7 Mortgage Questions to Ask When Building a Home

If you love a certain neighborhood but can’t seem to find your dream home, building a house is a great option. The chance to customize your floor plan and have complete control over the finishing touches is truly a unique experience. If you choose this route, the home-buying process can be different in many ways, including your loan options. Here's everything you need to know before you secure a loan to build your new house from the ground up.

How Construction Loans Work

Building a new home isn’t cheap, especially when you consider the rising costs of material and labor. Because most buyers don’t have the money upfront, a construction loan is a short-term financing option that covers the costs. This will help you borrow the money you need to draft plans, buy the necessary material, and pay for construction.

In general, construction loans are issued for 12 to 18 months during the building process, but some automatically become a permanent mortgage once the home is complete.

The three most common types of construction loans are:

  • Construction-only loans: Some buyers use a construction-only loan to finance the building of their new house when they know they’ll be able to pay it off with the sale of their previous home. Once construction is complete and it’s time to close, the loan must be paid off or converted into a traditional mortgage that you pay off over several years.
  • Construction-to-permanent loans: For homeowners who want to lock in mortgage rates, this is a great option because it enables the construction loan to convert into a fixed-rate mortgage once the house is complete.
  • Owner-builder loans: In the rare event that someone acts as a general contractor to build their own home, financing is provided to the owner-builder, not a third party. These loans are rare and you must have proven experience in the construction business.

Unfortunately, qualifying for these loans can be more complex than qualifying for a conventional loan because the house in question doesn’t yet exist. Lenders don’t like risk, and building a new home is inherently risky. For that reason, mortgage lenders will closely examine your financial qualifications, architectural plans, and building timeline before granting approval.

7 Mortgage Questions to Ask Before You Start Building

It’s important to have all the information you need before making a decision to build a new house. Here are questions to ask your lender and builder as you begin the process.

1. Do I need a standard loan or a construction loan?

The answer will depend on several factors. If you’re building a custom home, you'll need a construction loan to pay for everything from the land to the labor. On the other hand, new construction with a builder within an existing master-planned community may simply require a standard loan upon completion of the house.

2. How early can I lock in my rate?

Much like interest rates for other loans, your construction loan rate will depend on your credit score, as well as the loan term and amount. Most construction loans are also variable, which means they can adjust during the process. While every situation is different, these rates are usually about 1 percentage point higher than standard mortgage rates.

Although some rates can be locked in two or three months before closing, delays in the building process can shift the timeline and affect your rate. Remember, most construction loans require the building to be complete before you can close on your home loan.

3. Does building a custom home differ from building an existing plan with a developer?

The process of building a house with a developer is usually very different and can often look more like traditional home buying. Building a custom home that requires you to select and purchase the land will require a construction loan.

4. Is there a preferred lender that offers incentives?

Many developers in planned communities will provide information about their preferred lenders. There are plenty of benefits of using a preferred lender. In addition to streamlined communication between the two parties, builders will often throw in perks, such as free appliance upgrades. Just be sure to carefully examine the terms of the loan, including hidden fees.

5. What happens if construction goes over or under budget?

Delays often lead to projects going over budget. Likewise, the price of material can change because of demand and inventory. This can influence your loan, but every case will be different based on your contract with the builder and your lender’s guidelines. Although some builders take responsibility for problems that may be their fault, most construction contracts are designed to protect the builder.

6. What happens if construction exceeds the expected timeframe?

Supply chain problems and unexpected challenges always seem to occur in the construction industry. This usually leads to construction taking longer than expected. Ask your lender about the protocol in these situations. There may be a grace period that applies in the event of short delays.

7. Do I need a real estate agent when building a new home?

There is no doubt that a qualified real estate agent can be very helpful when you’re facilitating a new build.

Your agent can serve as an extra set of eyes when it comes to your loan and your building contract, reading through it with your best interest in mind. In addition, many real estate agents can work with the builder to help you negotiate upgrades and even a home warranty.

Before it’s time to close on your new house, your real estate agent can also help you navigate the final phases. This usually includes an inspection of the home to ensure everything has been completed as agreed upon.

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