How to Get a Loan to Build a House

June 5, 2019 9:00 am How to Get a Loan to Build a House Published by

Unless you just happen to have piles and piles of cash, the construction of your new home will most likely require a home construction loan. When you start the process of actually getting that home loan, it can be pretty overwhelming. This is especially true of first-time home buyers who may not be familiar with the process or the potholes that exist along this sometimes-treacherous road. 

Applying For The Loan

For the first step, you will need to do a little bit of research. In this case, I am not talking about the type of research that is conducted strictly with paper, pen, or computer. Your initial research will require you to go out and find the information that you want.

Start by driving around your town, concentrating on areas with plenty of new construction. Look for homes that suit your tastes and lifestyle, and try to get a feel for how expensive they might be. If the home is unowned, you can probably find out which realty company is doing the selling. There will usually be a sign out front, but you can look up the address if this isn’t the case. 

Once you have a good idea of what you want and how much you expect to pay, it is time to visit your financial institution. The first step is pre-approval, and it should go fine as long as you don’t have particularly bad credit. Be careful not to borrow more than you can afford to pay back! 

Deciding On A Home Type

Next, you will need to decide what kind of home you want to buy. You can either build your house from the ground up or buy a house that is currently under construction. The latter type will usually be part of a housing development project, and this makes for a slightly easier process. Often, the companies that build these homes will help you to find adequate financing options if they see that you are interested in buying. 

Homes that are custom-built from nothing are a little harder, but it shouldn’t be too bad. The only thing that can really become a problem at this stage is your credit. Home construction loans are considered to be somewhat high-risk, so don’t bother trying without good credit. You will probably need a down payment of 20-25%.

Types Of Construction Home Loans

There are two main options when it comes to negotiating the terms of your loan. This part of the process can be very confusing because these two options can sound very similar at first.

Option 1: Stand-Alone Construction Loan

The best thing about this type of loan is the fact that it usually requires a smaller down payment. At the same time, you will pay twice as much in closing fees. This type of loan is technically considered to be two different transactions, even though they are both a part of the same process. 

The first part of the process is the loan itself. When that goes through, you receive the money to build your house. Once the process is completed, the remaining balance of the loan is converted into a permanent mortgage. This mortgage is the second part of the process. 

Another small downside to this type of loan is the fact that changing interest rates can raise your costs at the last minute. If interest rates rise during the first phase of the loan, there will be nothing that you can do about the matter. Although most terms of your loan will be set in stone and unalterable, you cannot lock in the interest rate. 

Option 2: Construction-To-Permanent

This type of loan is a little bit more simple. Instead of being classified as two separate transactions, this sort of loan is classified as a single loan, which means you only pay one set of closing fees. However, you will probably have a larger down payment. As you can see, there isn’t a lot of difference between these two loan types. 

Like a stand-alone loan, this one can be vulnerable to the fluctuations of the market. If the Fed happens to raise the prime interest rate (on which loan and mortgage interest rates are based), your costs will go up. Sadly, this is a liability that cannot be avoided. 

Alternate Sources Of Funding

If you find yourself in a situation where you cannot seem to get approved, it may help to use your home as collateral. Because of policies related to equity, you cannot present that house as collateral if you live there and have equity in the home. This can be remedied with a temporary move. 

What you can do is take the risky step of acquiring a bridge loan. The basic idea is that they will loan you the money until your other home sells. The money from the sale is then used to pay back the construction loan, although there will almost certainly be interest. You need to be very sure before you take this step, as it is a “double-or-nothing” move. If things don’t go well, you stand to lose a lot. 

Conclusion

Getting a loan for your home construction project will certainly be a little bit of a hassle. However, no one wants to part with their money without guarantees, and banks/financial institutions are no different in this regard. You can’t reasonably expect them to bankroll your project without asking a lot of questions. Be patient and stay honest at every stage of the process. Understand that these lenders are taking a certain degree of liability.

We sincerely hope that this article has at least given you a small sense of what is involved in this process and what you need to do. We want to help you build the best possible living situation for you and your loved ones, so we hope that you will fill out the contact form below and receive more helpful advice articles like this one.