Congratulations! You’ve made the decision to build your dream home from the ground up. With a blank canvas as your blueprint, the sky is the limit for designing a space that’s uniquely suited to you. The next step in the homebuilding journey is to determine how to obtain a loan so that you can pay for it. Unfortunately, the construction loan process can be complicated.
But no need to worry — we’re the homebuilding experts, so we’ve done all the work for you. After all, we believe that building your new custom dream home should be a process that’s enjoyable and memorable. Here’s what you need to know about getting a new construction loan and what it takes to qualify for one.
What Is a Home Construction Loan?
Construction loans are typically shorter term, higher interest rate loans that cover the cost of building a home and can even convert to a traditional mortgage once construction is complete. Borrowers are required to begin paying them back anywhere from 6 to 24 months after the loan is granted. Each home construction project is unique, but generally, a construction loan will cover the costs of:
- Plans, permits, and fees
- Labor and materials
- Closing costs
- Interest reserves (for borrowers who prefer to make interest payments after construction)
- Contingency reserves (in case the construction process costs more than the original estimate)
Here’s how it works. A lender pays a construction loan to the home contractor, rather than the borrower, in increments as milestones are achieved throughout the build. Once construction is complete, the loan is either paid in full or converted to a permanent mortgage. There are a couple of different construction loans you can seek approval for, including:
- Construction-to-permanent loan (also known as “single-close” construction loans). This type of loan allows you to borrow the amount needed to build the home. Once construction is complete, the loan is converted to a traditional mortgage. In this case, your interest rates are locked in at closing. Because this type of loan converts to a permanent mortgage once the home build is finished, it’s best for anyone who has a relatively clear construction plan and prefers predictable interest rates.
- Construction-only loan (also known as “two-close” construction loans). With a construction-only loan, you borrow the amount of money necessary to fund the build, and pay if off — as well as any closing costs and fees — once construction is finished. You may need to reapply for a new loan to pay off the construction loan once building is complete, which will require a second closing process, along with more fees. Because this type of loan must be paid off at the end of the build and requires you to pay closing costs multiple times, it works best for those who aren’t financially restricted.
How Can I Get a Home Construction Loan?
The first step in getting approved for a home construction loan is to talk to your bank or preferred lender — even before you look at any homes. This way, you’ll have realistic expectations for what you can afford based on your budget. Here’s what your bank or lender will be evaluating:
- Credit score. Most lenders or banks require a score of 680 or higher for a home construction loan.
- Debt-to-income ratio. This refers to the total of your monthly debt payments divided by your gross monthly income. Generally, your debts should total no more than 45% of your income — and lower is better.
- Down payment. Typically, a 20% to 30% down payment is necessary for new construction.
How to Choose a Lender
When it comes to the financing of your new home, getting prequalified for a loan should be your very first step — even before you think about your new home’s design or layout. Otherwise, you might have your heart set on a project that isn’t in your budget, and if you’ve already spent money on specs and plans, those will be a wasted expense. Not every mortgage lender offers home construction loans, so do your research to find some in your area who do, and then compare their terms and rates. Here are some other tips to keep in mind when searching for you lender:
- Loan rates change on a daily basis, so you’ll need to gather your offers on the same day to make sure your mortgage rates can be compared accurately.
- Conduct all your loan inquiries within a two-week period. This is because most credit scoring agencies consider multiple mortgage-related inquiries made within 14 to 45 days to be a single inquiry. This way, your credit score won’t be affected more than necessary.
Looking for Custom Builders of New Homes in Austin?
The journey of building a new home takes time and involves countless decisions along the way. The best way to navigate the process smoothly is by choosing partners you can trust.
At Paradisa Homes, we know that building a new home is one of the most important investments you’ll make in your lifetime. That’s why we’re here to help make the process as easy and enjoyable as possible. Contact us today to learn how our full-service staff of architects, designers, engineers, and construction professionals can help you design and build a space you’ll be thrilled to call home.