Considering a New Construction Loan? Here’s What You Need to Know

Of the many decisions home buyers face, choosing whether to buy or build, is by far the biggest one.

Building a new home is appealing for several reasons. You can, within reason, get exactly what you want. Big kitchen? Check. Roomy closet? Check. Luxury bathroom? Check! The limits to seeing your dream home come to fruition via a new build is only controlled by your budget.

If you’re leaning toward building instead of buying a house, be aware that the mortgage process is a bit different. Educate yourself on it in advance, so you won’t be blindsided by unexpected regulations and expenses.

When it comes to a new-construction loan, we’ve laid out everything you need to know.

You’ll Probably Need a Construction Loan

“Regular” mortgage loans pay for the property you’ve decided on, and then you pay monthly payments to the lender over time (typically 15 to 30 years).

A construction loan is short-term, specialty financing that covers the home-building expenses. Once the builders complete the house, the homeowner needs to get a mortgage for the property, as they would if they bought an already-built home.

Construction loans may pay for some or all parts of the building costs, from the land to the raw materials to the labor involved in the build.

Qualifications for Construction Loans

Just like the mortgage process, borrowers must get approved for a construction loan. Since the house isn’t built yet, it can’t be viewed as collateral, making it riskier for the lender than a regular mortgage loan. That’s why the process for getting approved for a construction loan is more stringent than applying for a mortgage. 5 components that need to be in line before you can land a construction loan are your:

  • Credit score. With regular mortgages, there are some programs that help borrowers with fair credit get approved. Construction loans, however, typically require good to excellent credit scores for approval.
  • Down payment. Most lenders require a down payment for borrowers trying to land a construction loan.
  • The lender decreases the risk of not getting paid by looking at a borrower’s income statements and verifying their employment. The borrower needs enough income to pay for their debts and the construction loan.
  • Debt-to-income ratio. Mortgage approval requires a review of your debt-to-income (DTI) ratio, too. This is a comparison of your total monthly debt payments to your total monthly gross income. If you’re too far in debt, your DTI ratio will be too high to quality.
  • Budget approval. Since the house isn’t a reality, the lender will want to see the plans, budget, builder qualifications, and possibly other proof the home will end up being valued at the loan amount. The more thorough and detailed the borrower can be about the property, the better the chances of getting approved.

Types of Construction Loans

When a borrower decides to build a house, they’ll need to decide on the type of construction loan they need. Here are four of the most popular choices.

  • Construction-only. This loan only covers the construction period, so it’s a short-term loan. Most construction-only loans are for a 12-month period.
  • Construction-to-permanent loan. This type of loan starts as a construction loan. During this time, borrowers are required to make interest-only payments. Once the property is complete, the loan converts into a mortgage loan.
  • Owner-builder loan. If the borrower wants to act as their own general contractor, they may choose this type of loan. Lenders usually only approve borrowers for an owner-builder loan if they can offer proof they have experience building houses, or if they have a valid contractor license.

Building a home is exciting and provides the benefit of getting exactly what you want in a house, like the size, location, layout, and unique features. A construction loan, however, comes with some extra requirements. If building a home is in your plans, make sure you’re keeping your credit score in top shape, saving for a down payment, and avoiding taking on too much debt.

And, of course, find a lender skilled in new construction financing who is willing to answer your questions and meet your needs.

Are you looking for a reputable lender to assist you with your home-building loan? Call MIG today and learn more about our Builder Commitment for new builds.