Step 7: How to Finance Your Home

Most people seeking to build a home will have to finance it through a lending institution. Construction lending has been made easier and less expensive in recent years through the development of "Combo" loans. They allow you to close on the construction loan prior to the start of construction and then convert it to a mortgage loan upon completion of the building process. As we stated earlier, you can also include the lot purchase in with this loan if you do not already own your land.

The lending institution (bank) will require copies of all contract documents prior to loan approval. The bank will conduct an appraisal of the house plans and lot to ensure that they will have sufficient collateral in the home to protect them in case of foreclosure. Once the appraisal is completed the bank will send your application through underwriting for final approval. When this has been received your loan package will be sent to the closing company of your choosing. This whole process generally takes in the neighborhood of three to five weeks.

Your bank will also require that you carry a "Course of Construction" insurance policy while the home is being constructed. This policy covers the structure against natural disaster and vandalism while the home is being constructed. You can expect to pay around $900 for a six month policy on an average 2,000 square foot home in this area. We carry and we require our subcontractors to carry general liability and workers compensation coverage to cover against liability while we build your new home. It is wise to ask any builder for copies of his coverages. We will give them to you prior to starting construction of your home.

Loan Types

Aside from using your personal savings or getting a home equity loan on an existing property to finance construction, you have two chief options when looking for construction financing. You can get two separate loans or you can apply for a type of loan that virtually guarantees permanent financing when you take out the construction loan.

•Two Loans

In this arrangement the construction financing and the permanent loan are arranged separately, perhaps even with separate lenders. The construction loan typically has a six-month to one-year term. The borrowers pay monthly interest charges as they accrue, and all of the principal is due at the end of the term. Interest is paid monthly, preferably only on the amount you've withdrawn from the credit line (something to watch out for), usually at a rate fixed at about 1.5 to 2 percent above the prime rate.

In addition expect, an up front service charge ranging from 1 to 2.5 percent of the amount borrowed. Construction loans are expensive to administer, and this fee helps pay for those extra costs as well as to fatten the lender's profits on the transaction. You also will have many other fees common to a loan closing such as a title search, recording fees, and the like. After the home is finished, obtaining permanent financing would be just like applying for a loan on any other home.

Typically, the funds for the construction loan are paid after certain portions of the work are completed by us. The lender may rely on invoices or site visits to ascertain the state of completion of the work. Remember: Look for a loan that requires you to pay interest only on the portion of the principal you've used, rather than on the entire sum for the life of the loan.

•Combo Loans

Though similar to the two-step process outlined above, combo loans can save you significant amounts of money and stress. Sometimes you only have to go through a closing once, or if you do have to close twice, the up front fees on the construction loan may be reduced. Even with two closings, there should be much less paperwork; the chief new document required is an updated title report, which should also protect you from mechanics' liens in case a general contractor doesn't pay all the subs.

In other respects, while you've sacrificed the option of shopping around for permanent financing, you've gained the security of the permanent loan commitment. Not all lenders offer either form of construction loan. However, when searching for one, approach local banks and thrift institutions first. We will also supply you with financing leads. While construction financing is not as simple or convenient to obtain as a conventional home loan, there are still many lenders out there who will help convert your blueprints into your very own custom home.

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