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The application procedure for a construction loan is comparable to that of a regular mortgage, with the exception that the lender must additionally verify the builder. Here’s everything you should know about obtaining a home construction loan.
What Are the Different Types of Home Construction Loans?
A single-close construction-to-permanent loan or a two-close, stand-alone construction loan are the options available to buyers.
The primary distinction is that, according to Valdes, a one-time-close construction loan enables the acquisition of both short- and long-term funding simultaneously, whereas a two-time-close construction loan necessitates approval for two different loans and two closings. “.
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Construction-to-permanent, or C2P, loans finance both the land and the building process. After the building is finished, the loan turns into a permanent mortgage. Due to interest-only payments made by borrowers during the construction phase, this loan may have higher costs than a conventional mortgage. Depending on how much of the loan term is left, the payments may need to be recast when the loan converts to a regular mortgage.
A C2P loan has the benefit of requiring the borrower to complete underwriting and closing just once, which can result in time and cost savings. This loan offers another benefit during construction.
“The permanent loan is already closed, so it wouldn’t be affected if you lost your job, had a medical collection appear on your credit, or experienced any other disqualifying circumstance,” says Melinda Lou Hensley, a Re/Max Elite real estate agent and former mortgage loan officer.
She adds that you will also be able to lock in a rate on the permanent loan, “protecting against fluctuations in interest rates during the construction phase.” “.
Construction loan on its own: This is a short-term loan used to finance the building of the house. The borrower pays interest on the withdrawals made by the lender to the builder during construction, which is done in accordance with the builder’s percentage of finished work. When the loan matures, which is typically in a year, the borrower will have to pay it back or get a new mortgage.
The kind of mortgage to which you convert your loan will rely on your eligibility and individual financial circumstances, according to Valdes. She cites, for instance, “You must be on active duty, a veteran, or the surviving spouse of a veteran in order to be eligible for a VA one-time-close construction loan.” “.
A crucial warning is that if you require a permanent mortgage, a stand-alone construction loan may be more costly than a C2P loan. This is due to the fact that you will have two loan transactions and two sets of closing costs, and the permanent loan may have a higher interest rate.
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The usual prerequisites for obtaining a home construction loan are as follows:
- A strong credit score. Conventional loans may require a credit score of 700, though certain lenders may have more lenient requirements. Loans from the Department of Agriculture, the Department of Veterans Affairs, and the Federal Housing Administration may have less stringent credit score requirements.
- A sizable down payment. Your down payment will vary by loan type. You might be able to put down as much as 5% on a traditional mortgage, but a construction loan might require at least 2020% of the loan amount up front. Additionally, find out from your lender how to obtain a construction loan with no down payment. Down payments for FHA loans start at 3. 5%, and you might not be required to make a down payment on VA and USDA loans.
- A reputable licensed builder. Your lender will investigate the builder’s ability to pay suppliers and complete the project. Your builder will need to submit professional licenses, insurance documentation, and vendor references with payment history as part of the vetting process. The lender will also assess the builder’s financial situation and credit rating.
For those borrowers who prefer a construction loan over a conventional mortgage, the standards are typically higher. This is because, unlike a conventional mortgage, the loan has no collateral because the house hasn’t been built yet.
Lenders “see construction loans as risky,” according to Valdes. As a result, you may have trouble qualifying and pay a higher interest rate than you would with a conventional mortgage.
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What’s the Process for Getting a Home Construction Loan?
Similar to a standard mortgage, but requiring additional steps during the application process, is a home-building loan. How to get one:
Get preapproved for a home construction loan. When a lender determines how much you can borrow and your interest rate based on factors like your income and credit score, this process is known as preapproval. Before contacting a builder, try to get preapproved so you can create a budget for buying a house.
For preapproval, get in touch with a bank that provides loans for home construction. You consent to us verbally retrieving your credit report and giving the lender copies of the following documents:
- Recent pay stubs or proof of other income.
- W-2 forms from the previous two years.
- Tax returns from the previous two years.
- Bank statements from the last two to three months.
- Current statements for additional assets, like retirement or brokerage accounts
- Earning statement, if self-employed.
Upon being preapproved, you will typically receive a letter with a deadline. Most preapprovals are good for 60 to 90 days.
Compare offers from licensed builders. Next, youll find a builder or developer that can build your home. Try asking your friends and family members for recommendations, or check out this directory from the National Association of Home Builders for suggestions.
After obtaining quotes from several businesses and weighing the offers, you and a builder or developer will sign a construction contract. Keep this paper handy; you’ll need it when you submit an application for the home-building loan.
