New Home Construction: Loans and Financing

Building your dream home? Financing it is a crucial first step. Here's a quick guide to help you navigate loan options, rates, and terms for new construction homes. A key difference: builders of newly-built homes may offer attractive financing packages, either directly through their own mortgage subsidiary or via an affiliate as well bridge loans and new construction financing.

Why It Matters: Securing financing for a new home is different from buying a resale. Whether you're using builder financing or a traditional mortgage, understanding your options early on saves time and money.

What’s Ahead: We’ll cover loan types, down payment options, interest rates, government programs, and tips on comparing lenders—all tailored to new homebuyers.

The Basics: Preparing for a Construction Loan

1. Check Your Credit

• Start by reviewing your credit reports.

• Free access is available once a year via AnnualCreditReport.com.

• Fix any errors on all national credit bureaus (Equifax, Experian, Trans Union– credit scores impact loan approval and rates.

2. Gather Documentation

Prepare your income, employment, and asset documents. This includes tax returns, bank statements, 401(k) info, current household expenses, and assets. The more organized you are, the smoother the process.

3. Determine Your Budget

• Use mortgage calculators to determine what you can afford.

• Modern underwriting looks at your debt-to-income ratio, credit score, and employment history to set your maximum loan amount.

• Experiment with different rates, down payment amounts, and loan terms to see how that affects how much house you can afford.

Types of Loans for New Home Construction

Mortgage loans come in different shapes and sizes. Think of them in terms of their problem-solving characteristics:

FHA Loans for New Construction

• Best for: Minimal down payments (as low as 3.5%) and lower credit scores

• Benefit: Government-backed, less stringent underwriting

• Downside: Mortgage insurance increases monthly payments

VA Loans for New Construction

• Best for: Veterans and active-duty service members only

• Benefit: No down payment required, and no mortgage insurance

• Downside: Limited to those who qualify for VA status

Conventional Loans for New Construction

• Best for: Buyers with 10-20% down

• Benefit: Competitive rates; flexible options for fixed or adjustable rates

• Downside: Higher standards and fees for loans under 10% down, higher private mortgage insurance premiums

New Home Construction Loans

• Best for: Building a custom home

• Benefit: Short-term loans (6-12 months) that convert into permanent mortgages

• Downside: Requires a larger down payment (typically 20-25%) and higher interest rates during construction

Specialized Loan Options for New Home Construction

1. Construction-to-Permanent Loans

This loan combines the construction loan and permanent mortgage into one

• Benefit: Only one closing, reducing closing costs

• Downside: Requires a higher down payment and stricter eligibility

2. Bridge Loans

Used to cover the gap between selling your current home and buying a new one

• Benefit: Quick financing for down payments before your home sells

• Downside: Higher interest rates (often 2%+ higher than standard mortgages)

3. Two-Closing Loan

Used when buyer takes out a construction financing loan, closes upon build completion, and applies for a new loan for permanent financing

• Benefit: Helpful if construction costs go beyond budget

• Downside: More expensive due to two loan approvals and two closing costs

4. Government Grants for New Home Construction

Some local and state programs offer financial assistance or down payment assistance

• Benefit: Lower upfront costs for eligible buyers

• Downside: Typically requires meeting specific income or location criteria

Loan Interest Rates & Terms Comparison

• Construction Loan Rates: Typically higher than regular mortgages (around 6%-9% for short-term loans).

• Permanent Loan Rates: Convert into regular 30-year or 15-year mortgages, often around 6-7%.

• ARM Options: Rates can start lower but increase after 5 years (5/1 ARM, for example).

Tip: Consider a fixed-rate loan for stability, or an ARM if you plan to refinance before the rate adjusts.

Typical Closing Costs for New Construction Loans

• Builder Financing: Can reduce closing time but may come with higher interest rates or fees

• Construction Loans: Two closings if not using construction-to-permanent loans, meaning double the closing costs

• Closing Costs: Expect about 2-5% of the loan value, depending on your loan type and location

How Long Does It Take to Get Approved for a Construction Loan?

Approval time varies but generally takes longer than a traditional mortgage. Expect anywhere from 30 to 60 days for processing, as lenders will want detailed plans and construction timelines before proceeding.

Finding the Right Lender

• Mortgage Brokers: Look for brokers who specialize in new construction. They can guide you through the intricacies of builder financing, construction loans, and permanent mortgage conversion.

• Comparing Lenders: Shop around, comparing interest rates, fees, and down payment requirements. The right lender can save you thousands over the life of your loan.

The Bottom Line

Securing financing for new home construction is a detailed process.

• Consider FHA or VA loans if you're eligible for low down payments.

• Construction loans offer flexibility but expect higher rates and larger down payments.

• Whether you choose builder financing or traditional loans, always compare terms to ensure you’re getting the best deal.

Set Yourself Up for Success: Start by checking your credit, gather your documents, and explore all financing options. With the right preparation, your dream home is within reach.