Getting a Construction Loan Vs A Mortgage Loan – Learn the Differences

Unless you plan to pay cash for your home building project, you will need to obtain financing for the construction and a mortgage for the outstanding balance when it’s finished. While you may have qualified for a mortgage loan before, getting a construction loan for your home building project can be a little challenging. 

Although it’s certainly possible to get a construction loan as an owner-builder, lenders may shy away from you at first, thinking that you aren’t qualified to handle such an undertaking. Consequently, it’s important to be very prepared and to show yourself in a capable, competent light when presenting your case to the lender. For example, don’t say, “I’ve never really done this before, but I’m willing to give it a stab.” Instead, be positive, prepared and professional. Never lie, but anticipate questions and concerns and have answers ready.

There are several types of construction loans to choose from, but one of the most popular for people building their own home is a construction loan that converts to a permanent loan once the home is complete.  Although there are no standard specifications for this type loan, as a guideline, most only require that you pay closing costs once. That saves some money and makes the process easier.  You don’t have to go through the qualification process twice.   The downside is that it is next to impossible to lock-in a permanent mortgage rate, since you won’t be closing the loan for six months to one year.

No matter what type construction loan you choose, you will likely be required to pay monthly interest on the construction loan amount during the construction phase. The amount you owe each month will depend on the amount you have “drawn” out of the loan, not the overall amount that you are allowed to borrow. If you are approved for a construction loan of $100,000 but you have only drawn $50,000 then your interest payment will based on $50,000. Typically construction loans are standard interest (not amortized) and are one or two percent over the prime rate, or whatever you have negotiated with your lender. 

Qualifying for a construction goes beyond the income and credit qualification requirements for a standard mortgage loan.  Bankers or lenders will want to know how you plan to tackle your project and that you are capable of building a home yourself. A thorough presentation to the bank will be in order. The following is an outline of what you will need to apply for a construction loan:

  • all the same financial information you would provide to get a standard mortgage loan (financial statements, income verification, credit report, etc.)
  • a set of your plans (they may ask for several copies)
  • detailed specifications (the materials and finishes you plan to use)
  • an estimate of the cost
  • an appraisal (ordered by the lending institution.  The appraiser will use the plans, specifications and lot value to determine the amount)
  • your lot information (whether you own it, etc.)
  • contractor bids (not necessarily required, but might be if this is your first project)

You might also consider providing any other documentation you can think of that will help indicate your ability and preparedness to complete your project. The bank is essentially becomes a silent partner in your project and will be concerned about the home being properly built.  Demonstrating your ability to handle the project is key here.

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