Are you interested in renovating or building a custom home? Doing the math may have you realizing that the costs may be higher than you expected. But all is not lost. If anything, there’s an easy way out. See the way you can take out a mortgage on a built home? You can get a similar loan to build or renovate your custom home- what we call a home construction loan. Let’s get into what this loan entails and how you can secure one and get started on your dream home:


How Do Home Construction Loans Work?

A home construction loan is a short-term loan facility taken out to use in building a residential home. In essence, this is what your financial provider would give you to help you put up your custom home. Most loans last a year, after which you must provide proof of the certificate of occupancy.

Given the short terms on these loans, the interest rates are often on the higher side. Why? With a mortgage, the financial provider uses your home as collateral, and when you default, they sell the home at the market rate and recoup their principal and interest. But with a home construction loan, this collateral is not available, so the loan automatically becomes a high-risk loan facility.

To reduce their risk exposure, loan facility providers require a complete breakdown of the custom home construction. We at Hartel Homes will provide you with a full cost breakdown and construction schedule. We also detail the plans and note each component in the construction, including a contingency reserve that allows you to modify the construction. The financial institution requires this detailed report to assess your loan application.



What do home construction loans include?

Will the loan cover all the construction needs, or do you need to pay for some expenses? Typically, the home construction loan can help you pay for the land, contractor fees, permits, and building materials. It essentially covers everything to do with the structure of the house. That includes permanent appliances and any landscaping work. But it will not cover the furnishings in the house as these are not permanent works.

Before signing up for a home construction loan, learn what the lender is willing to cover in the loan. Keep in mind that it affects the loan to value ratio and the interest rate.


What happens when you succeed in getting the loan?

Home construction loans are high-risk because there’s no collateral, and there’s no telling if the client will complete the project. So, the financial institution puts you on a schedule per the home construction timeline. At each stage, you will pay the interest accrued on the loan, and you will then get more of the principal amount to move on with the next phase of the project. It’s like a drip-feed, and if you meet your end of the bargain, the financial institution injects more money into the project. Easy!


What are the typical stages in home construction?

Each financial institution bases its home stages on its policies. But the stages often include laying foundations, framing the house, fittings, and finishes. At the end of each stage, an inspector or appraiser from the financial institution checks out the house. If they are happy with the progress, they report to the institution to release more funds. On average, this inspector will visit the site about five times during the home construction.


Do you continue paying the home construction loan after presenting the certificate of occupancy?

Home construction loans are structured differently. Note that you will not have paid off the principal during the construction. Instead, you will have paid the interest accrued on the original amount. So, to pay off the principal, the financial institution can convert the loan to a mortgage, using the completed house as collateral. We will cover the types of loans below.


What Home Construction Loans Are Available on the Market?

Some people want loans to renovate existing homes, while others want to build houses from scratch. Lenders cater to different loan categories as follows:


Construction to Permanent Loans

Remember when we stated that a lender could convert an existing home construction loan into a mortgage? That’s how this loan facility works. The lender calculates the total cost of construction coupled with the value of the home at its completion. It then injects money into the construction at each stage, and you pay off the interest at each of these phases. Once the house is complete, the lender converts the loan into a mortgage and uses the home as collateral to hedge against the risk. The loan can then extend for up to 30 years, with you paying the interest plus principal at a fixed or adjustable rate.

This loan type has only one set of closing fees and is the more affordable option.



Construction Only Loans

This loan facility lasts a year or less and provides you with the cash to build your home. It works like a construction to permanent loan in that you pay off interest at each stage of the home construction process. But it has one key difference- you can either get a mortgage or pay off the loan when the house is complete. For people who can pay off the loan in a lump sum, this option is good. But those that take up a mortgage end up paying two sets of closing fees, making this the costlier option. Oh, there’s also the possibility that you may not qualify for a loan after completing the house and could lose it to the financier. Weigh your options and gauge if you are financially stable enough to take up these chances or go for the construction to permanent loan.


Owner Builder Construction Loans

With construction to permanent and construction only loans, the borrower and the builder are different. But owner builder construction loans feature the same borrower and builder. Most lenders shy away from these loans but will offer such facilities to builders with licenses.


End Loans

Where a lender does not offer construction to permanent loans, end loans come in handy. These allow you to pay off the mortgage on the completed house under a different arrangement. So, you don’t get one but two closings to move into the home.


Home Renovation Loans

Home renovations can be costly, ranging tens of thousands of dollars at a time. If you would rather pay off the amount in stages, home renovation loans are a good idea. They come in different forms, including cash-out refinances, home equity loans, personal loans, etc. With all of these, the lender barely reviews how you will use the money. So you enjoy freedom in how you direct the cash during the renovation.


Do You Qualify for a Home Construction Loan?

Getting a mortgage often requires that you jump through hoops. Is that the case with a home construction loan? Let’s find out what you need:

  • A good credit score: It’s impossible to avoid this requirement when requesting a loan facility. Assess your credit score and look up ways you can improve it to meet the current lender standards.
  • A low debt to income ratio: Can you keep up with your level of debt? How much disposable income do you have once you clear your regular debts? The lender will want to ensure that you can pay off the interest at each stage.
  • Income: Are you working? Do you run a business? The lender will want to see financial statements dated an average of three years to understand if your income stream can support the interest payments.
  • Down payment: Most lenders require that you put up a down payment for the home construction loan. It gives them a good loan to value ratio and instills confidence that you can afford the payments. The amount will depend on the lender’s policies and the amount you want.
  • A detailed plan: The lender will track the project budget and schedule to gauge the payment stages. This plan should cover every aspect of the project. We at Hartel Homes can compile a project budget and timeline for you to instill confidence in your lender.
  • An appraisal: An appraisal is not necessary to secure a loan, but it gives the lender an idea of how much the complete home will be worth. This figure enables the lender to gauge just how much collateral they will get for construction to permanent loans.


Should You Get a Home Construction Loan?

You should consider getting a home construction loan if:

  • Your home construction does not have significant scheduling challenges: Can you get the materials on time? How about labor? Is anything standing in the way of successful project completion? Talk to your builder now and work out these kinks before getting a loan.
  • You can afford the payments: Is there any reason you might not keep up with the interest payments? Can you qualify for a mortgage? You don’t want to lose your house after spending months agonizing over its budget and schedule. Work out the figures now and decide before putting any ink on that paper.
  • The loan structures work for you: You’ve got the options of construction to permanent, construction to loan, owner builder, end, and renovation loans. Can you see one that works for your case?
  • You have secured homeowners insurance: Anything can happen during the construction process, and you should prepare for this too. Most lenders will even ask that you take out this policy to protect them if the house gets vandalized, suffers water damage, etc. Do you have a policy in place?


Securing a Home Construction Loan

Are you ready to sign the paperwork and get started on the construction? Here’s what you need to get a construction loan:

  • Work with a licensed builder: The lender will want to gauge your builder and if they have what it takes to complete the project on time and within schedule. Luckily for you, Hartel Homes is licensed and can walk with you on this journey.
  • Prepare your documents: Other than the requirements we stated earlier, the lender will also require the contract you sign with your builder. We will also provide you with references and our business credentials.
  • Go through the pre-approval process: Find out how much money you can get from the lender and the interest rate charged on the same. It’s advisable to shop around and get different rates before settling on one. Only then can you gauge if you can afford the home construction loan.


Are you sold on the idea of a home construction loan? If this feels right for you or you can’t quite decide yet, we would love to advise you on the next steps to secure this loan facility. We can help you figure out which facility will work best for you and point you to some of the best home construction loan lenders. Talk to us about securing a custom home construction loan.