Most of our customers that build a home on their lot need a construction loan to finance the build. The construction loan is also known as interim financing because it is a short term loan only used during construction. Once the home is complete the interim loan is refinanced into a permanent mortgage. Most lenders issue the construction loan for a 12 month term. Longer terms of 18 to 24 months are available for larger projects.
To qualify for interim financing a bank will consider the credit worthiness of the borrower much like a mortgage approval. They also consider the cost, equity and value of the project based on an appraisal done prior to construction. There are some variables in the way banks may calculate equity. Some lenders may look at the current value of the land vs the actual cost depending on how long you have owned the land. If land ownership is less than one year, then most lenders will use actual cost vs appraised value. Some lenders may use the total appraised value to calculate equity and some may use actual costs. Down payment or equity requirements are usually at least 10% and most banks prefer 20% equity or cash down. Cash reserves are also an important consideration for obtaining an interim loan. Banks like to verify there are funds available to cover interest payments and cost overruns or changes.
To do an appraisal, the lender will need some paperwork from the builder. A detailed cost estimate, a contract between the owner and builder, specifications and house plans.
Once the construction loan is issued/closed then the bank will set up a draw schedule to fund the project in stages. Think of the construction loan as a line of credit. The lender funds the money for work completed which they verify with an inspection. The borrower is charged interest only once a month based on the amount drawn to date. For example, if the total loan is $400,000 and the amount drawn the first month is for $50,000 then interest is calculated on $50,000 x the rate divided by 12 months. If the rate is 5% then the first month interest payment is approximately $208. As the amount drawn each month increases so does the interest payment. Once the home is completed then the total amount drawn is refinanced into a mortgage loan.
Some lenders will give the funds directly to the borrower to pay the bills and some will only send the funds to the builder. At Owner Managed Homes we prefer that the borrower receives the funds, so they can pay the bills. If your lender will only fund to the builder, then have some control in place to verify all your bills are paid. Most lenders can set up a joint account requiring two signatures. Requiring notarized lien releases is another way to verify subs and suppliers have been paid.
An Owner Managed Homes consultant can refer you to one of our many lenders to answer your questions and preapprove you for a loan. Please contact one of our four locations nearest you for a free consultation.