Financing a custom home project is not nearly as straightforward as buying a resale home with a conventional 30-year mortgage. The best place to start on any building project is with a lot, this purchase not only determines where you will build but in many cases what you can build.
The other benefit gained from leading with the lot purchase is that it gives you an equity position to work from for the rest of the process. In order to use the lot as equity for the subsequent construction loan, you will need to own the land free and clear. If you have a loan on the property, it’s a good idea to prioritize paying that loan off before you take on more debt.
How Do New Construction Loans Work?
If you’re going to build a home, it’s a good idea to learn a little bit about “how new construction loans work”.
Construction loans generally require 20% to 30% of the total loan amount as a downpayment.
Let's say you purchased a lot with a value of $100,000. Your plan is to build a $500,000 house on this lot. Your total project cost would come to $600,000.
$100,000 lot
$500,000 house
$600,000 total value
In this scenario, the lot would account for 16.67% of the 20% downpayment required by most lenders.
This would leave you to come up with an additional $20,000 to $80,000 in order to qualify for the construction loan.
The amount the lender is going to require you to put down will depend on a number of factors like credit score and credit history as well as the particular type of loan program the lender or bank can offer.
If you have a particular builder in mind, they can be a great resource for finding out which banks have the most favorable construction loan programs. So, make sure to talk with builders and other real estate professionals about the best construction loan lenders in your area.
Single Close or One Time Close Construction Loan
One popular option is to use a Single Close Construction to Permanent loan. This is a mortgage that is used for the construction of the home and then upon completion of the home rolls into the permanent financing for the home.
In this type of construction loan, the entire process is simplified. You would use a single mortgage loan originator, a single loan, and a single closing process. All of this will save time and money.
If you own your lot free and clear, that value can be credited towards your downpayment in this type of loan as well. This simplifies the entire home-building process. With everything in the same place, the time for communication and approvals is greatly reduced. Additionally, your builder has one place to go for all of their financial requirements and questions.
In Conclusion
Building a home can be a fantastic experience or an absolute hassle. If you want to enjoy the process, it’s important that you simplify and plan the process before you spend a dime on a new home. Purchasing the lot is the first tangible step on the road to a successful new construction project. Once the lot is paid off, you are well on your way to obtaining the rest of the construction financing you’ll need.
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