If you are ready to become a home owner, but choose to build your own home, you can do it by taking out a type of mortgage known as a construction loan. This type of mortgage loan will allow you to use the borrowed money to build a home. The money will be paid by your lender in stages, based on what stage the construction of the home is in. The lender is involved in the building process for as long as construction takes, and will review the project at various stages.
Borrowers must also apply and get approved for a regular mortgage loan before they can be granted the construction loan. The mortgage loan and construction loan are usually bundled together in a construction to permanent loan, making applying and approval much easier, because you are essentially requesting only one loan.
Steps to Taking out a Mortgage Loan for Building a Home
Like with any other mortgage loan, there are several steps that you need to follow in order to receive a construction loan: find the best option for you, acquire the funds, and begin building your home. Here are the most important steps to taking out a mortgage for the construction of a home:
- Find out which type of loan works best for you. Similar to conventional mortgage loans, construction loans come with various options, like fixed-rate or adjustable-rate loans, long term or short term loans. Two popular options are taking out a short term, for example 1 year, loan which you can refinance into a regular mortgage after the construction has finished, or the construction to permanent loan which bundles the construction loan and the regular mortgage loan into a single loan. The second option seems more attractive because you’ll only be paying closing costs one time, unlike with refinancing when you will have to pay closing costs all over again.
- Get pre-qualified. Getting pre-qualified will allow you to determine how much you can afford to borrow and what your payment will be. Also, before giving out a construction loan, your lender will most likely need to know what your intentions are, why do you want to build a home or if you plan on living in the home after the construction is finished. Depending on your plans and the lender, you may receive various interest rates, and have more or less options.
- Shop around. Construction loans are a lot less popular than conventional mortgage loans, so you might have a hard time finding one, or finding a loan that will suit your budget and requirements. The best way to find a good construction loan is by shopping around and comparing offers from various lenders who are willing to give out this type of loan. Alternatively, you can hire a construction loan broker who works with several banks, and who can help you find what you’re looking for much easier.
- Submit your loan application. After finding a good loan, from a lender with enough experience in construction loans, it is time to submit a loan application. Like applying for a conventional loan, you will have to meet certain criteria, and submit additional info about your construction plans. You will also be given the option of locking in the interest rate, or letting it float hoping that the interest rate will decrease before closing.
- Sign a building contract with a home builder or contractor. The contract between you and the builder is included in something called the builder’s package, which also includes things like the builder’s resume, an item cost breakdown, and a list of all the required materials.
- Obtain construction insurance. Builders are not required to be insured, but the whole process of obtaining the construction loan will go much faster if the builder has insurance. There are three types of insurance that a builder can have: course of construction, general liability and workman’s compensation.
- Close on the loan and start building. If you have all the required documents and meet all the criteria, there is no reason why your lender should deny you the construction loan. The only thing left to do is pay the closing costs and start building.
Taking out a mortgage loan in order to build a home is a great opportunity for both people who want a home to their own specifications, and for investors who are looking to build a home and sell it for a profit. The amount that can be borrowed and the interest rates will probably differ between the two cases, but, with some research and proper understanding of how construction loans work, this type of loan can be a very advantageous option.