Not intended for legal or professional advice.

Once a budget has been addressed, financing the project is next. How do you plan to pay for the house? Will you need a loan? There is a difference in a construction loan and a mortgage or traditional loan. A traditional loan is on a house that already exists. A construction loan is usually to last about one year, while construction is taking place. This is a line of credit, like a credit card. Nothing is due until the contractor makes the first draw. If a construction loan is needed it needs to be secured prior to breaking ground. Also, there is a difference in a loan for a traditional house and a custom house. If you are building in a subdivision with a contractor who is developing the subdivision you might not need a construction loan. However, if you are building a custom house on your own land a construction loan may be necessary.

Here again the importance of hiring a seasoned contractor is so important. Your contractor can walk you through many of these questions. One question often asked is, “Do I have to sell my house prior to getting a construction loan?” Selling your current house may not be necessary prior to getting a construction loan. This depends on if your current house is paid for or if you have a large amount of equity in your current home. You will need to talk with your lender about your dept-to-income ratio.

A construction loan for a custom house can be tricky. Many lenders are leery of loaning for custom houses due to so many variables. Often the lender will ask for a complete detail of the project to be approved. When talking with your lender these are some things you will need to know.

A “one step loan” is the same lender for construction and mortgage. This type loan is more appropriate for building a house that the contractor has already built. If the contractor knows the cost and time frame. This loan will help with not having to pay two closing cost and maybe additional fees associated with two loans. There is no “wiggle room” with this type loan. You must know exactly how much the house will cost and how much time it will take. This is difficult to know with a custom-built house because there may be changes made along the way.

A “two step loan” is getting two loans. You will get a construction loan and then a mortgage loan. These do not have to be from the same lender. For custom houses this is a better fit because there is more “wiggle room”. If you decide you want to make a change, or if there is a delay in building you can adjust a construction loan. There is much more flexibility with a two-step loan.

The financial aspect can be tricky. Be familiar with different type of loans and the major lender associations such as The Mortgage Bankers Association of America (MBA) and The National Association of Mortgage Brokers (NAMB). Also, names to be familiar with that are heard quite often in the lending industry are Fannie Mae and Freddie Mac.