When you ask a lender for money to build a house, you're asking him to take a leap in the dark. Instead of having a house to put up as mortgage collateral, all you have is an empty lot. To get the loan before the house is built, you have to convince the lender your dream house will be worth the money.
If you pick one of a builder's standard designs -- possibly with a few changes or upgrades -- she may agree to let you pay for the house with an end loan agreement. Under the agreement, you take out a loan to pay her as soon as construction ends -- usually when you get a certificate of occupancy saying the house is safe. If the builder is satisfied you can deliver the loan, this is the simplest way to proceed, as you can take out a standard mortgage to pay her.
Talk to lenders before you start shopping for builders. If you can't prequalify for more than a $150,000 mortgage, you know not to ask builders for a $200,000 house.
If you want a custom-designed house, your builder may insist on a construction-perm loan instead. With a construction-perm, you take out a loan to pay the builder in installments and then convert the loan to a mortgage when the house is complete. Construction-perms are sometimes called story loans because they're based on a house that isn't real yet. The lender has to base his decision on the information you provide about the house you plan to build.
With a construction-perm loan, lenders want the same financial information, such as your income and credit history, as with a regular mortgage. You or the builder provide design drawings for the house and key details such as the type of materials you want. The builder provides an estimate of construction costs. If you get the loan, this information becomes the basis of your construction contract.
Lenders typically include a reserve for cost overruns and changes in the amount of your construction-perm loan. If the lender pays the builder out of the reserve, the amount you owe on the loan increases. Delays in building also increase costs, as interest rates run higher on the loan during the construction phase. Research your builder thoroughly before signing with her and keep an eye on costs and requested changes as the work progresses to keep them from inflating the loan to more than you can afford.
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