Financing building a house is slightly different to getting a regular mortgage. There are several ways how to finance building a home, depending on whether or not you also have an existing property to sell. Do you already own the land? If not, you can bundle that with the construction costs unless you can pay cash for it.
Here is generally what is involved in financing building a house, although each case is different and will depend upon individual circumstances.
How to Finance Building a Home: Loan Qualification
Your FICO score should be reasonably high. A construction loan is an act of faith on behalf of lenders, and they will likely not take a chance on applicants with low credit scores. They must be sure that you are able to pay at least until the house has been built. They do not want left with a half-built property on their hands. Your mortgage adviser or potential lender will be able to inform you of the preferred lower credit score limit.
The Down Payment
You will not get 100% finance when building a house. You must be able to make a sizeable down payment, or have some equity. If you own the land, that should suffice as equity. Even better if you already own a home, and intend selling it once your new property has been built. Try to have enough of a down payment to bring your loan-to-value ratio to at least 80% – then you can avoid mortgage insurance.
Financing Building a House: Construction Loan
If you also have to buy the land, its cost can be lumped together with a construction loan from a mortgage lender. The lender will require details of your new home; who is building it, what are the plans and how it will be constructed. There is no building for the lender to inspect or value, so they will seek drawings and specifications to give them the basis for a valuation.
You will also have to show how you will be proving that you actually own the property because the builder will actually own it until it has been built and handed over to you.
Construction Financing Options
A construction loan will usually last a year, and will be offered on an interest-only basis at a variable rate of interest. Cash will be released to the builders according to schedule drawn up by them. The interest payable for any one month will be calculated from how much has been used or ‘drawn’ in total by the end of that month.
Ask your builder if he offers temporary finance. Some will have their own finance options, enabling them to borrow until the property has been built. However, they must have security: your land if you own it, or a contract on the property so they can buy it from you less the loan if you default. They can then sell it at a profit. You pay the builder’s interest, and this enables you to get a regular mortgage. Not all builders will agree to this arrangement, but it’s worth trying.
The Permanent Loan
Once the construction loan has expired, and ownership title has passed to you, the principal borrowed becomes due for payment. You then have to take the mortgage loan to pay this. This involves another set of closing costs. However, many lenders will offer what is known as a construction-to-permanent loan, and this is what you should try to negotiate from the beginning.
With this, the construction loan reverts to a standard mortgage loan once you have been issued with the certificate of occupancy. Usually, but not always, this means that you only pay one set of closing fees. You may be able to lock in the interest rate from the start, but this is something you must discuss with a mortgage adviser or your lender.
Financing building a house is different to arranging a regular mortgage. Contact a professional mortgage adviser for more information on how to finance building a home.