When you are looking to build, the last thing you want standing between you and your dream home is a bank. New build construction loans can sometimes be difficult, but you do have options to get the money you need to build your next home. Before the recession, construction loans were a tool home builders used to finance subdivision build-outs or other construction projects. Periodically during the construction
project, the builder would request a “draw” – funds paid out on the loan. Someone from the bank would come out to the construction site to make sure everything was on track and the funding was being used appropriately. Once the construction was complete, the buyer would obtain a traditional mortgage including enough money to pay the builder’s costs and close out the construction loan. You will also be required to pay a large down payment – often 20-25%. During the construction process, you will only have to pay the interest on the loan. When the build is over, you
will have to refinance the construction loan into a conventional loan. The high risk, double closing costs, strict lending requirements, and large down payment can make construction loans difficult for some borrowers. But there are other options out there. Many lenders now offer a two-in-one mortgage option. With a construction-to-permanent loan, the lender advances construction costs, just like in a traditional construction loan. When the home
is built, the same lender will automatically roll the loan balance over into a traditional mortgage. This is a popular option because: If you own one home and are planning a new build construction, you may also be able to use your existing equity to pay the costs
of construction. An experienced loan originator can help you explore options to take out a second mortgage or home equity line of credit on your existing property to pay for the construction costs. When the build is done and you are ready to move in, the sale of your previous home pays off the balance off the HELOC. This option can be helpful if you are downsizing, have high equity in your existing home, or don’t qualify for a traditional construction loan. However, you will have to pay into the
principle on the HELOC during the construction process, so it may result in higher monthly obligations. There are many options available to homeowners looking to build a new home. At First Securities Mortgage, our licensed loan originators will help you review your mortgage options to find a construction loan that works for you. Fill
out an application to get started today. If you can’t find the right home to buy, you might be thinking about how much it will cost to build a new house or renovate the one you currently call home. The process of
borrowing the money to pay for this project is different from getting a mortgage to move into an existing property. Here’s everything you need to know about getting a construction loan. What is a construction loan?A home construction loan is a short-term, higher-interest loan that provides the funds required to build a residential property. Construction loans typically are one year in duration. During this time, the property must be built and a certificate of occupancy should be issued. Lightbulb Construction loan statistics
How do construction loans work?
Construction loans usually have variable rates that move up and down with the prime rate. Construction loan rates are typically higher than traditional mortgage loan rates. With a traditional mortgage, your home acts as collateral — if you default on your payments, the lender can seize your home. With a home construction loan, the lender doesn’t have that option, so they tend to view these loans as bigger risks. On average, you can expect interest rates for construction loans to be about 1 percentage point higher than traditional mortgage rates, usually falling somewhere between 5 and 10 percent. The initial loan term generally lasts the length of your construction project. Because construction loans are on such a short timetable and they’re dependent on the completion of the project, you need to provide the lender with a construction timeline, detailed plans and a realistic budget. Depending on the type of construction loan, you might be able to convert the construction loan to a traditional mortgage once the home is built. This is known as a construction-to-permanent loan. If the loan is solely for the construction phase, you might be required to get a separate mortgage designed to pay off the construction loan. Differences between construction loans and traditional mortgagesBeyond the cost and repayment timeline, construction loans and mortgages have a few main differences:
Types of construction loansConstruction-to-permanent loanWith a construction-to-permanent loan, you borrow money to pay for the cost of building your home, and once the house is complete and you move in, the loan is converted to a permanent mortgage. The benefit of the construction-to-permanent approach is that you have only one set of closing costs to pay, reducing your overall fees. “There’s a one-time closing so you don’t pay duplicate settlement fees,” says Janet Bossi, senior vice president at OceanFirst Bank in New Jersey. Once the construction-to-permanent shift happens, the loan becomes a traditional mortgage, typically with a loan term of 15 to 30 years. Then, you make payments that cover both interest and the principal. At that time, you can opt for a fixed-rate or adjustable-rate mortgage. Your other options include an FHA construction-to-permanent loan — with less-stringent approval standards that can be especially helpful for some borrowers — or a VA construction loan if you’re an eligible veteran. Construction-only loanA construction-only loan provides the funds necessary to complete the building of the home, but the borrower is responsible for either paying the loan in full at maturity (typically one year or less) or obtaining a mortgage to secure permanent financing. The funds from these construction loans are disbursed based upon the percentage of the project completed, and the borrower is only responsible for interest payments on the money drawn. Construction-only loans can ultimately be costlier if you will need a permanent mortgage because you complete two separate loan transactions and pay two sets of fees. Closing costs tend to equal thousands of dollars, so it helps to avoid another set. Another consideration is that your financial situation might worsen during the construction process. If you lose your job or face some other hardship, you might not be able to qualify for a mortgage later on — and might not be able to move into your new house. Renovation loanIf you want to upgrade an existing home rather than build one, you can compare home renovation loan options. These come in a variety of forms depending on the amount of money you’re spending on the project. “If a homeowner is looking to spend less than $20,000, they could consider getting a personal loan or using a credit card to finance the renovation,” Steve Kaminski, head