What is a Construction Mortgage?

Posted by Credit Financing Guru

In order to save money and design the home of their dreams, many people choose to build their home from the ground up. When building a home, one has to consider how they will finance the big project. One loan option many people choose is the Construction Mortgage.

A Construction Mortgage is a loan that is used to finance the building of a home. The money is normally given to the borrower in set amounts as each stage of the construction process is completed. Most construction mortgages involve paying the interest only during the construction period with full repayment required after the owner obtains a certificate of occupancy.

Before a lender approves a construction mortgage, they have to know all that will be involved in building the home. This includes the blueprint, materials, labor, other costs associated with the construction, and the time it will take to completely build the home. Construction mortgages are normally variable-rate loans which are priced at according to the prime rate. The home builder, lender, and contractor will set the schedule for withdrawal of funds for each stage of the construction process. Interest is applied on the amount of money withdrawn. Having the money released before each stage is complete is often seen as economically beneficial and helps prevent future funding problems.

Many homeowners will often choose to acquire a construction-to-permanent financing plan where the construction loan is switched to a mortgage loan after the certificate of occupancy is given out. You can often get a higher construction loan rate and then get a better mortgage rate when you switch to traditional mortgage financing. It is important to remember that with a variable rate, repayments can fluctuate each month. Generally, construction mortgage rates are quoted on a prime plus basis.

Like a traditional mortgage, how much you can borrow will depend on your financial status such as your credit rating and income. Lending can often range from 75 – 95 percent of the building cost. Some lenders provide a separate loan for the land. Funding for building costs is released when the home building plan has been approved. The best benefit of a construction mortgage is that it is usually cheaper than getting a mortgage for an existing home. The cost of building your own home is much less than buying a new house. As well, new self-built homes are worth more the day the home is finished so it makes for a good investment. When considering a construction mortgage, it is important to comparison shop from a number of different lenders. Many experts recommend consulting with a construction mortgage specialist.

From the size of the rooms and where the rooms are located, building your own home provides you with many more choices than if you were going to buy an existing home. A construction mortgage may be the perfect solution if you are looking to build your dream home at a much less expensive cost. When considering this type of mortgage, it is important to understand how it works, the cost to build, and the repayment terms and conditions. With the right knowledge, it will not be long before you will be living in your dream home.

Obtaining the best mortgage rates can be an important competitive advantage in the housing market. Another important factor to consider is finding the best GIC rates, which may help you in securing a stronger purchase or sale of your home.

Construction Mortgage FAQ:

Question: Can I ask for more money on a home construction/mortgage loan?
I recently built a house and asked for a $140,000 construction loan. I was approved for more than that and only took $140,000. I’ve gone over budget but the house is complete. I put in about $10,000 from my pocket. Is it possible to ask for more money from my lender? I was hoping to finish the house and with left over money pay off a personal loan I have which I took out to buy the acreage I built my house on. The interest rate on the personal loan is about 5.2-5.5 percent, don’t recall the exact number. Would it be wise to ask the lender for more money to pay off the personal loan and pay myself back what I put in from my own pocket. It won’t hurt me to pay my mortgage monthly, but will hurt to pay $10,000 out of my own pocket all at once and not get it back. Any suggestions on what I can do?

Answer: Especially in these times if an appraisal and your income will support the additional debt, your lender will probably go along with it with conditions. If they don’t, there are lots of programs out there that will.

It is very important with all of the housing inventory out there for your lender to have a home with a certificate of occupancy and a completed product. A work in progress is a bad thing for them if they take it back. That is a big incentive to work with you to complete the house.

I was exactly in the same position in terms of having access to more than I thought I needed when I started and then having cost over runs. The bank did an appraisal. There was plenty of equity so they restructured (not refinanced, fewer fees) the loan and we all moved forward.

Just call your loan officer and ask. They may want you to do it when you go from construction to permanent financing. It is in any event in your mutual best interest to have a completed house and you should preserve your own cash reserves.

