Financing Your New Home Construction
Although it may not be as enjoyable as selecting your paint colors, hardwood flooring or kitchen cabinets, the financing of your new home is an important and integral part of a successful new home construction project. Let’s take a look at some of the key factors in securing financing for building your new home.
Setting your budget and getting pre-qualified for a loan
The first step in financing a new home construction project is to assess your financial situation and set a realistic budget. Then work with a mortgage lender to take a close look at your income, savings and monthly expenses to determine how much you can afford to spend on your house. Having a pre-approval letter in hand to share with your builder will let them know you're serious and help them show you home designs within a price range you can comfortably afford.
Building your new home before selling your current home
Before you begin building, you should evaluate your living situation. While your home is being built, where are you going to live? The construction period could take anywhere from six to twelve months. If you own a home and plan to sell it, timing is very critical. You don’t want to put your house on the market too early and not have a place to live.
What if you are planning to use the proceeds from the sale of your current home to finance construction? A Bridge Loan, sometimes called a Swing Loan, is a short-term loan that allows you to start construction of your new home before your current home is sold. In this circumstance, Dollar Bank offers an Interest-Only Bridge Loan for borrowers who have a mortgage application in process, allowing you to use the equity in your current home to pay off your current mortgage and finance your down payment and closing costs on your new home.
Financing options for new construction
There are basically two ways to finance construction; a construction loan or an end loan. Both accomplish the same thing with different methods of disbursing the funds.
A construction loan is essentially two loans, the construction loan and the permanent loan, often referred to as a “construction/perm” mortgage. Your builder will provide the lender with the construction agreement and the plans at the time you apply for the mortgage. This will allow the lender to appraise the property and determine the amount they are willing to lend.
The total amount needed to complete the home is then placed in an escrow account with the lender at the time of closing. The amount escrowed would include the loan proceeds and any funds you are providing as the down payment.
The construction portion of the loan is financed with payments or draws made to the builder as different phases of the construction are completed. No payments are due until funds from the loan proceeds are disbursed. During the construction period you make interest only payments on the amounts drawn. The payments increase as the total amount drawn increases. The appraiser, or a bank inspector, will inspect the property prior to any draw disbursements. This will verify the work has been completed based on the original plans and specifications submitted.
Once the home is complete, the permanent or “perm” loan begins, and you start to make regular monthly mortgage payments. The term of this portion of the loan will be the remaining number of months after the construction period. For example, if the total loan is for 30 years and the construction loan is for six months, the permanent loan payments will be calculated on a term of 354 months.
Dollar Bank offers fixed and adjustable-rate mortgages to fund the construction of your new home. Your construction mortgage automatically converts to a permanent mortgage with the same low rate when construction is complete. Dollar Bank also retains the servicing of our construction mortgages, so you can feel confident knowing that your mortgage is in caring and capable hands for the duration of your mortgage term.
Typical draw schedule for a construction loan
If you are purchasing the lot at the same time as closing on the mortgage (this is very common), a portion of the mortgage loan may be used to secure the lot. The deed is then transferred into your name prior to construction. The amount drawn from the loan to secure the lot will be considered a draw and interest-only payments will begin.
The major difference between a construction loan and an end loan is the disbursement to the builder. A construction loan is paid in phases, and an end loan is one payment to the builder. Similar to a construction loan, the lender will require a copy of the construction agreement and the plans to appraise the home at the time of your mortgage application. The builder, prior to construction, usually requires a deposit in this type of arrangement.
Both financing options require some sort of down payment as well as funds for closing costs, taxes and insurance. These can be in the form of cash from savings, the sale of your current home or existing equity in the lot. If you own a lot, you can use the equity in the lot as your down payment. The rules vary from lender to lender, but generally the standard amount of equity is the price you paid for the lot. For example: You purchased a lot for $50,000 and are planning to build a home for $400,000. The total package or value would be $450,000. Since you own the lot, the lender will consider the $50,000 as your down payment. You will then be able to finance $400,000.
Paying your taxes
During the construction period, you will be responsible for payment of the real estate taxes. Typically, the tax bills due during construction are based on the lot value. Once your home is complete, your real estate taxes will be estimated based on the calculations done by the local schools, municipalities and/or counties. At this time, you will begin paying 1/12 of your taxes with your mortgage payment into an escrow account for impending tax payments.
Both construction/permanent loans and end loans have only one closing. A construction/permanent loan closes prior to breaking ground. An end loan closes when the home is complete, and the entire construction amount is paid to the builder in one payment. At the time of closing, you will need to have a Homeowner’s Insurance policy in place. This policy would include builder’s risk coverage as well as replacement cost, vandalism, fire and hazard. Closing is when you will also bring any funds being used towards the down payment and closing costs.
Building a home can be an enjoyable yet challenging process. Understanding the financing is just as critical as understanding the construction process. It can often be the key to successful results. Do your homework and be patient. It’s worth it!
If you’re considering building a new home, you’ll be glad to know that Dollar Bank makes construction financing easy and affordable. Our mortgage experts are available to answer your questions about financing your new home construction project. Talk to one of our professionals today. Stop by any Dollar Bank office, call 1-800-344-5626 or visit Dollar.Bank/MortgageExperts.
This article is for general information purposes only and is not intended to provide legal, tax, accounting or financial advice. Any reliance on the information herein is solely and exclusively at your own risk and you are urged to do your own independent research. To the extent information herein references an outside resource or Internet site, Dollar Bank is not responsible for information, products or services obtained from outside sources and Dollar Bank will not be liable for any damages that may result from your access to outside resources. As always, please consult your own counsel, accountant, or other advisor regarding your specific situation.
Posted: October 30, 2023