If you have ever thought of owning your dream home, you may have considered building one yourself. Building your home gives you the flexibility to design a home that meets all or most of your desires. As exciting as building a home is, not many people are aware of how to secure financing when building a home. In this article, we will cover the requirements for securing a loan to build your dream home.
What is a Construction Loan?
A construction loan is a short-term loan used to cover the cost of buying land and hiring contractors to build a home. Construction loans can either be transferred once the construction is complete and the owner takes possession, or they can be released in phases as the project progresses. Securing a construction loan is more complicated than a conventional mortgage because the lender assumes more risk on the loan. With a conventional mortgage, the loan is based on the equity of the property. However, with a construction loan, there is no finished product to use as collateral, so the lender assumes more risk if there is a default on the loan payment. Construction loans generally have variable rates that are higher than conventional mortgage loans.
Types of Construction Loans
A construction-to-permanent loan is a construction loan that turns into a conventional mortgage once construction is complete. Once the building is complete, the construction loan is converted to a variable or fixed-rate mortgage. This type of construction loan requires a single application and typically has lower closing costs.
With a construction-only loan, the loan needs to be paid off or refinanced into a permanent mortgage once the construction term is up. You would need to apply separately for a new loan or mortgage and will be subject to closing costs.
A renovation loan allows buyers to finance the repair or remodelling of a home. These loans can be included with a standard mortgage or refinanced with the property’s equity.
How to Secure a Construction Loan
When applying for a construction loan, you will need to prove to the lender that you and the project are worth the risk. To do that, most lenders require a detailed list of expenses and a project timetable. A typical down payment for a construction loan is 25% of the estimated project cost. It is important to create a realistic budget to avoid underestimating your building costs. Like a traditional mortgage, the lender will require you to provide proof of sufficient income, a good credit score and a good debt-to-income ratio.
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