Financing can be a confusing when building a new home because custom-home buyers need to obtain a construction loan and a permanent mortgage. The construction loan acts as a short-term line of credit while the permanent mortgage funds on a long-term basis with an amortized payoff. It's smart to investigate your borrowing capacity prior to beginning the home-building process, but you probably won't need to secure your financing until you've purchased or reserved the lot for your new home, approved the design, building plans and written specifications for your home and signed a contract with the builder.
Your credit line
Most subcontractors and suppliers won't wait until your home is completed for payment for the labor, materials or products they've provided. This is where a construction loan comes into the process. This credit line is used to pay the subcontractors and suppliers on a timely basis during the construction process.
Partial payments
Once each month or as specific phases of construction are completed, you or the builder prepares a request for funds called a “construction draw,” which is submitted to the lender or the title company to pay for work completed thus far. Partial payments may be made to some subcontractors whose work extends through several stages of the building process. Subcontractors and suppliers typically agree to waive their lien rights against the home upon payment. Most lenders require that you pay for extras and changes as those expenses are incurred. It's also typical to pay a portion of the builder's overhead and direct job expenses with each draw, unless your contract with the builder states otherwise.
Apply for a mortgage
Although it seems odd, you must apply for a residential mortgage and have the lender's commitment for a permanent loan before you will be able to obtain a construction loan. Very few lenders will approve a construction loan without being assured that a permanent mortgage will pay off or "take-out" the construction loan when the home is completed.
Documentation
The documentation required for both the construction and mortgage loans usually include verification of your employment (e.g., 1099. W-2 forms, and paycheck stubs) or documentation of your self-employment income, verification of your assets (e.g., savings and investment account statements), your income tax returns for the last two or three years, your construction contract with the builder, the plans, specifications and cost breakdown for building your home and the purchase contract for title to the site where your home will be built. The construction loan lender will require a take-out commitment letter to verify that you've applied for and obtained a permanent mortgage.
If you obtain both loans from the same lender, you might be able to minimize providing duplicate documentation; however, these loans usually are handled by different departments, so you may still need to provide two complete sets of documents.
Lenders and loans
Lenders usually make construction/perm loans, which wrap both parts of the financing into one package. The construction loan converts to a permanent mortgage when construction is completed. Although construction/perm loans can work well, they aren't necessarily the best option for many situations. Try to obtain the best rate and terms available for your permanent mortgage, regardless of whether it's connected to a short-term construction loan. Once you have a commitment for your long-term financing, a construction loan usually should be relatively easy to obtain. |
