Building a new home can be an exciting process. Before the excitement can begin you must make sure you have the financing to start building. Unless you have hundreds of thousands of dollars at your disposal you will need to apply for a construction loan.
Construction loans are different from other kinds of home loans. With mortgages, lenders consider the home collateral for the loan. Should you fail to keep up your end of the deal, the lender can simply sell your home to recover the amount of the loan. There is no such collateral backing a construction loan thus, the lender has no guarantee that the loan will be paid. Once you have been approved for the construction loan, the lender won’t just write a check for the amount of the loan and allow you to begin building.
To combat this, the lender will only disburse the loan in increments according to an agreed upon schedule, known as the draw schedule. The draw schedule might dictate that the loan will be disbursed in 25% increments with each 25% of the construction that is complete. Once a portion of the construction is completed, appraisal of the work is done. After the appraisal states that 25% of the work has been completed, the lender disburses 25% of the loan. You then begin making interest only payments only on the part of the loan that has been disbursed. Your monthly payment increases as more of the loan is disbursed.
Once the construction is complete, the amount of the loan will be due. Lenders are aware that don’t have that kind of money to spend at one time, so they make provision for you to use a mortgage to repay the loan. You must be approved for a mortgage before the lender will approve you for the construction loan. When you are ready to apply for the construction loan, you will need a commitment letter from your mortgage lender, along with the plans for the construction, and a qualified builder.
There are two basic types of construction loans for which you can apply. With a one-time close construction loan, the mortgage and your construction loan are closed at the same time. The interest rate for both the construction loan and the mortgage is locked in at the time of closing. Should you choose to get a two-time close loan the construction loan and mortgage will close at two different times. Your mortgage interest rate will be determined at the time of closing, once construction is complete.