If your dream home exceeds your budget, you can still get yourself a nice pad if you buy a partially built home. Such homes often come onto the market when construction firms go bust. You can finance the purchase of the property and the rest of the construction work although you can't use a conventional mortgage to buy an unfinished home.
If you default on your mortgage, your lender can sell the property and use the sale proceeds to settle your debt. Foreclosure laws vary between states, but this process can drag on for months or years. Property taxes continue to accrue during this time frame and your lender has to settle the back taxes before it can sell the home. Lengthy foreclosure proceedings result in hefty tax bills for lenders. You can't finance the purchase of a half-built home with a standard mortgage because construction costs would add to the lender's bill if you defaulted on the loan. From a lender's perspective, a home needs to be in tip top shape before you apply for a conventional home loan.
Mortgage companies, including government backed Freddie Mac and Fannie Mae, do offer special financing programs for home construction. Construction perm loans are basically two loan products rolled into one. You receive a line of credit for the home construction and then you refinance that debt into a regular mortgage when you have finished the work on your home. You have to hire a certified or licensed contractor to build the home and the loan amount depends on the value of the land plus the construction costs. Some lenders allow you to take out a construction perm loan on a house that has already been partially constructed. This means you can get a cash out refinance loan on a home you are building if you run out of money.
The Federal Housing Administration insures property rehabilitation loans and you can use these mortgages to purchase or refinance a home. You can't use a 203k rehab loan to install luxury items, but you can use it to add an additional room, repair a roof or to fund other necessary maintenance. You can even rebuild a home that has previously been demolished as long as the original foundations are still in place. The FHA bases the loan amount on the projected value of the finished property. You can use 203k loans to finance both a primary residence or an investment property.
You can often get good deals on unfinished homes, but these properties do have certain drawbacks. Wooden frames and foundations can start to crack and rot after several months of rain or sun exposure. Water in unused plumbing systems can freeze and cause the pipes to burst. Condensation in rooms that are not climate controlled can cause mold to develop. You can hire a certified home inspector to look for these types of hazards before you buy a home. You can ask the seller to resolve any major issues before you make an offer. It is better and less expensive to deal with these problems before you complete work on the home rather than allowing underlying problems to come back and haunt you further down the line.