Building a new custom home in Northern Virginia is a very different process from buying one that’s already been built. At Abbey Design Center, we believe the advantages and benefits of designing and constructing your dream home far outweigh any of the unique challenges. In talking with our clients, we’ve discovered that one area many of them aren’t familiar with is construction loans. Most homeowners can’t afford to pay for home construction up front, and it isn’t easy asking a bank or mortgage lender to loan you money for a house that doesn’t even exist yet. Standard mortgages don’t apply here, but you can use this special type of loan for your custom home needs.
An Intro to Construction Loans
While lot and purchase money loans provide funds for buying a real asset, a construction loan acts more like a line of credit that you withdraw funds from to keep the work progressing. As the home is built, lenders conduct routine inspections to make sure work is proceeding as planned. A typical scenario would include draws after completion of:
- Grading the lot and pouring the foundation
- Framing the house
- Heating, air conditioning, wiring, and plumbing installation
- Drywall and other interior surface installation
- Cabinet, fixtures, and trim installation
- Interior painting and other finishing touches
Construction loans are structured differently from conventional mortgages and, it’s extremely helpful to understand those differences before you start out. Before a lender will finance the construction of your new home, it needs to know what your plans are for the property. Where the timing of a purchase money loan is evident – you’re buying an existing home – there is more uncertainty with a construction loan.
As it weighs the perceived risks, the lender relies on the overall story of your construction plans, including the current facts, valuation, future plans, and budget. This is why construction loans are often referred to as “story” loans. Simply put, the more the lender knows about your plans, the easier it is to approve your loan. Applying for a loan that covers your home’s construction from the ground up involves different paperwork, procedures, and funding methods. Though construction loans are short-term, they can be more difficult to obtain. But if you prepare in advance, the process can go smoothly.
The Typical Construction Loan Process
It used to be that building a custom home meant you got two loans – the short-term construction one and a long-term permanent mortgage that would also be used to pay off the construction loan. This resulted in double fees and costs for borrowers, so today the more common option is the construction-to-permanent, or all-in-one, loan which converts to a conventional mortgage after construction is complete. Here’s how a typical construction loan plays out.
- In the initial stage, you get prequalified by one or more lenders. This provides you with a rough idea of what you can afford to borrow. The lender you choose may issue you a pre-approval letter that lets the builder know you’ve qualified for a specific loan amount.
- Once you’ve reached an agreement with the builder, an application is completed. This is the time you want to explore ways to lock in the interest rate and protect your loan from rate changes during construction.
- On the flip side, there are also rate-drop options. These allow you to float down to current rates should market rates decline.
- Most lenders offer an interest-only payment structure, so be sure to ask.
- After construction is complete, you transition to a permanent loan and start making regular mortgage payments.
Let’s Get Building
Construction loans are complex, but they don’t need to be confusing. Keep in mind that not all construction loans are created equal. An experienced local custom builder like Abbey Design Center can help guide you through the process. Contact us for a free consultation. With the right knowledge and assistance, a good construction loan will transform your vacant lot into a dream home.