Building a construction loan
The American Dream of home ownership is more alive than in recent years with the housing market improving daily. But what about the American Dream of building your own home? Are future homeowners ready to take on the financial risks associated with building from scratch in order to have that once in a lifetime experience of building their dream home?
The first hurdle to overcome, if you’ve decided to take on the thrill of new home construction, is how you pay for it. If you can’t afford to pay for the cost of the construction up front and need to obtain financing, it could be a little tricky. Basically you’re asking a bank or lender to give you money for something that doesn’t exist and to have faith in not only you as the borrower, but also in your contractor.
Construction loans are typically short term loans usually around a year to allow you the time to build your home. Funds required during the construction process are disbursed in the form of a schedule of draws. Interest is due on only the money borrowed as it is disbursed. Then at the end of the construction process, you will need to get a new loan to pay off the construction loan, essentially refinancing into a conventional mortgage.
Usually constructions loans require a pretty sizeable down payment with 20 percent to 30 percent not uncommon. Some lenders are also combining the two loans, the short term loan and the refinanced conventional mortgage, into a single loan product called construction-to-permanent financing. This type of loan does streamline the process and will result in closing cost savings, however, you might be paying an extra quarter to a half percent higher than if you wait to refinance after construction is completed.
Lenders are very careful when handling constructions loans and will impose some strict requirements including, but not restricted to, the following: A qualified licensed builder with an established reputation for building quality homes is essential. If your intention is to build your own home or have an owner/builder arrangement, it could be difficult to get a loan.
You also will have to present detailed specifications including floor plans. Details about the materials being used, ceiling heights and insulation are just some of the required specifications. Based on the specifications and land value, the lender will require an appraisal to verify the completed home will have a value within the same range of similar homes in the surrounding area.
There are serious downsides to building a home, which could be both expensive and inconvenient. If your home is not completed on schedule, you may be required to pay a fee to extend the construction loan or be forced to carry two mortgages. If there is a market adjustment during the construction period and your newly completed home is worth less than anticipated, you may need to come up with extra cash when it comes time to refinance into the end loan. Or if your income or personal finances change during the construction time, you may not be able to qualify for the refinanced loan.
In the final analysis, before you start to build your dream home, make sure you have the funds, security and discipline to weather any financial crisis or setback that is sure to occur. You and your family can live the American Dream in an existing home or in one you built; you’ll have to decide which is best for you.