Home Construction Loans: The Basics

If you’re interested in purchasing a new construction home, you’ll likely need to obtain a loan just as you would with an existing home. A new construction loan can be taken out by either the homebuilder or the buyer, but it’s typically easier for the individual buyer to get approved in the current financial climate.

New construction loans are generally short-term, lasting one year at the maximum. They tend to be variable-rate loans, and the interest rate will rise and fall with the prime rate. These loans also have special requirements, including a construction plan, a detailed budget and monitoring to ensure the home is being built along the lender’s approved timeline.

Lenders put new construction borrowers on a bank draft schedule that follows the home’s construction plan and timetable. During this time, the borrower is usually only required to make interest payments on the loan.

When the home is completed, the lender will request a certificate-of-occupancy before paying all contractors in full. At this point, the lender knows the full principal amount the borrower owes on the new home, and they will typically rollover the new construction loan into a conventional mortgage. It’s at this juncture that the borrower will pay closing costs and establish the future terms of the mortgage loan.

New construction loans pose more risk to the lender, and many are not forthcoming about their offerings. For those looking to build a new home with a new construction loan, it’s typically best to approach smaller regional banks and credit unions for assistance. Prior credit with the financial institution is always a plus, but isn’t usually required. As with any loan, borrowers with excellent credit and solid income will merit superior loan terms.

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