Two Types of Construction Loans

Building your own home can be a nightmare if you don’t know what you’re doing. Know and understand what you’re getting yourself into before you apply.

Types of construction loans

The two types of construction loans are:

Construction-to permanent – This type of loan is where the lender advances the money to pay for the construction, and once the home is built, the lender then rolls the loan balance into the mortgage. This is the most common loan option.

Stand-alone construction – The lender often advances the money to build the home. Once the home is complete you get a mortgage to pay your debt of construction costs.

The nice thing about a construction-to-permanent loan is there is only one closing. The interest is paid on the balance of the loan during construction, and it converts into the mortgage once the home is built. Your maximum mortgage rate is set at the beginning when the papers are signed.

The stand-alone-construction loan is worth it because it allows for a smaller down payment. One of the negatives of this loan is your interest rate could rise, simply because you aren’t locking in the rate at the beginning. To go along with that, you could pay for two closings if your circumstances change during the building; you end up paying one for the construction loan, and then again for the mortgage.

Difficult to qualify

Qualifying for the construction-to-permanent is a difficult loan to acquire. It’s different than a typical mortgage because the lender doesn’t hold the house as collateral to back the loan during the construction. You have to at least put down 20% of the loan amount, while rarely allowing you to go down to 10%. The lender will size you up and see if you can afford the loan payments during construction while you are paying your current living expenses.

Have sufficient savings

There are unexpected costs, and the lender takes this into account and makes sure you have the funds to pay for them. They will tell you up front not to use every single nickel in your bank account because it could end up completely bankrupting you. Borrowers often change their minds on what they want during the process which easily leads to cost overruns.

Due diligence on the builder

Building the right home for you means choosing the right builder. Find one that builds the kind of home you want. Check out their style, price, size, and look for the credentials with the homebuilders association and talk to their previous clients. The better business bureau also will know if there are any complaints with them.

The lender will also help you out by taking a look into the builder’s credit standings, financial situations, and licenses. They will let you know about their history and record for similar homes.

Ongoing inspections

Lenders will be making sure everything is going as planned by sending routing inspections. The lender will be paying the builder in stages, and sends their inspectors and appraisers to make sure everything is on schedule. 

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