financialtreat – will explain about the Financial Steps to Building a House that you will get in the following article. let’s look at this article carefully!
Today’s tight housing markets and low interest rates have raised home prices in many areas. Instead of competing to buy an existing house, you might consider building a new home. There are great perks to building your own home: you have control over the layout and materials, you can choose the location, and there’s no competition from other buyers.
Financial Steps to Building a House
However, financing a home construction project is more complicated than buying an existing home. So it’s important to understand the process and costs involved before jumping in.
Building a house: the basics
Building a home is very different from buying a home off the market — especially when it comes to financing the cost of construction. A mortgage on an existing home is fairly straightforward: you take out a single loan which involves one application, on appraisal, one closing date, and one set of closing costs.
With a new home construction, the process can be complicated. There’s not just a mortgage to consider, but also financing for the land, labor, and materials. If you’re considering building a home, here are a few things to keep in mind:
- Financing your dream home project may require a series of loans with multiple rounds of paperwork and fees. However, certain loan programs and lenders can consolidate this process
- “One-time-close” construction loans could help you finance the land, construction, and mortgage all with a single loan
- Expect to make a larger down payment for a construction loan than for a traditional mortgage — typically 20% to 25% (versus as little as 3% for a home purchase)
- Planning is essential. The lender has to approve your builder and your construction plans along with your personal finances
- Building versus buying — Costs vary widely by location, but may be similar in many areas
you want a custom home in your ideal location — and you have the time and money to make a construction loan happen — building a new house could be a great choice. If you’re in a rush, though, you might be better off buying an existing property off the market.
Purchasing a home is usually faster than building one, and you’ll typically have lower hurdles to clear for things like down payment and credit score.
How construction loans work
Building your own home could require one, two, or even three separate loans. For example, you need financing to:
- Buy the land
- Pay the construction costs
- Pay off the lot and construction loan with a standard mortgage, which you can pay off over up to 30 years
‘True’ construction loans are short-term loans, usually 6-18 months. They’re used only to finance home construction (not the land or permanent mortgage). And in most cases, you pay interest only on what you borrow.
Construction loan rates are usually variable interest rates based on the prime rate plus a certain percentage
Some programs let you wrap construction loan interest into the permanent financing. This can be helpful if you’re also trying to pay an existing mortgage or rent while building your new house.
How much does a home construction loan cost?
Expect to pay more for construction financing than you would for a traditional home loan — even if the cost to build or buy is virtually the same. New home construction loans cost more for a couple reasons:
- More risk — Lenders take on a bigger risk because the construction process includes more variables. And, the home being used as ‘collateral’ for the loan amount does not yet exist. This risk translates into higher interest rates compared to standard mortgages
- More paperwork — Money is disbursed at different points in the construction process, and the lender has to verify enough work has been completed to justify the next “draw” of funds
Lenders also require lien waivers proving builders have paid their subcontractors before issuing draws. Draws can be done in stages, for example, a lender might divide the project into seven stages and release money at each stage. Or they may allow builders to request money based on the percentage of completion.
In general, the more draws allowed, the nicer it is for the builder. However, every draw adds to your costs because of the admin work involved.
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Is it cheaper to buy or to build a home?
The idea of building a new home might scare you because you believe it’s the pricier option. But, depending on location and home features, the cost of building a house is comparable to buying an existing home.
The average new home costs $296,652 to build, according to the National Association of Home Builders’ 2020 study. Real estate site Zillow reports the average price of an existing home at $269,039. Both of these numbers vary widely — by hundreds of thousands of dollars in some cases — depending on the state and specific area where you plan to buy or build.
Types of construction loans
Some home buyers use up to three separate loans to build a home: one loan to buy the land, one to build the home, and one to convert the construction costs into a permanent mortgage (which works like a typical home loan).
You could consolidate these steps, especially if your builder is willing to finance construction costs until you use a standard mortgage loan to pay off the builder. Or, you could look for a mortgage that finances the entire process with one loan.
One-time-close construction loans
Some lenders offer “one-time-close” or “construction-to-permanent” loans. These are construction loans that convert to traditional mortgages after you get the certificate of occupancy for your home. For instance, Fannie Mae, FHA, VA, and USDA programs all offer one-time close construction loans.
These mortgages require only one closing, and you get approved only once, alleviating the risks of two Finance approval processes. If you get a fixed-rate mortgage, you can lock in your interest before construction begins. For more information, see:
- FHA one-time-close construction loans
- VA one-time close construction loans
- USDA one-time-close construction loans
However, these mortgage programs can be harder to find from mainstream lenders, so you should expect to shop around if you want one of these loans. Getting separate loans for each stage of the construction process might be easier from a lender standpoint. It might give you more control as well, because you can shop for the best rates on each loan.
However, using two or three loans means paying two or three sets of closing costs — and going through the underwriting process multiple times.
Fannie Mae construction-to-permanent loan
Many shoppers who prefer the “single-closing” strategy choose Fannie Mae’s construction-to-permanent loan option. With this program you’d make no mortgage payments while the home remains under construction. Instead, loan repayment begins after closing.
Like any construction-to-permanent loan, Fannie Mae will roll construction costs into your permanent mortgage once you have a certificate of occupancy. This loan can generate “instant home equity” because Fannie Mae bases its loan-to-value ratio on construction costs, including lot acquisition, assuming that number is lower than the home’s eventual value.
For example, if a home costs $200,000 to build, but an appraiser values it at $250,000, Fannie Mae would still base its LTV on the $200,000 in construction costs. You could put $40,000 down (20% of $200,000) and take out a $160,000 loan.
Because of the home’s value of $250,000, you’d instantly have $90,000 in home equity ($250,000 minus the $160,000 loan balance). It’s important to remember construction costs and property values vary a lot by state.
The other financing option is a two-time-close construction loan — two separate loans. You’ll get a construction loan first, and then repay it when construction ends by refinancing into a permanent mortgage. This means applying for two different loans with two closings, and all the associated closing costs for both.
Many lenders require you to have a permanent mortgage lined up before they’ll release funds for the building process. This two-loan strategy gives you flexibility if there’s a construction delay requiring you to extend the construction loan term. And, you may have access to better refinancing choices than with a construction-to-permanent or one-time-close loan.
Which construction loan is best?
The beauty of a construction-to-permanent mortgage is that you avoid multiple loan applications, packages of lender fees, and title charges. That’s the article on Financial Steps to Building a House. Hopefully it will be useful for you and that’s all thanks.