Building a new home is one of the most expensive things that the average person will ever do. Indeed, the high cost is what prevents many people from purchasing a new and custom-built home. However, you shouldn’t make the mistake of thinking that you need all the money up-front. Many financial institutions will provide construction loans that are meant to cover the cost of building your new home.
Single-Close versus Dual-Close Loans
When you get a construction loan, you will normally have to get another loan to finance the first one. This is the case because construction loans are short-term loans. Their terms usually only last until the point when construction is completed. Unless you can afford to pay the whole thing in a lump sum, you’ll have to get another loan to pay off the first one. Of course, this second loan will have a much longer-term than the first one.
When you get to that point in the process, you will have to choose between two basic types of loans: Single-close and dual-close. The main difference lies in the fact that a dual-close loan is dealt with as two separate loans, which might even come from two separate financial institutions. This type of loan is sometimes referred to as a “construction-only” loan. The single close loan, on the other hand, combines two loans into one convenient plan, and both are usually from the same lender. These combined loans are often called “construction to permanent” loans.
There are good reasons why you might choose one or the other. On the one hand, the dual-close approach seems great because it is more convenient. Also, it involves only one set of closing costs. However, convenience usually does come with extra costs, and this is no exception. With a single-close loan, you will lose a lot of your ability to shop around for a better deal, as you will be locked into a deal with one specific lender. This means that your premiums and interest will probably be higher.
How Much Will A Construction Loan Pay?
In most cases, the bank (or another lender) will not pay for 100% of the construction costs. Instead, they will probably pay 75-80% of the estimated cost of construction. As for the other 15-20%, that will still be required as a down payment on any loan that you get.
It is possible to get 100% financing, but it often involves having to use a cross-lien. This is just a lien in which you use an existing property as collateral with which to finance a new home. Obviously, this involves a higher amount of risk, but it can potentially get you out of the down payment.
How Are Such Loans Disbursed?
Most of the time, you won’t get the entire amount of the loan in a single payment. Luxury home builders and custom home builders tend to charge a lot, so that would be a huge amount of money for a financial institution to give out at one time. Instead, they usually prefer to break up the payments throughout the various stages of construction.
For instance, let’s say the total loan is $20,000. They might give 40% for the initial phase, and then pay out the remaining installments when certain benchmarks are met. Before you sign on the dotted line, check out these terms, and make sure that they are providing enough money for each phase of the construction. If you run out of money at a certain phase, you may end up in a hard predicament.
Concerning Interest Rates
As with most loans, you will probably have a choice between fixed and variable interest rates. When you choose one or the other, you are essentially making a bet on the U.S. economy. You see, interest rates are set by the Federal Reserve bank and are followed by all lower banks. These interest rates change from time to time, as the needs of the economy change.
If you go with a fixed interest rate, your loan will not be affected by the later decisions of the Federal Reserve. Your interest rate will stay fixed at the current market rate. If you go with a variable interest rate, the interest payments on your loan will be subject to any changes that the Fed chooses to make.
Obviously, this decision should be based on the current level of interest rates. You can look at some statistics on the matter to get an idea of what is considered “high” and what is considered “low.” If interest rates are currently high, go with a variable interest rate so that you can (hopefully) get some relief later. If interest rates are currently low, you should go with a fixed interest rate so that your costs don’t go up unexpectedly.
Getting the financing for a home construction loan isn’t as difficult as you might think. You will need to have a decent credit score, especially if you plan to bundle your loans into one. Other than that, you just need to work hand in hand with your building contractor to make sure that the financial arrangements do not interfere with the construction itself. If you have enjoyed this article, please feel free to fill out the contact form below.