Tuesday, March 12, 2013

FAQ: How does a construction loan work?


We've had a few friends and family members ask us questions about house building. The ones that come up the most are about the financial and lending part. I've compiled a list of FAQs to better explain construction loans. Because I was pretty clueless before I started this process too!




1. You haven’t closed on the house yet?

We have been paying interest-only each month on an open line of credit with the bank. As the line of credit gets larger, so does our payment. But unlike a mortgage payment, $0 is being applied to the principal. Construction loans are usually 6-9 months, sometimes longer depending on your lender. Our loan began May 2012 and our loan matured last month. 

2. When will you close?

We are currently in the process of closing on the home.
We have finally rounded up all the bills from each contractor. (annoying to have to ask some of the contractors for a bill several times…you’d think they’d want to get paid!) Then the appraisal is scheduled. Which is TODAY! Cross your fingers and toes for us! We are nervous.

3. Why? What is the big deal about the appraisal? 

The appraisal will tell the bank and us how much the home is worth. The bank needs to know that they are lending us at the very least what the home is worth. If we borrowed more than the home is worth, then we would be upside down on the loan. This means the loan could be a high risk loan for the bank. This is one reason we paid cash for as many items as we could while building.

4. What is the reason to put your own cash in while building a home? 

PMI, or Private Mortgage Insurance. PMI is required by lenders on all conventional (Fannie & Freddie) loans over 80% LTV (loan to value). PMI is an extra charge to the borrower on top of the principal and interest payment. If PMI is require you pay it until the loan reaches 80% LTV. It can be anywhere from a few bucks to almost $200 depending on your loan amount and the LTV. 

Why pay more money every month when there is no real benefit? I could be spending that $100-$150 bucks each month on shoes and pinterest projects! Err…I really meant put it into savings.
Let me break it down for you*:
Appraisal Value: $100,000.00
Loan Amount: $80,000.00
Loan to Value (LTV): 80% No PMI Required
Appraised Value: $96,000.00
Loan amount: $79,000.00
Loan to Value (LTV): 82% PMI required = extra fee on top of mortgage payment.
*These are just examples our loan amount and projected AV is much different

Essentially, we are hoping the large sum of cash we paid into the home--plus, the land (which we also paid cash for) will save us from PMI.


5. What else can you do to avoid PMI?


We put a heck of a lot of sweat equity into the home. Labor can be a huge charge, DIYing what you can saves big bucks!
Some of our DIY items included:
These items help to save us approximately $15,000 in labor costs alone! We are hoping these items help avoid the PMI monster that lurks.

6. What happens after the appraisal comes back?

Our loan to value is determined and our monthly loan payment is figured. We also have regular closing costs just like buying a home; credit report fee, appraisal charge, underwriting fees, etc. Then we close the loan with our loan officer like everyone else…only we already have the keys!

Find out our appraisal results!
See the rest of our home in the house tour!
Our projects page shows the rest of our DIYs!

Disclaimer: Every lender and bank is different, so your experience will most likely be much different than ours. I am not a professional, and my opinions and thoughts are my own, and  I am not affiliated with any institution. Get advice from your own lender and building professional. 

49 comments:

  1. Good post... it is very stressful! Hope it all works in your favor :)

    ReplyDelete
  2. Ahaha, I love the last one. Special, indeed!

    I'm glad you posted a link to your closets - I've been wanting to check them out!

    ReplyDelete
  3. Good good info, Trina! I've always wondered how the heck it works when you build a home. It's crazy to see the approximate savings from doing so much of it yourself!! Your home is beautiful! Fingers crossed the appraisal goes well!!

    ReplyDelete
  4. Good luck with the appraisal!!! I have my fingers {and toes} crossed for you! And that stupide PMI is a major pain in our butts! I can't wait until we reach 80%...we are at 90% now if our refi goes through this month! Eeeeeek!

    ReplyDelete
  5. I read some of this. I comprehended none of this. I totally suck at grown-up things like loans. Good thing I married an accountant. I have my doctorate yet my brain shuts down with stuff like this.

    Fingers crossed for the appraisal. I DO get that one. ;)

    ReplyDelete
    Replies
    1. adam feels the same way about the financing portion..minus the doctorate part!

      Delete
  6. Awesome! I know someone else who did this and it really is a sweet feeling going in their home knowing they did all the pieces top to bottom, including all woodwork!

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  9. This FAQ about construction is a helpful guide for people who want to construct their own home, but don’t have enough budget. If you’re a first timer in this matter, the best thing to do is to ask for an advice from a professional who is knowledgeable about construction loan and all other related stuff. Don’t take the risk of handling it yourself, if you can have someone to help you on this.
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  10. So, in even more laymen terms, you
    1. get a construction loan (to pay off the contractors/materials)
    2. Build the house
    3. Get an appraisal
    My misunderstanding is this: Are you taking out two loans? Or are you only paying on the construction loan, with interest, or will you end up with two loans? The construction loan and permenant loan? I thought to build a home you pay for land, materials, labor and once complete you paid off what you borrowed to accomplish this. Am I wrong?
    Thanks

    ReplyDelete
    Replies
    1. Yes Kristen you are correct. It is an interim loan at start, basically, a line of credit. Which is refinanced at the end into perm financing/regular mortgage.

      Delete
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  17. Construction loans are basically loans that has the lender investing on something that doesn’t exist yet. If you want your application to be approved, you better have a pretty convincing story to tell your lender. Asking them to put money down on something that has an equal chance of succeeding and failing puts both you and the lender at great financial risk. Working like a credit card, you only have a set maximum to spend to build your new home, requiring interest-only payments during construction and becoming due upon date of completion, to which it will then be rolled over into a 30 year mortgage.

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