Buying a home may require a mortgage, but building your dream home requires a different type of mortgage – a construction loan. New construction loans can help pay for home building or renovations and work differently from traditional loans. We’ll delve into what you need to know about a construction loan and how it works.
What is a new construction loan?
A construction loan is a short-term loan that covers the costs of work and materials for new-build homes. Some of the items you can finance with a construction loan include permits, contractor labor, roof framing costs, and many other expenses that come with building a house.
Types of New Construction Loans
Construction lenders provide different types of loans for a variety of homebuilding scenarios. Here are some financing options when building a new house:
Also known as “single-close” construction loans, this type of loan converts to a permanent mortgage after construction is completed. The benefit with construction-to-permanent is that there is only one set of closing costs to pay, reducing your overall fees.
Construction-only loans are also referred to as “two-close” construction loans that require closing on two different loans. The first loan is taken out for the construction. Once work is completed, the loan is paid off with a new loan, called an end loan. The end loan is based on terms locked-in as the home nears completion.
Renovation Construction Loan
If you want to upgrade your existing home instead of building one, you can look for a renovation loan. This type of loan comes in various forms depending on the amount of money you’re planning on spending.
How Construction Loans Work
As mentioned previously, new home construction loans work much differently from the typical mortgage loans. The lender pays the loan to the contractor, not the borrower, in installments. Once the project has been completed, construction loans can be either converted to permanent mortgage or paid in full.
How to get a Home Construction Loan
Before applying for a loan, the borrower should meet with the designated contractor to understand the total cost to build so a loan amount can be established. The lender will then review a borrowers’ employment history, savings, income stability, and ability to pay back the loan. A property appraisal will also be obtained to support the value of the project. To qualify you will need an excellent credit score, stable income, low debt-to-income ratio, and a down payment of 20 percent.
How to Find a Lender
It is important to find a lender who specializes in construction lending and isn’t new to the process. Research several lenders to obtain detailed information about their background and specific programs. We recommend that you compare construction loan rates, terms, and down payment requirements to make sure you’re getting the best deal possible.