Sorting Out Construction Loans
August 31, 2007In the process of getting ready to buy a new home many people often try to decide on buying an existing home or building their dream home. Everyone knows how to buy an existing home. You settle on the real estate agent, you look at a few dozen homes that don?t match the criteria you originally gave said real estate agent until you magically find that one you want, then you head to the bank and get a mortgage. That is the overly simplified version of that scenario but, for the most part, it is how it works. Building a home to your specifications is quite different.
When you are building a home to your specifications you need to get a construction loan. A construction loan is not a mortgage. A construction loan can become a mortgage eventually, but when it starts out a construction loan is not a mortgage. A construction loan is financing set up with the bank of your choice that allows you to pay contractors as they build your home. If you already own the land you want to build on then you sometimes do not need a down payment on your construction loan. That depends on the bank. But a construction loan has closing costs just like a mortgage and differing interest rate scenarios just like a mortgage, but a construction loan is an ongoing relationship with your bank that can make or break your dream home.
You, Your Bank, and Your Construction Loan
When choosing a bank to do business with it is always best to choose one that has experience in new home building and also can offer you a loan officer that has experience in administering construction loans. Without a good relationship with your loan officer your experience in building your dream home could go horribly wrong. So how does a construction loan work and what is the dynamic between you and your bank?
When you get approved for a construction loan you are basically getting approved for a line of credit to build your home. The bank does not just cut you a check when the loan is approved. After the loan is approved you and the bank work together to make sure that the general contractor secures all of the necessary permits and gets everything in order so that you may start construction. It is not until the bank is satisfied that everything is in order that they will approve the beginning of construction. As your home construction proceeds, the bank will release periodic payments to you based on the terms of your loan. You use these payments to pay the general contractor, sub contractors, and any other expenses that may come up during the construction of your home. But be careful, balancing these funds is not easy and that is where an experienced bank officer can be very helpful.
Many home owners run into sub contractors that want payment up front. This should send up a lot of red flags and it should be something you avoid. It is often best to let your general contractor hire the sub contractors and therefore be responsible for paying them. The money you think you save in hiring your own sub contractors can be eaten up in grief, mistakes, and possible fraud if your sub contractor takes your upfront payment and vanishes for good. So be careful and work with your loan officer from your bank, and your general contractor, when it comes to hiring sub contractors.
When your home is finished, and the county you live in has granted you an occupancy permit, then it is time to convert your construction loan into a mortgage. A construction loan is meant to be short term financing and you need to have a plan in mind when it comes to converting to a permanent mortgage. Probably the easiest way to convert to a permanent mortgage is to make sure you get a construction-to-perm loan from the very beginning. This kind of loan allows you to buy the land, finance the construction, and convert to a permanent mortgage all for one closing cost. It is the easy way to reduce the stress on a complicated financial transaction.
Building a new home can be both an exciting and harrowing experience. If you do some research, follow some guidelines, and make sure you partner with a bank that has experience then you can reduce the issues that may come up during construction.