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Talking about finances is never fun, but it's always necessary — especially when building a custom home.
Funding influences where you build, who you hire to design and create your home, what features and materials and trends you include, and more. The more funding you have available, the better. So, how do you secure the financing you need? And how do you know which type of funding is best?GTG Builders is here to help! In this blog, we review frequently asked questions from our customers on construction loans, land loans, and home builder financing to help you identify the right choice for your home.
What is a Construction Loan for a House?
A construction loan covers the costs associated with building a custom home, such as land, design fees, building materials, labor, and permits.
Construction loans are relatively short-term, have higher interest rates than other loans you may encounter, and typically require a 20-to-30 percent down payment for new construction. The increased interest rates are a result of lenders viewing construction loans as more of a risk than a mortgage loan, for example; this is because, in a mortgage, your house serves as collateral the lender can seize if you miss your payments. No such collateral exists in a construction loan because the home doesn't exist yet.
The loan duration is usually about a year — the length of time it takes to build a custom home. During that time, your lender will want project updates to ensure their investment is well on its way to completion. As such, you and your builder must provide a detailed construction plan, budget, and timeline upfront to satisfy the construction loan requirements. From there, an appraisal on the new construction will be assessed by an inspector from your lender. These inspections occur multiple times throughout the building process, usually after your project passes a significant milestone, such as foundation laying.
The inspections aren't just a way for your lender to keep an eye on their interests; it's the basis for how the funding is doled out to you. Rather than receiving one lump sum, construction loans come in multiple installments. Your lender creates a borrowing schedule based on the construction timeline for your build, and you get a sum as you enter each new phase of the project. While construction is underway, you are responsible only for interest on the payments you have already received. In other words, you don't pay the full interest of your loan until the entire amount has been issued to you.
Types of Construction Loans
That's the basics. Now, let's get a little more specific by diving into two common types of construction loans!
What is a Construction-Only Loan?
With a construction-only loan, once construction wraps, you are responsible for paying back the total loan (usually within a year) or securing a mortgage for permanent financing. Starting with a construction-only loan and transitioning to a mortgage after construction can be more costly because you may encounter more loan fees.
What is a Construction-to-Permanent Loan?
A construction-to-permanent loan starts as a regular loan and becomes a mortgage once you move into your new home. A construction-to-permanent loan allows you to skip out on extra fees and can make the financing process simpler.
Other Home Financing Options
Construction loans are one way of funding your custom build, but plenty of other options are available. In this section, we go over two common alternatives to construction loans.
What is a Land Loan?
What happens if you find the perfect lot for your custom home but aren't quite ready to build? You want to snap the property up before someone else closes on it; however, the quick turnaround of a short-term construction loan isn't going to work for your circumstances. Here's where a land loan comes in.
Like a construction loan, land loans tend to have higher interest rates because you don't have anything to put up for collateral. Land loans are also short-term loans, but they give you more time to pay up than a construction loan, with the average length of a land loan being two to five years.
What is Home Builder Financing?
You can also look for funding directly through your builder.
Some builders may partner with financial institutions to offer builder-financed homes. If this option is available, your builder and the accompanying lender will present you with various funding packages you can sort through to find the best fit for you. You may benefit from the existing relationship between your builder and lender in the form of easier loan approval and upgrades or incentives for your custom build. However, we recommend you shop around the marketplace before choosing builder financing to ensure you get a competitive offer.
A Guide to Custom Home Building
Financing is just one facet of the custom home-building process. There's still much to learn, and this Custom Home Building Guide from GTG Builders gives you our insider knowledge on how to pick a budget, find land, select a building team, choose a floor plan, negotiate your contract, and more.
