Financing Your Forever Home: A Primer on New Construction Home Loans
When deciding between buying or building a new home, one question we hear often is, How do we finance it? Often people assume that they need a mortgage for their new-build home, and are surprised when we tell them about new home construction loans instead. We asked the experts at Chicago Construction Loans (Associated Bank) to give a primer on everything you need to know about new home construction loans.
HOW DOES A NEW HOME CONSTRUCTION LOAN WORK?
Often clients are not as familiar with construction loan and worry that the process will be overwhelming. Fortunately, securing a construction loan is just as easy as getting a conventional loan. A new construction loan is usually structured as a line of credit. Borrowers are assigned a certain limit against which they can draw to move the project forward, and are only charged interest after the first draw against the balance is made.
Construction loans are often interest-only during the construction of your home and the interest charged is only on the amount of money that has been drawn. The home construction loan can be used for all expenses incurred to complete the project, including contractor expenses, materials, and even the land.
The Difference between a Mortgage and a New Home Construction Loan
A traditional mortgage
- is a longer-term financing solution for an existing home, where the house itself is used to secure the loan.
- Typical mortgages have terms that last up to 30 years wherein the borrower makes payments against the principal and interest for the life of the loan.
- Traditional mortgage loans are sold to investors in the bond market by the lender. As such, there isn't much flexibility in mortgage rates.
For a new home construction project,
- a mortgage does not apply since the house does not yet exist to serve as security.
- This type of loan is in place only for as long as it takes to complete the construction.
- Construction loans remain on the lender's books. These are known as portfolio loans, which means that lenders have more discretion in determining the rate based on factors like the borrower's credit history, income, and the equity value of the project.
It's important to note that construction loans have a maximum loan to value ratio of 80%. That means that borrowers need to have 20% of the total project value as a down payment to qualify, though some construction loans accept as little as 10% down. Use the construction loan calculator to help you figure out what your initial interest-only payment, maximum interest-only payment, and the principal and interest payment after your project is complete.
What to know before getting started
Many construction lenders offer a lot loan option along with the construction loan that allows borrowers to purchase vacant land or an old dilapidated home to build upon—a conventional lender doesn’t usually provide financing for this kind of project.
Also, a construction loan is disbursed through draws to ensure the proper work has been completed before the builder gets paid. This helps keep the process moving and all parties accountable.
Once the loan has fully funded the home’s construction, you will then need a mortgage to pay off the construction loan. Your mortgage doesn't need to be arranged with the same company that provided your home construction loan, so you’re free to shop around for the company that best suits your mortgage needs.
Building a new home can be exciting, and sometimes confusing. We are here to help answer all your questions to ensure that your home-building experience is positive and enjoyable. After all, you’re not just building a house, you’re creating a forever home.