Types Of Construction Loans Available For Building Your Dream Home

It's finally happening! After months — maybe even years — of dreaming, planning, and saving for a down payment, it's time to start building your dream home. Before getting started, you'll need to apply for a construction loan. It's hard to know how much house you can afford without one, let alone how to budget for the project. Like a traditional mortgage, many construction loans will require a 20-25% down payment based on the total cost of the project. Budget the home build carefully and leave some wiggle room; it's one of the rules you need to know before building on your property.

There are two main types of construction loans: construction-only loans and construction-to-permanent loans. Both types of loans cover construction and end with a traditional mortgage, but there are differences. Construction-only loans are loans that only cover the cost of construction. The lender pays contractors directly from the funds while the homeowner makes interest-only payments. Once the home is complete, the homeowner either pays off the loan or refinances it into a traditional mortgage. This option is a short-term loan, and one of the pros is a lower monthly payment because you're only paying interest. The cons, though, are higher interest rates, no reduction in principal, and you'll have to apply for a conventional mortgage once construction is complete. Meanwhile, construction-to-permanent loans cover construction and completion. Take your time planning your budget and look for tips and tricks to make building a new house more affordable to reduce the overall cost you'll have to finance.

Construction-to-permanent loans provide financing for both construction and the completed project, but there is only one set of loan qualifications and closing costs, and one trip to the closing table. This loan converts to a conventional mortgage once construction is complete, which also allows you to lock into a fixed rate now rather than shop around later for a good rate on a conventional mortgage. The disadvantages are that it could have higher qualification requirements and require a larger down payment. Still, this option reduces the amount of fees you'll pay at closing, and its simplicity makes it the most popular choice for financing a new build. 

There are other types of construction loans, so talk to a lender about the best option for your needs. A VA Construction loan is available to veterans and qualifying military families that offers 0% financing and no Private Mortgage Insurance (PMI). A USDA Construction Loan offers low or no down payments for homeowners in rural areas if they meet certain eligibility guidelines. While it seems like buying an existing house is less complicated and less expensive, there are benefits to buying a new construction home. The biggest benefit is the ability to build a home that is completely and truly yours.