Construction Loans 101: How do they work?


Construction Loans 101: How do they work?

By Tim O'Brien - Zipfel Mortgage

Building a new home offers many advantages in comparison to purchasing an existing home. As the buyer, you have the ability to customize the home to your specific needs and personal preference. You avoid the costly and burdensome task of replacing and repairing outdated features in an older home. Newer homes also are commonly energy efficient and technologically advanced in comparison to older homes.  

A construction loan is a completely different process than applying for a mortgage loan to buy an existing home. From a lending perspective, there is more risk associated with a construction loan for the lender because the home being built serves as collateral. In other words, the lender is making a loan without collateral for which they could recover a loss in case the loan goes bad.

Because of the increased risk that comes with building a home, lenders typically require at least 10% down payment and a credit score of 700+. Many lenders require 20% down, but the requirements vary based on the lender we use.

Much like applying for a traditional mortgage, you will be required to provide documentation verifying income, assets and credit history. The builder will also provide extremely detailed information regarding the building plans, specifications, timeframe and cost of the construction.

There are two types of construction loans. Construction-to-Permanent loans and Construction loans. The Construction-to-Permanent loan is usually the preferable choice of borrowers because you avoid the extra expense of two closings when building your home. You can save costs with title & appraisal fees that would occur if there were 2 separate closings. In a construction loan, you have typically a 12 month loan at which point you’d need to refinance when the home has been built and a building inspector provides a certificate of occupancy.

In both the construction-to-permanent and construction loan you are paying interest only during the construction phases. You also are only paying interest on the amount of money the builder draws from our lender. For example, in a $1MM loan, say the first draw is for $250K. As the buyer, you’re paying interest only on the $250K until the builder draws more money from the lender. The interest only period is typically 6-12 months, but can be extended in extenuating circumstances or if it is a build that will require more time.  In a construction-to-Permanent loan after the home is built and an inspector issues a certificate of occupancy the loan automatically becomes fully amortizing so a buyer is paying principal + interest. Your permanent monthly house payment begins at that time.

In summary, construction loans are a fantastic option for aspiring homeowners who want to build their custom dream home from the ground up.  I have a number of lending relationships with the very best construction lenders the market has to offer and would love to help assist you in building the home of your dreams.

For more information, feel free to reach out to Tim O'Brien -

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