Building a new home from the ground up is a dream for many homeowners, but the undertaking itself can be quite a hassle. On top of all the logistical details to juggle, financing your project comes with its own unique complications. Even if you’ve been through the process for a traditional mortgage, construction loans are an entirely different type of home loan altogether. That said, an experienced mortgage broker can explain your options and help you navigate every step with confidence.
There are two basic types of home construction loans: new construction loans, and home rehabilitation loans on existing properties. In both cases, home construction loans typically have higher interest rates and much more stringent qualification standards than standard mortgages.
A mortgage lender will need to approve a borrower’s credit profile and the builder will need to provide proof of financial solvency. Additionally, home construction loans often require a larger down payment. To estimate projected costs, you’ll be expected to present building contracts, construction plans, and other materials beforehand.
Sound like a lot to figure out? It can be, but with an expert in your corner, it’s thoroughly doable. Let’s talk about your plans, and see how we can make it all come together!
When it comes to new construction loans, there are two main types of home loans to choose from: construction-to-permanent and stand-alone construction. Situationally, there are many reasons why either may be more appealing to a borrower than the alternative. Here’s the rundown...
With construction-to-permanent loans, the loan is used to pay for the cost of construction. Once a home construction loan has been approved, these payments are handled between your mortgage lender and the builder. This means that, during the construction process, the lender will pay the contractor once a predetermined construction goal is reached.
You are only responsible for the interest while the home is being built. However, during construction, the interest rate is wholly dependent on the Fed’s current short term interest rate. This rate can increase or decrease with little or no warning, and mortgage rates normally follow suit. Once construction is completed, the loan is transformed into a permanent mortgage loan, so you’re essentially dealing with two home loans in one lump-sum package.
Stand-alone home construction loans
With this type of home loan, the mortgage lender will advance the money to the contractors during construction, similar to a construction-to-permanent loan. However, after construction, a separate mortgage is then used to pay off this home construction loan.
While the construction-to-permanent loan exists as two loans in one, the stand-alone construction loan involves two separate loans. This consequently means two closings and normally two sets of closing fees. (This is commonly known as a so-called “take-out” in the industry. The take-out loan pays off the temporary mortgage and then replaces it with a standard long-term home loan.
Consider an FHA 203K rehab loan
It’s important to note that you may be able to use an FHA loan to build a new home.
An FHA construction loan functions just like the aforementioned construction-to-permanent loan, however, the key difference is that an
FHA 203K loan is meant for rehabilitation purposes only.
You can use an FHA 203K rehab loan to buy a house and include extra funds to modify the property. Unlike the aforementioned take-out loans, an FHA 203K rehab loan involves one lump-sum close. The rehab repair budget of the home loan remains in escrow to be dispensed to the contractor as predetermined building milestones are achieved.
For those so inclined, the FHA 203K rehab loan program allows you do tackle some major property overhauls, however this type of home loan cannot be used to buy land and build from scratch. Many of the FHA loan advantages also apply to FHA construction loans, including lower down payments and rather flexible credit score considerations. Come in today to learn more!
Conventional Rehab Loan: The “Fannie Mae Homestyle” Program
A conventional rehab loan is similar to the FHA 203K rehab loan program, however those seeking more extensive rehabs may find the former more appealing. The conventional rehab loan program can provide up to $80,000 in the rehab budget with a less rigorous contractor review. The conventional rehab loan allows a mortgage lender to finance 97 percent of the acquisition plus the total rehab cost or 97 percent of the "as completed" appraisal value.
Rather than purchasing a new home, many homeowners instead choose to invest in their existing property with a home improvement loan. This kind of loan can be used to fund necessary structural rehabilitations, or luxury additions. As with any home improvement loan decision, there are plenty of tax deduction benefits to consider.
There are multiple FHA home improvement loan and home addition loan programs to choose from as well. If you have your eye on the home of your dreams, but it needs some TLC and a whole lot of elbow grease, you could be an ideal candidate for the FHA rehab loan program. Many buyers assume they’ll have to pay for such repairs out of pocket, and there are scenarios in which that might be your better option, but if you’re looking at a large repair or restoration project, it’s definitely worth considering the option of financing the costs as a rehab home loan.
There are two routes for clients considering an FHA rehab loan: the FHA 203K Limited (also known as the “203K Streamline”) and the Full FHA 203K rehab loan.
The Limited program is ideal for financing modifications with a total price tag less than $30,000 and the Full FHA 203K program is geared toward projects above $30,000. Furthermore, the Full FHA 203K loan requires the participation of a Housing and Urban Development (HUD) counselor and a contractor whereas the limited FHA 203K loan requires neither.
If your project is on the smaller side, it’s important to note that rehab home loans include added fees and costs, and there are other unsecured home improvement loan options that are often far more cost-effective for minor repairs, upgrades, and appliances. Whatever your home or future home’s specific needs, there are many ways to take advantage of the rehab home loan program.
Similarly, another great use for rehab financing would be to purchase a home or property that would not qualify for conventional financing. (This is often a home in a state of extensive disrepair.) Purchasing such a property certainly adds a layer of complexity and risk, however, this could be a tremendous investment down the road.
When it comes to existing home rehab and renovations, or a rather ambitious home makeover, the FHA 203k loan is another popular option. This program is similar to other one-time close home loans, however, many mortgage lenders will tack on their own overlays pertaining to credit score and other factors.
There are certain lending stipulations for these types of home loans, and not all repairs will qualify for financing under the FHA home addition loan umbrella. If any of these aforementioned options pique your interest, come in for a chat, and we can go through FHA rehab loan guidelines and find a solid option for your project!
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