Whether you are an adventurous person, a DIY expert or just a discerning home buyer, the thought of building your home could be an electrifying prospect. After all, when you choose to build your mansion, you can call all the shots. This means you can determine the precise layout, dictate the exact number and type of rooms, manually select all finishes, and even add an indoor pool, aquarium wall, or stair slide, for that matter.
While building a one-of-a-kind home from scratch may seem exciting, financing such a major business is a completely different story. Obviously, most homebuyers don’t have enough hidden money to cover the cost of building their bespoke home, which means they’ll need a loan. Unfortunately, getting a loan for a home build project is easier said than done.
Key points
- If you are considering building your home, here are some things to keep in mind when looking for a loan.
- Many people want to build their dream home rather than buying an existing property, but a traditional mortgage won’t help you with that dream.
- A construction mortgage is a loan that is borrowed to finance the construction of a home and typically only interest is paid during the construction period.
- Money is advanced incrementally during construction as construction progresses.
- Once construction is complete, the loan amount becomes due and becomes a normal mortgage.
A standard mortgage loan won’t do the trick
For buyers buying an existing home, it is relatively easy to get approved for a conventional mortgage as long as they have good credit and reliable income. On the other hand, it is virtually impossible to get traditional financing when you build your home. Because? Think of it this way: you’re basically asking the lender to shell out money for something that doesn’t yet exist. To make matters worse, construction is a risky process and lenders don’t like risk.
Look for a construction loan
If you plan to build yourself, you will have to pursue more specialized funding avenues. Enter the construction loan . Sometimes called a home loan or home loan, a construction loan is typically a short-term loan (usually a one-year maximum) used to cover the costs of building your home.
These loans generally have floating rates that are higher than traditional mortgage rates. Once construction on your home is complete, you can refinance the construction credit into a permanent mortgage or get a new loan to pay off the construction credit (sometimes called the ” end loan .”)
Get ready to lay a lot of groundwork
As you prepare to apply for a construction loan, you should probably do a serious stretch. These loans require a lot of leg work on the part of the borrower. You will need to jump through numerous hoops to prove that your home construction project is real, feasible, and relatively low risk to the lender.
For most construction loan applications, you will need to provide the lender with a project schedule and realistic budget. You’ll also need to provide a full list of construction details, including everything from floor plans and the type of building materials to insulation and ceiling heights. (Experienced builders typically create a “blue book” that includes all of these details for a home construction project.)
Prepare for a large down payment
At a minimum, most lenders require a 20% down payment on a construction loan, and some require up to 25%. Why are the down payment requirements so high? Because construction loans are seen as a “higher risk” than a traditional mortgage loan, and the lender wants to make sure they don’t abandon the project.
You know where you land
If you do not already own the lot where you intend to build, the cost of the land will have to be included in the total amount of the construction loan. If it is financially possible, try to pay the land up front. Otherwise, you will have to pay a much larger down payment to qualify for the construction loan.
Work with a qualified builder
To get approved for a construction loan, you will need to prove that you have a qualified builder involved in the project. A qualified builder is generally defined as a licensed general contractor with a solid reputation for building homes.
Whether you intend to act as your general contractor or build the house yourself, this presents a unique challenge and you will likely not be approved for a standard construction loan. In this scenario, you may want to turn your research into owner-builder construction loans. In today’s real estate market, it can be difficult to qualify for these types of loans; but it is possible if you provide a well-researched construction plan that demonstrates your home building knowledge and skills. Don’t forget an emergency fund for unexpected surprises.
The bottom line
While building your home from scratch can be an extremely rewarding process, getting a construction loan isn’t a walk in the park. To increase your chances of approval, put together a detailed project plan, involve a qualified home builder, and save enough money for a large down payment before applying.
