Subscribe to the Blog
Receive available home info, home building tips, inspiration, and much more.
While applying for and obtaining a mortgage may be a familiar process to many, the same may not be true for a construction loan. What is a construction loan, and how does it differ from a conventional mortgage? Must you always secure a construction loan if you plan to purchase a new-build home? How does the application process differ, and what are typical terms of a construction loan? Why is obtaining financing such a hassle?!
First, understand the difference between builder-financed and owner-financed. Typically, a builder who develops and builds multiple homes within a given subdivision obtains his own construction financing, selling homes directly to buyers who obtain their own mortgages. A buyer wanting to build a custom home using his or her own lot and plan, on the other hand, would typically obtain a construction loan to finance the project. The custom buyer chooses a builder, works to get financing in place, and then pays the costs of building the home as construction progresses.
Just as it sounds, a construction loan is intended to pay for all costs involved in building your new home from the ground up, including permits, utilities, contractor labor, builder’s fees, interior finishes, and even landscaping. It does not cover items deemed “removable,” such as furniture. This type of financing differs from traditional loans in that there is not an existing house to appraise, so the amount of the loan is based on the pre-determined future value of the home, as calculated by an appraiser.
Each month throughout the building process, you will make draws, or advances, on your construction loan. Think of a construction loan as a line of credit. During each step of the building process you will take a draw on the available funds. Typically, an inspector from the bank will inspect the job site each month to ascertain that the expenses submitted on that month’s draw are in line with the amount of work completed in the home. After the final draw, and the completion of your home, the builder obtains the Certificate of Occupancy from the governing municipality and the bank will then convert your construction loan into a traditional mortgage.