What Are Construction Home Loans?

You’ve looked high and low and you can’t find a place you want to call home. So you decide maybe you’ll just have the perfect home built for you on a piece of property that you have either found or already own. When it comes time to finance the project, you can’t just take out a traditional mortgage. Instead, you need to obtain what are known as construction loans. The steps to obtaining these funds are a little more difficult than a traditional mortgage is.

Getting Construction Loans

When you buy a home, you put some money forward as a down payment and the bank uses the property as collateral on the note. However, if you are obtaining funds to build a home, there is no building in existence for your lender to use a collateral. In order to get one of these loans, you will have to have some sort of banking history. There are also special guidelines, that vary from lender to lender, that govern how these funds are released.

In one of the first steps in getting the funds to build your own home, you will need to present the project’s “story.” This is simply a set of detailed plans and a realistic budget that the lender can see. There should also be a timetable that shows how long it will take to build the residence and plan for payment dispersal.

If the request is approved, you will not receive a check for the total amount. Instead, you will be put on what is known as a bank draft. The draw schedule for the draft will follow the outline of the project’s timetable. A representative from the lender will also monitor the property closely to ensure that the home is being built as planned. The lender must approve withdrawal of funds from the draft by verifying progress has reached the point of the next disbursement.

After Construction

Typically, the original loan term is one year. That doesn’t necessarily mean you have to come up with the funds for your new home one year after it is built. It is simply a reasonable period to having the new property built.

When the contractors have signed their lien releases and a certificate-of-occupancy is issued, the borrower’s liability then rolls into a traditional mortgage. Usually, the lender combines the construction terms and the mortgage into one 30-year mortgage and you pay the closing costs. The good part is, because of the construction-to-permanent financing, you will only pay closing costs once instead of twice.

Important Information You Should Know

Construction loans are not common; they make up a very small part of the percentage of mortgages. As this type of financing is a higher risk than a traditional mortgage, you will find that lenders often won’t cover the full cost. Usually, they only offer up to 80 percent of the total amount. You will have to come up with the additional funds yourself. Some will allow you to use land you own as equity to obtain the funds.

When planning your timetable you need to be realistic. Delays due to material availability and weather are common. Make sure you add extra time into your plans to cover these issues.

If you are planning to obtain construction loans, be sure to talk to your lender about the different options before you submit your application.