By Krystal Frederick Mortgage lending consultant supervisor at Dupaco Community Credit Union Maybe your household has grown. Or your income has increased in recent years. Maybe you’re simply ready to trade your first house for one with a larger footprint.…
Building your own home has its perks. With new home construction, you call the shots.
How many bedrooms and bathrooms do you wish you had? Where would you put them? What does your dream kitchen look like?
You make your home your own—literally—from the ground up.
But unless you have an unlimited supply of savings stashed away, you’ll likely need to borrow money for the construction phase. Financing new home construction isn’t the same as taking out a traditional mortgage for a house that’s already been built.
Of course, there are pros and cons to building your home. So knowing more about the process—and how financing the endeavor works—can help you decide whether new home construction is right for you.
Borrowing for home construction
Loans used for home construction go by different names, depending on the lender you use. And each lender’s loan has its own terms and requirements.
At Dupaco, borrowers take out what’s called a one-year ARM, which also is called a 1/1 ARM. It’s short for adjustable-rate mortgage, which means the interest rate you pay on your loan balance can vary over the life of the loan.
At Dupaco, the loan can be used to fund up to 80% of the costs associated with building your house, which might include labor, equipment or even the lot itself, said Jeann Digman, vice president, mortgage lending.
Think of the loan as a temporary financing option. Once your house is built, you can refinance the loan into a traditional mortgage.
Here’s how Dupaco’s one-year ARM works:
- During the first eight months, you take out money as needed to fund construction expenses.
- Interest is accrued on your outstanding balance daily.
- During that eight-month period, you don’t have to make any payments.
- After that window, you pay off the interest you’ve accrued. And you’ll start making monthly payments on your loan balance.
- Your interest rate stays the same for the first year. But it can fluctuate up to 2% every 12 months after that. (Over the life of the loan, your interest rate will stay within 6% of the original rate.)
“You can pay off the loan before the one-year period is over, which is nice,” Digman said.
What you can expect during the loan process
Remember, each home construction loan can work differently depending on the lender. Make sure you understand your lender’s rules before you move forward.
Your down payment
While the loan is there to help you through the construction phase, you’ll still need to have some skin in the game. Most lenders typically require at least a 20% down payment, which is the case at Dupaco.
You’ll also need to take out a special insurance policy, known as a builder’s risk insurance policy, while the building is being constructed, Digman said.
Once your house is complete, your insurance agent can roll the policy into a regular homeowner’s insurance policy.
Know who can build
Who can build your house? Some lenders won’t let you be your own general contractor.
At Dupaco, you can hire a general contractor or serve as your own.
Save your construction bills
Many general contractors put you on a payment schedule, where you’re expected to make payments at different stages of the process.
That’s when you’ll need to withdraw funds from your loan. Be ready to provide those construction bills to your lender to prove how you’re spending the money. You also might need to have lien waivers signed each time you withdraw funds.
Know that some financial institutions charge you each time you withdraw funds from your loan (not the case at Dupaco). Find out what the lender’s policy is ahead of time.
Be prepared for inspections
During the construction process, your lender will schedule multiple inspections to check on the progress of your project.
“As we disperse those loan funds, we want to make sure they’re going into the house,” Digman said. “We need to see that construction is progressing.”
Other tips to keep in mind
Building your own home is a big undertaking. Here are some other tips to consider.
Use reputable contractors
Know who you’re working with, and choose reputable contractors that you trust.
“You have to feel comfortable with who you’re working with,” Digman said.
While it can be tempting to go with the lowest bid, remember that you get what you pay for.
Expect it to cost more
Like any project, it’s easy for your costs to climb and wreak havoc on your budget.
Bids can increase. You might discover new, more costly, light fixtures. An unexpected expense can creep into the construction phase.
“We always tell homebuyers to borrow on the high side of what they think they’ll need,” Digman said. “Ninety-nine percent of the time, their final dollar is more than what they thought it would be.”
If the project costs less than your loan amount, great! You don’t have to use all of the loan funds, Digman said. But at least you have the money available if you need it.
Help keep your budget on track by always asking about the cost. If your builder suggests a new idea, ask how much that changes the price. If you have the money available and want to move forward, fine. Otherwise, consider whether it’s something you can do later.
Plan for it to take longer
It’s best for your calendar—and your expectations—to prepare for the construction process to take longer than you think it will.
“They can’t predict the weather. And materials can go on back order,” Digman said. “There’s no guarantee the house will be ready when they think it will be. Anticipate it will take longer.”
Even if you’re not personally building your home, you’ll still need to remain hands-on throughout the process.
You’ll need to visit the construction site to check on the progress and make decisions. You’ll need to stay in contact with your lender as you request money. And you’ll have to stay on top of payments to both the contractor and, eventually, your lender.
“It can be stressful to build, and some people have a hard time projecting what something will look like unless they can see it,” Digman said. “But it can be rewarding too.”