Home Construction Loan Basics

If you are looking to build your own house, and don’t have the cash to finance the construction, you will probably be considering a home construction loan. The following are facts about home construction loans, and the two basic ways that lenders handle this situation:

  1. Standalone Home Construction Loan
    A standalone home construction loan is the simplest construction loan you can get. You will probably have a substantial down payment, a heavy interest rate considering the risk involved in building a home and the things that can go wrong, with a balloon payment at the end of construction to pay off the balance.

    In this scenario, there are probably two lenders, and you will need to close two loans, the construction loan with the first lender, and then the permanent loan with the second lender. This is not typically what people want to do, because there are two sets of closing costs, the general headache of dealing with two lenders, getting qualified separately for each, and much more paperwork.

  2. Combination Home Construction-to-Permanent Financing
    For most people that want to build their own home, this is the more logical way to go. In this scenario, there is only one lender, and one qualification process. The lender will approve you for the construction loan, and probably will only charge small interest only payments during the construction phase of the project. There will likely be a “draw” process by the particular lender’s policies and procedures to pay the contractor incremental payments during construction. Check with you lender as to how stringent they are with the draws. How often can you draw? Do they have to inspect before releasing funds? Both are good questions to get answered before choosing a lender.

    After the construction phase is complete, there will be an automatic conversion to permanent financing. Usually all that is left after the last draw will be the final closing, where your permanent loan will be put in place. From there, it is just like any other home mortgage, so be sure to get all the details from the lender as to term, interest rate, down payment, etc. Try to ask as many questions as possible before getting involved with a lender to be sure you don’t miss something important.

These are the two typical ways that lenders loan money to people wishing to build there own home. But be careful, as lenders are not construction experts, and do not really help you build your house. You need to be very sure of the contractor you hire to build your house. Spend some time checking references, and looking at other homes that the contractor has built or is in the process of building. Get to know them, because contractors have some of the worst reputations compared to other industries when it comes to getting what you pay for. One last note, you need to make absolutely sure that you do not give the contractor the final check until ALL of the work is complete. Once you have paid them the last bit of money left on the contract, they are gone, and I mean gone for good. Until next time…

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