Financing Building your Own home
Building your own place is a tradition as old as civilization itself. Of course, it's a bit more complicated than it used to be.
No matter how handy you are, you’ll need the right kind of financing for your house to go from first architectural draft to completed structure.
Types of financing
Construction-to-permanent financing: Lenders provide a single loan that includes the cost of construction and the home's mortgage.
During the duration of construction, usually 6 to 12 months, you make interest-only payments on the loan. Some lenders may offer an extended period of interest-only payments before principal payments kick in. When the house is done, the loan converts into a standard 30-year loan. There’s only one closing, which means less closing costs. However, you won’t be able to shop around for mortgages from different lenders.
Construction loan: A short-term loan provided by a lender to complete a specific project. When construction is complete, the principal amount is due. You can shop for your own mortgage to accompany this loan.
It can be difficult to get a loan for both the construction project and the land. Not only will you need great credit, you’ll also need to show a lender a detailed plan.
Most lenders are very wary of lending to someone without a proven track record of building homes, so this is where the wind may be removed from the sails of many buyers.
“It is very difficult to find a lender that will finance a self-managed project, " said Melissa Cohn, president of New York City-based lender and brokerage GuardHill Financial. "A few banks may offer it, but expect the rates to be higher.”
Paying for land
With that in mind, it helps to already own your land. It will cut down on overall costs, and you can leverage the land to get better rates. With down payments typically starting at 20% for construction loans, not owning land in advance of construction can be a deal breaker for some buyers.
For your best chance at approval (and a lower down payment), have a detailed plan ready for the lender to review, and plan on starting construction as soon as possible. If you’re looking to finance land now with plans for construction beginning later, expect to shell out a higher down payment.
- Set aside some money and hire a lawyer familiar with construction law to go over the builder’s contract before committing to a project.
- Lenders view construction loans as riskier investments than traditional mortgages. Expect to pay a slightly higher interest rate. For construction-to-permanent financing, you're likely going to have to pay a quarter-point more.
- You may want to find a lender who will let you lock in rates during the construction or preconstruction period if you believe rates are going to rise. If not, adjustable-rate mortgages for construction loans are also common.