In this video I talk about some general common question in regards to construction loans. Below is an expanded list of common questions I have compiled over my career as a lender. I have been lending since 1991 so make sure to scroll down as there are a number of questions and there is a good chance I have answered many questions you may have. If there is something I missed, let me know so I can add it to this page for others.
How does a construction loan work?
Traditionally, construction loans are done two different ways. The first option is a construction-permanent mortgage and the second option is a construction-only mortgage.
A construction-permanent mortgage is both your construction loan and long term mortgage combined into one loan, which means you only have one closing for both your construction loan and your long term mortgage. This saves you time and money. Best of all, with this type of construction loan, your interest rate is guaranteed up-front, which means that you don’t have to lose sleep over what happens to interest rates while your home is being built. You have peace of mind knowing exactly what your interest rate and monthly payment will be.
A construction-only mortgage is just that. It is a short term mortgage that provides financing for just the construction period. Your end loan (permanent long term mortgage) is taken out upon completion of your home. Your construction loan and end loan are two separate loans, which means you have two separate costs and generally the interest rate for your end mortgage is NOT guaranteed until completion of your home.
How much of a down payment am I required to have?
We will typically finance up to 95% of the cost to build your home (land and construction cost). Down payments of less than 20% will typically require Private Mortgage Insurance (PMI). In some cases, the cost of PMI insurance can be either reduced or eliminated depending on your loan structure. The minimum 5% down payment is required to come from your own personal funds and cannot be in the form of a gift. In some cases you can borrower your down payment and have it be an acceptable source of funds provided that the loan is secured by an asset in which you have sufficient equity and your income can support the required monthly payment.
What are my payments?
Your monthly payments are interest only and are billed on a monthly basis. The amount of interest you are billed is based on the actual amount your builder has drawn against your construction loan. Your payments will gradually increase as your builder draws funds toward the completion of your home. You will only pay interest on the actual amount borrowed and for the actual period of time it was borrowed for. This ensures you do not pay interest for funds that you did not use. Interest only payments help to keep your total costs during construction as low as possible.
Your full monthly payments (both principal and interest) will begin once your home is completed and your mortgage converts (construction permanent mortgage) to your permanent mortgage. If you desire an escrow account for taxes and insurance, it can be added to your monthly payment at this time.
What will my interest rate be for my loan?
With a construction permanent mortgage, the rate for both your construction loan and permanent mortgage are locked in at the time you close your construction loan. Because you close on both your construction loan and end mortgage at the same time, you have the peace of mind in knowing what your rate is, and, best of all, you only pay one set of closing costs. If interest rates at the time your home is completed are lower than the interest rate on your construction loan, you can pay nominal cost to have your interest rate reduced (some restrictions apply). This option is only available once your home is completed. With this flexibility you can have your cake and eat it too!
What will my cost be to take out a construction loan?
As with the two different options, there are two different sets of costs. Generally, closing costs for a construction permanent mortgage are lower than those for a construction only mortgage. With a construction permanent mortgage, you close one time – saving you time and money. With a construction only mortgage, you have two separate closings – which increases your overall costs.
Can I build my own home if I don’t have a license?
As a general rule, we DO NOT allow you to build your own home. In some cases, clients who are well qualified to construct their home and have a strong financial position may be eligible to act as their own general contractor. In order to be eligible for a self build project you must demonstrate previous experience in building a home or work in a related trade that would support your ability to successfully complete the project. Because building your own home can be more challenging then what most clients expect, we prefer clients work with a licensed builder. If you need a recommendation of qualified builders in your area please contact us for details.
Can your programs be used to finance major remodels or even a “tear-down”?
Yes, these projects are more complex to finance and generally have less flexible guidelines when compared to building a new home from scratch. Typically these projects require a larger cash investment then typical construction loans. In addition, these projects can often times have difficulty with an appraisal. This is especially true if your home with the addition will be one of the larger homes in your neighborhood.
Should we pay off our lot before we apply for a construction loan?
There is probably no reason to pay off your lot loan prior to the construction loan. If you have a lot loan, the new construction loan will pay off that lot loan just like any refinance would. The lot and the new improvements constitute only one piece of real estate, and the lot loan has to be paid off so the bank ends up in a first lien position. If you pay the lot loan off prior to applying for a construction loan, you may be handcuffing yourself by putting too much cash into the deal. Construction loans are almost always “no cash out” loans, so it may not be possible to get this cash back on acceptable financing terms. You are often better off having cash on hand during construction to handle upgrades and changes.
