Buying land and building a custom home from the ground up is an exciting prospect for many prospective homeowners With a construction loan, you can design and build your dream house exactly how you envision it However, financing a construction project requires some careful planning and preparation. In this comprehensive guide, we’ll walk through all the key steps involved in securing financing to buy land and build a house.
Overview of Construction Loans
A construction loan also known as a builder loan, is a short-term financing option that provides funds for buying land and paying costs related to building a new home. It works by providing access to the money needed for construction in phases over the course of the project.
Here are some key things to know about construction loans:
- Designed specifically for financing new construction projects
- Typically have variable interest rates
- Require only interest payments during construction period
- Loan balance is disbursed in multiple draws as construction milestones are met
- Once construction is complete, the loan converts into a traditional fixed-rate mortgage
Construction loans make it possible to build a customized home without having to pay for the entire project upfront. The loan provides access to the necessary funds when you need them to keep construction moving forward.
Step 1: Find Land to Purchase
The first step in securing a construction loan is identifying and purchasing a lot or parcel of land to build on. There are a few options for acquiring land:
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Buy land outright: One option is to purchase land completely with your own funds through cash or a land loan.
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Finance land in construction loan Many lenders allow the land purchase to be rolled into the total amount borrowed for the construction loan
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Use land you already own: If you already own a suitable plot of land, you can use it for the home building project without having to buy.
Make sure the land meets local zoning and building requirements before finalizing the purchase. Factors like size, terrain, access, and utilities will impact overall feasibility and construction costs.
Step 2: Find a Reputable Builder
Next, you’ll need to find a qualified general contractor to oversee building your new home. Look for an experienced local builder with proven expertise constructing similar properties. Key things to look for include:
- Strong reviews and references from past customers
- Examples of recently completed construction projects
- Extensive knowledge of local building codes and permitting
- Adequate insurance coverage
- Financial stability
Vet potential contractors thoroughly—this is a very important relationship that impacts the success of your build. Make sure you connect well and can communicate clearly.
Step 3: Choose a Construction Loan Lender
With the land and builder in place, the next step is finding the right lender for your specific construction financing needs. Shop around with multiple lenders to find the best loan option. Here are some things to look for:
- Construction loan experience and expertise
- Competitive interest rates
- Low fees
- Flexible draw schedules and dispersal options
- Strong customer service throughout construction
Look beyond big banks and explore local credit unions, community banks, and online lenders. Compare interest rates, loan terms, and fees to find the most affordable financing package.
Step 4: Complete the Loan Application
After selecting your lender, you can submit a formal application for the construction loan. Be prepared to provide:
- Detailed personal financial documents
- Information about the land/property
- Your credit history and score
- Plans and specs for the home build
- The builder’s credentials and project timeline
- Permitting and approvals
The lender will evaluate your creditworthiness, assets, debts, and income to make an official loan decision. Provide complete, accurate information for the strongest loan approval position.
Step 5: Close on the Construction Loan
With loan approval secured, you can complete the closing process to access the construction funds. This involves signing final loan documents and paying closing costs like appraisal and origination fees. Ask the lender for a full breakdown of estimated closing costs.
At closing, you’ll likely receive an initial loan disbursement to cover land acquisition, permits, and design work. Construction will begin soon after!
Step 6: Receive Draws Over Construction Period
Once building is underway, loan funds will be issued in predetermined installments called draws. Draw schedules are agreed upon upfront and issued upon inspection and confirmation that work is complete.
Typical draws align with major phases like:
- Foundation/footings complete
- Framing done
- Roofing complete
- Interior finish work
- Final Completion
Draws simplify cost management and ensure adequate financing is available to keep the project moving on schedule.
Step 7: Construction Completes – Loan Converts to Mortgage
When construction wraps up and you receive a certificate of occupancy from the local building department, your construction loan converts into permanent financing. This is usually a traditional 15 or 30-year fixed-rate mortgage.
Your lender will arrange for the final inspection and appraisal needed to transition into the permanent mortgage. You’ll then begin making principal and interest repayment on the fixed-rate loan.
Finding the Right Construction Loan
Securing financing is one of the most important steps to buying land and building a custom home. With a construction loan, you can build your dream home from the ground up over time as funds are needed to pay for materials and labor costs. Do your homework to find the perfect loan for your unique new construction project.
USDA construction loan disadvantages
The biggest drawback to a USDA construction loan is that they can be difficult to find and are rarely offered by lenders.
- Its hard to find a lender: Even though USDA backs them, not many lenders offer this type of loan
- Lengthy closing times: USDA construction loans require patience from everyone involved. “They take longer to close and could involve Realtors, insurance agents, city or county permitting requirements, builder approval, multiple underwrites of your credit file, appraisals, and more,” Duncan notes.
- Paying guarantee fees: USDA charges both upfront and annual guarantee fees based on your loan amount. The annual fee is broken into 12 installments and included in your regular monthly mortgage payment
- Higher interest rates: The interest rate you’ll be charged will likely be higher than for a standard home purchase or refinance loans
However, you might only be stuck with that higher interest rate for a while.
After your home is built (at least 220 days later) and after making six on-time payments, if market conditions allow, “you can opt for a streamline refinance or rate-and-term refinance to lower your interest rate, if possible,” adds Duncan.
While many requirements and restrictions are involved, “once obtained, this is one of the best loans for a borrower to build their dream home with little to no money paid out-of-pocket,” says Duncan. “As a result, you can save your liquidity, increase your landholdings, and avoid the higher 10 to 25% down payment requirements that other traditional lenders may stipulate with more associated risks.”
Submit your loan application
After you’ve gathered all the necessary information, you’re ready to send off your USDA loan application.
Before submitting your application, confirm your contractor and the location of your property, as these details are required for qualification. Depending on your specific circumstances, the loan process can take up to 60 days to complete.
Use A Construction Loan To Build A House?
FAQ
Is it better to buy land first and then build?
Is it harder to get a loan to build a house?
Should I pay off my land before you build?
How hard is it to borrow money to buy land?
Can I finance a land purchase & construction for my home?
Yes, if you want to finance a land purchase and construction for your home, you can apply for a construction loan. This is a short-term loan covering the land, labor, materials and permits. Once your home is built, you’ll convert the loan into a mortgage to pay for the completed home.
Should I get a land loan or a construction loan?
If you have circumstances pushing your building project out a year or more (or you’re still getting your home plans together), a land loan is likely a better choice for you. While I, Rocket Mortgage, don’t offer land or construction loans, you can still qualify for a mortgage on a new-construction house.
How do I get a Home Builder loan?
You can obtain a land or construction loan from a local credit union or community bank. Remember these loans get your house built, but in most cases you will also need to obtain a mortgage. If you are not ready to begin construction right away, a land loan is probably your best option.
What type of loan should I take out when buying land?
The type of loan you should take out for buying land depends on where you’re buying land and how you intend to use it. A land loan is different from a construction loan, which is another type of loan often used by people looking to build a house.