Do you need a home loan?
If you want to build a new home from scratch, you will likely need a construction loan.
This is a short-term loan that can be used to fund land, materials, and labor – in short, any cost associated with building a home.
There are different types of construction loans. Some have to be paid back after the house is built, others can be converted into a mortgage that you will pay back over time.
The right type of home loan for you will depend on your budget, your construction schedule, and the ways in which you plan to use the home after construction.
Check Your Eligibility for Home Loans (October 23, 2020)
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Home loan explained
Unless you can cash out
To build a new home, you will need a construction loan to finance that
Construction loans allow you to finance the materials and labor needed to build a home from the ground up – unlike a traditional mortgage loan that only applies to completed houses.
A home loan is a short term loan – usually 12 to 18 months – that is used to provide funds for the materials and manpower needed to build the residence.
The money from this loan can also be used to buy the land on which the house is being built (or you can get a separate "land loan" for this purpose).
The interest rates for construction loans are variable and can change during the term of the loan.
In general, however, home loan interest rates are typically 1 percent higher than mortgage rates.
Check your new plan (October 23, 2020)
How construction loans work
With a construction loan, you usually do not receive the full loan amount in advance. Instead, you will receive the loan in installments to pay for the construction work gradually.
Michael Gevurtz, CEO of Bluebird Companies explains how this works:
“First you create an estimated budget for the entire project. Then make at least the minimum down payment required by the lender, ”he says.
As the construction project progresses, you can gradually draw on the loan money to cover the costs involved. Each “draw” pays the client for this completed construction phase.
“Usually the work is done and you apply for a loan withdrawal,” says Gevurtz.
“The lender sends out an inspector to examine the work and approve the request. Then part of the loan can be transferred or transferred to your bank account. "
Construction loan types
There are three main types of construction loans:
A construction-to-permanent loan finances the construction costs as well as the finished house. Once the work is complete, it will be converted from an initial variable rate home loan to a permanent fixed rate mortgage loanA pure building loan is a short term variable rate loan that is only used to finish the building of your home. In this case, this loan must either be repaid in full or refinanced into a mortgage loan for permanent financing A home builder loan is for homeowners who also want to act as general contractors for their own project. “These loans can be cheaper and offer lower interest rates than the other two options. However, lenders often see them as very high risk, so it may be harder to get them, ”says Gevurtz. You usually have to be a professional contractor to get one
As with a mortgage, you want to explore all the financing options and compare quotes from a few different lenders.
The right type of construction loan for you depends on your finances, your schedule, and who can offer you the best interest rate for your situation.
Steps to Get a Construction Loan
It can be more difficult to qualify for a home loan than a traditional mortgage.
"This depends on your financial strength as a borrower, your plans and specifications for the project, your project budget, and your planned activities with the house once it's ready," explains Robert Withers of M1 Capital Corp.
Each lender has their own application process and requirements. In general, however, you need to provide detailed information on:
Income EmployerCredit (score usually needs to be over 720) Down payment (you will likely need at least 10%) Budget for contractors / general contractors
At some point, the property also has to be assessed and inspected.
Once the loan is approved, the loan will eventually be closed through a title company, as it would be with a mortgage loan.
Instead of receiving a lump sum payment upon completion, your borrowed funds will be withdrawn upon request at any stage of the construction project.
“You should choose a home loan company based on their home finance experience. Shop carefully, ”suggests Withers.
He warns that finding and qualifying for a construction loan is particularly difficult these days due to the current economic downturn.
To help you find the best deal
When financing housing construction, it can be worthwhile to look for an experienced and reputable broker
to help you compare loans
Construction loans vs. Renovation loans
Home loan funds can be used to pay for land, supplies, labor, and other costs related to building a home.
But what if you want to buy a fixer-upper house instead?
In this case, you would like to apply for a "rehab loan" instead of a building loan. Funds from a rehabilitation or renovation loan can cover the cost of repairing or remodeling an existing home.
A popular home renovation loan is an FHA 203k rehab loan.
"With this (loan) you can borrow funds to buy the house and pay for any repairs or renovations you need or need," says Paul Welden, director of the 203k Contractor Certification Program.
“FHA 203,000 loans cannot be used for new construction. And they can only be used for existing one- to four-unit properties that have been completed for at least a year. "
Welden adds that an FHA 203k
Loan requires a minimum of 3.5 percent down – what
is quite a bit less than the 10 to 20 percent that is required for a home loan.
Similar to construction loans, the interest rates on the FHA 203k can be up to one percentage point higher than on a traditional FHA mortgage loan.
Check your eligibility for a home renovation loan (October 23, 2020).
Opportunities to finance renovations to an existing home
Construction loans exist to finance new residential construction.
