Home construction loans: How to get a loan to build a house

Instead of buying an existing house for your next home, have you considered building?

Building a new home from the ground up can be an exciting and rewarding experience. There can be many advantages to owning a brand-new house, such as higher energy efficiency, lower repair costs, and the opportunity to customize many features. However, this can also become an expensive endeavor. Unless you can cover the sale price in cash, you will likely need to secure financing to build a house. Fortunately, you may be eligible for home construction loans options than can help you turn your vision into a reality.

What are home construction loans?

How do home construction loans work?

Unlike a traditional mortgage, home construction loans are not given in a lump sum. Instead, they are disbursed in stages as the construction happens. These are known as “draws” or “disbursements.”

Typically, when you apply for a home construction loan, you will submit your plans and specifications to your lender. The lender will then order an appraisal to determine the value of the property once the home is completed. Based on the appraisal, the lender will determine the loan amount.

The lender will then disburse funds at each stage of the construction process, generally after an inspection is completed to ensure that the work has been completed per the plans and specifications. The builder will submit a request for a draw, and the lender will release funds for the work that has been completed.

Steps to getting a home construction loan

The initial steps of obtaining a new house building loan may be  like getting a mortgage for an existing house:

1. Meet with a lender to get pre-approved for the amount you can afford.
2. Develop your wish list, including locations and features.
3. Visit new home communities and builders in your selected price range.

Remember that even though you’re looking to build a new home, working with an experienced real estate agent can still be beneficial. Your agent may be able to help you ask specific questions of the builders about your new home and potentially help you negotiate a final sale price.

Your next financing steps may depend on whether you have decided to buy a house in production or custom-built home.

Buying within a development

If you buy from a builder who is constructing multiple houses within a specific development – a practice called “production building” – the financing process may be very similar to getting a loan for an existing house.

In most cases, the builder can arrange financing for you—but make sure it is a competitive offering. You can do this by researching mortgage lenders and comparing what they offer to the builder financing.

The main difference from other loans is that you apply for your loan when you sign the contract with the builder, but you typically don’t lock in the loan terms until the property is complete.

Buying a custom-built home

If you’re having a house built on your own lot with your own design, you have many more financing options, but could have  more steps involved.

Unless you’re paying in cash, you may need to arrange for a home construction loan. These are not as widely available as regular home loans, so you may have to shop around.

When you’re approved for a new home construction loan, you can expect to receive short-term financing with relatively high interest to pay for the build. You may be able to find a loan option that allows you to only make regular interest payments while construction is ongoing.

Once construction is complete and your new home is built, you’ll likely convert the home construction loan into a permanent mortgage with a lender. At that point, you may start to make monthly payments on both the principal and interest.

If you need additional funds during the construction phase, an inspector or appraiser may need to assess the state of the build for the lender to authorize a higher loan amount.

Requirements for getting a construction loan

To qualify for a home construction loan, you will likely need to have good credit, stable income, and a down payment. Specific requirements will vary between lenders, so be sure to research and compare different lending institutions before making a decision. Lenders will also likely require an appraisal, detailed plans and specifications, and proof that you own the land on which you plan to build. Additionally, lenders may want to see a budget for the projects, which could include the cost of the land, building materials, labor costs, and other expenses.

The specific down payment amount required can be determined by the cost of the land and planned construction. If you already own the land, you may be able to use its equity for your construction loan.

Your lender will check the credit and credentials of your builder as well. Drawdowns on the funds are usually at prescribed completion points, requiring that inspectors approve the progress.

Different types of construction loans

There are several types of construction loans that may be available to you. Here are a few:

1. Construction-to-permanent loan: This type of loan is a combination of a construction loan and permanent financing. With this type of loan, you can borrow money to pay for the construction of your home and then convert the loan into a permanent mortgage after the construction is completed.
2. Stand-alone construction loan: A stand-alone construction loan covers only the construction phase of a project and may be replaced by a permanent mortgage once the construction is completed.
3. Renovation loan: A renovation loan is used to finance the renovation or remodeling of an existing home.
4. Owner-builder loan: An owner-builder loan is designed for individuals who want to act as their own general contractor during the construction process.

Other funding sources for new construction

If you have equity in your current home, your lender may offer a bridge loan to use while your new home is being built and you’re waiting for your current one to sell. This type of loan may help you to access your equity in your existing home to make a down payment on the new one. This may be an expensive, somewhat risky situation since you’re planning on your home to sell – but it may help you get through if you’re pressed for time.

LEARN MORE: How to use your home equity to buy another house

Another approach is to sell your current home and rent a temporary home while waiting for your new one to be built. While this requires you to move twice, it may free up the equity in your home to use toward your new property.

Final thoughts: Home construction loans

There are a few extra steps involved in financing the building of a new home. When you consider all the pros and cons, you may find that the advantages of a brand new home outweigh the complexities.

If after researching how to get a loan to build a house you decide that you’d rather stay in your current home, you might consider tapping into your home equity to renovate, remodel, or upgrade.

Home improvement is a popular reason for taking out a home equity loan. You can use the cash from your equity to take on a custom remodel or to build a new addition to your home. This may increase the value of your home and improve the overall living space.