Request multiple mortgage rate quotes. In this manner, you can use them to evaluate each offer’s terms for repayment, interest rates, and closing costs. To recap, when you approach lenders about home construction loans, they will ask you a series of questions to determine which program is best for you.
You might be able to get a single- or double-close construction loan from Freddie Mac or Fannie Mae if you’re looking for a traditional mortgage. Alternatively, FHA, VA and USDA programs offer single-close construction loans.
The permanent loan component of a C2P loan may have a 15- or 30-year term. But initially, you’ll need to decide on a loan term, which is typically six, nine, or twelve months.
Hensley advises “taking the longest term available to have time in case weather or labor and material delays happen.” “.
Apply for the home construction loan. To ascertain whether you qualify, your terms, and the amount you can borrow, an underwriter will review your income, debt, and credit history.
The underwriter will evaluate:
- Your bank statements, tax returns, W-2 forms, pay stubs, and credit reports
- The written building agreement you have with your builder or developer, which includes a schedule for construction and an itemized budget
- The builders financial statements, licenses and insurance documents.
- The land survey showing where the house will be built.
- The land’s title policy, if applicable, at the time of purchase
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How Are Home Construction Loans Different From Traditional Mortgages?
Construction loans for new homes are special because they cover the cost of hiring a builder as well as the possible down payment for a mortgage that you will eventually pay off. This is not the same as a traditional mortgage, which gives the seller of an already-built house the money up front.
Construction loans are also different because:
Financing is a two-part process. An initial short-term loan, typically for up to a year, is used to fund construction before switching to a permanent mortgage. This arrangement is known as a construction-to-permanent loan. A construction-only loan is another option, but it requires a separate 15- or 30-year mortgage, requiring two closings.
Lenders impose stricter credit standards. A conventional construction loan typically requires borrowers to have a credit score of at least 700, however they may be able to get a conventional purchase mortgage with a score as low as 620. Standards are more flexible with FHA, USDA and VA loans.
Borrowers usually have to fork over larger down payments. Lenders might request payment in full up front, but a government-backed construction loan enables you to make a small down payment.
Borrowers also pay higher interest rates. You might pay roughly 1% more for a construction loan without collateral than for a conventional mortgage. Additionally, variable rates on construction loans typically follow a benchmark rate, like the Libor.
The lender vets the builder. When granting a construction loan, the lender wants to be certain that the builder will complete the project as scheduled. In addition to providing the lender with comprehensive plans, a construction schedule, and a budget for your project, the builder must demonstrate its financial stability.
The loan is not disbursed as a lump sum. Rather, according to Hensley, “The lender parses out the money as the house is completed in draws.” “The first draw will be used to buy the land if the customer does not already own it.” “.
Following closing, you will have to begin making interest-only payments on these disbursed funds. “Your construction loan will be converted to a permanent loan following a final inspection,” says Valdes.
The payment changes to one of principle and interest, which is spread out over the remaining loan term.
Inspections are frequent. As construction moves forward, funds will be drawn upon; the lender will check the work before issuing another check. The lender will schedule an inspector to confirm that all necessary benchmarks have been met.
Also, you will need to stay in contact with the builder and request updates on the paperwork. Keep in mind that subcontractors have legal recourse against you in the event that your builder fails to pay them, and you would need to sue the builder to recoup losses.
Reviewed on Aug. 4, 2023: An earlier version of this article was published.
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FAQ
What credit score do you need for a construction loan?
A minimum 500 credit score is required for FHA construction loans, but this flexibility comes with a 2010 down payment requirement. However, if your score is 580 or higher, you can get away with just submitting three. 5%.
Is it harder to get a construction loan than a mortgage?
These loans frequently have a few more requirements than conventional mortgage loans because of the short time frame. For instance, you or your builder will have to submit additional paperwork to the lender, such as a budget for the build, a comprehensive construction plan, and a realistic timetable.
What credit score do you need for a USDA construction loan?
To be eligible for a USDA construction loan, you must also fulfill specific income and credit requirements. Generally, you must have a minimum FICO® credit score of 640. Your debt-to-income ratio (DTI) needs to be lower than or equal to 2041 percent. Your total income can’t exceed the USDA’s income limit requirements.
What is a single close construction loan?
A Single-Close Construction to Permanent (SC CTP) loan is a type of home mortgage that allows the borrower to close both the construction loan and the permanent financing of a new home simultaneously.
Read More :
https://money.usnews.com/loans/mortgages/articles/how-to-get-a-construction-loan
https://www.bankrate.com/mortgages/fha-construction-loans/