Homeowners looking to renovate
An existing home has other options including:
Home equity loans: These "second" mortgages take advantage of the value of your current home so you can use it for renovation projects. If you already have a mortgage, make mortgage payments on both loansHome Equity Lines of Credit: This loan, also known as HELOC, uses your equity, but you control when and how you take out loan proceeds. You can draw part or all of the HELOC when you close it. You only pay interest on the amount you draw. You can also repay it and then reuse the loan for other projects within a set period of time. Withdrawal Refinancing Loans: You can replace your current home loan with a new loan that is large enough to fund your home construction projects and repay your existing mortgage. The "payout" refers to the equity that you can withdraw from your existing house
Equity must be built up for all three options
Your House. The amount of money you can withdraw depends on your current equity
and the value of your home.
If you don't use VA payout refinancing, you won't be able to withdraw 100 percent of your equity.
Check your eligibility for a home renovation loan (October 23, 2020).
FAQ on construction loans
Do you have anymore questions? Here are some quick answers mainly given by Gevurtz to frequently asked questions about construction loans.
Can I get a construction loan without money?
No, you cannot get a construction loan with nothing down. A borrower must have cash or equity for a construction loan.
What are the requirements for a construction loan?
In addition to a detailed plan and a qualified, approved borrower, you also need money for a down payment and proof of ability to repay the loan.
As with a traditional mortgage, evidence of your "ability to repay" is provided in the form of credit reports, bank statements, W2s and other documents showing that you have sufficient stable income to repay the loan.
Is It Easier to Get a Construction Loan Than a Mortgage?
Because of the risk associated with construction loans, they are more difficult to come by than a mortgage.
Are you paying a building loan while building?
When using a home loan, an interest reserve fund is built into the total borrowed amount, which is used to make interest payments during construction.
What is the down payment for a construction loan?
A down payment of at least 10 percent is usually recommended for a home loan, but 20 percent is often preferable for lenders.
Which bank is best for building loans?
Private lenders and regional banks are often best suited for building loans. You are likely to take a greater risk and offer more innovative solutions.
What is the average home loan interest rate?
At the time of writing, this is a typical home loan interest rate of 4.5 percent, depending on the lender. That's about one percent more than a typical mortgage loan rate over the same period.
What is a Good Credit Score to Get a Construction Loan?
You may need a higher credit rating to get a home loan than to get most mortgage loans. A FICO score of 720 or higher is recommended for loan approval.
What is the recommended debt to income ratio for a construction loan?
The ideal debt-to-income ratio for a construction loan can vary but should never exceed 45 percent.
Is It Cheaper to Buy or Build a Home?
Usually it is cheaper to build than to buy a house. This is because you can create something exactly to your specifications and needs that is usually less than what you would pay to buy an existing home.
However, it is more difficult to qualify for a construction loan than a mortgage. For many people, buying an existing home is just more realistic – especially for first-time buyers.
What is a draw schedule?
A draw plan is the plan that specifies how you will send money to the builder. When building a home, you don't send the entire loan payment to the builder before the project even begins. That begs for trouble. Rather, your lender will slowly release funds as each project milestone is completed. Foundation completed? Some funds released. Is the framing done? More money for the client. This way you will minimize losses on a dishonest contractor or a contractor who simply goes out of business during your project.
In this way, a construction loan is similar to a line of credit. A "drawing" is carried out in one portion instead of a lump sum.
How high are the closing costs of a building loan?
Construction loans require closing costs like traditional mortgage loans. In addition to the processing and origination fees charged by the mortgage lender, you'll also need to pay for an appraisal, property insurance, and legal fees.
One benefit of construction to permanent financing is that only one set of completion costs is paid. With a home loan only, you pay the closing costs twice: once for the home loan and once for the permanent loan.
Do construction loans require private mortgage insurance?
Yes, a mortgage lender will need private mortgage insurance for a construction loan if you mine less than 20 percent.
Why are construction loan rates higher than standard mortgage rates?
With a standard mortgage, the lender can use the existing home as collateral. With a home loan, the new house does not yet exist, so it cannot be used to secure the loan. The real estate property you purchase has value, but the loan amount usually exceeds the value of the property itself. Mortgage lenders reflect this additional risk through higher interest rates.
Can I apply for a construction loan online?
Online banking has made it easier to get a standard mortgage, but getting a construction loan usually requires more personal interaction with a loan officer. To be approved, you need to share the unique details of your new home project.
Is a construction-only loan better than a construction-to-permanent loan?
This depends on your individual needs and a loan officer can help you make that decision.
For many borrowers, the temporary financing of a construction-only loan can offer more flexibility. For example, if you are ready for permanent funding, you have more control over the long-term loan as it would be separate from the home loan.
However, a single loan for permanent construction could save money on closing costs.
What are today's mortgage rates?
Interest rates on mortgages and other types of finance such as home loans remain near their all-time low.
But as always, prices vary from person to person. So get some quotes to see which lender can give you the best deal.
Check your new plan (October 23, 2020)