How New Home Builds Are Typically Financed
Financing the purchase of an existing home is pretty straightforward. You prequalify, find the house you want, make an offer, and finalize the loan. Funds are disbursed to the seller at closing. Though lenders can complicate the process unnecessarily, it is pretty straightforward in principle. The same is not true when you are financing a new build.
New builds are typically financed via a multi-stage process. It is possible to obtain single-step mortgage products in some markets, but they are not the norm. More often than not, lenders protect their own interests by tightly controlling how funds are released during new home construction.
As a general rule, here is how new home builds are financed:
New home construction begins with prequalification. Just as if you were purchasing an existing home, you go to your lender to see how much you qualify to borrow. This accomplishes two things. First, it puts your lender on notice that you will eventually be applying for a new construction loan.
Second, prequalification demonstrates to architects and builders that you are serious. It also gives them an idea of what you can afford to spend. Prequalification benefits them in the sense that they don’t have to worry about wasting their time or effort on tire kickers.
2. Loan Application
A solid prequalification sets your building project in motion. Now you can sit down with your builder and architect to finalize plans. This will give you a solid number to work with. You turn around and use that number to officially apply for your construction loan. Note that the lender will ask to see the plans. They will want to approve the plans and appraise the property.
3. Initial Closing
Almost all new construction loans require a minimum of two closings. Sparano + Mooney, a Park City, Utah architectural firm that specializes in custom-built luxury homes and modern mountain architecture, says that initial closing disperses the funds necessary to get started.
The initial closing pays for architectural and design services. It pays for the materials necessary to build a home. Essentially, funds disbursed during the initial closing cover all the upfront costs of building.
4. Additional Disbursements
In most cases, lenders and builders work out a schedule of additional disbursements to cover costs incurred during the building process. For example, builders have to pay subcontractors for their work. Subcontractors are not going to wait until final closing to get paid. They expect payment as soon as their work is completed. Paying them is made possible through an additional disbursement from the lender.
5. Final Closing
The last step is the final closing on a permanent loan. What is the permanent loan? It is a conventional mortgage that pays off the construction loan plus any additional expenses incurred along the way. Final closing is really no different than closing on existing home. It is fairly common to acquire one’s permanent mortgage from the same lender that provided the construction loan.
The important thing to remember with final closing is that it requires you to apply for a traditional home mortgage. You are going to have to go through all the paperwork again. You are also going to be subject to new lending verification. It is critical that you properly manage your credit and avoid any new debt during home construction so that your chances of getting a permanent mortgage are not harmed.
Needless to say, financing new home construction is quite a bit different than getting a mortgage for an existing home. But it is not a big deal if you work with experienced lenders, architects, and builders.