Home Construction Loan – Why Building Your Dream Home is a Better Investment Than Buying

Picture your Dream Home. Does it have a hot tub? A screening room? A subterranean garage for your collection of vintage roadsters? Everyone knows what their dream home looks like. So why do so few people actually build it? The truth is that building the home of your dreams often costs less than buying a house on the market. All it takes is good plans, an experienced contractor, and the right financing. Today, that means a construction loan.

In the past, the federal prime rate was so high that it made construction loans very expensive. People didn’t want to pay large sums to borrow funds, so they would finance their home construction with a line of credit on an existing home or by spending their cash reserves. Problems often would occur if the funds ran out or if the project went over budget.

With lower rates now available, more and more people are turning to construction loans. Not only are they economical, they also provide built-in protection for your project to ensure it is completed on time and on budget.

Even with dropping home values, home construction nearly always costs less than purchasing a home on the market. This includes buying a lot or a “tear down” and building from the ground up, as well as adding improvements to your own home or a property purchased out of foreclosure. Borrowing money for these types of projects is better than draining your own funds because, as all good real estate investors know, using leverage increases the return on your investment and allows you to invest your money elsewhere. With a construction loan, borrowers only need to invest a minimum amount of funds into the project (generally 5-20% of total project cost) and can finance the rest. Simply put, using debt to finance the building makes your home an even greater investment.

They also offer safeguards that help keep your project on time and under budget. First, the bank issuing the loan works hard to ensure you are working with a reputable builder. Most banks require that the construction loan request include a contractor package that needs to be approved. If your builder has bad credit problems, past lawsuits or has received complaints to the licensing board, the bank will generally catch this information and reject your builder. Second, the bank issuing your loan watches the construction process from start to finish. Unlike loans that are issued as a lump sum, with a construction loan the bank requires that your approved contractor submit for draws to get reimbursed as each phase of work is completed. The bank even schedules site visits to ensure that the work is done in a satisfactory manner and on time. The bank is offering to do due diligence on your builder and project.

Upon completion of the construction phase, some loans seamlessly rolls to permanent mortgage which is why they are known as a “one time close”. What will you have achieved by building your own home? Even more than the satisfaction of living in your dream home, the result and impact on your balance sheet can be dramatic. Upon completion, you will own a home valued at the full market price of a new home for the cost of the land purchase and construction, often as much as 25-30% less than the retail market value.

Build The Home of Your Dreams With a Construction Loan

With the current economy trend setting low real-estate prices, many assume that buying a used home is worth every dollar they fork out. Others engage in apartment loans, thinking of it as hitting two birds in one stone: having your own home while gaining some extra cash through rental income. While these are all very good strategies, some families opt to get a construction loan and build the home of their dreams.

Although it might sound difficult, building your dream home is possible, provided you understand how a construction loan works. Presently, the construction-to-permanent loan remains the most popular option. This loan encompasses full lot and construction coverage, and even converts to a mortgage the moment your dream house has been established. Once you’ve laid down the down payment, all you have to do is make interest-only payments at a fixed interest rate. And after the construction has finished, the loan will be transformed into either a 15-year or 30-year fixed rate mortgage.

Certain banks will dish out interest reserve accounts that allow you to make interest-free payments throughout the construction process. The bank will calculate the amount of interest-only payments and add the total amount to the overall loan. Funds will be deposited into a different account, which makes this ideal if you currently have pre-existing mortgage or rent payments on your plate. The licensed contractor you’ve hired will then mete out a ‘release schedule’ that details the monthly construction schedule with the necessary funding in tow.

Once you have determined that one of these new home construction loans suits your tastes, then there are five quick steps to set you off on the right track:

1. Know your Affordability Limits

You need to determine how much of the total loan you can afford by using an online loan calculator. Remember that you need at least 20% of down payment to avoid PMI payments.

2. Find Lenders

Compare the current loan rates from online lenders and local banks. Ask a reputable building contractor for past lenders they’ve worked with, and attain their contact information.

3. Attain Pre-Approval

Skim through the pre-approval process of each selected bank. Outline the closing costs and estimated tax rates. Ask for a copy of a pre-approval letter.

4. Find a Contractor

Settle on a reputable contractor that is licensed, insured and has experience in constructing new houses. Figure out a budget plan, building cost and architectural schematics to get your house project underway.

5. Select the Land Piece

Hire a reputable realtor to identify a suitable piece of land in line with your budget. Verify any attainable building permits from your local municipality, and make sure a septic and water system is readily available.

Once you have all these five steps pegged down, you’re all set to building that dream house of yours!