Most people who get excited about the idea of building their new home are inexperienced in how the process actually works. The most common belief is that the prospective homeowner finds a piece of land, has some home plans put together, and then goes out to get a mortgage. While that is mostly true, there is actually a loan that happens during the construction phase and before the mortgage kicks in. It is called a construction loan, and it is a critical part of the home building process.

The Basics Of A Construction Loan

When you decide to build your own home, you are initially going to apply to the bank for a construction loan. In general, construction loans have very short terms of one or two years and are not given out in one lump sum. A lender will want to see the plans you have for your new home and the exact budget associated with construction before it will consider approving a construction loan.

It is best to already own the land you want to build on before you apply for a construction loan as the land can be used to help secure a better rate on the loan. Lenders tend to be careful with construction loans because it is, for the most part, an unsecured loan because the house has not yet been built.

Using The Construction Loan

Before being approved for your construction loan, you and the contractor will be asked to submit a schedule of payments to the lender. When the loan is approved, the homeowner will be expected to apply for funds that would be used to pay the contractor’s ongoing invoices. Whenever the homeowner applies for funding to pay an invoice, the lender will usually want to send out someone to see how the project is progressing.

Once the term of the construction loan is up, it becomes due in full. This means that you and your contractor have to allow for possible work stoppages due to weather or lack of materials. In many cases, you can discuss an extension of the loan term for you new home if the building process is taking longer than expected, but your lender will want a good reason as to why construction is being stalled before approving an extension.

Rolling Into A Mortgage

Some lenders have a program that automatically rolls your construction loan into a mortgage, but that is not always the case. You cannot roll your construction loan into a mortgage until you have the certificate of occupancy from your local zoning office and the certified statement from the contractor saying that it has been paid in full and will not put any liens on the property. Once that paperwork has been submitted, your lender will then transition your construction loan into a 15 or 30-year mortgage, depending on your arrangement.

The process of getting funding to build a new home sounds complicated, but it really is not that bad. Most lenders have programs in place that help walk homeowners through the entire process, and some lenders have all-in-one products that make it even easier to finance your new build. The key is to find the right contractor and lender to work with that will help to make the entire process as simple as possible.