Whether you’re an adventurous person, a DIY expert, or just a personal shopper, the thought of building your own home could be an exciting prospect. Finally, if you decide to build your own residence, you can call all the shots. This means you can determine the exact layout, specify the exact number and type of rooms, manually select all finishes, and even add an indoor pool, aquarium wall, or stair slide.
When building a one-of-a-kind home from the ground up may sound exciting, financing such a large undertaking is a whole different story. Obviously, the majority of home buyers don’t have enough money to cover the construction costs of their custom home – which means they will need a loan. Unfortunately, getting a loan for a self-built project is easier said than done.
If you are considering building your own home, here are a few things to consider when looking for a loan. (To learn more, read Should You Buy or Build a Home? )
A standard mortgage loan doesn’t do the trick
For buyers purchasing an existing home, it’s relatively easy to qualify for a conventional mortgage as long as they have good credit and reliable income. On the other hand, it is virtually impossible to obtain traditional financing when building your own home. Why? Think of it this way: you’re basically asking the lender for money for something that doesn’t exist yet. To make matters worse, construction is a risky process, and lenders don’t like risk.
Search for a construction loan
If you plan to build yourself, you’ll need to pursue more specialized financing options. Enter the construction loan. Sometimes referred to as a self-build loan, a construction loan is usually a short-term loan (usually one year) that is used to cover the cost of building your own home.
These loans typically have variable interest rates that are higher than traditional mortgage loan rates. Once construction of your home is complete, you can either refinance the construction loan into a permanent mortgage or get a new loan to pay off the construction loan (sometimes called a “final loan”).
Ready to lay lots of groundwork
If you’re applying for a construction loan, you should probably stretch seriously. These loans require a ton of legwork on the part of the borrower. You have to jump through numerous hoops to prove that your construction project is real, feasible, and relatively low-risk to the lender.
For most construction loan applications, you must provide the lender with a project timeline and a realistic budget.You’ll also need to provide a comprehensive list of construction details, ranging from floor plans to types of building materials to insulation and ceiling heights. (Experienced contractors usually create a “blue book” that includes all these details for a construction project.)
Prepare for a sizable down payment
Most lenders require at least 20% down payment on a construction loan, and some require as much as 25%. Why down payment requirements are so high? Because construction loans are considered “higher risk” than a traditional mortgage loan, the lender wants to make sure you don’t walk away from the project.
Know where you land
If you don’t already own the land on which you plan to build, the cost of the land must be included in the total amount of the construction loan. If it’s financially possible, try to pay for the land up front. Otherwise, you’ll have to make a much larger down payment to qualify for the construction loan.
Work with a qualified builder
To get approved for a construction loan, you must show that you have a qualified contractor involved in the project. A qualified contractor is typically defined as a licensed general contractor with an established residential reputation.
If you intend to act as your own general contractor or build the home yourself, this presents a unique challenge – and you likely won’t be approved for a standard construction loan. In this scenario, you may want to direct your search to construction loans for homeowners. In today’s housing market, it can be difficult to qualify for this type of loan; but it is possible if you submit a well-researched construction plan that demonstrates your knowledge and skills in residential construction. Don’t forget an emergency fund for unexpected surprises. (See also: The hidden costs of new construction can burn buyers.)
The bottom line
Building your own home from scratch can be an extremely rewarding process. take a walk in the park. To increase your chances of approval, put together a detailed project plan, get a qualified contractor involved, and save enough money for a large down payment before you apply.