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Prior to applying for a construction loan, you should narrow down your choice of builders. Experienced builders may be able to save you time by giving you a list of local lenders, their requirements and expectations. Using a builder approved vendor can make a major difference in how quickly you move from planning to production. |
The Basics:
A Construction Loan enables a new house to be built by providing financing in stages throughout the duration of construction. The loans are structured around the estimated time it takes to construct the home specified by your plans, and typically range from 6 months to a year. The lender often has to approve the builder prior to approval, and then actually pays the builder after each phase of construction is completed and inspected. Buyers normally only pay interest on the amount withdrawn at each interval of construction, and repayment of the loan occurs once construction is done. The construction loan is paid off with a conventional mortgage loan.
Structuring a Construction Loan
Most lenders offer two primary types of home construction loans:
- Construction-to-permanent: This is essentially two loans in one. The construction is funded and when its time to move in, the lender converts the balance into a permanent mortgage.
- Stand-alone construction: This is two separate loans. The first loan funds construction. Then when the home is built, you get a permanent mortgage to pay off the construction debt.
Construction-to-Permanent Loans
Since this is a combination of the construction and permanent loan - also known as a "One-Time-Closing" loan - you'll only pay one set of closing costs. You'll lock in the interest rate on the permanent loan prior to closing (and before construction begins). While the home is under construction, you are paying only the interest on the outstanding balance. Once complete, the construction loan is rolled into a permanent loan product, usually a conventional mortgage program. Generally speaking, lenders will usually fund 80% - 95% of the estimated value (LTV), which means you need to plan for having a down payment from 20% to as low as 5% of the anticipated permanent mortgage. Keep in mind that these loans often lock in an interest rate at a higher rate than other products so that it reduces the risk to the lender.
Stand-Alone Construction Loans
This loan option is often ideal for people that currently own a home and don't initially have the cash for a large down payment, but will have more cash once the existing home is sold. Although sometimes easier said than done, you should coordinate the sale of your existing home to coincide as closely as possible with completion of construction. Otherwise, you may have a tough time getting a permanent mortgage if you are still carrying the note on your existing home.
While these loans allow for a smaller down payment, they do require that you pay two closing costs and two sets of fees: First on the construction loan, and second on the permanent mortgage. You also cannot lock in your rate for the permanent loan...if rates rise during construction, your ultimate mortgage rate may be higher than expected when you started the process. It is important to point out that you are not guaranteed a permanent loan at the end of the process! So watch your credit during construction...if there is any negative impact, your rate or approval could be affected.
How Raw Land and Lots Affect the Loan
Whether or not you already own the land on which the house will be built can have a major influence on the terms of the loan. Obviously, securing a loan will be easier and cost less if you already own the land where your new home will be built. However, many people either haven't settled on a particular lot or want to find out how much they can afford to buy before they even start looking at raw land. If the land you plan to build on is not part of an established subdivision, you should check government zoning restrictions to ensure your construction will be within compliance with existing requirements. Some lenders require a survey and an appraisal of the land prior to approving the loan, and/or may have additional stipulations about land ownership (or it's appraisal). Therefore, it is crucial the homeowner ASK AS MANY QUESTIONS AS NEEDED during an initial meeting with a potential lender!
Documents Needed for a Construction Loan
Securing financing to build a house, rather than purchasing an existing home, is a much riskier venture for mortgage lenders. So, in order for you to make the loan process as easy as possible, you should be prepared to provide a very detailed package of personal and technical documents to a lender.
Obviously, lenders want to verify your income, employment, residency, debt-to-income ratio, and (above all) ensure you have the ability to pay. Additionally, the financier wants to ensure the builder you chose has the ability, experience, and qualifications to complete the job. Finally, the lender will want to evaluate the scope of the work to be done as well as how the money will be used.
STANDARD PERSONAL AND FINANCIAL DOCUMENTATION
- The social security numbers for everyone who will be on the mortgage loan
- Proof of employment for the past 2 years (or more)
- Verifiable proof of income showing the year-to-date earnings
- Tax returns and W-2 statements for the last 2 years
- Self-employment documents (balance sheets, P&L statement, 2 years of tax statements)
- History of your residences for the past 5 years
- Bank account information, savings/investment account statements, and balances
- Credit report and additional credit information
- Some lenders may ask for a list of monthly expenses
- Any "gift letters" from others helping to fund the down payment
- Any "non-standard" documents (divorce decree, rental property income proof, etc)
DOCUMENTS THE BUILDER PROVIDES
- Detailed description of the materials to be used
- References from the builder that are used by the lender to verify credentials and experience
- Professional credentials, including license and insurance documents
- Proof of adequate insurance coverage that would cover mishaps during construction
DOCUMENTS PERTAINING TO THE HOME'S CONSTRUCTION
These documents should provide enough information to describe the property, all work to be done, and how the money is going to be used
- A written budget detailing how each phase will be paid. This should be a part of the Builder's contract (see below).
- A final copy of the building plans
- A detailed list of items that were pre-paid and how they were utilized
- A plat map of the survey
- Proof of ownership of the land or lot, if already owned
- A contract - signed by the builder and buyer - that details all aspects of construction to be performed
Of course, your chosen lender may require additional documentation, especially if the property is located in specially zoned areas (commercial or flood zones) or if there are special requirements to which the construction must adhere.
Article by Robert Carroll
Robert is a NAHB Certified Graduate Builder with Carroll Construction. Robert joined the team in 2007 after graduating from L.S.U. with a degree in Construction Management. Now as Chief Operating Officer, Robert Carroll is extremely active in the local builder community, a leader in the LHBA, and is an avid supporter of charity and community causes inside the Greater Baton Rouge area.
