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You'll need
both a construction loan and mortgage for a custom home
Financing can be a confusing aspect of building a new home
because custom-home buyers need to obtain a construction loan
and a residential mortgage. The construction loan acts as a
short-term line of credit while the mortgage supplies funds on a
long-term basis with an amortized payoff.
It's wise to investigate your borrowing capacity prior to
embarking on the home-building process, but you probably won't
need to secure your financing until you've purchased or reserved
the site for your new home, approved the design, building plans
and written specifications for your home and signed a contract
with the builder.
How construction loans work
Few subcontractors and suppliers can afford to wait until your
home is completed for payment for the labor, materials or
products they've provided. That's where your construction loan
comes into the process. This credit line is used to pay the
subcontractors and suppliers on a timely basis during
construction.
Once each month or as specific stages of construction are
completed, you or the builder will prepare a request for funds
called a "construction draw," which is submitted to the lender
or the title company to pay for work completed thus far. Partial
payments may be made to major subcontractors whose work extends
through several stages of the home-building process.
Subcontractors and suppliers typically agree to waive their lien
rights against the home upon payment. Most lenders will require
that you pay for extras and changes as those expenses are
incurred. Expect to pay a portion of the builder's overhead and
direct job expenses with each draw, unless your contract with
the builder states otherwise. Part 1 written By Tom
Stephani
Construction
Financing part 2
Although it
seems counterintuitive, you must apply for a residential
mortgage and have the lender's commitment for that loan in hand
before you will be able to obtain a construction loan. Very few
lenders will approve a construction loan without being assured
that a "permanent" mortgage will pay off or "take-out" the
construction financing when the home is completed.
Get your house in order
The extensive documentation required for both the construction
and mortgage loans will include verification of your employment
(e.g., W-2 forms and paycheck stubs) or documentation of your
self-employment income, verification of your assets (e.g.,
savings and investment account statements), your income tax
returns for the last two or three years, your construction
contract with the builder, the plans, specifications and cost
breakdown for building your home and the purchase contract for
or title to the site where your home will be built. The
construction loan lender will require a "take-out commitment"
letter to verify that you've applied for and obtained a
"permanent" mortgage.
If you obtain both loans from the same lender, you might be able
to minimize providing duplicate documentation; however,
construction and permanent loans usually are handled by
different departments, so you may still need to provide two
complete sets of documents. It can be beneficial and easier to
deal with one lender for both loans, but that's neither required
nor always the best option.
Lenders are beginning to make construction/perm loans, which
wrap both parts of the financing into one package. The
construction loan simply converts to a permanent mortgage when
construction is completed. Although construction/perm loans can
work well, they aren't necessarily the best option for every
situation. Try to obtain the best rate and terms available for
your long-term mortgage, regardless of whether it's connected to
a short-term construction loan. Once you have a commitment for a
mortgage, a construction loan usually should be relatively easy
to obtain.
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