Custom homes require custom mortgages

Financing for new construction is different!

Many large builders offer financing that is similar to the purchase of an existing home, and even offer incentives to use their ‘preferred’ lenders. Typically, the loan application is made when you sign a sales contract for the new home, but you won’t lock in your loan terms until the property is almost complete.

Smaller builders and custom home huilders, however, are another deal entirely.

Financing a custom home

Working with an architect or custom builder gives you the ability to choose endless customization features, which  to a mortgage lender, means endless loan changes!  Not every bank offers construction loans, so shop around early, and consider the lending costs beyond just the rate, as the rate will likely fluctuate during the process. 

There are essentially two ways a lender will handle a construction loan:

One-time closing: In this case, a lender will approve an interest-only loan for six to 12 months while the home is being built. The loan then converts to a fixed-rate loan once the home is finished. The lender usually requires an appraisal once construction is complete and will charge a conversion fee. However, most lenders find this loan arrangement too risky, so it’s more common to have two separate loans.

Two closings: You will take out an interest-only construction loan for the period while your home is being built and then refinance that loan into an end loan to pay for the purchase. This will require you to pay closing costs twice.

Qualifying for a Construction Loan

Since construction loans are considered riskier than standard home loans, you will need excellent credit and will usually need to make a down payment of at least 20% or 25%. The down payment is based on the combined cost of the land and estimated construction costs. For instance, if the land you are buying costs $150,000 and your estimated home-building costs are $250,000, your down payment must be at least 20% of $400,000 or $80,000.

Your lender will do a credit check and a background check on your builder, too, because part of the risk of building a custom home is that the builder might not fulfill the contract.

An appraisal and inspections are often required throughout the building process by the lender before funds can be released to the builder. Rather than handing over the loan proceeds as a lump sum, the lender is usually involved in determining when more funds should be made available to the contractors working on your home.

Choose your construction lender carefully to be sure you are working with someone who understands the special requirements of building a custom home.