The real estate market has been a hot topic for a while now. With Interest rates at all time lows and houses selling faster that you can list them, people are making moves now more than ever. At a time when we are working and learning in and basically never leaving our homes; it only makes sense that we want our homes to meet our every expectation. Inventory is low and many people are considering building their dream homes. We are breaking down construction loan financing for you. Happy building!
What is a construction loan and how does it work?
A construction loan is different from a traditional, permanent home mortgage (15 year fixed rate or 30 year fixed rate) you would put in place on an existing completed residence. A construction loan is a straight line of credit whereby you have a fixed dollar amount available and can only draw as the funds are needed on the line of credit. The proceeds will be used to build your home and the line will not revolve like a home equity line of credit or credit card would. This is an important distinction. A quick outline of some additional terms to be aware of:
- Cash Equity into the project. The lender will be looking at how much cash you are requesting to invest in your home and/or how much you may already have in a lot you previously purchased.
- The length of the loan is generally six to eighteen months depending on size and complexity of the home being built. For example, if it’s a traditional construction project ($548,250 or less) it will generally take 12 months to complete, but if it is a jumbo construction loan on a luxury home, $1 million or more construction project, it may take 18 months to complete.
- The interest rate will be either variable or fixed, depending on the lender, and is generally higher than the permanent mortgage given the additional risk and monitoring of a new construction project.
- The payment will be interest only during the term of construction.
- There will be additional costs to monitor the advances on the line of credit whereby payments are made to the contractor and subcontractors during the construction of the project. It is important that this process is monitored closely to reduce the likelihood of a mechanic’s lien being put on the property.
- Other standard closing costs will continue to apply (appraisal, title work, etc…)
- Disbursements are handled through the title company.
What should you expect when discussing your project with a lender?
Your builder may have directed you to a lender they are familiar with or you may have researched a local lender to make application on a new construction loan for your residence. At Flagship Bank, we are transparent on the process and want to outline expectations to allow for the most efficient and effective financing process so you can focus on the excitement of working with your builder on the completion of your new home.
It is important to be prepared in the application process for a construction loan or jumbo construction loan. As a starter, the bank will expect:
- You have prepared or can prepare a personal balance sheet with account statements to verify your cash available for the project, your savings, and other details on your assets and liabilities
- Verification of Income. Your lender will want to verify your income with your W-2, tax returns, and recent pay stubs.
- A home site has been located and is either purchased or under contract
- Final house plans and design for your new home are completed and you have already contracted with a reputable home builder who will build the home.
- To know your builder’s experience in building the type of home you are requesting so that it can be comfortable the builder can finish the home, organize the timing, and keep the project within budget.
Lastly, the bank will want to understand your plan after the construction phase of building your home, for instance, if you are looking to refinance into a secondary market permanent mortgage at completion or considering a portfolio mortgage product with the existing bank.
Construction loans can take several different forms depending on borrower’s specific needs. Working with a portfolio lender that can structure creative solutions for the construction phase to meet each borrower’s unique situation and also provide the corresponding permanent financing is ideal! - Tom Kleinschmidt, Senior VP Business Banking/ Flagship Bank Lender
Building a new home is an exciting time. As a lender on jumbo construction loans and single family construction loans, we try to provide great service with reliability and certainty. We are fortunate to have qualified lenders on staff with extensive experience in financing many homes and businesses that span over the years in the Minneapolis/St. Paul Metro area in both a permanent mortgage and construction loan capacity.
Flagship Bank Minnesota is a Member FDIC and Equal Housing Lender.