With a robust housing market and tight inventory, I wanted to continue my series on construction lending and the options it may open up for clients who cannot find their ideal home. 

How does a construction loan work?
Traditionally, construction loans are done two different ways. The first option is a construction-permanent mortgage and the second option is a construction-only mortgage.

A construction-permanent mortgage is both your construction loan and long term mortgage combined into one loan, which means you only have one closing for both your construction loan and your long term mortgage. This saves you time and money. Best of all, with this type of construction loan, your interest rate is guaranteed up-front, which means that you don’t have to lose sleep over what happens to interest rates while your home is being built. You have peace of mind knowing exactly what your interest rate and monthly payment will be.

A construction-only mortgage is just that. It is a short term mortgage that provides financing for just the construction period. Your end loan (permanent long term mortgage) is taken out upon completion of your home. Your construction loan and end loan are two separate loans, which means you have two separate costs and generally the interest rate for your end mortgage is NOT guaranteed until completion of your home.

How much of a down payment am I required to have?
We will typically finance up to 95% of the cost to build your home (land and construction cost).  Down payments of less than 20% will typically require Private Mortgage Insurance (PMI).  In some cases, the cost of PMI insurance can be either reduced or eliminated depending on your loan structure.   The minimum 5% down payment is required to come from your own personal funds and cannot be in the form of a gift.  In some cases you can borrower your down payment and have it be an acceptable source of funds provided that the loan is secured by an asset in which you have sufficient equity and your income can support the required monthly payment.

What are my payments?
Your monthly payments are interest only and are billed on a monthly basis. The amount of interest you are billed is based on the actual amount your builder has drawn against your construction loan. Your payments will gradually increase as your builder draws funds toward the completion of your home. You will only pay interest on the actual amount borrowed and for the actual period of time it was borrowed for. This ensures you do not pay interest for funds that you did not use. Interest only payments help to keep your total costs during construction as low as possible.

Your full monthly payments (both principal and interest) will begin once your home is completed and your mortgage converts (construction permanent mortgage) to your permanent mortgage. If you desire an escrow account for taxes and insurance, it can be added to your monthly payment at this time.

What will my interest rate be for my loan?
With a construction permanent mortgage, the rate for both your construction loan and permanent mortgage are locked in at the time you close your construction loan. Because you close on both your construction loan and end mortgage at the same time, you have the peace of mind in knowing what your rate is, and, best of all, you only pay one set of closing costs. If interest rates at the time your home is completed are lower than the interest rate on your construction loan, you can pay nominal cost to have your interest rate reduced (some restrictions apply).  This option is only available once your home is completed.  With this flexibility you can have your cake and eat it too!

What will my cost be to take out a construction loan?
As with the two different options, there are two different sets of costs. Generally, closing costs for a construction permanent mortgage are lower than those for a construction only mortgage. With a construction permanent mortgage, you close one time – saving you time and money. With a construction only mortgage, you have two separate closings – which increases your overall costs.

Can I build my own home if I don’t have a license?
As a general rule, we DO NOT allow you to build your own home.  In some cases, clients who are well qualified to construct their home and have a strong financial position may be eligible to act as their own general contractor.  In order to be eligible for a self build project you must demonstrate previous experience in building a home or work in a related trade that would support your ability to successfully complete the project.  Because building your own home can be more challenging then what most clients expect, we prefer clients work with a licensed builder.  If you need a recommendation of qualified builders in your area please contact us for details.

Can your programs be used to finance major remodels or even a “tear-down”?
Yes, these projects are more complex to finance and generally have less flexible guidelines when compared to building a new home from scratch.  Typically these projects require a larger cash investment then typical construction loans.  In addition, these projects can often times have difficulty with an appraisal.  This is especially true if your home with the addition will be one of the larger homes in your neighborhood.

