How is the Mortgage Lending Process Different for Custom Homes?

June 22, 2020

Buying an existing home tends to be a fairly straightforward process. You go to a lender, hand them over your financial information, they tell you what type of loan you can get, and you get approved for the home. If you have a home you already want, the lender will tell you if you qualify and, if you do, will start all the paperwork to get you into the home of your dreams.

But when you’re buying a home that doesn’t exist – a custom home that is going to be built specifically for you – the process is a little different. Even the type of loan changes, as does the amount, the interest rate, and more.

What to Know About Construction Mortgage Loans

If you’re planning to build your own house, what you will need is a type of construction mortgage loans. These loans can act in some ways like a traditional mortgage, at least in terms of monthly payments, but the process to apply for them and the terms are different:

  • Draw vs. Completion – There are two types of construction mortgage loans: draw loans and completion loans. Completion loans are not that different from other mortgages. The payment comes when the work is completed, just like paying for a new house. Draw loans pay different amounts based on what stage they are in the process.
  • Interest Rates May Be Higher – Because you’re paying for a home that does not yet exist, there are risks involved. Poor construction, poor design – these are all things that could reduce your home’s value, which puts the lender at risk. Luckily, most home construction loans can be refinanced for a lower interest rate in the future, but that may be something you need to account for.
  • Land Financing – Before you can build a home, you will need to buy land to build it on. There are complexities involved lumping those loans together, and in many cases, they are completed separately. Recognizing the costs of land will be important depending on where you’re planning to build your home.
  • Down Payment May Also Be Higher – Though this is determined by the lender, it may be more difficult to find a low down payment loan when you’re buying your own home. That said, there may be ways to get down payment assistance if you need help.
  • Construction to Permanent Home – Draw construction loans will eventually need to be converted into permanent home loans. To do so requires a rigorous approval process that makes sure every inch of the home is up to code. That is one of the reasons it is important to partner with an experienced home construction company.

There are also very different types of loans depending on the lender – something that is not necessarily true of traditional home loans. There are short term loans, interest-only loans, different qualification amounts, and more.

Before you consider a home construction loan, it is always a good idea to talk to a lender and see what they say. They will be able to tell you more about the loan options available and what you need to qualify.

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