Financing new home construction is more detailed than any other type of loan. Banks are less willing to hand out these loans to just any borrower because they hold such an element of risk. If you do not have an adequate credit history or have any other factors that make your loan profile seem risky, you will likely not be able to obtain the loan. If you are among the lucky that are able to secure this type of loan, here is the process that you will undergo.
The First Step
The first step is to get your financing started. This is important even if you do not have your blueprints drawn up yet or have the site finalized. Builders and architects need to know that you are prequalified before they start working on your project in order to avoid wasting their time. The largest benefit of performing this step early is to enable you to know how much you can borrow. You might go into the process thinking you will be eligible for a certain loan amount when in reality, you are not approved for that amount. This would require you to redo all of your home plans and could incur more costs with the builder and the architect.
Getting prequalified for a new home construction loan is similar to the process for any other type of loan. The lender will pull your credit, looking for a credit score of at least 700 in order to qualify, although some lenders require scores over 750 to consider a construction loan. Once your credit is determined to be acceptable, the lender will require income documentation, verification of your employment, and proof of your liquid assets. These items will be verified and analyzed to determine the amount of loan you qualify to receive. In general, lenders are looking for stable employment (jobs or self-employment you have held for at least 2 years); stable income over the last two years; and adequate assets not only to pay the minimum 20 percent down payment, but money to have in reserves which equals a certain number of months of your principal, interest, taxes, and insurance payments.
The preliminary review of these items will help the lender determine the amount of money you will be prequalified for, enabling you to go to builders with your prequalification letter in order to get the process started. Once you know what you can afford, blueprints and plans can begin taking place and the first phase of the loan process can begin.
Applying for the Loan
Once you have finalized plans for your home, you can apply for the actual new home construction loan. This cannot occur until all of the plans are in place, however, as the plans play a vital role in the entire process. The lender will need to see and approve the plans and approve them. In addition, an appraisal will need to be ordered in order to determine the final value of your home based on the plans that are created. The appraiser will use the specs that were created for the house; the proposed plan; the value of comparable surrounding homes; and the value of the land to come up with the proposed future value of the finished home. Once everything is in order and a fully executed purchase contract is in place, your loan can be approved and eventually closed upon.
The First Closing
Unless you are using a one-step new home construction loan, which combines the construction portion of the loan and the permanent loan, you will have two closings. The first closing is the completion of the construction portion of the loan. This is when the funds are provided to get the materials purchased and your home building started. Not all of the funds are disbursed at once at this closing, as is the case when you purchase an existing home or even a new construction spec home. The only funds that are disbursed are the funds that are needed upfront to purchase materials and get construction started. The actual disbursement schedule is a component of the approval process and will be provided at closing. Your builder and lender will agree on amounts that are to be disbursed at certain intervals in order to keep the job going and the home building on schedule.
The closing process is similar to that of any other home closing, with the exception of the disbursement of the funds. The closing agent will let you know how much money you need to bring to the closing in order to complete the loan closing – this amount includes your closing costs as well as the down payment you agreed to pay. Once the closing is over and the funds are disbursed, construction is expected to be started on your home.
According to the schedule that was put together by your lender and builder, funds will be disbursed to you throughout the building process. Every lender has their own process when it comes to disbursing funds. Some lenders require an inspection during every phase of disbursements while other lenders strictly offer disbursements at the beginning, middle, and end of the process. Typically the initial money provided to the lender comes from your down payment in order to minimize the risk that the lender has in the process until it is determined that the process is going as planned and the risk is minimized. The final disbursement is not made by any lender until a final inspection and appraisal is completed to ensure that all aspects of the contract were met. Once the final draw takes place, the loan becomes due and payable and the permanent loan must be used to pay it off.
Closing the Permanent Loan
The final step is to facilitate the closing on the permanent loan for your home. This loan is the standard mortgage that you would receive on any home and is the money that will pay off the new home construction loan that is now due. This process can be done with the same lender that provided the construction loan or a different lender, depending on who provided you with the best rate and terms. Regardless if you used a new lender or the same one, you will need to provide your credentials again and qualify for the loan. It is important to ensure that your credit, debt-to-income ratio, and income do not change during this time to ensure that you still qualify for permanent financing.
At the closing of this permanent loan, the entire amount of the funds is disbursed in order to pay off the construction loan. This closing requires the final appraisal, inspection, and a Certificate of Occupancy from the county to ensure that the home is now livable. Once the loan closes, you have your permanent financing and a beautiful, custom home to live in!
Justin McHood is America's Mortgage Commentator and has been providing expert mortgage analysis for over 10 years.