When you make the decision to buy a custom home, you’ll need to apply for a mortgage. Once the project is underway, you soon find a construction loan is also essential. So, how does this process work and what should you know?
The Basics
Even though a builder will be constructing your home from the ground up, both loans – a construction loan that transitions into a standard mortgage – need to go through the future homebuyer.
However, as recent housing market trends have shown, this is easier said than done. For one, procuring a construction loan proves to be a challenge because the project lacks collateral. Then, the lender often institutes project monitoring guidelines for repayment.
Yet, the construction loan usually has a very short term – a maximum of one year – and has a variable rate based on the prime rate. So, expect to pay higher interest initially before your mortgage kicks in due to this latter point.
Why the short term? Lenders underwrite the loan for the theoretical length it should take to construct a home. At the same time, this portion also includes a line of credit up to a specific limit. Thus, you and your builder need to realize the project must be completed within a certain budget and by a specific deadline. Once you’re living in the property, this loan converts into a typical mortgage.
Additionally, lenders write this program as a portfolio loan which, instead of being strictly based on the bond market, further factors in credit, financial history, your income and project equity.
How It Works
When you first apply for a construction loan, the lender requests a timetable that illustrates your budget and overall plan for funding. After you’ve been approved, you’ll be put on what’s known as a “bank draft schedule” based on the project’s stages. From there, you’ll make interest-only payments during construction, but be aware that as the funds are requested, the lender periodically checks up on the job’s progress.
Once the home build is complete and you’ve moved in, the loan converts to a mortgage with a 30-year term.
Loan Options
Just like there’s no single program to purchase an existing property, loans for building custom houses have a couple of options:
- One-Step Loans: Here, you use the same lender for both the construction loan and mortgage. In the process, you’ll fill out paperwork for both at the same time and, when you’re ready to close, do both together. While this looks convenient at a glance, be aware that this option has more restrictions. Mainly, the lender sticks with a strict limit and timetable, allowing for no variables in and delays with your project.
- Two-Step Loans: With this option, you can split up the loans – key if you need a jumbo loan. This option allows for greater cost and timeline flexibility because the loans can be handled by different lenders.
No matter which program you select, all construction loans have a limit, which directly effects how much your project can cost. Thus, in the planning stages, it’s wise to allot a portion to potential expenses, such as excavating a large boulder from the building site, the appliances you add and any changes made to the structure.
Interested in a custom home in Central Connecticut? Direct your search to By Carrier’s communities. To learn more about our properties, contact our team today.