Financing a new construction home with a construction loan

This post features a guest interview with Colin Myers of Monument Home Loans.

If you need help with construction financing, you can contact Colin at (703) 407-1377 or colin@monumenthomeloans.com.

Low inventory and incredibly competitive market conditions are turning more and more homebuyers on to the idea of building a home instead of buying an existing one. The thinking goes something like this: “Why compete with 10 other buyers and pay top dollar for an existing home that is less than ideal, when I could build my own home and have full control over the location, finishes, and floor plan?”

It’s a reasonable thought process, but all but the bravest souls eventually shy away from the idea of building a new home, and with fair reason.

First, contrary to popular belief, unless you get a great deal on the land, building a new home is usually more expensive than buying an existing one. Therefore, while you’re less likely to find yourself in a bidding war with 10 other buyers, buying land and building a home may be financially less sensible than buying a resale home.  

Second, the time it takes to find a suitable site, settle on a builder, and build a new home often exceeds 12 months. Permitting alone can take 3-4 months. And – depending on your specific plans for the site and whether an architect is involved – you could easily spend more than $50,000 on due diligence, engineering and environmental studies, architectural plans, and permitting before you even break ground.

On the other hand, there is a subset of buyers for whom building a home is a good option.

Older home buyers often have a preference or legitimate need for single-story living, and in some parts of Northern Virginia the inventory of single-story homes is virtually non-existent. Other types of housing that are limited in our market are houses with two master suites and houses without a basement. Therefore, one compelling reason to build a home is to fulfill a unique functional requirement.

There is a second subset of buyers who are well-versed in the costs and challenges of building a home but choose to proceed for the experience and enjoyment. These are often mechanically minded people who derive a lot of satisfaction from the experience.

Finally, there are wealthy buyers for whom the financial burden of a designing and building a custom home is much more manageable. For this subset of buyers, the purpose of building a home has less to do with function and more to do with lifestyle.

Whatever your rationale for building a home, one of the questions you must ask yourself is, “How am I going to finance the construction of my new home?”

Financing a new construction home can be considerably more complicated than financing a resale home.

For example, if you’re already carrying a mortgage on a primary residence, you must consider whether you will (1) carry your current mortgage along with the construction loan, or (2) lessen your debt burden by selling your current home and either doing a rent back or moving to a rental property while your new home is under construction.

There are many other considerations to take into account. I recently asked my colleague, Colin Myers at Monument Home Loans, for his thoughts on the subject, and he was kind enough to offer the following insights. If you ever need a construction loan, Colin is a great person to talk to!   

For someone who has never built a home before, can you explain the difference between a construction loan and a traditional loan?

Construction loans are meant to fund the cost to build a new home whereas a traditional loan is meant to finance the purchase of an existing home. Construction loans can cover the cost of purchasing the lot and the cost of the construction. 

The term of a construction loan runs for the duration of construction, during which the borrower makes interest only payments based on the cost of construction. Therefore, payments increase as construction proceeds because more money has been spent on construction.

Are the qualifying criteria the same for a construction loan as a traditional loan? 

Compared to traditional home loans, the qualifying criteria for construction loans, such as the debt to income ratio, minimum down payment, and credit requirements tend to be more stringent. This is because the lender takes on more risk during the construction phase. The stricter requirements also minimize circumstantial risks such as the borrower incurring new debt or experiencing a job loss.  

Are there different types of construction loans?

There isn’t much variance in types of construction loans. The two most common types of construction loans are a one-time close and a two-time close. 

A one-time close means there is only one closing, but the tradeoff tends to be a slightly higher interest rate. A two-time close means a closing occurs pre-construction and then again when the loan is refinanced into a standard conventional loan. 

With both options, during the construction phase the payment is interest only based upon the construction rate.  Once completed, the interest rate goes into the permanent rate. There are a number of construction loan products that offer varying benefits, which include: conventional, jumbo, FHA, and USDA.

If someone is shopping around for a construction loan, what criteria should they consider when comparing competing quotes?

When shopping for construction loans, in addition to the interest rate, you should review lender-specific up-front costs. Also, it’s good to understand how the payments are disbursed to the builder throughout the construction phase. This ensures the builder has a full understanding of how he will receive the payments. You should also find out how much time is required to request an extension to the length of the loan in the even construction takes longer than anticipated.

How much can you borrow with a construction loan?

I can’t speak for all lenders, but the maximum construction loan amounts at Monument Home Loans are $1,500,000 for a primary home and $548,250 for a second home or investment property.

How is interest paid on a construction loan?

Monthly payments during the construction phase are interest only. Some products provide for payments to be rolled into the loan amount, which is tremendously helpful if you’re struggling to pay both current housing and construction payments.

Looking for land for your new home construction project? Search all of our land for sale in Northern Virginia or call Jonathan at 202-750-4050 to get started!