Financing New Home Construction

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New home financing differs from a traditional mortgage. Equity is still required, but managing the construction loan differs depending on the financing vehicle you choose. Fewer first-time homeowners are buying brand new homes, according to the National Association of Home Builders (NAHB). That may be because it’s hard to finance a newly built home without a major asset to borrow against. Michael Carliner, an economist with the NAHB, adds that most homebuyers need a house for collateral when building their new home. As a result, present homeowners are responsible for most of the new home starts. New home buyers tend to be married with children and are typically trading up for bigger and better homes that can be customized to meet their needs, according to the Economics Group at the NAHB. But to build that home, owners will need a loan. How, then, does one finance a home under construction? Using an Existing Home for Construction Equity Financing new home construction usually follows one of three financing avenues: a home equity loan, a construction loan, or a bridge loan. A home equity loan is a great option for those who own their own home free and clear. Lower closing costs are a primary benefit since homeowners may not need an appraisal or a title search. With individual financing like this, the homeowner takes responsibility for paying the builder as work progresses. If the new construction costs more than the present house eventually sells for, a new, smaller mortgage is often sought when construction is completed. A construction loan is for those have sold their house and are using the proceeds to help fund the new home. While construction is under way, these people opt to live in temporary quarters. Some may even work out an arrangement whereby they rent their sold home from the new owners until construction is complete. A bridge loan is for homeowners who have not yet sold their present home and have a mortgage on it. With a bridge loan, the lender allows a homeowner to borrow against the present house before it is sold to “bridge” the funding for the new construction. The loan is usually equal to a percentage of the expected sale price, often 80 percent, and is good for six months. If the present house does not sell after six months, the homeowner then pays on two loans – for the present home and the new home. This is why lenders frequently apply the worst-case scenario in determining eligibility: A homeowner must qualify to pay both loans. Construction Loans The most common financing vehicle for new home construction is a construction loan. The application process is the same as for a mortgage. It requires a down payment, that typically equals 20 percent. Borrowers must provide proof-of-earnings statements, verification of employment, debts not noted on credit reports, and other information. Lenders offer a variety of construction loan options that can vary by region and even by borrower, based on duration of employment and credit score. Options also vary depending on whether the loan can be approved locally, which may provide some leniency, or whether it is dependent on computer underwriting, which works by a set of standards.

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