Getting a construction loan vs a mortgage loan – learn the differences

Getting a construction loan vs a mortgage loan – learn the differences

Unless you plan to pay cash for your home building project, you will need to obtain construction financing and a mortgage for the outstanding balance when it is completed. Although you may have qualified for a mortgage loan before, getting a construction loan for your home building project can be a bit of a challenge.

While it’s certainly possible to get a construction loan as an owner-builder, lenders may shy away from you at first, thinking you’re not qualified to handle such an endeavor. Therefore, it is important to be well prepared and present yourself in a capable, competent light when presenting your case to the lender. For example, don’t say, “I’ve never done this before, but I’m willing to give it a try.” Instead, be positive, prepared and professional. Never lie, but anticipate questions and concerns and have answers ready.

There are several types of construction loans to choose from, but one of the most popular for people building their own home is the construction loan, which turns into a permanent loan once the home is completed. While there are no standard specifications for this type of loan, as a guideline most require you to pay closing costs only once. This saves money and makes the process easier. You do not need to go through the qualification process twice. The downside is that it’s nearly impossible to lock in a fixed mortgage rate since you won’t close the loan for six months to a year.

No matter what type of construction loan you choose, you will likely have to pay monthly interest on the construction loan amount during the construction phase. The amount you owe each month will depend on the amount you have ‘drawn’ from the loan, not the total amount you are eligible to borrow. If you’re approved for a $100,000 construction loan but only took out $50,000, then your interest payment will be based on the $50,000. Typically, construction loans are standard rate (non-amortizing) and one or two percent above the prime rate or whatever you have agreed with your lender.

Qualifying for construction goes beyond the income and credit qualification requirements for a standard mortgage loan. Bankers or lenders will want to know how you plan to tackle your project and whether you are capable of building a home yourself. A thorough presentation to the bank will be in order. The following is a brief description of what you need to apply for a construction loan:

  • the same financial information you would provide to get a standard mortgage loan (financial statements, income verification, credit report, etc.)
  • a set of your plans (they may ask for multiple copies)
  • detailed specifications (the materials and finishes you plan to use)
  • cost estimate
  • appraisal (commissioned by lending institution. Appraiser will use plans, specifications and lot value to determine amount)
  • information about your lot (whether you own it, etc.)
  • contractor bids (not necessarily required, but can be if this is your first project)

You may also consider providing any other documentation you can think of that will help indicate your ability and willingness to complete your project. The bank essentially becomes a silent partner in your project and will be concerned that the home is properly built. The key here is to demonstrate your ability to handle the project.

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