Construction Loans Cover Short-Term Building Costs
Few things are more rewarding than seeing your design ideas come to life in a custom design-build home. But unlike conventional mortgages for existing houses or big-box new construction, a custom design-build usually requires a construction loan.
In short, construction loans are interim loans to cover short-term building costs. As work progresses on your home, the lender pays out in increments. These construction loans tend to be short term (max. is usually 1 year), and they have variable interest rates which is usually a bit higher than rates on a standard 30-year mortgage. The construction loan is simply a loan to cover construction costs, and it is used in conjunction with permanent loans (mortgages) that will cover land and the remaining home price.
In this article we will lay out the two basic types of construction loans, as well as some of the financial criteria you’ll need in order to secure a construction loan.
Construction Loan to Permanent Loan
This is a combination loan. Your construction loan and rate cover the initial building of your home, and then once completed, the loan converts to a permanent mortgage. During the construction, you’ll pay a variable rate on the construction portion of the loan along with the interest on the outstanding balance (you won’t pay toward the principal until completion and you move in).
Once the house is built, the loan will convert to the permanent 15 or 30-year mortgage with either a fixed-rate or variable-rate option.
If you opt for a construction only loan, you’ll end up taking out two separate loans: one for construction and a permanent mortgage for the rest of the home cost and land.
One of the biggest advantages of a construction only loan is that you do not need as much of a down payment since you’re just covering construction costs in the short term. For many, this allows them to live in their current home during construction, and then as construction nears completion, they can sell their current home and use the money toward a downpayment on a mortgage.
The biggest draw back is that you’ll be going through two separate loan processes, including two different sets of fees. A construction-only loan is also riskier for the bank, so rates and criteria for applying may be more difficult.
How to Qualify for a Construction Loan
Much like a mortgage, qualifying for a construction loan requires you to supply a lender with documentation that show the following. Some find that construction loans are harder to obtain because of the greater risk to the bank. Generally, all lenders are looking at the following criteria:
- Good to Excellent Credit Scores
- Stable Income
- 20% Down Payment
- Low Debt-to-Income Ratio
- Lot and Home Plan Information
- Contractor and Material information
The bank will need to see that you have savings to cover unplanned costs. Working with a reputable contractor will help. Choose a design-build contractor that knows the process and can help you with the documentation.
Additionally, it’s worthwhile to shop around when looking at lenders. Get your documents in order and ask your contractor or local realtors for recommendations. Set up meetings and see what is available to you.
To learn more about Odom Design and how we can make a custom design-build easy and enjoyable, contact us today.