What is the process of buying land only and having a house built?
What you’re describing is called a Construction Loan.
This is typically a short-term loan (around a year) to pay for the cost of building a home. Once the house is complete, you will need to get a new loan to pay off the construction loan. This means you would refinance, and enter into a brand new loan for your completed house.
How is this process different from buying a traditional home?
Qualifying for a construction loan is harder than qualifying for a home that already exists. It’s riskier for the lender so they try to protect themselves for a few reasons:
- There isn’t a complete home for the lender to use as collateral (it’s easier for you to walk away).
- The builder could do a poor job.
- If property values fall, then the property isn’t worth as much as the loan.
Also, if the lender thinks you can’t make your current rent/mortgage payments while your house is being built, then you won’t qualify.
How do Construction Loans Work?
Once you have qualified for a construction loan, the lender begins paying out the amount the agreed to loan you. However, it is not all at once. A schedule of draws is set up.
For example, in one scenario the builder may get the first 10% when the loan closes, and the next 10% after the lot is cleared and the foundation is poured. The next draw may come after the house is framed, and then the final payout after the house is under roof and sealed up.
The number of draws and the amount of each is negotiated between the builder, the buyer, and the bank.
What kind of Rate can I expect?
Typically, construction loans are variable rate loans. In many cases, construction loans are also set up as interest-only loan. This means you only pay interest on the money you have borrowed instead of paying down any part of the principal loan balance. This makes payment of construction loans more feasible.
What are the Disadvantages?
Construction loans make it possible to build a home that is unique to your tastes, but there is a much greater risk than just purchasing an existing home. Potential risks:
Not completed on schedule and/or on budget.
This may lead to additional costs for rental accommodations, or two mortgages for longer than expected since you won’t be able to move in. Final payment on your construction loan may become due and you will have to pay a fee to extend that loan.
When finished, the home is not worth as much as it cost to build.
If the builder does a poor job, or if the overall housing market drops this will cause you to come up with extra cash when it comes time to refinance the construction loan.
Unable to qualify for refinancing at the end of the construction loan.
If your income or credit drastically changes, you may not be able to qualify for refinancing at the end of the construction loan. Construction loans are not meant to be permanent. When the project is done, the balance has to be paid off. If you can’t refinance to pay off the entire balance and the lender refuses to extend the construction loan, you could end up losing the new home to foreclosure if you can’t make the payment.
If you are willing to take on the risks of a construction loan, then this might be the right choice for you. Since the lenders that mortgage brokers work with generally don’t offer construction loans, your best option would be to walk into your local bank or credit union and see if you qualify.
Once you are ready to refinance, you’ll likely qualify for the competitive rates offered by ‘A’ lenders. At this point, it might prove to be worthwhile to seek the help of a mortgage broker who can find you the best lender for your mortgage at that time.