Building a Home: Construction Financing

January 21, 2013 by · Leave a Comment 

So you’ve decided to purchase a new-construction home. This series of posts will detail the process from start to finish, and hopefully give you a good idea of what to expect throughout the process. In part one, we’ll look at how to get started by securing construction financing and what to expect from the lender.

Financing New Construction

The first thing you should do before embarking on the journey of building a home is to secure financing. Actually, this is true no matter what type of home you’re buying, be it resale or new construction. You need to know how much house you can afford.

You’ll need to shop for lenders. Compare rates and loan terms. Construction loans sometimes have a higher interest rate than a traditional resale mortgage. During construction you may be paying a bit more in interest, but when the project is finished, the construction loan will convert to a long-term note and you should be able to get a lower rate going forward.

Be aware of the time limit on the construction loan. If the loan term is for nine months, be sure the builder can complete construction in that time, or you’ll likely be paying penalties every month that construction drags on (this happened to a member of our team). The penalty will vary from lender to lender, so it’s important to ask about this when shopping around.

Construction financing differs from a mortgage used to buy a resale home in other ways, as well. For starters, the bank has to approve your builder. Some of the larger builders will already be approved by multiple banks, or they may have an in-house or affiliated lender that offers incentives to use them. You might get some discounts if you go with an affiliated lender, and sometimes this is the most cost-effective way to go. But don’t be afraid to comparison shop. Building a home is a huge undertaking, and you want to be diligent every step of the way.

If you go with a smaller builder, then the bank will likely need to check out the company finances before they will give the go-ahead to your project. This protects both you and the lender, and any reputable builder will be happy to provide the necessary paperwork to gain approval. If a builder balks at this, this should raise red flags. The last thing you need is for a builder to go belly up in the middle of building your home.

Another difference with construction loans: The bank holds onto the money and makes payments to the builder in installments, called draws. Before the bank will release a draw to the builder, an inspection will be scheduled to make sure work on the house is progressing in a timely manner and the work is up to par. Some banks require the borrowers’ permission to release the funds. If possible, go to the house yourself to check and make sure the work that has been done is what is in the contract. If there’s a problem, notify the builder and the bank immediately. And consult an attorney before withholding payment.

As with all financing, do your research. Ask questions about the process, fees, terms, etc, so you don’t wind up surprised at any point during the process. Building a home can be stressful, but some of that stress can be reduced if you understand what you’re getting into, starting with the construction financing.

Questions about building a home or financing? Contact us! We’ll be happy to help.

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