What Is A Home Construction Loan?

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If you have been thinking about building a home instead of purchasing a pre-made one, building can be a wonderful experience. You get to design the home as you wish and feel like you are a part of the process.  Building your own home takes a great deal of time and it takes money. Most people do not have all of the money up front to build a home, so they have to take out a construction loan.

What is a home construction loan?

A construction loan is a short loan that you take out from the bank to pay for your new home construction. What typically happens is that you take out a short-term loan for the amount of time it takes you to build your home, usually about one year. When the new home is completed, it is then that you will have to get a new loan to pay for the rest of the construction loan. Sometimes this is called the “end loan”.  The end loan will typically be a new loan that is more conventional when it comes to financing a home, such as a fixed-rate 15 year mortgage.

How to qualify for a construction loan

Banks are typically a bit more cautious when it comes to lending money for a construction loan because the building process doesn’t always go smoothly. Sometimes builders don’t do the kind of job they were supposed to do or the house isn’t worth what it was supposed to be worth.  Sometimes construction stops for one reason or another.

Because of this, banks usually have strict requirements for construction loans.  Here are several:

The builder must be qualified

Banks like to have proof that a licensed general contractor with a good reputation will be in charge of building the home. If you want to act as general contractor, you might have a more difficult time obtaining a construction loan.

Detailed specifications needed

The bank will require that you have professional blueprints and a list of materials needed to build the home.

An appraiser must be involved

The bank will require an appraiser to appraise the estimated value of the home once it is built. The appraiser will take a look at all of the information plus neighborhood comps in order to make an estimated appraisal.

A 20% down payment is needed

Most banks require a 20% down payment to ensure that you will stay in the project even if things don’t go as planned.

As long as you have good credit and meet these requirements, you shouldn’t have any problem getting a construction loan.

How the loan is dispersed

Once you are approved for a construction loan, the bank will pay you certain monetary amounts at certain intervals while your home is being built. For example, you may get 10% of the construction loan at the beginning, 10% after the lot is excavated, another percentage after the house is framed, and so on.  The number of payouts, or draws, is determined by the bank, the builder, and the buyer.

Final thought

Building a home is an exciting and rewarding process.  Be patient and expect a few bumps in the road.  If you have any questions, feel free to talk to your lender further about construction loans.

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