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Getting a Mortgage When Building My Own Home

By Laura Agadoni · Jul 13, 2016 · Real Estate

Getting a Mortgage When Building My Own Home

Image courtesy of Flickr, Garreth Wilcock

If you have a large ''must-have'' list, you might be the perfect candidate to build your own home.

Unless you're lucky enough to be living in your dream home, there are probably some things you wish could change about your house. Or you might wish your home had some extra features, such as a laundry room, a master bedroom on the main level, or a walk-in pantry. The more particular you are about the sort of home you want, the more difficult it will be for you to find the perfect home. If you have a large ''must-have'' list, you might be the perfect candidate to build your own home. That way, you can design it any way you like, and you can choose all the finishes while you're at it. But first, think about whether you can even get a mortgage.

Building a Home Is Expensive

Building your own home will probably be more expensive than buying an existing home. The National Association of Home Builders found that the median price of a new home in November 2015 was $305,000, but the median price of an existing home was only $221,600. If you plan to build a brand-new home, chances are you'll need a mortgage. And the process for obtaining a mortgage to build a home might differ from your standard mortgage procedure.

It Will Be More Difficult to Obtain a Loan

Mortgage lenders, particularly after the 2008 housing crisis, want to avoid risky loans. And loaning money for a home that doesn't yet exist is riskier than loaning money for an existing home. So you might not be able to get a mortgage from a traditional mortgage lender. But you do have other options.

Look Into Construction Loans

A construction loan is usually structured as a short-term loan of one year or less that covers the costs of building the home. These loans have a variable rate, but even if you have impeccable credit, the rate you'll get on a typical construction loan will probably be higher than it would be for a traditional mortgage loan.

Your lender will want to see the construction plans, a timeline, and a budget before approval. Your builder must be qualified, generally as a licensed general contractor who has built homes before. You will likely be required to put down at least a 20 percent down payment or more. And if you don't already own the land the house will be built on, expect an even higher down payment requirement.

If you are approved for a construction loan, you will be put on a bank draw schedule, where the builder requests funds during various stages of the project, instead of getting the loan in one lump sum. Generally, your down payment serves as the first draw. You typically pay only interest, not the loan's principal, during construction. After your home is built, your construction loan will either convert to a conventional mortgage, or you refinance it to a conventional mortgage because the loan becomes due at the time of completion.

A Note About VA Loans

Veterans can take advantage of a VA loan program. This program lets veterans borrow money without needing to make a down payment. Theoretically, veterans can use this VA entitlement to get a mortgage to build a new home. But the challenge is finding a lender willing to participate.

What typically needs to happen is veterans would need to get a construction loan from a lender or a builder. Veterans can then refinance the construction loan to a VA mortgage. The problem for many veterans is coming up with the large down payment that's usually necessary to obtain a construction loan.

The Risks Involved

There are risks involved when getting a construction loan to build a home. You should know what they are before you apply for a construction loan.

The most common risk is that your home might not be built on time. If that happens, you might have to shell out more money to extend the loan since you probably won't be able to refinance until the home is complete.

Another risk to prepare for is your house not being worth as much after completion as you thought it would be. That could happen if the builder did a bad job or if the housing market falls. If that happens, you might not be able to refinance the total amount, and again, you'll have to come up with more money.

If you have a change for the worse in your financial situation, such as losing your job, you might not qualify to refinance the loan. If that happens, you could lose the home to foreclosure since the construction loan is really a balloon payment loan that becomes due at the completion of the build.

Bottom Line

If you want to build a new home, you should have money saved for a large down payment and in case there are snags along the way. If you don't have money saved to help you deal with risks, you might be better off buying an existing home with a conventional mortgage.

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