of U.S. Residential Lending at TD Bank, says. “For renovations starting at $25,000 or so, a home equity loan or line of credit may be appropriate, if the homeowner has built up equity in their home.” Another viable option in a low mortgage rate environment is a cash-out refinance, whereby a homeowner would take out a new mortgage at a higher amount than their current loan and receive that overage in a lump sum. As rates tick up, though, this option becomes less appealing. With any of these options, the lender generally does not require disclosure of how the homeowner will use the funds. The homeowner manages the budget, the plan and the payments. With other forms of financing, the lender will evaluate the builder, review the budget and oversee the draw schedule. Owner-builder construction loanOwner-builder loans are construction-to-permanent or construction-only loans where the borrower also acts in the capacity of the home builder. Most lenders won’t allow the borrower to act as their own builder because of the complexity of constructing a home and experience required to comply with building codes. Lenders that do typically only allow it if the borrower is a licensed builder by trade. End loanAn end loan simply refers to the homeowner’s mortgage once the property is built, Kaminski explains. A construction loan is used during the building phase and is repaid once the construction is completed. A borrower will then have their regular mortgage to pay off, also known as the end loan. “Not all lenders offer a construction-to-permanent loan, which involves a single loan closing. Some require a second closing to move into the permanent mortgage, or an end loan,” Kaminski says. What does a construction loan cover?Some things a construction loan can be used to cover include:
It’s important to discuss these items with your lender, specifically what will be included in your loan-to-value calculation, according to Kaminski. “Oftentimes, construction loans will include a contingency reserve to cover unexpected costs that could arise during construction, which also serves as a cushion in case the borrower decides to make any upgrades once the construction begins,” Kaminski says. “It’s not uncommon for a borrower to want to elevate their countertops or cabinets once the plans are laid Other costs to build a houseBuilding a home costs more than just the material and labor required to erect the structure itself. Fortunately, the cost of permanent fixtures like appliances and landscaping can generally be included in the loan amount. Home furnishings, on the other hand, are not covered within a construction loan out.” Construction loan requirementsThe companies that offer construction loans usually require borrowers to:
How to get a construction loanGetting approval for a construction loan might seem similar to the process of obtaining a mortgage, but getting approved to break ground on a brand-new home is a bit more complicated. Generally, if you’re wondering how to get a construction loan, you should follow these four steps:
Get homeowners insurance: Even though you may not live in the home yet, your lender will likely require a prepaid homeowners insurance policy that includes builder’s risk coverage. This way, if something happens during the construction process — the halfway-built property catches on fire, or someone vandalizes it, for example — you are protected. Factors to consider about construction loansBefore you apply for a construction loan, ask yourself these key questions. Could your project face significant timeline issues?Talk to your contractor and discuss the timeline of building the home and if other factors could slow down the job. Keep in mind there are still bottlenecks plaguing production, which first started with pandemic supply-chain disruptions and still persist. Be prepared for material prices to stay high, especially in light of inflation, and ongoing shortages to affect your project. Do you want to simplify the borrowing experience?Decide if you want to go through the loan process once with a construction-to-permanent loan or twice with a construction-only loan. Consider how much the closing costs and other fees of obtaining more than one loan will add to the project. When getting a construction loan, you might not just be accounting for building the house; you may also need to purchase the land and figure out how to handle the total cost later, perhaps with a permanent mortgage when the home is finished. In that case, a construction-to-permanent loan can make sense in order to avoid multiple closings. If you already have a home, though, you might be able to use the proceeds to pay down the loan. In that case, a construction-only loan might be a better choice. What is the drawing process from your construction loan?Ask your lender how money gets disbursed from your loan amount. Some lenders allow for monthly draws, while others will only authorize a draw after a passed inspection. Inquire about any processes or documentation required to pull money from your construction loan so that your contractor can use it. Understanding this process — and ensuring your contractor does, too — can help to avoid delays because of insufficient funds. How to find a construction loan lenderCheck with several experienced construction loan lenders to obtain details about their specific programs and procedures, and compare construction loan rates, terms and down payment requirements to ensure you’re getting the best possible deal for your situation. “Because construction loans are more complex transactions than a standard mortgage, it is best to find a lender who specializes in construction lending and isn’t new to the process,” Bossi says. If you have trouble finding a lender willing to work with you, check out smaller regional banks or credit unions. They might be more flexible in their underwriting if you can show that you’re a good risk, or, at the very least, have a connection they can refer you to. Can you use a home equity loan to make a down payment on a home?Can you use a home equity loan to make a down payment on a home? Yes, if you have enough equity in your current home, you can use the money from a home equity loan to make a down payment on another home—or even buy another home outright without a mortgage.
Can you use a Heloc for a down payment on another home?As long as you meet the requirements of the home equity loan or HELOC lender, you can use these funds toward the purchase of another house. However, some lenders may regulate the source of your down payment funds when buying a new property.
Should I shop around for a construction loan?During the construction phase, borrowers make interest-only payments. These types of loans can be much more expensive than traditional mortgages, so if you decide to go in this direction, shop around, compare rates and find the best deal before you pull the trigger.
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Using home equity for down payment on construction loan
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