Construction Financing Process for Land and Lot Loans

January 1, 0001

How does a construction loan work?

A construction loan can be completed with two different options. The first option would be a construction loan that turns into a permanent mortgage, while the second is a construction only mortgage.
The construction to permanent mortgage would include a person’s construction loan as well as their long-term mortgage all in one. A loan like this will only have one closing, which saves people time and money. Plus, the interest rate that a person secures in the beginning is guaranteed, so no one needs to worry about the interest rates rising before they can secure the mortgage loan for their new home as it is being constructed. Instead, homeowners can relax, because they know their interest rate as well as what their monthly payment will be.
A loan that only covers the construction is considered a short-term mortgage that will only cover the costs during the construction period. A person would either need to pay that loan off in full once the house is completed or take out a permanent mortgage. Anyone that does the loans in this way will need to understand that they will need to have two closings, which is going to increase the amount of money they are paying out of pocket. It also means that the interest rate for the mortgage loan is not guaranteed until after the house is completely constructed.

How much of a down payment is required?

A down payment of at least 10% percent is necessary, but anything under 20% requires Private Mortgage Insurance. There are a few scenarios where the Private Mortgage Insurance can be eliminated or at least reduced, but it depends on the structure of the loan. It is important to note that the down payment must be from the homeowner’s personal account and cannot have been received as a gift. A person may be able to borrow the money for their down payment as long as they have the income that can support the monthly payments.
What are the payments each month? The monthly payments would only include the interest that is due, and that amount is determined by how much the builder has taken from the loan. This means that the payments will be less in the beginning as the work is starting and higher as the home is getting close to being completed. These payments help people keep their costs down during the construction process. However, once the home is completed, the full payments will begin and includes both principal and interest. Homeowners can also have an escrow added to their account, so that taxes and insurance can be paid directly from there. However, that will increase their monthly payment.

What are the interest rates for the loans?

Anyone that wants to know the exact interest rate for their long-term mortgage will want to take out a construction to permanent mortgage before they build. This will allow them to know exactly what their interest rate is going to be at the end. This will ensure that no one gets hit with a higher interest rate when the construction of their home is finished, plus there is only one closing cost fee to pay. There is always a chance that the interest rates can decrease as a person is having their home built, but if that happens, people have the opportunity to have their interest rate reduced if they pay a small fee.
What is the cost to take out a construction loan? The cost for a construction to permanent loan would be the one set of closing cost fees, while the construction only loan will require everyone to have two different closings and therefore two fees.
Can a person build their own home if they do not have a license? Most of the time, homeowners are not allowed to build their own homes, unless they can prove that they have the knowledge and experience to do it. Lenders prefer that every homeowner works with a qualified builder, because home construction can be quite challenging, even to those who have experience.

Can the programs by used to finance major remodels or to complete a tear down?

A major remodel or tear down can be quite complex, and there are normally more guidelines to follow for the loan process. Everyone will want to be aware of the higher costs of these projects and the difficulty of achieving a good appraisal. Should a lot be paid off before a person applies for a construction loan? There is not any reason why a lot loan needs to be paid off prior to getting a construction loan, especially since the lot loan can be paid off in full by the construction loan.

Does a homeowner need to sell their current home before beginning to build their new home?

Everyone’s situation is different, but certain people may need to sell their current home before they will qualify for a construction loan. It all depends on how financially secure a person is and whether they will qualify for the new loan with an existing loan in place.

When does the down payment need to be made?

The down payment is due on the day of the closing for the construction loan. If the new home is going to cost $150,000 and the homeowners puts down $75,000, the down payment would be used to pay the construction costs first. That means that the homeowners will not need to pay any interest until the money from the loan is used.

Can a person get a construction loan for only part of the construction process and then complete the rest at a later date?

This is not something that can be done by any lender, as the home would not be completed when the loan is due. There are certain items that a homeowner can leave unfinished, such as ceiling fans, landscaping, swimming pool, and even finishing up a bonus room. However, everything else in the house needs to be completed.

Can construction begin using personal funds before a homeowner requests a construction loan?

