A person who desires to construct a home that meets his/her specifications cannot hope to circumvent the tedious construction loan process.
Availing a residential construction loan is very different from obtaining a mortgage loan. Residential construction loans are often referred to as ‘story loans’, since the lender needs to be aware of the construction plans, and the details regarding construction in progress, before sanctioning money to the borrower, who withdraws money from the construction fund after submitting the requisite proof detailing the progress on the house. Residential construction loans can be classified into two categories: Construction Only Loans, and Construction to Permanent Loans.
Home Construction Loan Process
Planning the Construction
A plan starts germinating in the mind of an aspiring home owner who may have contacted a builder to help further the process. Once the individual is convinced that the home can be built in accordance with his/her desires, the next step is procuring the necessary finances.
Documents Required for Construction Loans
The home owner needs to be equipped with the following documents in order to apply for a loan: proof of income; details of construction plans and specifications; estimated cost of construction; settlement statement or deed for land, whichever is applicable; the contact details of the builder; and details regarding construction insurance. An individual interested in constructing a private well or septic system needs to have the necessary certificate.
In addition to these documents, the borrower would also need to provide copies of the checking, savings, and asset account statements for the last 30 days. Asset accounts include money market accounts, mutual funds, stock accounts, IRAs, and CDs. The purpose of demanding all these documents is to verify the authenticity and the creditworthiness of the borrower, since the borrower is not expected to put up any collateral for the loan. Hence, the borrower is also expected to explain any credit inquiries.
Appraisal of the Proposed Property
If the lending institution is satisfied with the documents, it will undertake an appraisal of the proposed construction. The evaluation will be based on the lot that has been chosen for construction, and the feasibility of the plan finalized by the aspiring homeowner and the builder.
A borrower has the option of seeking a construction only loan or a construction to permanent loan. The former is provided for a period of 12 months during which the borrower is expected to finish construction, while the latter converts to a mortgage loan at the end of the construction period. If the lender is satisfied with the documents and the results of the appraisal, the loan is closed and the construction begins.
Drawing from the Construction Fund
During the construction phase, the lender will need to know the story behind each phase of construction in order to let the borrower withdraw money from the construction fund account. Copies of checks or deposits, that have been made to the builder or the seller of the land, also need to be submitted to the lending institution.
Completion of Construction
Once the construction is complete, the borrower will have to obtain a Certificate of Occupancy.
As mentioned earlier, a person can opt for a construction only loan or a construction to permanent loan. The latter is useful for people who are interested in converting their construction loan to a mortgage loan. In other words, instead of obtaining a construction loan from a lender and then a mortgage loan from another lender, the borrower seeks a single loan that automatically converts to mortgage loan at the end of 12 months from the date of closing the construction loan. Any unfavorable changes to a person’s prior credit score may disqualify the borrower from seeking a mortgage loan at the end of the construction period.