The Builder In You

A construction loan is one of the very first steps in the home building or remodeling process.  This allows you to know the scope of the project you qualify for. But where do you start? You have probably applied for home loans in the past but will it be the same for a construction loan?  A construction loan is somewhat different than any mortgage you may have applied for in the past, and, depending upon your needs, there are several types of loans available. Once a loan is approved, the money is put into an account from which you will draw funds as needed to pay your suppliers and subcontractors.  While lenders you talk with might offer these loans with different features, there are basically 4 types of loans available.

THE 4 TYPES OF LOANS

1.      Construction to Permanent Loans – this loan takes you through construction and allows you to convert to your permanent home loan when your home is finished.  You would only close on the loan once which means you only pay closing costs one time.  With this type of loan, many lenders will give you rate protection.  What this means to you is if the interest rate goes up during construction, you will be locked in at the lower rate you committed to when you closed. If the interest rate has gone down by the time you complete your home, you would receive the lower rate when you convert to a permanent loan.  In addition, you would not make any payments during construction.

2.     Lot Loans – What if you find a great lot before you are ready to build your dream home?  No problem!  You can obtain a loan for the lot and purchase it in anticipation of building on it in the future.  The requirements from most lenders are that the lot is normal for that area and at least one utility be available from the street.

3.      Bridge Loans – If you don’t want to sell your current house before your new house is built, you can access the equity in your current house to use as a down payment on your Construction to Permanent loan.

4.      Remodeling Loans – If you are making major improvements to your primary residence, this second mortgage calculates the value of your home by adding the planned improvements to your home’s current value.   With many lenders, you then receive immediate access to the funds at loan closing.

The more you know the better prepared you will be to discuss construction financing. There are many terms that might be new to you, and helpful as you research your options.

1. Soft Costs – These are permit, architectural, engineering, survey, school taxes, utility connection fees and any other fees incurred before your actual construction begins. Funds from your construction loan become available at the beginning of actual construction. These soft costs frequently occur before construction begins. Based on your choice and your lender’s options, you may choose to be “paid back” for these costs when your funds are available at the beginning of construction.

2. Hard Costs – These are the actual costs for all materials and labor associated with the actual building of your home.

3. Closing Costs – These are the costs associated with closing your construction loan such as title cost, loan fees, discount fees, insurance, and appraisals.

4. Interest Reserve – This reserve account is established to pay the estimated interest on the loan during the construction process. This way, you do not have to make any payments during the construction of your home. In the rare occurrence that this reserve is depleted due to lengthy construction times, then you will begin to make interest only payments on your loan.

5. Contingency reserve – This reserve is created to cover unforeseen cost overruns in the construction of your home. It is usually equal to 5% of the hard cost of your construction.

6. Lot Value – The value of your lot will be determined by one of two methods. If the property was purchased in the last 12 months, the purchase price is used to determine the value of the site. If the property has been owned for more than 12 months, an appraiser’s estimate of the site value will be used.

7. Inspection fees – Some lenders require that inspectors determine of the progress of your construction project. If these are needed, there may be a fee charged for each inspection.

8. Loan to Cost Ratio(LTC) – This ratio compares the project cost of your home to the total loan amount. As an example, if the project costs for your home are $350,000 and your loan is $325,000, your LTC ratio is 93%. Maximum LTC ratios vary from lender to lender, and may be a factor you want to take into account when selecting a lender.

9. Draws – Monies drawn during construction to pay for materials and/or suppliers.

While there are a few more elements to construction financing than with your traditional mortgage, you are now better equipped to talk with lenders to determine how they can help you build your dream home.