Home Construction Loan Information

Good contracts help home construction projects.
i Brand X Pictures/Brand X Pictures/Getty Images

The first step in arranging financing for building a new home should be to discuss the matter with banks in your area. Community banks, which tend to specialize in such lending, should be able to ensure that the project will proceed as smoothly as possible. With their experience, they might also be willing to recommend contractors for the prospective homeowner's consideration.

Construction Loan

After verifying a loan applicant's assets and credit, the home-construction lender reviews the plans for the house and approves a builder. The builder submits his proposal. The bank then reviews all bids from participants in the project -- for example, electricians and plumbers -- and calculates the total cost of building the home. The builder submits a draw schedule -- usually for four to eight draws -- and gives the lender an estimated completion date. The builder draws funds as work is completed and inspected. During construction, the owner pays interest on the money that has been drawn. After the final draw and completion of the project, the lender sends an appraiser to verify the correctness of the final value of the structure. An inspector verifies that all work has been done. Finally, a local building inspector issues a certificate of occupancy.

Construction Contract

The home construction contract, which should be reviewed by attorneys for the homeowner and the builder prior to signing, should include each party's responsibilities, the amount of money to be paid to the builder and the requirement for insurance. The contract should identify the subcontractors and, if applicable, the architect. If an architect is named, his responsibilities should be listed. The main costs should be recorded as line items. The construction draw schedule and procedures should be included. There should be provisions for changes during the construction period. The contract should contain the street address of the home or the location's legal description.

Construction Costs

Various types of costs are associated with home construction projects. Major categories include the cost of the lot; hard costs -- the actual cost of building the house, including final landscaping; soft costs -- fees for architectural, engineering, survey and other work done before construction begins; closing costs -- such as lender's fees, attorneys' fees and title insurance -- associated with closing the loan; interest reserve -- an amount equal to 60 percent to 70 percent of the interest on the total loan, used to make payments during construction; contingency fee -- an amount up to 10 percent of total construction cost, to be available in case of price increases or cost overruns; and final inspection fees.

Longer Term

Construction loans are intended for the construction project only. Construction lenders normally require borrowers to have commitments for permanent mortgage loans before entering into construction financing agreements. When construction is completed, there will be a mortgage closing for the permanent loan. The mortgage lender will disburse funds to repay the construction lender in full. At that time the construction lender releases all claims against the homeowner. Some banking institutions offer construction-to-permanent loans, which combine construction loans and permanent mortgage loans into a single process. Such loans are convenient for the borrower who has to deal with only one lender and is responsible for only one set of appraisals, attorneys' fees and closing costs.

the nest

×