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Step 7: Home Construction Financing

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financing home construction
home construction line
residential mortgage
construction/perm loan
what's needed
Step7b: Understanding Escrow
Step7c: Getting Qualified

Find Home Construction Financing

saylending note: view mortgage rates
saylending note: about type financing (see below)
saylending note: home mortgage steps
saylending note: use your mutual loans for a down payment
saylending note: using your home equity as a cash reserve

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Notes: Financing Home Construction

  • Home construction lending is a little different than regular mortgage financing.

  • First, you will need a home construction line of credit that will used to pay subcontractors and suppliers who perform work and provide supplies.

  • Second, at the end of the construction project, you will use a residential mortgage to pay off the construction line.

    These are the two parts to home construction financing:

    1. Home Construction Line
    2. Residential Mortgage

1: Home Construction Line

  • You will submit for lender approval an application for a home construction line of credit. You will use the construction line to pay subcontractors and suppliers during the construction phase of the project. Generally, these players require payment within 30-60 days following work completion.

  • Once each month, or after each stage of the home construction, your builder will submit a request for funds to pay for subcontracting work and supplies that was used during the construction phase.

    The lender will release funds after they have verified that the amount requested will be used for the construction phase that has been completed.

  • Typically, the lender will send out an inspector to verify that the work has been completed. If passed, funds will be released to line the next day.

  • Lenders normally require scheduled withdrawal amounts tied to each major phase of the construction. If you request more draws than allowed per project, you may be charged a nominal fee per draw.

  • Don't underestimate your need for up front cash. You will normally spend more money during the first construction phase than what you can withdrawal up front.

    You should maintain a cash reserve account for cost overruns during a construction phase. See our affiliated site for more information about using your home equity as a cash reserve account:

  • The construction line generally carries a higher interest rate than residential home mortgages.

2: Residential Mortgage

  • You will need to apply for a residential mortgage to pay off the construction line when you finish the construction project. In most cases, your approval for a residential mortgage will be required prior to obtaining the construction line.

  • The residential mortgage is like any other single-family home mortgage loans. These include conventional and non-conventional loans, fixed, adjustable rates, etc.

    We have complete information on residential mortgages at our affiliate site:

3: Construction / Perm Loans

  • Some lenders offer both construction lines and residential mortgages as one loan.

  • The Construction/Perm loan is a combined loan made directly by the lender to the borrower. It functions as a construction line for financing home construction; then it serves as a permanent mortgage by paying off the construction line after you complete the construction project.

  • The Construction/Perm loan has several advantages, namely:

    • the borrower can save money by paying for only one set of closing costs, attorney's fees, appraisal and taxes

    • since the construction line is contingent upon approval of residential mortgage, obtaining a construction/perm loan allows the borrower to submit and provide documentation for one loan application and work through one lending institution.

    • because the loan is made directly to the homeowner, the borrower can take full tax advantage of the interest rate charges.

  • The Construction/Perm loan may also carry some disadvantages, namely:

    • obtaining the best rate and terms. Some Construction/Perm loans carry higher than prevailing market rates.

    • even though you may be working with one lender, usually the loan is managed by two separate departments. You may need to provide duplicate documentation.

    • your best option is to shop around to determine your best options.

What's Needed

  • Startup Construction Budget:
    set aside a cash budget prior to obtaining your construction financing. Builders suggest anywhere from $5,000-10,000, depending on the size and scope of the construction.

    This up front expense is considered part of the overall project cost and is often part of the down payment or "reimbursed" as part of the construction loan.

  • Down Payment:
    generally a minimum of 20% of more. The down payment may be cash, equitable securities, or the equity in an existing home or land purchase.

    If you are using the equity in an existing home, make sure you obtained a true market value of your home and anticipated time to sell your home.

    Existing homeowners often use the equity value of their existing home as required up front money for construction loans. They may take out a home equity line of credit to pay the up front money or a percentage of the estimated construction cost.

    For more information about home equity lines: see our site at YourEquity.Com

  • Planned Budget:
    know your limits. It can become tempting to add additional items to the home that place the entire project out-of-budget. Some buyers setup a budget cushion for upgrades and other changes.

    See our affiliated site: using your home equity as a cash reserve account for home construction: click here

  • Documentation:
    your submission of an application will require documentation of income and employment similar to a home mortgage application.

    This will include verification of employment (W-2s, pay stubs, etc.), or if self-employed, documentation of income, savings and investment account statements, etc.

    In addition, the lender will require construction specifications and cost breakdown for building your home. You will also need to provide the purchase contract or title to the construction site.

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