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Financing Your Custom Home

Securing a construction loan financing is very different from a standard mortgage loan. When you take out a mortgage, you purchase an existing home and the land it was built on. The process is pretty straightforward. You apply for a mortgage loan through your bank or shop around a bit by using a mortgage broker. The lender has a wide variety of lending options and loan types. All-in-all, the process is considerably straightforward. Construction loans for building a new home are a bit more complicated. After reading this blog, Anderson Homes hopes you better understand financing your custom home. 

Financing Your Custom Home: What are Your Options?

Financing New ConstructionUnlike buying an existing home, there are three main types of transactions in financing your custom home. They are the purchase of the land, the construction of the house, and the mortgage. Many people go into building a home hoping to secure financing for all three of these through one lender. But most likely, you will need an independent loan for each transaction. Some financial institutions offer loan packages that group the various loans. 

The Process of Financing a New Construction

The process goes like this. To build, you must purchase the land. This is the first loan you obtain. The cost of land and the interest rate you’re approved for depend on the plot’s location, the land’s appraisal, and credit factors. The next loan you need is a construction loan. This loan is unconventional in a few ways. The purpose of a construction loan is to finance the entire building project through structured disbursements. This means that periodically, at various stages of construction, the bank will disburse money to the builder to cover the costs. Lastly, you take out a regular mortgage. This loan pays for the purchase of your completed home. 

Specific Types of Loans for Financing a Custom Home

Lot/Land Loan

Unless you already own a plot of land outright, meaning it is fully paid for with no outstanding loan or plan to purchase it with cash, you will need a lot loan. These loans are available at various financial institutions and come with various terms, from fixed rates to floating rates, and loan periods anywhere from two to twenty years. 

A lot loan’s qualification process is stricter than a traditional mortgage loan. Lenders need to know your credit score, debt-to-income ratio (30-40% is optimal), and annual income. They will also want to know how much you’ll be putting down on your land. Many lenders require a sizeable down payment of 20-30%. 

Before you even begin looking at model homes or interviewing custom home builders, selecting a property that’s right for your new house and your lifestyle is essential. Consider the value of the land, the neighborhood, local amenities, and your proximity to work. Think about how long you plan to live in your new home. Will children be a factor? If you don’t already have children, will you want to while you live on this land? What is the quality of the school system? You will also need to check the area’s laws on zoning and land use to ensure you’re able to build. 

New Home Construction Loans

Like most people, you plan to finance your custom home. This is done through a construction loan. These loans are specific financial tools that you won’t be able to find at every bank or credit union. Anderson Homes recommends talking to your builder and asking them for construction loan recommendations. Reputable builders have working relationships with lenders and may even be able to help you secure the financing you need. 

Construction loans are unique. They are short-term loans. Depending on the timeline of your custom home-building project, terms are usually between 12 and 18 months. Like land loans, construction loans also require a substantial down payment. It’s fair to estimate a construction loan down payment between 20 and 30% of your total loan. Also, interest rates on construction loans run higher than on a home mortgage. Because construction loans are a bit more complicated, let’s go over the different types.

Construction-to-Permanent Loan: This loan, also called a C2P loan, automatically converts to a standard mortgage loan once your home is constructed. Depending on the lender, you may also hear this type of loan called a one-step or single-close loan. These terms all mean the same thing. The most significant benefit of a C2P loan is that once construction ends, you will have to go through a refinance or loan modification, but you won’t have to do any of the loan application processes again. A downfall is that your initial payments may be higher, with the possibility of lessening after the conversion. 

Standalone Construction Loan: A standalone construction loan funds the building project and nothing more. This short-term loan must be paid off once construction is complete on your custom home. If you cannot pay the loan off in full at that time, you have to secure a separate mortgage loan. Before finalizing your construction loan, lenders will want documented evidence of a pre-approval for the mortgage. With this, they can accept your construction loan application. 

Permanent Loans

Known most commonly as mortgages, permanent loans are the type of loans that most people use to finance their home purchases. As with the previously mentioned loans, the rates and terms of mortgages vary depending on your financial situation. The same credit factors apply. 

Now that you understand the different types of financing needed to build your dream home, let’s go over the most significant differences between a new home construction loan and a traditional mortgage. 

New Home Construction Loans VS Traditional Mortgage Loans

Mortgages traditionally provide long-term (up to 30 years) financing for an existing home. The home is used as collateral to secure the loan. The homeowner makes the regularly scheduled payments toward the principal (the amount financed) and interest, with most of the early costs going more toward interest. Because the home is used as collateral, should you default on a mortgage loan, the home is returned to the financial institution. In addition to fluctuating interest rates, some mortgage lenders charge higher upfront fees. 

Unlike traditional mortgage loans, new home construction loans do not involve an existing house. This is why new home construction loans have such short terms. The intention is to only have the loan out for the time it takes to complete the home’s construction. Also, because there is no collateral to secure construction loans, lenders generally require lendees to pay the needed equity at the beginning of the loan (also known as the down payment). Construction loans are interest-only payments, which make for lower monthly payments allowing you to continue to save toward your traditional mortgage. These loans come with added scrutiny from lenders, helping your construction project stay on track and on budget. 

Building Your Custom Home with Anderson Homes of Wisconsin

Anderson-Homes-Luxury-Custom-Home-BuilderAnderson Homes, an award-winning, Milwaukee-based custom home builder, was built on superior service, strong relationships, and lasting trust. The team at Anderson Homes has decades of experience in custom home building. They believe in giving every client the personalized attention they deserve. Anderson Homes understands their clients’ commitment and investment when building their dream home. That’s why they strive to give you expert opinions on everything from financing your custom home to home warranties that far outlast the building process. 

 In addition to helping you secure financing with a trusted lender, Anderson Homes can assist you with finding the perfect land or lot! Whether you’re looking for easy access to the city or a hidden county subdivision, they help locate and evaluate the ideal land! 

Take a look at Anderson Homes Lots and Lands for Sale, or reach out to schedule an appointment today!