You’ve chosen to build a new home. But what does it take to finance a home build? And how can you prepare?
It’s okay to feel uncertain or overwhelmed. Some buyers pay cash, but the majority of our clients choose to finance their new home. At Gateway, we’re old hats at working in partnership with our clients and their lenders. But we know this may be your first time.
In this blog, we cover the things you generally need to know to finance a home build, including tips to set yourself up for success before and during the lending process. Then we’ll explain Gateway’s unique process (we think you’ll like it!).
Applying for a Loan: How to Prepare
Lots of people think everything starts when you go for pre-approval. In reality, there are things you could – and should – do to improve your chances of being pre-approved and to streamline the process.
The first thing is simple (and free!). Obtain your credit report before you seek financing. You can do this for free on websites like credit karma.
Many people who don’t actively monitor their credit report are surprised by their credit scores when it comes time to finance a new build. Credit scoring systems are complex, and most people don’t really know what factors affect their credit and how much of a role they play in the overall score.
Pulling your own score before starting the pre-approval process has advantages:
Proactive vs. Reactive: If you find out your credit is too low (called “subprime” credit) or not high enough to qualify for the rates you desire, it’s better to have as much notice as possible so you can start working on raising it.
Soft Pull: Pulling your report through a service like credit karma does not actually count as a hard credit pull like what the lender will pull. So it benefits you to pull it first to see if you qualify to finance a home build.
Mistakes: The Federal Trade Commission reports that 20% of people have an error on their credit reports. It takes time to notify the credit bureau(s) of a mistake and get it remedied, so you need to discover these in advance.
Another way to prepare is to do your homework. Take the time to research all the options before choosing a lender and a home builder . A regular mortgage usually only involves two parties – the borrower and the lender – but a construction loan normally involves a third party – the builder.
Home builders play a key role in completing the construction plans on time, meeting milestones, adhering to a budget and more. Check references. Get personal, detailed referrals. Ask your loan officer for referrals. It’s also helpful to know what credentials your lender may request from the builder, such as work history, proof of insurance, a detailed budget, and a signed construction contract with the completion date.
Want to skip the hassle of a construction loan? Check out the Gateway Makes It Easy to Finance a Home Build section below. Otherwise keep reading.
Mortgage vs. Construction Loan: What’s the Difference?
There are numerous differences between obtaining a mortgage for an existing home and obtaining a construction loan to finance a new build.
For one thing, construction loans are short term and have higher interest rates. This is in part due to the greater risk for lenders. Unlike buying existing, with a new build, there is no completed house for the bank to use as collateral (e.g. take possession of and sell should you fail to pay).
Due to uncertainty, lenders may also be more diligent and scrutinizing of borrowers and their builders.
Construction loan down payments for new builds are typically higher as well. Unless you qualify for a special loan program, expect to pay 20% to 30% down payment on your construction loan.
Fun fact: Construction loans are paid to the builder in “draws” throughout the build as certain milestones are met. This is how working with an inexperienced or disorganized builder could significantly delay your build process.
Two Types of Construction Loans
There are two types of construction loans relevant for people considering building a home.
Construction Only: Also called “two-close” construction loan, this entails borrowers taking out a construction loan that must be paid off when the home is built. They then must obtain a new mortgage loan using the home as collateral.
The downsides of this loan are that borrowers have to pay closing costs on two separate loans and if the market changes during construction, they may find it difficult to get a loan to finance the completed home.
Construction-to-Permanent: This loan is also called a “single close” construction loan, because it combines construction financing and mortgage financing into one loan. Normally a mortgage loan can only be granted on an existing home, but this loan can be granted before construction is complete.
The loan then converts to permanent mortgage when the house is fully built and inspection is complete. The interest may be higher on this type of loan due to the increased risk for lenders and increased convenience of a single loan for borrowers.
Gateway Makes It Easy to Finance a Home Build
Gateway does things a little differently than most custom or semi-custom builders. We take every opportunity to make things easier for our clients. Earlier, we explained how some people who are building a home are required to get a construction loan and later convert it to a mortgage.
We found a way to simplify that process. If you buy a home built by Gateway, we carry the construction loan. So Gateway buyers only have to take out a loan to buy the house upon completion.
Of course, this puts more liability on us to carry the costs of building a house that is customized to our buyer’s specifications. That’s why we have buyers pay a builder fee. Don’t worry, this may sound like an additional cost, but it is not. Think of it as earnest money or a deposit on the dream house we’re building for you. When your home is complete, your builder fee is credited toward the price.
The builder fee varies based on the level of customization in your home. We strive to be as flexible as possible, so our buyers get the homes they want. A more customized home has a higher builder fee than a less customized home. But no matter what your builder fee is, you get to apply it to the house when it’s built and you close.
Another benefit of the way our program is structured is that we are incentivized to get your home built on time. Since we are carrying the loan, delays cost us more money. We pride ourselves on being organized and experienced. We are accustomed to the rigor of meeting milestones and working with inspectors to keep the building process moving smoothly. High quality workmanship and timeline efficiency are primary goals in every home we build.
Tips for Rocking Your Loan Eligibility
If you have purchased an existing home in the past, these tips may look familiar. If not, pay close attention.
Debt-to-Income Ratio: Potential borrowers look their best as long as their monthly debt payments are no more than 45% of their monthly income. Can you get even lower than that?
Credit Score: Shoot for 680 or higher. Don’t disqualify yourself if your score is lower, but that’s the goal number. Individuals with a score in the 700s typically get the best interest rates.
Down Payment: It is good to plan for a 20% down payment. There are several loan programs that allow a lower down payment, but they require mortgage insurance, which is an additional monthly cost to the borrower.
Choose the Right Partners: You have two partners in the course of financing your new home: your builder and your lender. Choose both carefully and after doing thorough research. This is not the time to choose a friend – unless that friend is a residential home builder who has spent the last 20 years raising the bar for building in Southeast Wyoming and Northern Colorado. (Cough, Gateway Construction, cough.)
We wish you luck! Preparation is the name of the game, but don’t be afraid to dream along the way. After all, you’re not settling for someone else’s dream house, you’re building your own.
Contact us to get started today.