When a borrower is looking to build a house of their own or possibly renovate their own home and they do not have cash for the whole project, they will most likely need to take out what is called a construction loan.
The process of obtaining a construction loan is not complicated, though it is pretty stringent. You will also need a larger down payment to build a brand new property. While this process can be cumbersome, it is necessary so that the bank can assure that what is being constructed will have the adequate value that it is lending.
First of all, you must be financially qualified and the bank will determine that based on many factors, but the most common are the value of the land, the amount of the loan, an estimated valued of the completed house as determined by an assessment of your property blueprints, and the community you are constructing in. If you are remodeling your home, they will also want to see the blueprints, estimates and also the future appraised value in order to make sure that your remodel makes financial sense by showing that your homes value will rise after it is completed.
Some mortgage professionals will refer to this as a “story loan” because the lender will generally want a detailed story about how the borrower plans to build or remodel the property and how long this process will take to complete. The bank will take all of that information into account and reach a decision as to whether the project is a “wise investment” from their standpoint and if it is will proceed to evaluate your creditworthiness for the loan.
Many times you will find that lenders will offer a specific type of construction loan based on the type of property being built and the goals of the borrower. For example, a new construction loan on a regular single family home will be little different than a manufactured home loan.
A lot of people will apply for a manufactured home loan which is typically short term as well because the homes are much less expensive to build. But keep in mind that this loan will also carry other costs that include the moving from a factory to the specific spot the owner wants to build. There are actually many other loans that are specialized for manufactured or log homes as well.
Here are some different types of loans for building a home or remodeling your current property that you can look into.
These loans are also known as “one time close”, and “all-in-one” loans. A construction-to-permanent mortgage or one-time close loan initially finances the land and construction of the property and then converts to permanent financing, with just one closing. Typically, you will need a 20% downpayment and some lenders require as much as 25% down.
This type of mortgage is when the lending institution allows a certain amount of money to be lent out while the home is being constructed and then converts to a permanent loan once the home is finished. For example, if the borrower estimates that the home should be completed in two years, they will generally then have to make 24 monthly payments for construction part the loan to be paid by the time the project is complete. Once the construction phase is finished, the lender will then automatically convert the loan into to a permanent mortgage.
A note modification loan is another common type of construction mortgage.
Like a one-time close loan, this type of mortgage can also become a traditional home mortgage after the home is complete. This type of mortgage typically will start out with a low monthly payment and slowly increase as time goes by. Once the home is completely built, the borrower will be able to choose from a fixed rate or variable mortgage.
With a variable rate, it is important to remember that your payment may increase a significant amount over time. You will also need a 20-25% downpayment.
Another type is called a two-time close loan.
This loan has a set payment schedule that will pay off the cost of construction when the house is finished. Generally, after the home is completed, the borrower can refinance into a new loan such as a 30 year fixed with a better interest rate. You will also need a 20-25% downpayment.
If you are looking to buy a property in need of repair, or looking to remodel your home, we offer loan solutions that are cost-effective and streamlined. Many properties can now be financed AS-IS, regardless of condition, all with a single mortgage that provides you with the funds you need for renovation, repairs, and/or upgrades.
These loans are called:
- FHA 203(k) Standard
- FHA 203(k) Streamlined
- Fannie Mae (FNMA) Homestyle® Renovation
- Fannie Mae (FNMA) HomePath® Renovation
Assuming it’s a go and you have been approved for a new mortgage, what happens next?
Well if you are approved, the bank will typically assign another agency to oversee the disbursement of the funds directly to the agreed upon contractors at specific checkpoints along the construction time line. Typically this third party agency will ensure that the proper inspections have been made and passed, that the correct materials were used, and that the contractors are fulfilling their obligations – including providing proper evidence of workman’s compensation insurance, paying their suppliers, fulfilling their bonding requirements and other requirements.
If everything is in order, they will “release” the funds to pay for the work complete up to the defined checkpoint and approve the project to continue. So it is important to realize that the borrower will not be provided all of the funds up front. Lenders will only supply the funds in installments just in case an emergency arrives and the property cannot be completed. These installments limit the risk on the lenders behalf.
Please keep in mind the fact that home construction loans are meant to only be a short term mortgage. The interest rate will be a lot higher than it would with a regular loan, and you may end up having to pay additional penalty fees if the home is not completed on time according to the loans agreement. But keep in mind that this a short term loan that you should keep only until the home is finished which is typically right around 12 – 24 months for most projects.
What happens when the home is completely built or remodeled?
The construction period ends once the lender receives the contractor’s final lien affidavit, a final survey, final completion certificate and occupancy permit, and when your lender performs a final inspection of the property. If you are getting a temporary construction loan to build the property, once the home is completely finished, the new construction loan will be due in full.
The majority of borrowers will pay off this loan by securing a regular 15, 20 or 30 year fixed mortgage right before construction is complete. If you have already secured a permanent mortgage, the lender will automatically convert your construction loan into the mortgage you have chosen.
If you are remodeling your property with for example a FHA 203(k) loan, then you do not have to worry because it is one loan and you will only need to apply for one fixed or adjustable rate loan that will cover the acquisition (or refinance) and rehabilitation costs of a property.
If you have any questions or you would like to discuss your loan options, please call me, Erik Sandstrom, at 1-800-779-4547; or email me at Erik@LoansReduced.com.