints
- Materials list
- Draw schedule
- Signed construction contract
A lot of documentation is required for new construction loans. For a more comprehensive list, check out this helpful guide.
Finding the Right Lender
Not all lenders offer construction loans. Look for a lender with a dedicated team experienced in these types of loans. Look at the lender’s policies and draw schedules to ensure they fit your project’s needs.
Working with a local credit union is ideal because construction loans require an understanding of the housing market in your specific area. Look for a local credit union that is comfortable with lending to members of their community.
Borrowing through a credit union can also offset some of the higher interest rates typically associated with construction loans. Since credit unions are member-owned and not-for-profit, their rates are typically lower than regional banks.
The right lender combines all these elements: loan policies that fit your needs, competitive rates, and immediate support from a team ready to work directly with you and your builder.With new construction loans, not only can you dream it, but you can build it.
