Construction Loan Basics

September 6, 2013
Jennifer Hermes
Construction Loan Basics
A construction-to-permanent financing loan gives you money to bu
Ready to finance your project? Here’s how:  

There are two types of construction loans, says Penn Johnson, president of Stamford Mortgage, a company which provides construction loans throughout Connecticut.

One is a straight, short-term construction loan, which does not automatically convert to permanent financing. The drawback to this is when construction is complete, you must pay another set of closing costs. And interest rates could be higher at that time.

The better option, Penn says, is a construction-to-permanent financing loan. This type of loan gives you money to buy the land and build the house. As the house is completed, the loan rolls into permanent financing.   The construction-to-permanent loan is a multiple advance loan. “You’ll get the money in stages,” Penn says. “First toward the purchase of land, more as you get the shell of the house up, more again as you begin putting in electrical and plumbing.”

Three Basic Steps for Financing 

1. Evaluate your financial capacity. First, set your project budget. “There’s no use designing this beautiful house if it’s $200,000 more than you can afford. Get pre-approved,” says Penn.   Some banks, such as Wells Fargo, offer a no-obligation prequalification consultation to help you estimate how much you might be able to borrow.

2. Find land, your house plans, and a builder. “You’ll need these three things to apply for the loan,” says Penn. “The bank will ask you for your plans. They’ll also want the cost estimate, which the builder will give you.”

3. Apply for the loan. There’s really no difference between a mortgage company and a bank, according to Penn. If you’re seeking a bank, check with the local ones: “I’ve been in this business 30 years, and construction-to-permanent financing loans tend to come from the small local banks. They’re the ones that do this best.”   The lender will look at the cost estimate and suggest an advance schedule. This could pay out in four to six advances during construction. When your builder completes each stage, they call the bank, an inspector visits, and they advance more money.

Three Important Tips  

--Find an experienced loan officer.
When seeking a lender, it’s important to find a loan officer with plenty of experience with construction loans. “They’re the ones who will explain the process. They need to be a good communicator and have done a lot of this kind of lending,” Penn explains. “If the loan officer has only done a couple of these, it will be bumpy. It doesn’t matter if you use a mortgage broker or a banker, as long as he or she has the experience.”

--Be prepared to put 20% down. You’ll generally need 20% because it’s hard to get private mortgage insurance on a construction mortgage. “I’ve heard it’s possible, but have never seen it,” Penn says.   That 20% is for the total cost of the project, but includes the money you may have already paid for the land. “If you paid $100,000 for land, and need $400,000 for the house, the total is $500,000. You’ve got the 20 percent and could get the loan,” he explains.

 --Understand the advance schedule. “Be on your toes and make sure the builder understands the advance schedule and accepts it. Some builders are more liquid on when they need the money. Others need it following a more strict schedule. The bank will assume the schedule will work, so it’s not always set out too clearly.”  

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