Step Six: Construction Financing
Financing the construction of a new home is very similar to the purchase of an existing home. You select a bank or lender, they review your personal records, you put money down on the home and the bank finances the rest.
Here’s how the construction loan process works:
Let's assume (1) you have your land, (2) your house plan selected, and (3) you have signed a contract with Scott Homes, Ltd., to build your home. Now it’s time to meet with your bank.
When you meet with your bank representative, they will likely pass along your information to a bank underwriter. The underwriter will review your personal finances and the cost of the home. The bank will also hire an appraiser to validate that the price of your home is consistent with other homes in the area. After their review, the bank underwriter will put together the financing plan for your home. The financing plan will be based on either the appraised value of your home or the cost of your home, whichever is less.
The financing plan will specify the amount of your down payment, the dollar amount the bank is willing to finance, the interest rate and the length of the loan. All very similar to the purchase of an existing home or the purchase of a car for that matter.
What is different for a house under construction, is that during the construction of your home you will have a construction loan. As soon as the construction of your new home is complete the loan converts from a construction loan to a permanent loan, such as a 15-year or 30-year mortgage (equal to what you would carry on an existing home). You make your monthly payments just like normal.
How a Construction Loan works:
The construction of a new home is a structured process that involves the purchase of many materials and professional services each step of the way. To pay for these materials and services, we approach your lender each month to “draw” money from your construction loan to pay these bills and expenses.
The moment we draw that money from your loan to pay for materials and services, the interest “clock” starts ticking, meaning you owe money. From this point forward each month during the construction process you will receive a bill from your lender for interest on that money. Some lenders allow you to create an interest reserve. This is a predetermined budget amount, like cabinets, carpet etc., that the lender can go to to get their interest payments. You have a choice, you can pay the interest from cash on hand or borrow it from the bank. Your tax situation, may influence your decision.
This bill will be for the amount of interest that has accrued on the amount of money that has been drawn from your loan. It is important to note that under a construction loan you are only paying interest on the money drawn, you are not paying on the principal.
As the building process progresses, we will continue to approach your lender each month to draw funds to pay for building materials and services. For the second through the last draw request, your lender will require that we provide evidence of all payments we have made to date. We do that through the use of draw request forms and lien waivers that all trade contractors and suppliers sign showing documented evidence that they have been paid. We use a restrictive, lien waiver endorsement on each check we issue.
When the construction of your home is complete, we will “close” on your permanent financing loan. All remaining funds due Scott homes, Ltd., will be paid at this time. Once this is completed you are ready to move into your new home.
At this point, your loan will convert from a construction loan to a home mortgage. You will begin making monthly installments on your new mortgage, paying both interest and principal on the loan amount.
The financing portion of new home construction works very well. Lenders are very efficient with the process making it easy on both the customer and the builder.
This is the typical Construction Loan process. There are other options as well to consider. Financing called a “One Step Loan” can be used to combine the Construction financing and the Permanent Financing into one loan package. The advantage of this program is lower total costs and the long term interest rate is established from the initial loan execution. Contact us directly for details on this type of loan. Not all lenders offer this program.
Scott Homes, Ltd., can also obtain construction financing on your behalf. However, with this type of loan, the interest paid is not tax deductible by you. This type of financing typically will increase the cost of the house.
If you would like to learn more about building or financing your new home, just Contact Us.