Making Sense Of New Home Construction Loans

Paying for the costs that come with build a residence can be challenging, but one way to address the situation is to acquire a new construction loan. The new construction mortgage is a financial vehicle aimed at a very specific set of customers: folks who need financing before or while they're involved with builds.

This is a significantly different situation for the bank than a mortgage on an existing house because in that scenario there's a clear asset that serves as collateral. From a financial institution's viewpoint, that means taking on the unusual risk of financing something that doesn't exist yet. If you think it's time to visit a new how construction loan service provider, here are some issues to keep an eye on.

What Is a New Home Construction Loan?

If you plan to build a house and then also have a mortgage against, a new home construction loan serves to bridge the gap between the building process and the more typical process of having a mortgage. It is foremost a short-term loan. The logic is that you'll pay for construction, establish the house as an asset and then refinance into a more normal mortgage, such as a 30-year one, upon completion of the project.

Draws

The big surprise for first-timers is the draw system. This means that tranches of money will be made available only once certain requirements have been satisfied, reducing risk exposure. 10% may be provided up front, and then the next 10% will be drawn once concrete is poured for the foundation.

Qualifying

In light of the risk that the bank is taking on with such a job, it's not surprising to learn that the qualification process for this kind of loan is more involved. First, you'll need to show evidence that a licensed general contractor will be managing the project and that they have a proven track record for quality builds. Second, the lender will need to have all the specifications for the site on file, and they will reserve the right to veto features that hurt their ability to get money from the house if you go into default. Third, an appraiser will assess what the value of a comparable house that's on the market would be.

Most financial institutions will want to see between 20 and 25 percent of the loan value put down. They will also conduct a thorough credit check.

For more information about new home construction loans, reach out to a lender near you.

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