When it comes to building your dream home, securing the right financing is crucial. Residential construction loans provide the necessary funds to turn your vision into reality. In this primer, we will introduce you to the process of shopping for loans, explore the various funding programs available, discuss the pros and cons of each, explain how draws are handled, delve into inspection intervals, and shed light on interest and origination fees.
Shopping for Loans
Before diving into the different funding programs, it’s important to understand how to shop for residential construction loans. Start by researching different lenders and comparing their loan products. Look for lenders who specialize in construction loans and have a solid reputation in the industry. Consider factors such as interest rates, loan terms, and customer reviews. If you plan serve as your own general contractor, be sure to discuss that with your lender. Some lenders will not work with owner/builders who are not licensed contractors.
Prior to meeting with a lender, gather necessary documentation, including your income verification, proof of funds, and construction plans. This will help lenders assess your eligibility and provide accurate loan quotes. We recommend visiting at least one local credit union or community bank to compare their loan programs to other lenders. Local lenders may have greater flexibility to craft loans unique to your situation.
Funding Programs
There are several funding programs available for residential construction loans. Let’s explore some common options:
1. Construction-to-Permanent Loans
Construction-to-permanent loans are a popular choice for those seeking residential construction loans. These loans provide financing for both the construction phase and the long-term mortgage once the construction is complete. Ask the lender about one-time closing programs to determine if you might save money when converting your construction loan into a mortgage. There is the potential to not only save money on closing costs, but you may be able to lock in a lower interest rate in a rising rate environment.
2. Stand-Alone Construction Loans
Stand-alone construction loans are another option for financing your residential construction project. These loans cover the construction phase only and require a separate loan for the permanent mortgage. While stand-alone loans offer flexibility, they may come with higher interest rates and additional closing costs.
3. Renovation Loans
If you’re planning to renovate an existing property, renovation loans can be a suitable choice. These loans provide funding for both the purchase or refinance of the property and the renovation costs. Renovation loans often have stricter eligibility requirements and may require a higher down payment.
Pros and Cons
Each funding program has its own set of advantages and disadvantages. Here’s a breakdown:
Construction-to-Permanent Loans
Pros:
– Simplified application process
– Lock in mortgage rates upfront
– Single closing for both construction and mortgage
Cons:
– Rates locked in early on may fall over time in a declining rate environment leaving you with a higher rate
– Not available through every lender
Stand-Alone Construction Loans
Pros:
– Flexibility in choosing a permanent mortgage lender
– Pay interest only during the construction phase
Cons:
– Additional closing costs and fees
– Interest rates may be higher than construction-to-permanent loan option
Renovation Loans
Pros:
– Financing for both property purchase and renovations
– Potential to increase property value
Cons:
– Stricter eligibility requirements
– Often has down payment requirement
Draws and Inspection Intervals
During the construction phase, lenders disburse funds in increments known as draws. These draws are typically based on the percentage of completion of the project. The lender may require inspections at specific intervals to ensure the construction is progressing as planned.
It’s important to establish a clear communication channel between the builder, lender, and inspector to ensure a smooth draw process. The builder will submit draw requests, and upon approval, funds will be released to cover the costs of the completed work.
Interest and Origination Fees
Interest rates for residential construction loans can vary depending on the lender, loan program, and your creditworthiness. It’s essential to compare rates from multiple lenders to secure the most favorable terms.
In addition to interest, borrowers should be aware of origination fees. Origination fees are charged by lenders to cover the administrative costs of processing the loan. These fees are typically a percentage of the loan amount and can vary from lender to lender.
Before committing to a loan, carefully review the interest rates and origination fees to ensure they align with your budget and financial goals.
Conclusion
Securing a residential construction loan is a critical step in building your dream home. By understanding the different funding programs, their pros and cons, the draw process, inspection intervals, and associated fees, you can make an informed decision that suits your needs and budget. Remember to shop around, compare rates, and choose a reputable lender to ensure a smooth and successful construction journey.