How You Can Benefit From Home Construction Loans

By: Geri Mason

New home construction loans differ from those loans that are used to purchase existing homes.

With a new home construction loan, there is no home to use as collateral because the home has not yet been built. In this case, the bank only has your word as guarantee for payment of the loan.

It would be nice if banks could simply take your word for it, but when hundreds of thousands of dollars are at stake, John Smith's signature isn't enough for the bank to simply hand over a check for you to begin construction.

Because of the nature of the home building process, the financing process concerning a new home construction loan is more stringent.

Once the lender has agreed to allow you to borrow a new home construction loan, a draw schedule will be outlined. In this draw schedule, the lender details how the loan will be disbursed.

Typically, new home construction loans are disbursed in 25% increments. When 25% of the construction has been completed, the lender will give you 25% of the loan amount. The lender will require an appraisal of the progress to ensure that said work has been completed.

You will not make any payments on your new home construction loan until the first disbursement has been made. At that time, interest only payments will be due on the loan.

The good news is that you are only required to make payments on the portion of the loan that has been disbursed. As more construction is completed and more of the loan is disbursed, your monthly payments will increase. This is because you are paying interest on a larger amount of money each time a disbursement is made.

When construction of your home is complete you the entire balance of the new home construction loan will be due. Don't panic. You will have a way to pay this balance well in advance. "How", you ask? Before you can be approved for a new home construction loan, the lender will require that you first are approved for a mortgage.

To ensure mortgage approve, the new home construction lender will request a commitment letter from the lender of your mortgage. Once construction is complete, the amount of the mortgage is used to repay the balance of the new home construction loan.

You can choose between a one- or two-time close new home construction loan.

The primary difference between the two types of loans is the time at which the interest rate is locked in. With a one-time closing, both the construction loan and the mortgage close that the same time, locking in the interest rate for both loans.

On the other hand, with a two-time close the construction loan closes first, and then the mortgage closes when construction is complete.

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