Many potential homeowners plan to build their own dream home. While this plan does come with some challenges, particularly in obtaining financing, a new home comes with several advantages, including:
- More space,
- Improved safety features,
- Energy efficiency,
- Options and upgrades
- Potential builder incentives.
If you want to build your own home, rather than buying an existing home, you may want to consider a construction loan. Construction loans are used by builders and potential homeowners, and they differ from a standard mortgage loan.
This specialty type of loan is short-term, unlike most mortgages, and most are designed to be repaid when the construction period of the home is complete. Funds are typically granted and released to a builder, who uses the money as needed to build the home. Payments are often interest-only during construction, and become due upon completion of the home. Completion means the house has a certification of completion.
Most construction loans are variable-rate loans. When you obtain the loan, the contractor and the lender will establish a draw schedule based on construction stages, and interest is charged on money disbursed to date. These loans often have additional documentation requirements. Custom building projects usually require construction project and builder validation, inspection reports submitted prior to any payments to the builder, and verification prior to the final loan preparation.
One important consideration when choosing a construction loan is how much of the project cost the lender will provide. These loans are easier to obtain if you already own the land, as it may be considered equity on the loan. If the land is not purchased at the beginning of the loan, expect to pay a high down payment to qualify for construction financing.
The down payment is typically a percentage of the cost of the project, including land and construction costs. Most loans require a down payment of 20% to 30%.
Construction loans have various features for borrowers who want a short-term loan. The most popular feature is a construction loan that may be rolled over and transferred into a regular mortgage without paying closing costs a second time.
Many homeowners choose a construction-to-permanent financing program, in which the loan is converted to a mortgage once the certificate of occupancy is issued. The advantage to this program is that you will have a single application and closing.
This option is becoming more common with lenders, who combine both the construction loan and a mortgage into a single 30-year loan. While this will save on closing costs, some borrowers prefer the ability to shop around for mortgages later, as interest rates on construction-to-permanent financing loans tend to be higher than conventional mortgages.
If the builder, not the homeowner, applies for the construction loan and funds the project, the owner will have the option of rolling over the loan. In this case, the owner must apply for a mortgage.