The answer to this question is also no, because the lender would not have a clear title to work with.

Can a homeowner use the services of any builder?

Homeowners can use any builder that they wish, but the builder should complete the builder review application prior to starting on the construction of a home. Lenders will use that information to see if other homeowners have been happy with that builder’s work in the past, so that they can try to warn homeowners of builders who have completed shoddy work.

How many draws do builders get and where does the money go?

Draws are typically done in three-week intervals, but that can be changed if the circumstances require it. The money is then sent to the title company who gives it to the builder or the homeowner. The homeowner is required to authorize the funds each time and no money will ever be sent for work that has not been completed.

Can the loan balance be paid down at the end of the construction loan before it turns into a permanent mortgage?

Absolutely! Homeowners can always make a principal payment on their loan and once that payment has been applied, the amount due for the permanent mortgage will be recalculated.

If a homeowner owns a lot, can they use the equity in that for their down payment?

The answer to this question is yes, as long as the appraisal of the land supports the amount of equity that is requested.

Where do homeowners start?

Building a home is not as easy as some people think that it is. The first thing that everyone will want to do is find a builder that has a wonderful reputation.

How should the initial interview be conducted?

Excellent custom home builders should expect an initial interview with all potential new homeowners, as it is important for everyone to meet and get to know each other. This interview will ensure that everyone is on the same page as to what to expect through the entire process.

How does a homeowner choose the builder that they want to work with?

There are many questions to consider before a homeowner hires the builder that they want to work with. Here are a few questions that homeowners should ask themselves before they make their final decision:

  • Am I comfortable with this person?
  • Do they focus on quality and offer warranties?
  • Do they listen to me and will they consider changes as needed?
  • Have they built a custom home in the past?
  • Do they have multiple references for me to call?
  • How long have they been in business and where are the homes that they have built in the past?
  • What is their reputation?
  • Are they part of the Home Builders Association?
  • Do I think that they can offer ideas or guide me through the entire process?
  • Will they allow me to review all the contracts and documents prior to signing them?

What is considered a good building site?

There are numerous building sites available, but homeowners will need to choose the one that will fit the home that they want to construct. It is a good idea for homeowners to have a builder hired before they begin to look at different building locations.

How does a homeowner pick out a home plan?

Almost every homeowner will have an idea of what they want in their new home, and that is where the builder steps in to help. The builder’s first job is to determine if the items that the homeowners want will fit within their budget. After that, it is on to the planning stage. Some builders have plans already made, while others will create them from scratch to fulfill their clients’ needs.

How does a homeowner decide on the materials that will be used?

Every homeowner will want something different in their home, yet the materials that are used will also depend on the available budget and the lifestyle of each individual homeowner. No builder is going to want to use materials that need a lot of maintenance if the homeowners are never going to have the time to do the work.

What are the responsibilities of the homeowners during the construction process?

There are numerous decisions that need to be made during the entire construction process, so homeowners will need to be available at all times to answer potential questions or make necessary changes.

What happens if homeowners want to make changes during the construction process?

Changes are sometimes necessary as a home is being built, but some changes may need to involve the bank as they can affect the amount of the loan. Anything related to the size of the home will need to go through the bank first, but other than that, the builder will take care of answering whether certain changes can be completed.

Constructing a home personally or hiring a builder – Which is cheaper?

Homeowners that want to construct their home on their own will find that they will not get the discounts that a builder can get on many of the materials. The same holds true for all the subcontractors that would be needed to finish the work.

Homeowners should ask themselves the following questions before attempting to build their own home:

  • Do I have the time to learn everything I need to know to construct my own home?
  • Do I have the time to interview and hire subcontractors?
  • Am I willing to take a chance and cut corners with my new home?
  • Do I understand that it can be difficult to sell a home that was built by me in the future?
  • Do I understand that my home will be over scrutinized by building inspectors if I construct it myself?
  • Do I understand that I am responsible for the warranty on my home if I construct it myself?
  • Am I qualified enough to manage to get financing?

In case you haven’t found the answer for your question please feel free to contact us, we will be happy to help you.

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