When you are obtaining a loan to build a home from the ground up, there are a lot of questions to be answered. How do you know what the costs will be? How much will the loan to be in the end? Who gets paid and when? These are just a few of the key questions that come up during the process. If you are working with a lender that is experienced in construction loans, you should not have any problems as long as you also employ contractors that fully understand the process. Because the full amount of the funds are not disbursed right away, it is important to understand the construction loan figures and how they play into your loan so that you have a successful experience building your custom home.
The Cost of the Land
The first thing that will need to be determined is the cost of the land. Are you purchasing the land with the construction loan or do you own it already? If you already own it, the cost of the land does not play a role in the loan with the exception that it works as your down payment for the loan since land is usually around 25% of the value of a finished home. If you are purchasing the land with the loan, you will need to put down at least a 20% down payment on the project in order to get the construction loan. The exact numbers depend on the chosen lender, of course.
There are two types of construction costs to deal with on a construction loan. There are hard and soft construction costs. Hard construction costs are the costs for the actual work that is done on the home. These are the costs of the labor and materials needed to build the home. The soft costs are the costs that are not directly related to the construction of the home, but that are necessary in order to get the project completed. An example of soft construction costs includes the costs for any permits, outside fees, and the cost of any architectural plans. Each of the fees will have to be detailed for the lender, including the amount, date needed, and what it is needed for. The bank needs this information because they are not going to disburse funds for work that is going to be done in 3 months down the road. They are only going to disburse funds for work that is being done right now. As each phase is completed, inspected, and approved by the lender, the next phase is disbursed for the work to begin. This is the way that the bank stays ahead of the builder and keeps him responsible. By not disbursing all of the funds ahead of time, the builder cannot just stop working on the home and leave town – he has to complete each phase to get each disbursement.
Every construction loan must have a contingency reserve available in the event that something was to go wrong. As with anything in life, things can go wrong when you are building a home. If there is a sudden problem, you need the extra funds to take care of the problem. Sometimes it is not a problem, but rather something that was overlooked; maybe a detail that you want added into the home. Whatever the case may be, there is always at least a 5% contingency reserve set aside for these instances. The 5% is based on the hard construction costs rather than the entire amount of the loan. This amount is figured in the total that you need to construct your home.
Some banks also require you to keep an interest reserve. This is in your own best interest as it allows you to skip payments during the construction phase of the home, which can be crucial if you are paying living expenses elsewhere while your home is built. The interest reserve if figured based on the length of time the construction is to take place and equals the amount of interest payments you would normally have to make on the construction loan as interest is the only payment that is necessary until the house is built and livable. The interest reserve is built right into the loan amount for your home construction mortgage.
Closing costs will vary by lender and title company. In general, you will pay for underwriting, origination, credit reports, title insurance, and processing fees. There are no standard amounts; every lender is different. You can sometimes negotiate these fees as well.
Once you have the total of all of the fees necessary to create your custom home, you can determine the construction loan amount. If you do not own the land the home will be on, you will subtract at least a 20% (sometimes higher) down payment from the total as you will be responsible for that portion of the loan. In addition, oftentimes, the closing costs can also be rolled right into your construction loan as long as you do not go over the maximum LTV that you qualify for given the exact circumstances of your loan application.
Once the lender has all of these numbers, they figure out your loan amount. All of the costs are totaled, including the interest and contingency reserve. The future appraised value is determined and the down payment is deducted. Once you have the final amount, this is the loan amount that you would need in order to purchase the home. The lender then needs to determine if that loan amount would work with the maximum loan amount you qualify for given your credit score, credit history, income, and debt ratio.Click to See the Latest Mortgage Rates»