With a shortage of homes for sale on the market, you may be looking to build your new dream home. Building your own home can be a tremendously rewarding experience. You get to make choices about everything from location and floor plan to colors and landscaping. At the end of the process, you have a truly special place to live, something uniquely yours. But how do you pay for it? And how do new construction loans work?
While a project like building your home can be both exciting and fun, there are many things to consider before you begin building. Probably the most important consideration is how this type of project gets paid for.
If you’re planning to build a new home securing financing through a construction loan is a crucial first step. But before signing on the dotted line it’s important to understand all the closing costs involved. Construction loan closing expenses can range from 2% to 5% of the total project budget. Being aware of these costs helps you budget accurately and avoid financial surprises down the road.
In this comprehensive guide, we’ll break down the typical closing costs associated with construction loans. I’ll provide details on common fees to expect, strategies to save, and how to choose the right lender for your new home build. Whether you’re building from the ground up or completing a major remodel, read on for insider tips to make the financing process smooth sailing.
What are Construction Loan Closing Costs?
Closing costs refer to the various fees and expenses charged to finalize and fund a construction loan. These charges are in addition to your down payment amount. Closing costs are typically between 2-5% of the total construction loan amount. With new builds often costing $200,000+, closing expenses can easily exceed $10,000.
It’s crucial to research and budget for these costs when applying for construction financing. The lender pays the costs upfront, and you’ll repay them over the loan term. Being aware of the exact fees helps avoid an unwelcome surprise at closing. Below I’ll outline the most common closing costs to expect with a construction loan.
Major Construction Loan Closing Costs
While specific charges vary, here are typical categories of closing costs on new construction loans:
Loan Origination Fees – This covers the lender’s costs to process the loan application. Often 1% to 2% of the loan amount.
Appraisal Fee – Paid to the appraiser to estimate the as-completed home value. Typically $300-$500.
Credit Report Fee – Covers the expense of the lender pulling your credit history. Usually under $100.
Title Search Fees – Paid to research liens, easements, or other title issues. Ranges from $500-$1500.
Attorney Fees – For attorneys to review contract documents and facilitate closing. Between $500-$2000.
Recording Fees – Charges to officially record your deed and loan documents. Varies per state and loan size.
Permits & Surveys – Municipality and surveyor fees for site permits and property surveys. $1000+ in most cases.
Interest Reserves – Funds set aside to cover mortgage payments during construction. Depends on your rate and build time.
Inspection Fees – For required structural, plumbing, and electrical inspections during the build. Typically $200-$500 total.
Homeowner’s Insurance – Required policy to protect against damage during construction. Cost based on home value.
Property Taxes – Prorated share of property tax for the portion built within the tax year.
As you can see, costs add up quickly. Don’t forget to factor in your down payment amount in addition to closing expenses.
Strategies to Reduce Closing Costs
Luckily, there are some options to lower your construction loan closing costs:
Increase your down payment – Putting more money down upfront reduces the loan amount and associated fees. But keep enough reserves on hand.
Ask about lender credits – Some lenders offer a credit toward closing costs based on factors like your credit score.
Pay discount points – Pay an upfront fee to receive a lower interest rate and long-term interest savings.
Shop multiple lenders – Compare quotes to find the best rates and lowest costs. Local banks and credit unions may offer deals.
Avoid high origination fees – Weigh origination charges vs. the overall interest rate when choosing a lender.
Waive escrows – If allowed, you can pay property taxes and insurance separately to avoid upfront escrow deposit.
Time the build – Schedule construction to avoid prorated taxes in high-tax areas.
How to Choose the Right Construction Loan Lender
Selecting the right lender is key to getting favorable loan terms and minimizing closing expenses. Here are tips for finding the best construction loan partner:
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Check interest rates and origination fees – Balance the two to find the best overall value.
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Ask about construction payment options – Look for structured draws vs. lump-sum distribution.
