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Home construction financing is a little more complicated than buying an existing home. You can't get a mortgage until you can occupy the new home. How are you going to finance the lot and the construction project? Will you have a fixed rate construction loan from a bank? Or is the builder going to finance this as part of the cost of doing business? Are you going to have a "paying agent" paying cash to the builder after checking that various steps have been completed?
There are basically two types of loans to consider when building a home.
- Construction Line of Credit:
This is a credit line that the lender setups on your behalf for the payment of contractors and supplies during the construction phase of your home.
Cash disbursements may vary by lender. Typically, the first disbursement buys the land and then successive disbursements will be made when certain phases in the construction project have been completed.
Most lines have a term of about 12-18 months, depending on the size of construction and area. Some lenders will offer an extension if needed, but often with up front penalties.
You will pay interest on the amount that you borrow from the line during the construction phrase. The interest rate on construction lines are slightly higher than residential mortgage rates.
- Permanent Construction Loan (residential mortgage):
At the end of the construction phrase, the line closes and the amount borrowed is paid off with a mortgage loan of your choice.
Many lenders offer the combined construction line and permanent loan as a bundled product. There are advantages and disadvantages. See our discussion on construction/permanent loans.
If you are unable to obtain the combined construction/perm loan with the same lender, you will need to:
- first qualify for long-term financing (i.e., mortgage loan) with one lender and then,
- meet with a second lender for the construction line of credit — these lenders will typically extend credit once you have the permanent loan arranged.
Here are some common-sense tips that can help you cut through the red tape and finance that home of your dreams with maximum savings.
- Pre-qualifying is the first step which helps you determine how much home you can afford. The process typically takes about 30 minutes and, while it can be done at a builder's model or showroom, it now can be facilitated through a secure line via the Internet on your home computer, or for convenience, by mail. Pre-qualifying covers all the key financial elements of your situation, and provides up-front assurance that you build or buy the home that you can truly afford.
- You can include the required site improvements in your mortgage loan, whether you are building on land you own, or plan to buy land when you find a suitable floor plan. These include clearing the land or putting in your well, septic tank or driveway. Your builder can supply estimates for each of these items.
- If you have land on which you are making payments and want to pay it off before you build, you should consider current interest rates, and what they might be when you pay off your land. Interest on your lot payments is not tax deductible, while interest on your new home will be tax deductible. And if you're paying rent in addition to paying off your land, if you add both payments, the total of the two compared to a monthly tax-deductible house payment should result in a significant tax saving.
- If you are paying off other debts, you may also be able to fold some of those payments into your mortgage loan, reducing your total monthly payment. Some of this folded-in debt also may be tax deductible. Your own CPA or tax advisor can help you decide.
- You may be able to include a decorating allowance in your mortgage loan for major items before you start building your home. This will help you save the money you would have spent for these items.
- Many buyers today purchase a home to be built, and the land to build it on, at the same time. Many lenders offer 100% financing to their most creditworthy customers, which can include the land, improvements to the lot and construction of your new home.
- Many people who want to build a new home don't have perfect credit. Many lenders specialize in working with prospective home buyers who have had previous credit problems, so don't let this concern stop you.