Building a home is a dream for many people, but figuring out how to finance such a project can feel like a daunting task. Fortunately, construction loans are available to help you build a home that reflects your personal and functional needs—whatever they may be.
Much like the homes they finance, construction loans have multiple uses. And whether you’re a first-time homebuyer or a current homeowner looking to upgrade, understanding how to use construction loans is essential for financing your new home.
How They Work
With a construction loan, a bank or lender provides the money for your home’s construction in stages as your home is being built. During construction, you usually only pay the interest on the amount borrowed. When the home is finished, the loan either automatically converts into a regular mortgage with fixed monthly payments or you apply for a second loan (more on that below).
Qualifying for a construction loan is usually more stringent than a standard mortgage because your lender is financing something that doesn’t yet exist. In addition to a higher down payment, your lender will want to see plans for your home, a construction schedule, and a realistic budget—plus your builder must be licensed, insured, and approved by your lender.
Using Construction Loans
You can use a construction loan in several ways. One approach is to use the loan to purchase a build-ready lot and build a home from the ground up. This works well for people who have a certain floor plan in mind but haven’t found an existing home on the market that fits their needs. With a construction loan, you can search for a lot you like in a certain location and then finance both the lot and the building costs.
You can also use a construction loan to build on land you already own. If you’ve inherited property or previously purchased a lot with the goal of building on it one day, this option lets you use the equity in your land as part of your financing. The loan pays for the cost of building the home, including labor and materials. Depending on the loan type, it can either convert into a long-term mortgage when construction ends or be replaced with a separate home loan.
A third option is to finance the purchase of a custom home from a homebuilder in a planned subdivision. Many builders offer customizable floor plans in new communities. In this scenario, the construction loan can cover the cost of the home and lot together. This option offers a balance between customization and convenience for buyers who prefer a newly built home in an established neighborhood.
Closing Options
There are two types of construction loans available—a one-time close and a two-time close. With a one-time close, borrowers typically lock in their interest rate for their permanent mortgage at the beginning of the loan process. Then, once construction is complete, the loan automatically converts to a permanent mortgage with monthly principal and interest payments.
With a two-time closing, you’d start with a short-term loan that covers the cost of building your home. When construction is complete, you apply for a permanent mortgage to pay off the first loan and finance the finished home, which requires a second closing and new loan terms. Some borrowers prefer the two-step process because it can offer more flexibility when locking in a mortgage rate. This can be useful if rates fall during construction.
Right By You Mortgage offers construction loan solutions to help you realize your dream of building a home. Our Two-Time Close Construction Loan offers interest-only payments during the construction phase, no charge1 for periodic inspections, extended rate-lock options, and up to 90% financing2 and no origination fee3 on the permanent mortgage.
The right choice depends on your goals, your budget, and how much flexibility you want. Either way, a construction loan from Right By You gives you the tools to build your dream home with confidence.
Have more questions? The loan experts at Right By You Mortgage can help. Find a local mortgage loan officer or send us an email at inquiries@rightbyyoumortgage.com.
- No charge for periodic inspections within 40-miles of a Fidelity Bank branch. An inspection fee of approximately $75 per inspection will apply for homes more than 40-miles away from a Fidelity Bank branch.
- A borrower’s land can be used as an equity injection into the project.
- An origination fee will apply for the construction loan.
For example purposes, a 1-year interest-only construction loan for a home worth $750,000 with 10% down at a note rate of 9.00% and an APR of 9.00% would have a monthly interest-only payment of $5,062.50. Once construction is complete, the same home worth $750,000 obtaining a 30-year fixed-rate mortgage with 10% down at a note rate of 7.875% and an APR of 7.897% would have a monthly Principal and Interest payment of $4,894.21.
