Obtaining a construction loan is not the same as a mortgage
“Homesteading” a piece of undeveloped land can be a challenging yet reachable goal. According to a Federal Reserve report, continuing strength in the labor market and continued low mortgage rates are contributing to a favorable building environment. A construction loan may be the only loan you will ever apply for on an asset that does not exist – yet.
However, a construction loan is a legitimate financial tool to turn your dreams of having a custom-built home into a reality.
It takes an experienced “guide” to navigate a path from envisioning a new home to finalizing your punch list items on the final walk-through. Building a home can get very complicated, especially if you need to take out a short-term loan for construction and a second, longer-term mortgage to permanently finance your new home.
Everything starts with a construction loan, a short-term loan that provides both the financing necessary to build the house and the safeguards to ensure expenses are measured and monitored throughout the process. From a business standpoint, banks consider construction loans more of a lending risk than traditional mortgages. That’s because your completed home acts as collateral with a traditional mortgage. In the case of a home construction loan, the bank has no collateral to claim, since your house is still under construction.
To acquire a construction loan, aspiring builders usually start off with architectural plans as the basis for estimating the projected value of the finished home. When the plans are approved and accepted by all interested parties, construction loan providers generally offer a loan based on a percentage of the completed projected value of the house. Typically, a 20 percent down payment by the borrower is contemplated, requiring a remaining loan value of approximately 80 percent of the projected value, to provide all the funds necessary to build your new home.
Construction loan disperse the loan in installments called “draws” as needed during various stages of construction. For instance, a concrete contractor will likely request payment after foundations are poured and set. As the construction progresses, other building trade contractors will want payment for their services. Then there are costs for extra items, like titling, inspections, appraisals, landscaping and interior finishing millwork.
Your construction loan provider should be your partner from the first building blueprints to the final walk-through of your completed home.
When the building phase is completed, the construction loan is paid back immediately when a more traditional long-term mortgage is put in its place. Provided you had no cost overruns and your home appraises at the original projected value, obtaining the mortgage loan financing is not nearly as arduous a process. Some loan providers offer a financing package that includes both the construction and mortgage loan.
Homesteading is a journey involving many partners along the way, and it’s good to have an experienced advisor to help navigate the financial crossroads.
Brian Watkins is the Commerce Trust Company’s director of private banking and Greg Benton is a Commerce Bank mortgage banker.
