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Owning a home definitely features as a big part of the American Dream, but owning a home that fits your exact specifications makes the experience all the more desirable. This is possible when you choose to build a custom home. You get to include that dance studio, in-door pool or personal game room you’ve always dreamed about.
Certain considerations must be made when building a custom home, one of which is the costs it will incur and how you will cover these costs.
Financing a home construction project can be quite different from financing a home purchase. While both have to do with getting some sort of loan, it’s important to understand the differences. Amy Bell highlights the main differences:
If you’re considering building your own home, here are a few things to keep in mind as you search for a loan.
A Standard Mortgage Loan Won’t Do the Trick
For buyers purchasing an existing home, it’s relatively easy to get approved for a conventional mortgage, as long as they have good credit and reliable income. On the other hand, it’s virtually impossible to score traditional financing when you’re building your own home. Why? Think of it this way: You’re basically asking the lender to shell out money for something that doesn’t exist yet. To make matters worse, construction is a risky process, and lenders don’t like risk.
Seek Out a Construction Loan
If you plan to self-build, you’ll need to pursue more specialized financing avenues. Enter the construction loan. Sometimes called a self-build loan, a construction loan is typically a short-term loan (usually one-year maximum) used to cover the cost of building your home.
These loans generally have variable rates that are higher than traditional mortgage loan rates. Once construction on your house is completed, you can either refinance the construction loan into a permanent mortgage or get a new loan to pay off the construction loan (sometimes called the “end loan.”) Via Investopedia
When seeking a construction loan, it’s important to prove that your project is not one that will expose the lender to a high level of risk. As such, you will likely need to do a lot of legwork and provide various documents.
For most construction loan applications, you’ll need to provide the lender with a project timetable and a realistic budget. You’ll also need to supply a comprehensive list of construction details, including everything from floor plans and the type of building materials to insulation and ceiling heights. (Experienced builders typically create a “blue book” that includes all of these details for a home-building project.) Via Investopedia
But even with all these, the high-risk nature of a construction loan also demands a sizeable down payment. You’ll also need to include the cost of the land if you don’t already own a piece.
Prepare for a Sizeable Down Payment
At a minimum, most lenders require a 20% down payment on a construction loan, and some require as much as 25%. Why are the down payment requirements so high? Because construction loans are viewed as “higher risk” than a traditional mortgage loan, and the lender wants to ensure you don’t walk away from the project.
Know Where You Land
If you don’t already own the lot where you plan to build, the cost of the land will need to be included in the overall amount of the construction loan. If it’s financially possible, try to pay for the land upfront. Otherwise, you’re going to have make a much larger down payment to qualify for the construction loan. Via Investopedia
Another important consideration for getting a construction loan is to work with a qualified builder. This usually means a licensed general contractor that has already has an established reputation in home-building.
When shopping for a construction loan, it’s best to not be in a hurry. Construction loans comes in all shapes and sizes – in other words, just like any product, there are loans that are really good and others that a downright bad deals you’d would rather not get into.
As such, you need to be able to tell between a good loan and a shady one, and finding the best one may require you to take your time shopping around.