If you have never built a new home before, you’re probably wondering how you’ll finance the whole project, pay your builder, his suppliers and end up with a mortgage at the end of all this. Hopefully we can help make things a little easier to understand.
A construction loan is usually a loan that encompasses the lot and the house and is broken up into small chunks called “draws”. As the builder completes certain items, the banker or bank’s inspection service will inspect the work to ensure that they are paying for only what is completed or partially completed, and pay out for those items in a “draw”. The draws traditionally add up to the total amount for the construction loan. So when you borrow $200,000 to build your new home, you are not really borrowing $200,000 the day you sign the papers. You are signing to borrow up to that amount, and your builder will “draw” on that amount each time they reach a milestone or specific time. Some builders draw on a specific date (say the 1st of every month) and others draw at key milestones. On most of our projects, we draw at the following milestones:
- Permit/Construction Start
- Completion of Foundation/Sitework
- Completion of Framing
- Completion of Rough-Ins (Electrical, HVAC, Plumbing)
- Completion of Drywall
- Completion of Home
Depending on the size and complexity of the home there can sometimes be fewer draws or more draws. Again, this depends on the project and the builder.
Most construction loans are made through local community banks. Your average large national bank such as Bank of America or Chase don’t typically engage in construction loans. Your builder will usually have a relationship with a key local lender(s) who can help you finance construction. These local lenders will typically offer a two part approach to your loan. The first part of the loan will be a construction loan, which will allow you to purchase your lot and/or begin construction. This loan is typically interest only and sometimes can be rolled into the cost of the home. If you are living in your current home or renting a temporary home, you obviously don’t want to have two housing payments. This is why the construction loan is made interest only and can sometimes be rolled into the cost of building the home. That way you’re not paying two payments every month for 4-8 months while you build your new home.
When the home is completed, the construction lender will typically roll-over your loan into a “perm” or permanent loan which is your typical 15 or 30 year fixed rate mortgage that most people are familiar with. Rates are usually the same and at this time is when your typical “closing costs” will occur. Many times, the construction loan is opened without any money or minimal money down. Sometimes the lender will require that you “park” some of your money in their bank, as security to make sure you don’t run off to Mexico and forget about the home you’re building. However, each and every person’s financial situation is different and your builder and lender can help guide you through the process.
Of course, some builders also finance construction of new homes. The builder owns the lot and home and you contract to purchase the home. The builder finances construction with their own funds and/or their own construction lender. In some cases, where the buyer is a first time buyer without a large down payment this is the only way to purchase a new home. The builder and it’s lender will often require a down payment, as the days of absolutely no money down are over. But for FHA buyers with 3-10% down, this is another option. Unfortunately not all builders have access to these construction loans as credit has tightened, however the most fiscally responsible of builders still have access to these construction loans. We are proud to say Silverthorne does as well.
Hope this helps you understand construction financing a little better! If you have any questions, please feel free to contact us and we will answer any questions you might have along the way to building your new home!