Financing a New-Build with a Construction Loan

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.

What is a construction loan?

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.

What documentation will you need to apply for a construction loan?

• The pre-approval process begins with the bank asking for copies of your tax returns, income statements, and all paperwork relating to your existing debt. Next, a credit report will be obtained to assist the bank in determining how much credit they are willing to extend.
• After loan pre-approval is secured, the search for land begins. You may wish to involve a builder at this stage to assist in locating a suitable lot. The builder will see qualities–both pro and con–that may not be as clear to you in a given parcel of land. Once the desired property is identified, you will work with your builder to create a project budget, or quote, to submit to the bank as part of the final loan approval process.
• The bank will review your paperwork and order an appraisal to determine the future value of the home. Most banks require a 20% down payment.

Ways to save money on your construction loan.

• Ask your builder to refer a lender. They will often know which ones are the easiest to work with and which ones can offer the most attractive rates.
• Establish your budget before you apply for the loan. You know best what you can realistically afford. Just because you can qualify to borrow a greater amount of money doesn’t mean that you should.

What happens after the final draw?

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.

Trust Sheffield Homes from start-to-finish to walk you through the custom home-building process. We’ve been building homes in the Denver metro area and in Northern Colorado for over 40 years. Put our experience to work for you!