Question: No comparable sales within the last year, can I go further back?
I am currently disputing an appraisal done at closing on my home construction/mortgage loan that has put me in a bind. The appraisal was super low compared to what it cost to make the house and buy the acreage I made it on. I was given a rebuttal form by the bank financing the loan, only they asked me to find comparable sales. I haven’t found any within the past few months, people mostly build around these parts and not buy. They did not want me to put new construction, but rather sales. Since the nearest sales go months maybe even 2 years back, does this entitle me to put them down as comparables? I am not going to put forclosed homes as comparables because that’s what the appraisal company did to me and got me in this mess. They put homes that are half the size of mine and foreclosed as comparables. If I go a year or two back, there are houses that match mine in square footage and surrounding acreage that are in the price range that it took to build mine and buy the acreage.

Answer: No, you can’t go back 2 years, you would be lucky to go back 6 months.

You have to include foreclosures, they effect the value of property, you can’t disclaimed them, otherwise the appraisal would be incorrect.

Anything more then 6 months old has no bearing on today’s market. You can use smaller properties too, it is not a big deal, as you figure out the value per square foot, not per property.

All appraisals are under construction costs, while property value has gone done, labor and materials has not.

Question: Can I move a construction loan from a mortgage broker to another lender?
I am building a house & it is 85% done. My mortgage broker is withholding money from me to finish my house. He avoids my calls & when I do get a hold of him, he tells me he has no money to give me. Can I go to another lender & take this loan away from him?

Answer: Yes, you could refinance the whole deal with another lender. There are lenders that only deal with construction loans. You just need to find one in your area.

Question: What do you call a loan that covers land and then construction of a building later on under the same mortgage?
I’ve heard of a loan that is given for land and then later on can be extended to cover construction of a building under the same mortgae but I can’t remember what it’s called?

Answer: Sounds like one of the newer ‘One time close’ loans. Usually you have to get a loan for the construction, which you are allowed to use to purchase the land. Once the home is built, you are required to refinance the construction loan with a long term permanent loan. That is why they are called construction to perm loans. Now however, a lot of banks are offering ‘one time close’ loans. You simply have one loan that covers the construction and the permanent financing so you don’t have to close, and pay closing costs, twice. Ask around at your local banks for ‘one time close’ loans and shop around for the lowest rate and terms.

Question: Construction Loan to Mortgage?
I currently have a construction loan on the house that I live in but we can’t qualify for a mortgage. Our bank keeps extending the loan even though the house is completed and we’ve lived in it for over a year. How long can the bank continue to do this? Are there federal regulations that the bank has to follow in this situation or is it at their discretion?

Answer: They are not required to continue to extend it and I am amazed that they are doing that. If you qualified for the construction loan you should qualify for a regular mortgage unless something major has changed. Have you tried for an FHA loan? 620 credit, 2 years income & 3.5% down.

Question: I have a credit score of 676 will I have a problem getting a construction loan or new mortgage loan?

Answer: Construction loans are very difficult these days. Mortgage? Depends on how much you have down payment, debt ratios, etc. If you have 20% down plus closing costs saved up, no debt, you should be able to find a mortgage despite the tight markets these days.

Question: Where is the best place to get a construction loan (mortgage) for a new motel? I have the land already Zoned at approx. $950,0000.

Answer: I would put it out on the Internet. I know its not the same as a home loan but there sure seems to be a lot of money out there. The problem I see is that you will have to be able too prove its a winning proposition

Question: What are the ins and outs of getting a construction loan to build a home?
My husband and I are 1st time homebuyers. We have been preapproved for a house loan, but are not having luck finding what we want. We have toyed with the idea of building our own. What are the differences between getting a preapproved loan and buying a already built house and going through getting a construction loan? Do you have to put money up front for a construction loan? Do you make mortgage payments while the house is being built, or do you wait until the house is completed? Is there a time frame that the house must be built within? If we were preapproved for a certain amount with a homebuyers loan, would we likely be preapproved for the same amount for a construction loan? What other differences should I know about? Since we are first time homebuyers we do not have much collateral (we do have some savings, but not a ton), would that affect our ability to get a construction loan?

Answer: No, you are not automatically approved for a construction loan, it’s a different animal. To get a construction loan you need to already own the property and have a lot of equity.

The “ins” are that the bank loans you a large amount of money for a short term to build your house. The “outs” are that you have to replace the construction loan with long term permanent financing once the home is built and you don’t know what the rate will be when that happens so you are under the gun to finish as soon as possible.

Building is risking and not for 1st timers unless you have lots of cash to gamble. If you want to try it, buy an older house at a good price, fix it up and sell it. Then you will know what you are in for.

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