A Guide to Home Construction Loans: Everything You Need to Know

The cost of building an average 2,000 square foot home is around $290,000.

It is not easy to have that kind of money lying around. As such, most people turn to mortgages and other types of loans to finance their homeownership dreams.

However, if you are intent on constructing your own house rather than buying one, you are likely not going to be getting a mortgage. This because financing institutions rarely lend money for something that does not exist.

Fortunately, you have the option of a construction loan. This article will discuss everything you need to know about this financing option.

What Is a Construction Loan?

Also known as a homebuilding loan, it refers to a type of short-term loan that pays for the costs associated with building a house.

Most construction loans are usually offered for a set term – typically around a year – to give you time to construct your home.

Once the construction process is done and the home is complete, you might need to get a new loan in order to pay off the construction loan. That loan is referred to as the end loan.

There are different types of construction loans. The main ones, however, include:

• Construction-to-Permanent Loan

In this option, the loan usually starts out as financing to construct the home. However, once the construction is done and you have settled into the house, the loan converts into a traditional mortgage loan.

This type of construction loan is usually ideal for most prospective homeowners since you will have just one set of costs to pay.

• Construction-Only Loan

This option covers just the home’s construction.

Thus, if you decide to take a mortgage, you will need to get a separate one. Nonetheless, the mortgage can be used to help pay for the construction loan. The benefit of using this option is that it does not request a large down payment.

How Does a Construction Loan Work?

While conventional loans such as mortgages are usually paid in lump-sum by the financing company, home building loans are typically paid out in installments.

Thus, the lending company pays your builder per construction phase. The total costs are then transferred to you once the project is done.

These installments are usually referred to as draws. However, before a draw is made, the lending institution will conduct an inspection to verify the estimated costs that the builder has given them.

As such, because the financing of homebuilding loans varies considerably between phases, it is critical that you work with a good home builder.

Benefits of Using Homebuilding Loans

There are some advantages to be enjoyed by choosing construction loans over other types of credit financing. They include:

• Interest-Only During Construction

Due to the fact that the loan is not paid out in full until the building is complete, the financing institution will not ask you to start paying down the principal until then.

Therefore, you will only be expected to pay smaller, interest-only payments on the loan. This allows you more time to save.

• Flexible Terms

Even though you have to provide the lending company with specific project plans, homebuilding loans are typically more flexible in regards to loan terms and guidelines as compared to conventional loans.

As such, you will be able to work your loan terms around your project needs.

• More Scrutiny

As mentioned earlier, before the lending company makes a draw, it performs an inspection to ensure that the proposed costs are accurate. The benefit for the homeowner is that it ensures that your project stays on budget.

Qualifying for a Home Construction Loan

The reason why most financing institutions are leery of homebuilding loans is that they have to put their trust in the building.

The banks and other lending institutions are usually more comfortable giving loans for things they can see, not that are to become.

It is not hard to see why since if things were to go wrong – for example, if a builder does a bad job and the property has little value – the institution will have made a bad investment.

This is why home construction loans tend to have stringent requirements. These include:

• Qualified Home Builder

There is no other way of ensuring that the end product will be of value other than getting a reputable builder involved. The builder must be licensed in addition to having a track-record for constructing quality houses.

Thus, if you are intending on acting as your own contractor, financing companies might find it hard to grant your wish for a loan.

• Detailed Specifications

The lender will require to see details such as building plans as well as the materials to be used. The builder is responsible for preparing those specifications.

• Valuation by an Appraiser

The lender is also likely to bring in an appraiser to help them estimate the value of the projected house as well as the land it is being built on. The appraiser obtains this value by comparing the project with similar features.

• Down Payment

Your lender is also going to require that you put down a down payment for your construction loan.

This serves as security so that you cannot just walk away unscathed if things were to go wrong. Thus, it ensures that everyone has only good intentions or the project.

If you have good credit and can meet the above criteria, a construction loan should be fairly easy to get.

Nonetheless, the financing institution may also require other information such as your income – so they can know whether you can afford payments – as well as your current home.

Work with the Right Lender

Even if you might have difficulties finding a lender willing to finance your project, do not sign up with the first one you come across. It is important to ensure that you are working with a professional and reputable company.

Such a company will ensure that you only work with similarly professional builders and other associates so that you can avoid projects that can lower your home’s value.

Making the Decision

There is something about seeing your dream house come to life that simply buying a finished house cannot give. This is why many people decide to build their own homes.

If you fancy building your own home, you should probably consider getting a construction loan to finance your project.

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