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Building a Home – The Loan Process

To finance a home on a vacant lot you will need to obtain a construction loan. These vary drastically when compared to residential loans since they are directly associated with building a house. Construction loans have different terms and bring different value to the borrower. Here are the steps simply outlined to build your dream home from the ground up.


Getting the Land

 Before you can build a home, you will need to secure the land to build it on. You can either purchase the land prior to construction using a land loan or cash, or you can purchase the land when you are ready to build – in this scenario, the construction loan will cover the costs of the land and the home. Each offer their own pros and cons.

If you want to use a construction loan to purchase the land, the land will need to be ready for immediate construction. This means that the land has already been identified as buildable and the plans for the home are ready to be executed. These steps to getting here can be long since you will be required to go through permitting and zoning ordinances, as well as factoring in state, federal and health department regulations. However, if you are at this phase, then getting a construction loan can offer you better terms.

If you are less decisive and want to have more time to design a home specific to a lot that you have identified, or if you have identified land that is not ready for construction, then you will need to obtain two separate loans: the land loan and then the construction loan. The challenge here will be getting the land loan because lenders are less inclined to provide these types of loans.


Understanding Construction Loans


Once you are ready with the homes design, found your builder, and have purchased a plot of land, you can now get a construction loan. This loan will finance the project and help you develop a home specific to your desires.

Within construction loans there are two types of loans you can consider: stand-alone construction loans and construction-to-perm loans.


Stand-Alone Construction Loans

 This type of loan is specific for the construction of the home. The term of the loan is generally shorter, limited to the length of construction of the home (one to five years depending on the lender). Most lenders require 20% to 25% down for a construction loan, and, for many of these loans, they are interest only – this means that during the term of the loan the borrower is only paying the interest. Then at the end of the term the entire amount is expected to be paid off.

Once the home is built the homeowner can now finance their home using a mortgage. Again, they will need roughly 20% down but the interest rate on this loan will be lower and the term will be longer (-15 or -30 years). The terms of the mortgage depend on the borrower’s qualifications, Fed. rates, and the institutions guidelines for lending.


Construction-to-Perm Loans

 A construction-to-perm loan is one that combines the construction loan and mortgage for the home. Instead of an individual requiring two separate loans, they can utilize one lender for the entire process. This one is similar to a conventional loan in that it will require 20% down. Once the construction is done the loan will be restructured into a conventional loan. However, similar to the organization of a stand-alone construction loan, often the payments during the construction of the house are interest only. The terms of this loan can vary depending on the borrower’s qualifications and the preferences of the borrower. In this case though, the interest rates are similar to that of standard mortgage rates.

The primary reasons that someone would chose to not use a construction-to-perm loan is because they either want to get a VA or FHA loan, which are not offered with construction loans, or they want to finance with a lender different than the one they used for the construction loan, specifically if another lender will give them more favorable terms.


Cost to Build A Home

 The type of loan you may want to pursue can vary depending on the cost to build the dream home that you desire. Remember though, the location of your home can have a major impact on the expenses associated. There is permitting and construction that must be assessed for every build.

Homes building can cost as little as $120/SF to as much as $400/SF or more. The factors that can impact this value include construction quality, grade of exterior materials and level of interior finishing of the home. And the biggest cost variations from region to region have to do with the price of land, the cost of labor, the cost of materials and the cost of permits.

The quote provided includes labor costs, costs for material and equipment, project costs (surface preparation, component, and machinery), and cleanup fees. This can range from a hundreds of thousands to millions depending on the process and your preferences.


Getting Started

There are many options to consider when determining if you want to buy an existing home or build a home from the ground up. Obviously, purchasing an existing home can be much quicker and simpler; however, the costs can be drastically higher.

If you are uncertain about which avenue to pursue it is recommended that you consult with a local real estate agent, your bank, and a local contractor. Gaining the input of these three professionals can give you direction on the best choice for your future.

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