If you’re considering building a semi, or fully custom home one of the first things you’ll want to consider is how you’ll finance the construction of your new dream home. Construction loans are not only more difficult to qualify for, but they are also more complex and can be a bit overwhelming. It’s important that you understand the intricacies of these loans before you apply for one.
There are two main types of home construction loans:
Construction-to-Permanent: With these loans, the lender advances the money to pay for construction. After the home is built, the same lender rolls the loan balance into a standard mortgage. This is by far the more popular option.
Stand-Alone Construction: With these loans, it’s often the lender that advances money to build the house. When construction is finished, you get a mortgage to pay off the construction debt.
With a construction-to-permanent loan, there is one closing. During construction, you pay only interest on the outstanding loan balance. It converts into a mortgage after the home is built. You lock a maximum mortgage rate at the beginning, when construction begins.
A stand-alone construction loan could be worthwhile if it allows a smaller down payment. Because this type of loan doesn’t allow you to lock a maximum mortgage rate in advance, you risk a rise in interest rates which in today’s market is a serious risk. Another disadvantage is that your circumstances could change during construction, making it impossible to qualify for a permanent loan—and you pay for two closings: once on the construction loan, and again on the mortgage when the home is complete.
More Difficult to Qualify
Qualifying for a construction-to-permanent loan could be more onerous than getting a regular mortgage. This is because the lender doesn’t have the completed house as collateral to back the loan during the construction period.
Your down payment is likely to be at least 20% of the loan amount, although some lenders go as low as 10%. The lender will determine whether you can afford the loan payments during construction while you’re paying the rent or mortgage on your current home.
Have Adequate Savings
The lender will make sure you have savings to pay for unexpected costs. There are always cost overruns when you’re building a home (especially a fully custom home and one the builder has not built before) many of which you won’t know about until you are into it. Lenders don’t want to ensure borrowers have sufficient reserves and that they aren’t positioned to use everything they have before they start. While most cost overruns come about as a result of borrowers changing their minds about what they want as construction proceeds, for example hardwood floors in the master as opposed to carpet, a fully enclosed steam shower with multiple heads as opposed to a simple rain head shower, a dedicated 11.2 channel system with a 4K Projectors as opposed to a 7.1 channel with a 1080P Projector.
Do Your Due Diligence on the Builder
An important aspect of building your home is choosing the right builder. Find one that has built the kind of house you want in terms of price, style and size. Look into the builder’s credentials with the local Building Industry Association (BIA) and ask for references from your Real Estate Agents as well as previous clients (including residents of the community in which you wish to live). You could also see if there are any complaints against the builder with the Better Business Bureau (BBB).
Typically, your lender will look into the builder’s credit standing, financial situation and licenses, as well as the track record for building similar homes. Lenders seek to assess risk and with construction loans there is an added element of risk associated with the builder and the fact the home which typically serves as the collateral doesn’t exist yet.
Lenders will conduct routine inspections as the home is built. During this period, the lender pays the builder in stages—called “draws”—and usually sends an appraiser or inspector to make sure that construction is proceeding as planned and that the prior draws have in fact been allocated towards the construction of the home. The lender is constantly looking at how much it is going to cost to complete the house to ensure your project stays on track. In most instances you will be required to sign off on each draw request to ensure that you are kept informed about how the work is proceeding.
If you, or someone you know is considering Buying or Selling a Home in Columbus, Ohio please contact The Opland Group. We offer professional real estate advice and look forward to helping you achieve your real estate goals!
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