Many understand how the purchase of an existing property works. However, when considering building a new home instead, there are differences that can be confusing. A new construction loan differs in many ways from a traditional mortgage, but provides a number of great advantages for the borrower. It’s important to understand how new construction loans work, and what is involved to make the best decision possible. In many cases, it is the best option, but it is always wise to consider both the pros and cons before deciding on which way works best for your unique situation.
With a new construction loan, the lender is borrowing the money to build the property on the expectation that the finished home will then become collateral for a mortgage. Because there is no actual collateral, construction loans have special guidelines and are carefully monitored to help reduce the level of risk for the lender. Typically, a construction timetable, comprehensive plans, and a practical budget are required before the loan is processed. When a borrower is approved, the cost of building the home will be provided to the contractor on a schedule that follows the construction timetable. As construction progresses, funds from the loan will be released. For the borrower, there is typically a down payment required, followed by interest only payments each month.
New construction loans are usually short-term loans that are designed to cover the cost of constructing a new home.
The largest and most obvious benefit is the ability for a borrower to build a brand new home that meets their needs and desires. A new home can be customized in both the floor plan and the finishing touches to match the exact style a person is seeking. Another benefit is that a newly constructed home is much less likely to have problems that older purchased homes may have. And, if there are problems, the new home is likely to hold warranties on the construction and components installed such as a furnace or water heater. A new home gives the borrower an opportunity to create the home of their dreams and reduce the risk of costly repairs that existing properties may have. Some other benefits of a new home include larger and more efficient floor plan designs, improved safety including hard-wired smoke and carbon monoxide detectors, and greater energy efficiency.
Other financial benefits are also part of a new construction loan. In many cases, because the loan will transition into a mortgage, closing costs are only paid once. It will save both time and expense that would be required when using other loan types. Another benefit is that the lender will likely conduct inspections throughout the construction process. This allows them the safety of knowing that construction is being done right and within budget. The benefit is that the inspections are an assurance to you that you will be getting a quality built home. Also, if you already own the lot, it can be used as collateral which may lower the interest rate.
Often, a construction loan that transitions into a mortgage is only available to those who plan to make it their primary residence or a second home. Also, because there is not yet a home to use as collateral, a good credit history may be required. Finally, there can be delays and other issues that come up during construction; therefore it’s important to figure for the possibility of additional expenses.
Like any other financial decision, new construction loans are a phenomenal option, but only if it’s the right option for you. There is no question that the benefits to a new construction loan are great, but knowing how they work and what it would mean for your unique situation is important. It’s helpful to speak with a professional and experienced mortgage professional to help weigh your options and navigate the process.
Navigating mortgage and loan rates is complicated! Why not let our team do the hard work for you? Equity Source Mortgage is a trusted mortgage broker in Minnesota. We believe that people deserve a home to call their own. At Equity Source Mortgage, our number one goal is to match you with the best loan for you. Contact us or call us at 763-657-2000 to begin exploring your home ownership journey – YOUR Dream Is Calling!