Building can allow you to customize the layout and not compromise on features of your home. If you’re looking to build a new home, you may need to apply for a residential construction loan. But how does it work? And what’s the process you’ll need to follow to secure a construction loan?

Do I Need a Construction Loan?

If you’re building your home, you’ll likely need a construction loan instead of financing the project with a traditional mortgage. While a traditional home loan is based on the market value of the home, compared to other homes in the area, construction loans are based on the projected value of the new home upon completion.

Construction-to-Permanent Loans: With construction-to-permanent financing, the lender pays the contractor while the work is underway. The loan is then converted to a more conventional mortgage upon completion, locking in an interest rate at closing.

Construction-Only Loans: Construction-only financing is a loan that must be repaid once construction is completed. These loans are typically for borrowers who have significant savings to work with or who plan to use the profits of the sale of their current home to cover the loan of the newly constructed home. Sometimes, a traditional mortgage can be applied to cover the difference after the construction loan is paid off.

How is a Construction Loan Different?

When building a home, there are a lot of moving parts, such as material delivery, weather that affects the timeline, subcontractors’ schedules, and more.  Because of all these variables, new home construction is sometimes considered higher risk, and it can be harder for the borrower to qualify for a loan.

However, if you qualify, there are several benefits of a construction loan.  First, because the loan isn’t paid in full until the structure is complete, the borrower is not required to pay any principal until after closing. This means you’ll only be obligated to pay on the interest, and you’ll have more time to save for a down payment at closing.  Construction loans are also typically more flexible than traditional mortgages, and the inspections your lender will periodically make (often before paying a draw) will help to ensure your contractor stays on schedule and within budget.

There are, however, other factors that you should consider.  For example, construction loans usually have variable interest rates, which can translate to higher interest.  Often lenders require higher credit scores and higher down payments than for typical mortgages. Additionally, you’ll want to be sure to read the terms and conditions of your loan carefully.  Sometimes lenders require that if a build is not completed on time, borrowers will owe a fee to extend the terms.

Construction Loan Process

First, you’ll want to hire a reputable builder, a highly qualified and experienced builder, to ensure that you’ll get a beautiful home in the end.  Additionally, finding the right builder can give you a step in the right direction to finding financing, as many builders have lenders they work with and can offer you a referral.

Once you have a builder and lender, you’ll need to provide your lender with detailed specifications for the home you are planning to build.  Don’t overlook any detail, as many lenders need to know every specification, from the type of insulation to the ceiling heights.  

Also, as one of your first steps, you’ll want to hire an appraiser to determine the value of your home. The appraiser will assess the value of other similar homes and determine a fair market value for the home you are building.  

At McKesson Title, we specialize in construction loan services.  While all lenders and underwriters have different requirements, McKesson Title can provide minimum title search updates directly to the lender and manage documentation of and payment to subcontractors.  We also offer a full range of endorsements to enhance your loan policy coverage.  

While construction can be a complicated and lengthy endeavor, McKesson Title makes the process as smooth and seamless as possible.  If you are planning a major construction project, call us at 574-936-2555, or schedule an appointment as early as possible so we can determine the best path forward for you.