In August the building industry reported a surge in new construction permits, as the housing market continues to regain the momentum it lost over the past several years. Consumers wanting to build a home can take advantage of incredible mortgage pricing, snagging interest rates that are the lowest in history. Then they can leverage that financing to buy homes that are still bargain priced, because builders are still hungry for work.
But financing new construction can be a little confusing, even for people who have lots of experience with buying and selling preexisting home. New construction loans don’t work quite the same way that other more conventional mortgages do. So if you want to know your options when it comes to new home buying, it helps to get an overview of construction loans and how they can be structured.
Builder versus Bank Financing
Many builders and construction companies offer home buyers in-house financing. This can be a great option, as long as the terms of the loan – including the interest rate, down payment, and monthly payments – fit your financial goals.
Builders may have their own network of lenders, such as private loan specialists. But consumers should realize that major banks, savings and loan companies, and traditional mortgage companies can often more competitive rates. You should do everything you can to bolster your credit rating and then shop around, being sure to crunch the numbers to do accurate side-by-side comparisons.
Loans for Construction Only
Once you decide on a lender, you’ll have some choices of loan products. You can use a construction-only loan if you just want to borrow during the period of time while your home is actually being built. Most of these cover a fixed period of time, outlined in the loan contract, and they usually involve variable, short-term interest rates. While a rather typical period of time for a construction loan is six months to a year, you need to make sure that you have enough time to finish the home. Unexpected delays can cause big problems, because if your home is not ready but the financing expires you’ll have to finish repaying the loan before you are able to enjoy your home. Since the home isn’t ready to inhabit, traditional lenders not be able to offer you a conventional mortgage to cover it, and you might be stuck between a rock and a hard place.
Construction Loans that Convert into Mortgages
That’s why lots of borrowers instead use a different type of loan that starts off as a construction loan but gives you the option to then turn it into a normal mortgage. Whereas you can use a straight construction loan to build and then pay off that loan with a new mortgage loan (paying two separate closing costs) with a “wraparound” construction loan you’ll only have to pay closing costs once. The loan is structured so that as soon as the construction is done your loan turns into a mortgage, with the new home used as the mortgage loan collateral. Regarding your interest rate, that is typically set up front, when you break ground and start building. So if you think that rates are going to fall significantly between the time you start building and the time that you are ready to borrow against the home with a mortgage, you might be better off using two loans. But if you aren’t concerned about getting locked into an interest rate several months ahead of time, a loan that wraps may be the best and most affordable solution.
Sticking to the Schedule
Usually the lender draws up a borrowing schedule so that money is loaned in increments as phases of construction are finished. If you get too many delays it could cause you to miss an agreed-upon deadline with the lender, who may then want to raise your interest rate. When construction gets too far behind homeowners sometimes have to do a completely new loan application, too, with fresh documentation. So before you sign on the dotted line, make sure you have all your ducks in the row and can rely on the builder and lender to meet your timeframe.