Building vs. Buying. Construction Loan Basics

For the Home, Uncategorized

Basics of construction loans

Looking for a new home and not finding what you want? Building a home can be very enticing. And if your budget allows it, you can get the exact floor plan and finishes you prefer, and everything is brand new. Just make sure you know what to expect before you finance a new construction home. A lot of patience is required to navigate the process of finding the right builder, obtaining a construction loan, and having your home built.

What is a construction loan?

Construction loans fund the building of a new home as it progresses though the construction process. They are usually short-term, and typically range from six to twelve months depending on how long it takes to build your house. Once you have identified a builder you trust, who has a great reputation for completing projects on time and within budget, you need to know if they offer financing.

Your builder will be required to submit detailed plans of what it will cost to build your home, segmenting the expected costs into a schedule based on intervals of work. The lender will compensate your builder according to the schedule (usually on a monthly basis). With most construction loans, the buyer will pay interest only on the money that is drawn out each month. You will begin to repay your lender for the bulk of the costs once the home is complete.

If you want to build a home outside of a builder’s development, you’ll need to take the additional step of securing a lot. Land price factors into your overall pre-approved budget, so be sure to add this expense to your construction budget.

Once construction ends, your loan repayment begins and you will need a way to transition to a longer-term loan, such as a fifteen, or thirty-year mortgage. Many home buyers combine their construction loan with the standard mortgage plan upfront, eliminating the need to refinance after construction or have two separate closings. This is called a single-close construction loan. There are also two-close construction loans that allow more flexibility, but also carry more risk.

Single or Two-close Construction Loan?

Two-close construction loans keeping the permanent loan separate from the permanent mortgage. Some people consider this as it allows you to continue to shop rates, fees and terms on the second loan. But there are risks and fees associated as you need to apply and get approved for two loans. You may get a lower rate (providing they don’t rise during the build) on the permanent loan once construction is complete. However, as previously mentioned, you will have two applications, two closings to go through and additional fees, so this is something to weigh carefully. Because of the associated risks, Directions Credit Union recommends the single-close method.

Single-close construction loans allow the buyer to get both the construction loan and the long-term mortgage at the same time. This type of loan is designed to convert to a traditional mortgage loan once the building phase is complete. There is only one application process and one closing. Many people find this type of loan most appealing because there is less risk and fewer unknowns, giving them financial peace of mind as they begin the construction process. Having permanent financing in place takes away the worry if something should change with your job during the construction phase. You’ll also know what your interest rate will be so you can budget for monthly payments well in advance.

If you are someone who favors one-stop shopping, you may prefer a single-close loan. Which scenario is best really depends on individual circumstances, but it is good to be aware of your options.

Choose the Right Lending Partner.

Building a new home involves lots of choices beyond flooring and faucets. Choosing the right financial partner from the beginning is important to reduce your stress and start the construction journey on a worry-free path.

Many lenders treat constructions loans and conventional mortgage loans differently. They may charge a higher interest rate and/or require a larger down payment (20%-30%) for a construction loan. At Directions Credit Union, both types of loans are treated the same. You’ll receive the same rate and down payment requirement for a construction loan and a conventional mortgage.

Let us make the financial part easy. Call 888-508-2228 to schedule an appointment or visit directionscu.org for more information.

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