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Inquire about waiving junk fees – See if they can remove unnecessary charges for you.
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Review additional fee disclosures – Make sure you know all upfront and ongoing costs.
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Compare total closing costs – Don’t just look at interest rates alone. Calculate the entire expense.
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Check lender credentials – Look for an experienced construction lending specialist.
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Read reviews and talk to past clients – Get references on their service and fees.
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Make sure they have access to funding – Avoid delays by working with an established lender.
The lender you choose can significantly impact your total costs and the loan experience. Invest time upfront to find the right partner for your construction project.
Itemized Closing Cost Example
To give a better idea of specific charges, here’s an itemized list of sample closing costs for a $300,000 construction loan:
- Loan Origination Fee – $4,500
- Credit Report Fee – $50
- Appraisal Fee – $425
- Title Search – $825
- Attorney Fees – $900
- Recording Fees – $120
- Permit Fees – $1,250
- Survey Fees – $975
- Inspection Fees – $375
- Homeowner’s Insurance Premium – $2,400
- Property Taxes – $1,800
- Interest Reserve – $7,875
- Total Closing Costs: $21,495
As shown above, closing expenses can significantly increase your total construction costs. Careful budgeting and shopping for the best loan deal can yield huge savings.
Plan Ahead and Investigate All Costs
From loan fees to attorney charges and permits, construction loan closing costs encompass a wide range of upfront expenses. But armed with the right information, you can avoid sticker shock and make informed decisions. Now that you know what fees to expect, research options, compare multiple lenders, and budget accordingly. With diligent planning, you can achieve your dream home build affordably. Here’s to a smooth financing process and a successful construction project!
the construction loan process
Unless you have the cash on hand to fund your construction project, youre going to need a construction loan in order to finance the cost of the building project –and sometimes the purchase of the land itself.
A construction loan is a short-term loan that covers the cost of construction until the home is complete, and a traditional mortgage can be taken out. New construction financing differs from resale finance because the home itself doesn’t exist. This means if the payments stop and the lender needs to foreclose, they must finish constructing the house first. Naturally, this makes construction loans riskier and lenders more wary.
If you’re on the fence about building your own home – and curious about funding options, here’s a look at what you should know about new home construction loans.
types of construction loans
Construction Loans are usually short-term higher interest loans that last until the home is completed. In most cases, the lender pays the funds directly to the contractor rather than the borrower. These payments – also known as draws – often come in installments at different stages of development rather than all at once.
Now, let’s get more specific and look at some of the different types of custom home financing that are available today.
Buyers who choose a construction-only loan are usually looking for the best deal possible on a permanent loan. With this loan, the lender will typically offer enough money to cover the cost of the project, and the borrower will usually make interest-only payments until it’s complete. The principal balance is commonly due in full once the project is complete or one year later. This allows the borrower the freedom to apply for a mortgage once the project is complete. If the buyer chooses this route, make sure you know what to ask your lender before choosing a loan product.
Construction-to-permanent loans are very popular with homebuyers. With this type of loan, the buyer takes out a loan from the lender that’s essentially a line of credit, and the builder can draw from it at each stage of construction. There are on-site inspections at the various draw stages. At the end of the draw period, the construction loan converts into a permanent amortized loan.
The construction-to-permanent mortgage loan usually covers the cost of the construction project and the mortgage on the completed property. An interest-only payment during the construction period is typical with this type of loan. Theres only one closing with this type of loan because the borrower will be working with the same lender for the construction and the mortgage loan. The interest rate is usually the same for both loans, and there may be a penalty if construction exceeds one year.
The single-close loan eliminates a second set of closing costs. This loan requires only one application, and once it’s approved, theres no secondary approval process required.
Do I Pay Closing Costs Twice? (Construction Loan, Refinance)
FAQ
What are the closings costs on the loan estimate?
Is a construction loan harder to get than a mortgage?
What happens at the end of a construction loan?
What is loan to cost in construction?