How To Get Your Dream Home With a Construction Loan

If you’ve spent a long time thinking about a dream home, it can be very exciting when the prospect of actually building it becomes a reality. Whether you want a large home in the South Georgia countryside or a smaller house closer to town, building your dream home can be very fulfilling.

It’s also an experience you should be prepared for. Building a dream home is different in several respects from getting a mortgage on an already existing home. Let’s go over the major considerations in applying for and receiving a construction loan.

Construction Loan 101

Considerations

Construction loans are different than mortgage loans. A construction loan is a loan for the expenses involved in building a home. If you don’t currently own land, for example, a construction loan can provide money to buy the land. (The land will need to be zoned for residential construction and may require permits before construction can begin.) A construction loan can also pay for hiring an architect or draftsman to draw up the plans for the home.

A construction loan provides money that will allow you to hire a builder or contractor to break ground on the home, pour the foundation, complete the frame, finish the interior, and so on. The expenses of labor and materials are covered by construction loans. You can even hire landscapers to complete the grounds. Construction loans also cover the costs for required permits and fees and closing costs.

In a construction loan, many of these monies are given to the builder or contractor. The contractor is usually provided with a specific portion of the loan, termed a “draw,” for each major, completed part of the building process. Lenders often inspect the process before the next draw is provided.

Remember, a mortgage, by contrast, is a loan that pays for an existing home. Once your dream home is complete, it will be assessed at market value. You will need to obtain a mortgage for that value, just as the buyers of an existing home do. If your dream home is assessed at $200,000, in other words, you will need a mortgage for that amount, including down payment, principal, interest, property taxes, and any required mortgage insurance.

In other words, the process of building a dream home includes obtaining both a construction loan and a mortgage loan. We’ll talk more about that in a minute, but first, let’s talk about what you need to qualify for these loans.

Application and Financing

Prequalification is a good idea in any home loan process, but it’s especially crucial for a construction loan. Why? Because building your dream home is going to require expenses for hiring an architect or otherwise obtaining designs and plans for the home. You don’t want to go through the entire process of designing a house, and paying for the design, only to find you can’t qualify for the construction loan to build it.

You also want to make sure that you can eventually receive a mortgage for the amount your house will command on the market. In other words, you don’t want to build a $275,000 home only to find that lenders won’t approve you for a mortgage of more than $200,000. You need to find out how much home you can afford before building it.

Prequalification means that your lender fully reviews your application to determine whether or not you qualify for a loan, and decide upon the size of the loan they are willing to give you. You don’t receive the actual loan upon prequalification. The lender provides a document indicating that the lender is willing to go forward with a loan of a certain amount.

Construction loans are harder to get than mortgages, and lenders review your qualifications rigorously. You may end up with a higher interest rate than a mortgage, for example. Why? Well, construction loans pose a larger risk to the lender than mortgages do. Mortgage loans have existing houses as collateral. Simply put, if a mortgage holder defaults on a mortgage, their lender has the house as collateral. But a construction loan doesn’t have collateral. If you default on a construction loan, the lender has only a partially built home.

As a result, construction loan lenders look carefully at qualifications indicating your financial reliability and ability to pay off the loan.

Lenders will likely require a minimum credit score of 650 or higher, for example. They will also look for a debt ratio that implies you will be able to pay both the loan and any existing debt you already carry comfortably. (The debt ratio is arrived at by dividing any monthly debt payments by your gross income – before taxes – per month.) CBC Bank, for example, requires a 43% debt ratio or better.

Generally, lenders require a loan to value ratio of roughly 85%. Loan to value compares the home’s likely assessed value with the amount of the loan. Lenders do not like to see a loan to value ratio that is too close to a home’s assessed value.

You will have to provide indications of your financial stability, such as tax returns, proof of your salary or other income, your bank statements, your employment history, a financial statement, and your credit history, including any current outstanding debt.

Lenders will want to know your cash reserves for a mortgage down payment as well. Construction loans often require further proof of cash reserves also, because construction doesn’t always proceed according to schedule. If the building encounters delays, as many building projects do, can you continue to pay?

Construction loan lenders will also want to see your building plans, blueprints, and specifications as part of their review.

They will review your contractor’s budget based on those plans. Lenders frequently want to review financial information from contractors, including cash flow statements, profit and loss statements, the length of time they have run a similar business, and any applicable licensing. In a construction loan, the contractor’s financials and record is a part of the transaction in a way that it isn’t in a conventional mortgage.

Typically, you will need the following documents to obtain prequalification for a construction loan:

• Credit score
• Proof of salary/other income/tax returns
• Personal financial statement
• Employment history
• Bank account statements
• Credit history
• Plans for house, such as blueprints, architectural drawings

Obtaining a Mortgage

Most construction loans are granted for a specific period of time, often 6 to 12 months. During that time, many construction loans require you to pay only interest. At the end of the period, you’ll be required to obtain a certificate of occupancy.

Once you build a house, unless you have the cash to pay for the entire thing, you must obtain a mortgage. It can save time and effort to keep your loans with a lender who offers both an in house and secondary market mortgage, like CBC Bank.

It can also save money. Lenders charge origination fees and appraisal fees, for example. But many, such as CBC Bank, will reduce these fees or use the same appraisal if you have both a construction loan and mortgage with them.

You will need to decide on your options for a mortgage. Do you want a 30-year fixed rate mortgage, for example, in which the interest rate remains the same for 30 years? Interest rates are currently at historic lows. Or do you want a balloon mortgage, where you pay a low interest rate for five to seven years and then the remainder is due all at once? This can be advantageous if you will have a lump sum to pay off your mortgage when the balloon payment comes due.

It’s very important to comparison shop for a mortgage. Most lenders charge fees and other costs, but the fees and costs can vary widely. So can the interest rates and down payment required. Look at what you’re being offered side by side: the closing costs, interest rates, fees, what your monthly payment will be, and make an informed and educated decision. Make sure that you will be able to make your monthly payments comfortably on your income.

Be sure to allow sufficient time for the mortgage approval process to be completed.

How To Find a Home Construction Lender

Not all lenders offer construction loans, and not all lenders offer both construction loans and mortgage loans. What should you look for in a construction loan lender?

First, check their programs and procedures. These can vary, and it’s important to know what you are eligible for and what you have to supply. Ask if they also offer mortgages.

Second, interview them to make sure they have the knowledge and expertise required for construction loans. Ask how many construction loans they have made and how long they’ve been construction lenders.

Third, choose a construction lender with understanding of the local area. Construction lenders should enjoy good, strong relationships with local home builders and realtors. Real estate prices and local zoning vary tremendously, and the more understanding of all these factors your lender has, the smoother the loan process will be.

CBC Bank: A Local Lender in South Georgia

If you are planning a dream home anywhere in South Georgia, talk to a CBC Bank representative today. We offer advantageous terms for both construction loans and mortgage loans. We’re happy to work with you to achieve your goals.