Do we need to sell our current home before building a new home?
Depending on your overall financial position, you may be required to sell your current home prior to qualifying for a construction loan. Well qualified borrowers may be eligible to finance the construction of their new home without selling their existing home prior to the start of construction. We will discuss specific options that may be available to you upon receipt of your loan application.
When do we have to make our down payment?
At the time we close on your construction loan, you will have to furnish your down payment. For example, if the home you are building costs $200,000 and you will only be financing $100,000, you will need to furnish your $100,000 down payment at the time we close your construction loan. The $100,000 down payment is held by the bank and is used to fund your builder’s draws. Once we have exhausted your funds, we will begin to fund the builder’s draw requests from your construction loan. There is no interest paid on your down payment.
Can I get a construction loan for part of the project and finish the work later?
No. No lender will enter into a deal where the end result is an unfinished house. You could leave items such as landscaping, a swimming pool, finishing a bonus room, a security system, ceiling fans, and a garage door opener out of the build. However, you cannot leave out items such as cabinets, floor coverings, or a driveway. In addition, all items that were included as part of your plans and specifications will need to be completed. In other words, you must build a minimum of what you disclosed to us you were going to build. If you build less that what was disclosed, your loan amount will be adjusted down in most cases and there may be serious problems with the bank and building inspector.
Can we start construction with our own funds and get a construction loan later?
No. All lenders require a clear title, and this situation can be thought of as a title problem. There are some exceptions to this rule and you should contact me for details if this is applicable to you. Many title insurers will no longer insure these projects which may eliminate this from being an option. If you have sufficient funds and can build the house for cash, you can take a mortgage out on the home upon completion. However, the title company will require evidence and waivers of lien to insure all subcontractors have been paid. If you do not have sufficient funds to build the home for cash, you must close your construction loan before you break ground on your home.
Can we use any builder?
Yes, however, we do require that your builder complete a builder review application. We will check for “happy homeowners” for whom the builder has completed similar projects and vendor references to insure they have a good history with the builder. While we do conduct a review of the builders qualifications, we do not warranty the builders work or their ability to complete the project according to contract terms. In the end, you as the homeowner are ultimately responsible for your builder selection and should research your builder in depth prior to executing a contract.
How many draws can my builder get and where does the money go?
Again, the answer depends on the builder and the builder’s proposed draw schedule. A rule of thumb is that we typically do not like to do draws at less than 3 week intervals, but nothing is cast in stone. If frequency of draws is a hot issue for your builder, we can usually handle the arrangements. As to where the money is sent, it is usually wired to the title company who will disburse the funds to you or your builder depending on your preference. We do require your signed authorization before releasing any funds to your builder. In addition, we will not allow the builder to draw funds for work and/or items that have not been completed. We will have the appraiser inspect your home each and every time the builder request funds. What the builder is requesting funds for must match up with what the appraiser says is completed.
Can we pay our loan balance down at the end of our construction loan before our loan flips over to our permanent mortgage?
Yes, you can. A common occurrence is that the borrowers have now sold their previous residence, and they wish to use some of these funds to buy down the construction loan prior to the loan flipping over to their long term mortgage. You can make a principal payment of any amount, we will apply your payment and “re-calculate” your payment on your permanent mortgage for you.
If we already own our lot, can we use our lot equity for all or part of our down payment?
Yes! Provided a current appraisal of the land supports equity in your land, you may be able to count some if not all of any equity position toward your down payment.
Where do we start?
Building a home can be a complicated process. The first place to start is with a reputable and professional home builder. Not all builders are created equal. Some home builders build primarily “spec” homes and may lack the experience necessary for a custom home. In other words, they are not experienced in building custom homes and the unique challenges they can pose. We strongly suggest a custom home builder whose primary focus is custom new homes. Your builders expertise in building custom homes will provide you with the expert guidance you will need throughout the building process.
What is the initial interview about?
A good custom home builder will likely have an initial interview with all of their potential clients. It is important for them to meet you and for you to get to know them. This meeting will allow you to start and sort through the many options that are available in building a home. In addition, it will help to give you a better understanding of your needs, wants and budget. This initial interview will also allow you to review your compatibility with the builder. Quality builders work best with clients who are concerned with high quality, expert craftsmanship and attention to detail. A high quality builder has likely built a reputation for expert craftsmanship and superior quality. They will not likely be comfortable building a home that would impair the reputation they have worked hard to build.
