17 Jun How to Get a Construction Loan for My Custom Home Build

How to Get a Construction Load and the difference between a regular mortgage and a construction loan

A traditional home loan is a mortgage on an existing home, that generally lasts for 30-years at a fixed rate where the borrower makes principal and interest payments for the life of the loan. a construction loan is underwritten to last for only the length of time it takes to construct the home (about 12 months on average), and you are essentially given a line of credit up to a specified limit.

Getting a construction loan is actually very similar to obtaining a regular mortgage. The main differences are:

• Construction loans require more paperwork (plans, cost sheets, builder contracts, etc.) A list of requirements will be provided to you by your lender.
• Construction loans require more upfront discussion and lender expertise.
• Construction loans can be more difficult to qualify for (Especially the client is currently paying a mortgage or rent while simultaneously carrying the construction loan and related costs).

When you apply for a loan to build a home, the lender doesn’t have a complete home as collateral, so qualifying for a loan can be more difficult. The lender will want details about the home’s size, the materials used and the contractors and subcontractors who do the work. The general contractor can pull all this information together.

How do construction loans work?

Construction loans work like a line of credit or a high-balance credit card. The borrower is approved for an amount of money for the project. The credit line is tapped in stages or “draws.” The borrower can request a draw at various stages of completion.

An important feature of a construction loan to understand is that draws can only be given for “work in place.”—This means that the borrower can not get money in advance for items that need to be paid for upfront. The draw is granted for the work that is completed to that point—not for what will be completed later.

Types of construction loans

There are two types of construction loans—one-step loans (sometimes called “simple close” loans) and two-step loans.  There are advantages and disadvantages to both.

An advantage of the single close construction loan is that you spend a bit less money than you would on two closings. However, the two close construction loan offers program flexibilities and long term lock advantages that very often end up saving you more money and time than the one time close.

While one is not better than the other, one might be better for your specific needs. That’s why it’s important for a borrower to be matched with a construction lender that is highly experienced, creative and advice driven. Otherwise, you are buying whatever the lender has to offer instead of being advised of how to best maximize your experience and results.

Here are the differences:

One Step Loans:

With a one-step construction loan, you are selecting the same lender for both the construction loan and the mortgage. All the paperwork for both loans is done at the same time. When you close on one a one-step loan, you are in closing on the construction loan and the permanent loan. This is an excellent choice if you’re absolutely certain what your home will cost when it’s done, and the exact amount of time it will take to build.

This may not be the best option for a custom home where you may make changes along the way and the exact price  building process may change. With a custom home build, that extra room you decide to add will require that you pay cash for it since there is no room in the single close loan. Similarly, if the build was expected to take 9 months and it is delayed for any reason, you will have major issues.

Two Step Loans:

When using a two-step loan, you split up the construction loan and the mortgage. With a two-step loan, you finish building your house and then close on the mortgage when the home is built.

This is a much better fit for those building a custom home. A two-step loan will give you more flexibility with the final cost of the home and the time line for building. This way, you can make changes to the scope of the home and add change orders and you’ll still be able to close on the mortgage. And, unlike the one-step loan, the clock is not running, so you can take a bit longer to finish building the house. This allows for delays for things like bad weather or other unforeseen circumstances. With a two-step, you will have the flexibility of extending the construction loan.

Credit Requirements

Construction loans are considered higher risk. You will need strong credit and a significant down payment. The specific down payment requirement is determined by the cost of the land and planned construction. If you already own the land, you can use it as equity for your construction loan.

As with traditional mortgages, “minimum credit scores, maximum debt-to-income ratios and down payment requirements vary from lender to lender, and are usually based on the amount of money borrowed,” Nard says.

Lenders will review your:

• Debt-to-income ratio: Lenders generally expect your debts to total no more than 45% of your income, and lower is better
• Credit score: Most construction loan lenders require a credit score of 680 or higher
• Down payment: A 20% to 30% down payment is typically required for new construction, but some renovation loan programs may allow less
• Repayment plan: With a construction-only loan, the lender might want to know if you’ll pay the balance in cash or refinance when building is complet

My current home isn’t paid off. Do I need to sell it before I can get a construction loan?

As long as you qualify for the construction loan and the end loan while carrying your current home, then you can keep it. If not, here are a few of  our post s that may help you sell your existing home fast and arrange for temporary housing.

• Should You Sell Your Existing Home While Building a New Custom Home?
• 6 Home staging ideas to help you sell your existing home
• 9 Ways to Kick Up Your Curb Appeal to Sell Your Existing Home

Building a new custom home may come with a bit of short term discomfort, but when your dream home is complete the payoff is worth it.