For a lot of people financing can be one of the most confusing aspects of the new home construction process. This is because custom-home buyers need to secure both a temporary construction loan and a residential mortgage. The construction loan basically acts as a line of credit during construction while the residential mortgage takes over once construction is complete.
The construction loan is used to pay the builder who in turn pays the subcontractors and suppliers he uses during construction. As specific stages of construction are completed (foundation, framing, roof, etc.) the builder will prepare a request for funds called a “construction draw,” which you will approve and then it is submitted to the lender so that the funds can be released to the builder.
Most lenders will require that you pay for changes and allowance overages as those expenses are incurred rather than adding them to the loan once it is in place. Because of this you will need to have some cash on hand after the construction process has begun in order to pay for them. Be sure and ask how your lender handles these extras.
Your lender will have you apply for the residential mortgage at the same time they are pursuing the construction loan for you. They do this because there is no point in securing a construction loan for you if you can’t afford the residential mortgage.
Your lender will require extensive documentation for both the construction and mortgage loans and will include items like verification of your employment (W-2 forms and paycheck stubs) or documentation of your self-employment income, verification of your assets (savings and investment account statements) and your liabilities (loans, credit card debt, etc.), income tax returns for two or more years, your new home building contract you signed with the builder, the plans and construction specifications, and your allowances.
Securing both loans from the same lender (called a “one time close”) will prevent you from having to provide duplicate documentation and should save you some closing costs. When construction of your new home is complete the construction loan simply converts to a permanent mortgage. Your lender should be able to explain whether a “one time close” is in your best interest or not.
Make sure you carefully read every document that you sign and if you are unsure of something then ask for clarification. Most people don’t know a lot about construction financing or residential mortgages so trust that you won’t be the first person to ask questions. A good lender will be happy to answer any questions you might have until you feel completely comfortable with your loan package.