Construction mortgage loans offer homebuyers who want to build their dream home an excellent financing option; however, they require extensive preparation work such as signing an agreement with their lender and creating detailed building plans. Lenders may require cash reserves as part of this loan agreement.
Before applying for these loans, it’s advisable to speak to multiple lenders. They will need access to your financial documents such as tax returns, bank statements and W-2s in order to evaluate them appropriately.
Types
Prospective home builders can access various construction mortgage loans. Certain lenders specialize in this form of financing while others only provide traditional mortgages. Before selecting one lender over another, compare rates, terms, and down payment requirements before making your choice.
Contrary to typical mortgage loans, construction loan funds are disbursed in draws as needed throughout the building process. Before each draw release occurs, however, an inspection and appraisal are often necessary by lenders before release of funds is granted.
Some construction mortgages can be converted to permanent loans once construction has ended – this process is known as construction-to-permanent loan refinancing. While it makes the financing process simpler and cheaper by consolidating two loan transactions into one loan transaction, completing two applications and paying two sets of closing costs could prove detrimental should your financial circumstances worsen during construction preventing you from qualifying for permanent financing later.
Qualifications
Construction loans require more scrutiny from lenders than conventional mortgage loans, including an examination of your credit history and cash reserves. Lenders also want to approve your choice of builder as well as your construction plan, such as blueprints, line item budgeting and payment schedule – more detailed is better! Typically lenders require home appraisal and builder’s risk coverage policies during construction as part of the application process.
In addition to these requirements, lenders typically expect at least 20 percent down from borrowers seeking stand-alone construction loans; those seeking construction-to-permanent loans (typically used by owner-builders) may require larger down payments. Once construction is finished, however, this loan converts into a permanent mortgage and repayment of principal and interest begins immediately; throughout construction an appraiser or inspector checks work regularly to ensure it complies with applicable codes.
Fees
Some lenders provide end loans, which you can repay after the build is complete, at higher interest rates than a traditional mortgage due to being riskier for them as your home does not serve as collateral.
Alternative lenders provide construction-to-permanent loans, which combine your home construction loan and permanent mortgage into one loan to help simplify and lower closing costs.
To qualify for a home construction loan, typically it requires having both an excellent credit score and debt-to-income ratio, along with making at least 20 percent down payment. Once these requirements have been fulfilled, shop around to find the best lender. Look for those offering low fees and quick approval processes as you might have to submit contracts between builder and yourself as well as plans detailing plans and schedule. In some instances, an appraiser or inspector from your lender may visit regularly to check progress against benchmarks set by them.
Payments
Construction loans often feature variable interest rates and require monthly payments of interest and principal; however, construction loan payments typically only need to be made during construction; once finished borrowers must return all disbursed funds as well as any unpaid balance plus accrued interest. Lenders also conduct various inspections during this stage in order to gauge progress and verify costs; each inspection requires payment to the lender separately.
Lenders also require larger down payments for construction loans to ensure they’re invested in the project and won’t lose out financially if construction runs over budget or is delayed, along with seeing personal credit history and being prepared for this additional step of the loan process. If borrowers lack cash for an upfront down payment option, another solution could be converting your construction loan into a permanent mortgage after construction has concluded, which avoids second set of closing fees but may cost more overall.