Building a custom home can seem daunting at first. But at Fortin, we do our best to make sure every aspect is simple and straightforward — and financing is no different. While you do have several options on how to pay for your custom home, a construction loan is a common choice. Here’s your definitive guide to construction loans.
What even is a construction loan?
A construction loan is a short-term loan that’s typically used to pay for the cost of building a home. It lasts for the duration of the construction process and essentially functions as a line of credit up to a specified limit. At the end of the construction process, when your home is complete, you’ll get a new loan, often called an “end loan,” to pay off the construction loan.
How does a construction loan work?
Like we mentioned, the loan will function as a line of credit, kind of like a high-balance credit card. You’ll be approved for a top amount of money, and the credit line can be tapped in stages, or “draws.” It’s important to note that these draws can only be performed for work that’s already been completed. You cannot get money in advance for items that will have to be paid for up front; the draw will only be granted for “work in place.”
Since there’s no existing collateral for the loan, the money down is pretty significant — usually about 20-25 percent. This down payment will signify to the lender that you are invested in the project.
Types of construction loans
For residential construction, there are just two different types of construction loans: construction-to-permanent and stand-alone construction.
For construction-to-permanent loans, you’ll just borrow for the home’s construction. Once the house is completed, the loan balance is converted into a permanent mortgage. It’s kind of like there are two loans in one. With only one loan, the amount of fees you pay is reduced.
While your home is being built, during the construction phase, your loan payments will only be interest, and it’s a variable rate, meaning it will move up or down with the market. Typically, once the construction phase is complete, the subsequent mortgage will work like any other mortgage, and you can choose between fixed-rate or adjustable.
Stand-alone construction loans
Stand-alone construction loan types require you to get two loans. The first is for the construction, and the second is the mortgage to pay off the construction debt. Because it’s two separate loans, you’ll have two closings and two sets of fees. And there’s no guarantee you’ll qualify for a mortgage once construction is complete.
You may be thinking, why would I choose this option? It does have some advantages. For one, stand-alone construction loans often require a smaller down payment, giving you a good bit more flexibility if you already live in a home and have a mortgage to pay. Once you sell your current home, you could use some of that cash for a down payment on the end loan, so it can help free up your cashflow situation during the construction phase.
How do I get a construction loan?
It’s true that construction loans require a bit more paperwork, and all that has to be in order before you can start the approval process. Different lenders have different lists of what they’ll need, but you can expect to see some of the following items on the list:
Because most of this information will need to come from your builder, you’ll need to meet with a builder first to map out all this information.
You’ll also want to speak with a lender for advice on which particular loan type will be best for your specific needs. Most custom home builders will be able to recommend some construction lender options based on those they have worked with previously. At Fortin, we have a list of approved construction lenders that we know are professional and easy to work with.
We also have a wealth of knowledge surrounding the financing aspects and are happy to offer our professional advice to you, no matter where you are in the home-building process. If you have any other questions about construction loans, please contact us.