Should we pay off our lot before we apply for a construction loan?
There is probably no reason to pay off your lot loan prior to the construction loan. If you have a lot loan, the new construction loan will pay off that lot loan just like any refinance would. The lot and the new improvements constitute only one piece of real estate, and the lot loan has to be paid off so the bank ends up in a first lien position. If you pay the lot loan off prior to applying for a construction loan, you may be handcuffing yourself by putting too much cash into the deal. Construction loans are almost always “no cash out” loans, so it may not be possible to get this cash back on acceptable financing terms. You are often better off having cash on hand during construction to handle upgrades and changes.

Do we need to sell our current home before building a new home?
Depending on your overall financial position, you may be required to sell your current home prior to qualifying for a construction loan.  Well qualified borrowers may be eligible to finance the construction of their new home without selling their existing home prior to the start of construction.  We will discuss specific options that may be available to you upon receipt of your loan application.

When do we have to make our down payment?
At the time we close on your construction loan, you will have to furnish your down payment. For example, if the home you are building costs $200,000 and you will only be financing $100,000, you will need to furnish your $100,000 down payment at the time we close your construction loan. The $100,000 down payment is held by the bank and is used to fund your builder’s draws. Once we have exhausted your funds, we will begin to fund the builder’s draw requests from your construction loan. There is no interest paid on your down payment.

Can I get a construction loan for part of the project and finish the work later?
No.  No lender will enter into a deal where the end result is an unfinished house. You could leave items such as landscaping, a swimming pool, finishing a bonus room, a security system, ceiling fans, and a garage door opener out of the build. However, you cannot leave out items such as cabinets, floor coverings, or a driveway. In addition, all items that were included as part of your plans and specifications will need to be completed. In other words, you must build a minimum of what you disclosed to us you were going to build. If you build less that what was disclosed, your loan amount will be adjusted down in most cases and there may be serious problems with the bank and building inspector.

Can we start construction with our own funds and get a construction loan later?
No.  All lenders require a clear title, and this situation can be thought of as a title problem. There are some exceptions to this rule and you should contact me for details if this is applicable to you.  Many title insurers will no longer insure these projects which may eliminate this from being an option.  If you have sufficient funds and can build the house for cash, you can take a mortgage out on the home upon completion.  However, the title company will require evidence and waivers of lien to insure all subcontractors have been paid.  If you do not have sufficient funds to build the home for cash, you must close your construction loan before you break ground on your home.

Can we use any builder?
Yes, however, we do require that your builder complete a builder review application. We will check for “happy homeowners” for whom the builder has completed similar projects and vendor references to insure they have a good history with the builder.  While we do conduct a review of the builders qualifications, we do not warranty the builders work or their ability to complete the project according to contract terms.  In the end, you as the homeowner are ultimately responsible for your builder selection and should research your builder in depth prior to executing a contract. 

How many draws can my builder get and where does the money go?
Again, the answer depends on the builder and the builder’s proposed draw schedule. A rule of thumb is that we typically do not like to do draws at less than 3 week intervals, but nothing is cast in stone. If frequency of draws is a hot issue for your builder, we can usually handle the arrangements. As to where the money is sent, it is usually wired to the title company who will disburse the funds to you or your builder depending on your preference. We do require your signed authorization before releasing any funds to your builder. In addition, we will not allow the builder to draw funds for work and/or items that have not been completed. We will have the appraiser inspect your home each and every time the builder request funds. What the builder is requesting funds for must match up with what the appraiser says is completed.

Can we pay our loan balance down at the end of our construction loan before our loan flips over to our permanent mortgage?
Yes, you can. A common occurrence is that the borrowers have now sold their previous residence, and they wish to use some of these funds to buy down the construction loan prior to the loan flipping over to their long term mortgage. You can make a principal payment of any amount, we will apply your payment and “re-calculate” your payment on your permanent mortgage for you.

If we already own our lot, can we use our lot equity for all or part of our down payment?
Yes!  Provided a current appraisal of the land supports equity in your land, you may be able to count some if not all of any equity position toward your down payment.

You can learn more about construction loans by visiting my website at www.danmoralez.com.