If you’ve been house hunting for a while now and just can’t find that perfect home, you may be thinking about having one built. Whether or not you’re a DIY type, the thought of building a home exactly the way you want it can be a thrilling prospect. After all, you get to determine the layout, the number of rooms, and handpick the finishes—for starters.
But unfortunately, although building a home from scratch may sound exciting, landing a loan for a self-build project is easier said than done. That said, it’s entirely possible if you play your cards right.
No ordinary mortgage
If you have decent credit and a stable income, it’s relatively easy to get approved for a conventional mortgage, but it’s virtually impossible to acquire traditional financing when building your own home because lenders don’t want to loan out money for something that doesn’t exist yet. Why? Because it’s too risky. Enter the construction loan, typically a short, one-year mortgage used to cover the cost of building.
Construction loan basics
A construction loan is meant to finance the construction phase alone. Typically, only interest is paid during this time. It’s worth noting, however, that these loans generally have variable rates higher than conventional mortgage rates. It’s also worth noting that most lenders require a 20-25% down payment on construction loans because they’re seen as “higher risk,” and they want to ensure you don’t abandon the project.
If you don’t already own the land you plan to build on, its cost will need to be included in the total amount of your construction loan. If at all possible, purchase the land beforehand to reduce the down payment you’ll need to pay to qualify for the loan.
Once you have a construction loan, funds are advanced gradually as construction progresses. Once the construction is complete, you can either refinance the loan into a regular mortgage or get a new loan (sometimes called an end loan) to pay off the original construction loan.
Applying for a construction loan
To be approved for a construction loan, you’ll need to take steps to show that your building plans are real, feasible, and relatively low-risk for the lender. You’ll probably be asked to provide a project timetable, a realistic budget, and a thorough list of construction details (i.e. floor plans, building materials, insulation, ceiling heights). Experienced builders usually keep a “blue book” which includes these details and more.
You’ll also need to prove you have a qualified licensed general contractor involved in your project. If you intend to build the home yourself, however, chances are you won’t be approved for a construction loan, and might instead need to aim for an owner-builder construction loan. It can be even more challenging to qualify for these loans, but if you have a well researched and organized plan and can demonstrate your home-building skill, it is altogether possible!
Bottom line: building your own home is anything but easy, yet it can be extremely rewarding. To increase your chances of approval, make a detailed plan, get a qualified home builder on board, and save up for a sizable down payment before applying.