You may have noticed a lot more new homes sprouting up recently. Residential construction activity has increased substantially in the last year or so, driven by rebounding home values, low interest rates and homeowners’ desires to live in homes custom-tailored to their needs. If you are considering constructing a new home, you’ll have a lot of decisions to make, including choosing a bank and construction loan program to fund the cost of construction.
A construction loan differs from the typical long-term, fixed-rate mortgages with which you may be familiar. Conventional mortgages are fairly homogenous and easy to compare. Once you obtain the mortgage, you typically have very little interaction with the lender, aside from making your payments every month. Conventional mortgages are often sold on the secondary market and you may end up making payments to several different lenders over the course of your loan.
With a construction loan, your lender will be substantially more involved. Loan proceeds are typically disbursed directly to your contractor through a series of draws against the loan based on a pre-determined draw schedule agreed upon by you, your contractor and the bank. Each draw will require an inspection by the bank to ensure the progress on the home is adequate for the amount of the draw requested. Some banks manage the draws out of centralized facilities, often located in other cities or states, while some manage the draws out of local branches. It is important for you and your contractor to fully understand the draw process, including who approves the draws, how long the draws take, and who you will talk to if issues arise. Working with a lender that you trust and can easily communicate with will help the construction process go more smoothly. Your contractor may be able to give you feedback on which banks have been easy to work with.
Some construction loans are short-term and intended to provide financing for the construction period only. Upon completion of the home, these loans are refinanced with conventional “permanent” mortgages at the prevailing rate at the time of refinance. These are often referred to as “two-time close” loans. The primary advantage to this type of loan is that you will have access to the long-term, low rates offered by conventional mortgages upon completion of construction. The drawback, however, is that you will not know what the terms of the permanent mortgage will be until after construction is complete. You will also have to pay certain closing costs, such as title and appraisal fees, both when you get the construction loan and again when you refinance the loan.
Other construction loans, often referred to as “one-time close” loans, provide a combination of construction financing and permanent financing in a single loan. These loans are attractive on the surface because of the convenience of not having to refinance the construction loan and the associated cost savings, but you will need to pay close attention to the details. Some of these loans convert to permanent financing at terms that are not attractive compared to conventional mortgage offerings. They may have a higher rate or carry an adjustable rate that many borrowers prefer to avoid. These one-time close loans may also have much higher up-front fees that outweigh the cost savings of the single close. It is not uncommon for people to get a combination construction/permanent loan and then realize after construction that they would be better off refinancing into a conventional mortgage anyway.
Whichever loan structure you choose, a down payment of 20 percent of the project cost will typically be required. You can usually include any existing equity in the land toward your down payment, though some banks may limit the amount of equity created solely by value appreciation that you can use. An “as complete” appraisal on the proposed house and land will be ordered prior to origination of the construction loan to verify that the value of the proposed house is at least as much as the project cost. If the appraisal is less than the project cost, the bank may adjust the loan downward.
Building your dream house can seem like a daunting task. Talk to prospective lenders early in the process to find out their specific loan terms, requirements and timelines. You’ll want to have your financing in place before any work is completed on the home. Choosing the best contractor and lender for your needs will help ensure the process is as smooth and rewarding as possible. QCBN
Country Bank is a full service community bank serving Yavapai County with offices in Prescott, Prescott Valley, and Cottonwood. Ryan Glennan, NMLS # 478327, is a vice president of Country Bank specializing in commercial lending and residential construction loans. Please visit www.countrybankaz.com or call 928-443-9595 for more information.
Leave a Reply