Even if you’ve gone through the home loan process before, the process of custom home loans is a little different. You’ll need a construction loan if you want to build a custom home from the ground up.
What are construction loans?
Most people don’t have the funds to pay out of pocket to cover the construction of a brand new home, so a construction loan is your best option. These are normally short-term loans (6-12 months) used to cover the actual cost of building a home. Once construction of the house is finished, you can either refinance the construction loan into a permanent mortgage or get a new loan to pay off the construction loan.
Which construction loan is best?
There are multiple construction loans available, but construction-to-permanent loans are often the best option. All of your financing is combined into a single transaction with this type of loan. This means you only have to go through one application and one closing process. By doing everything once, it makes it simpler and potentially more affordable since you only have to pay closing costs once. Additionally, once your dream home is done, you don’t have to worry about trying to get financing for a mortgage, as the loan will convert once construction is finished.
Benefits of construction-to-permanent loans include:
You only pay interest during the construction process, you don’t pay any principal.
You only pay interest on the portion of the loan you use.
You essentially get two loans in one rather than dealing with two separate loans.
How do you get a construction loan?
Of course the minimum credit score, maximum debt-to-income ratio, and down payment required for a construction loan will vary depending on the lender you work with. Shop around to multiple lenders to see what the best options are out there. Lenders will review your employment history, savings, income stability, and will do a property appraisal to support the value of the collateral.
Other Financing Options
Bridge financing can also be an important tool for you. Bridge loans are short term financings (6-9 months) designed to eliminate a cash crunch and “bridge the gap” between your two homes. For example, to help get you through the period of time before your current home is sold and when your new home is being built.
FHA loans are a good option if you have minimal cash to make a down payment and your credit history has a few blemishes. It’s a federal government-backed loan from the Federal Housing Administration that allows as low as a 3.5% down payment.
VA loans are another great option if you are a veteran, they require no down payments.