How do we select what builder to use with so many to choose from?
When hiring a builder it is important to remember you are buying a service – not just a product. The quality of service the builder provides will determine the quality of the finished product and your satisfaction with it. Here are some thoughts to consider when choosing a builder:
- Am I comfortable with them and do I feel they are a good fit?
- Are they quality oriented and do they offer a warranty?
- Are they a good listener and will they accept changes?
- Do they build primarily custom homes or “spec” homes?
- Can they supply me with multiple references from other people they have built for?
- How long have they been in business and can I see other homes they have built?
- What is their reputation in the building industry? Do they have subcontractors who would speak highly of them?
- Are they a member of the HBA (Home Builders Association) and do they abide by their standards?
- Have they built different home styles and have they ever managed a project like mine?
- Can they offer ideas and guidance throughout the entire building process?
- Can I review all of their contracts and required documentation in advance? Am I comfortable with the terms of the proposed project?
What makes for a good building site?
As with houses, building sites can come in all kinds of shapes and sizes. A good building site is the key to starting the building process on the right foot. The type of home you are building can also make a difference in your building site needs. Some homes will fit and work well on some sites, and other homes may not necessarily work well on certain sites. Working with a knowledgeable builder can make a big difference. Before you even purchase your building site you should have your builder inspect it with you to insure that the piece of land you are buying will work for your individual project.
How do we pick out a home plan?
Most clients will typically have an idea of what they want in their new home. A good builder will sit down with you and interview you about your needs, wants and budget. Then they can help you select a plan that will work according to your lifestyle and budget. Many builders will also have plans you can choose from or they can work with you to develop a custom plan for you based on your needs, wants and budget. They will work closely with you to insure your new home is comfortable with style and function.
How do we decide what types of materials to use in our home?
A number of factors can go into selecting the materials that are used on both the inside and outside of your new home. Part of the interview process is to determine your needs and lifestyle. A young family may choose different options compared to a mature couple without children. In addition, your budget can also have an impact in the materials that are used in the construction of your home. This is why the initial interview process is extremely important. You don’t want to leave anything to chance. You and your builder will want to make sure that the options that you select together are going to make your home all you hope it will be.
What responsibilities do we have during the construction process?
Throughout the construction process there are decisions that will need to be made. Your builder’s expertise in custom home construction, from time to time may lead them to offer suggestions for improvements to your home. These decisions are always left for you to decide. As the client, you always have the final say as to what happens with your new home. You should keep in mind that it is important to be mindful of your budget and the importance of completing your project on time.
What if we want to make changes during the construction project?
Changes are never a problem and are a common occurrence with custom home construction. If your changes result in a decrease in square footage, change in the home type (two story to a ranch, etc.) or some type of change that results in the value of your new home decreasing, you will need to notify the bank immediately. This can be a problem and changes like this should not be made prior to talking with us.
It is not uncommon for things to change during construction. Even though your builder may do a detailed review of your floor plan prior to starting construction, once they are in the field they may even suggest minor changes and modifications that will improve the functionality of your new home. They will encourage and welcome your feedback and thoughts as to things you may want to change while your home is being built. Changes can result in additional costs, or a decrease in costs depending on what the change is. Unless you have allowed funds in your construction loan for cost overruns, be prepared to pay for these changes in cash at the time you request the change.
Is it cheaper to build our own home vs. hiring a builder?
The truth of the matter is it is probably not cheaper but more expensive. Your builder can normally get better prices from subcontractors than what you could. In addition, a subcontractor will do more for your builder than what they would for you given the nature of their business and their relationship with the home builder.
You will want to carefully review all of your options. In most cases, we will not make a construction loan to a client who will be acting as their own general contractor. We prefer that you work with a licensed professional home builder.
So what really would you save on your home if you built it yourself? Do your homework before you decide to build your own home by asking yourself the following questions:
- Do I have the time to learn the home building business?
- Do I have the time to find and screen subcontractors?
- Am I willing to take risk on my home by cutting corners and learning as I go?
- Am I aware that Realtors have a very difficult time selling owner-built homes?
- Do I know that building inspectors have a real concern for homes being built by owner?
- Do I realize that I am the one responsible for all the warranty work on my home?
- Do I have sufficient resources to see the job through to completion?
- Are you qualified to get owner-builder financing?