What is a Home Construction Loan?

What is a Home Construction Loan?

Before a custom home builder in GA can start breaking ground and getting a project under way, the home buyer needs to secure a home construction loan to cover the cost of the build. This is often a misunderstood part of the home building process. Most homebuyers are used to applying for a single mortgage loan, but this is not the case when you’re building a home from scratch.

To help clarify this issue, here is everything you need to know about home construction loans and why you need one if you’re planning on having a builder build you a new home from the ground up.

Construction Loans Cover the Cost of Building

It can be difficult obtaining a standard mortgage from the bank for a home that doesn’t exist yet. Therefore, in cases where a home is being built, a construction loan is what is needed to cover the cost of the build. This is typically a short-term loan (usually around a year) that gives you the money and time needed to build your home.

Construction loans work differently than conventional loans. The money is paid directly from the bank to the builder on what is called a “schedule of draws.” For instance, the builder may receive 10% of the money upfront so they have the funds necessary to start the build. Then, at scheduled intervals, the builder will receive more money so they can continue the project. The number and amount of the draws is negotiated by the builder, the bank, and you.

Just like a standard home loan, a construction loan will require a down payment with the application, usually 20% of the total amount. The remainder of the loan will be financed with the buyer making regular monthly payments on the loan. Once the build is complete, the buyer will then have to apply for another loan, called an “end loan.”

What are End Loans?

When the builder is finished building your home, you will essentially have to refinance your construction loan at the end of its term. This will allow you to enter into a more conventional financing option for your new home, such as a fixed-rate 30-year home mortgage. This is known in the industry as an end loan.

What Are the Requirements for Qualifying for a Construction Loan?

Bankers are always nervous when it comes to financing risky ventures and for many, home construction falls into that category. Therefore, the qualifications can often be stricter on these types of loans. For instance, lenders will usually want certain provisions to be met, such as:

  • The builder needs to be a licensed general contractor with a long-standing reputation for building quality homes
  • An appraiser must provide the lender with an estimated valuation of the home
  • A full set of detailed plans, including everything from the floorplan to the building materials and insulation being used
  • The borrower will need to put a substantial down payment down, typically between 20% and 25%. This money is what the initial scheduled draw usually comes from so as to minimize the lender’s risk

What Happens if the Build Isn’t Completed on Time?

Construction loans are essentially balloon mortgages. At the end of the loan’s term, the full balance become due. In most cases, you will refinance it into a home mortgage, or end loan. But, when a build isn’t completed on time and the loan balance comes due, you will be forced to pay a fee to extend the loan.

Should your credit rating drop significantly between the time you get your construction loan and the time you apply for your end loan, you could find yourself getting denied for your end loan. This means you will be liable for the full balance of the loan. If you aren’t able to pay it, then your brand new home could wind up in foreclosure. This is reason alone for using a reputable builder with a history for finishing their projects according to schedule.

Need a Reliable Custom Home Builder in GA? Call Trinity Custom Homes

Trinity Custom Homes is a leading custom home builder in GA and we have an extensive building history. We work hard to ensure our customers always get the home they asked for, and then some. We are fully committed to the satisfaction of our clients and dedicated to building high quality custom homes specifically designed for today’s families. We’ll have your new home finished on-time and on-budget, guaranteed. Call us today at 888-818-0278 to start planning your new home.