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Construction loans: A guide to building your home

Jason Naber
03.17.21
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Building a home is an emotional journey. But when done right and with the right team to support you, it can also be very rewarding. Seeing your vision come to fruition and your dream house constructed the way you want it is a deeply satisfying feeling. Because of the emotional reward, building your own house can be a good alternative to buying.

As a mortgage banker with more than a decade of providing construction loan assistance to borrowers, I can share some important considerations before you embark on your home construction journey.

Considerations before building

In addition to choosing a construction loan closing option, here are some things to consider before you start your cabin or home building project:

Do your homework

Do you already have a builder in mind? Do you have the floorplan and specs? Don’t assume your builder will be able to commit to building your house immediately. You should also factor in ample time to get multiple quotes from builders before making a decision. Always ask for references, including the supply companies with whom the builder has done business.

Choosing the site

Where you decide to build your house matters. Unlike buying a home where your main concern may be the neighborhood, if you are building a house, you need to consider zoning and soil issues. If you are building in a rural area, you may need to build roads to your house and utilities.

Know your level of involvement. How much do you want to be involved in the building process and how much will your builder let you be involved? Some borrowers want to be heavily involved in the building process and work together with family to build their house. Others prefer working with independent contractors because it gives them more control in the building phase. If you like being heavily involved in the construction process, create a schedule and stick to it to avoid any delays in the building phase. Factor extra time into your schedule for any hiccups that may delay completion. If you are inexperienced or prefer a more hands-off approach, working with an experienced builder or contractor may be a good option.

Keep your project on schedule

What may seem like small changes can drastically alter your cost to build and expected date of completion. For instance, switching from laminate to granite countertops will require you to complete a change order. If the change increases your expenses, you may have to pay for it from your cash reserves. All coverages must be explained at the time of the draw request and coverages of more than 5 percent will require a review by your mortgage banker.

Be emotionally and mentally prepared

Building your own house gives you a deep sense of accomplishment but it is not always an easy journey. Understand that you might have to be committed to the project for months or even a year. Typically, the timeframe for a construction loan is a year and although the loan can be extended, most people want to finish their construction within the year. That means that you have to be mentally prepared to work on the project whenever you can to meet the deadline, especially if you are not using a builder.

Choosing between one closing or two

Construction loans are structured like a low-interest, short-term line of credit with draws to pay off construction costs during the building phase. Throughout the construction process, you make interest-only payments on your draws. Once construction is complete, the loan will transition from a construction loan to a permanent mortgage loan generally with a longer term.

There are two closing options typically available to borrowers: one closing or two. 

One closing option

With this option you are closing one time on both your construction loan and your permanent mortgage loan. The benefit of one closing is the ability to lock-in your interest rate early in the loan process to take advantage of a favorable rate. Having a locked interest rate means you do not have to worry about rising interest rates during the construction process. Some customers prefer a one-time closing because once they qualify for the loan, they don’t have to worry about submitting more documents and can focus on their construction project.

However, what you gain in locking in a good interest rate, you lose in flexibility. With one closing, you are given 10 months to complete the construction. If the construction cost goes up due to unforeseen circumstances or if you decide to change your home design or materials (e.g. switch from wood flooring to marble), you will no longer be able to change your loan amount. With one closing, you will not be able to make any adjustments on the loan value. If you find that you need an upgrade or more money during the construction phase, you will have to pay out of pocket or get another loan.

Two closings

Two closings work a little differently. You will close once on your construction loan and after construction is complete, you will close on your permanent mortgage loan. With two closings, you are required to update documentation and pay closings costs on each loan but there are no bank fees for the second closing. Although you do pay some closing costs twice, the low rate on the construction loan could provide enough savings to outweigh the second closing costs. The main benefit of selecting two closings is its flexibility. You are given a 12 to 18-month construction period, if your construction cost goes up during that time, you can still restructure your permanent loan if you are within the guidelines to make those changes.

If you are deciding between the two closing construction loan options, the key question to ask yourself is this: Are you confident that your numbers are going to stay the same throughout the construction period or do you think it might significantly change upwards? If you are hiring a builder and have signed off on the project cost, a one-time close may be a great option for you. However, if you are building the cabin or house on your own, there may be more variations to your costs. If you anticipate making a lot of changes during the building phase, a two-time close might be the better option. A two-time close could also be a good option if we are in a declining rate environment.

When it comes to choosing a lender, Bremer offers a one-time close with a fixed-rate mortgage loan as well as adjustable rate options, whereas most banks will do a one-time close with an adjustable rate mortgage loan only. Before you commit, I recommend speaking to a Bremer mortgage banker with expertise in financing construction loans to determine the best option for your situation.

The importance of having a single point of contact

Borrowers will often have many questions and need guidance. Having a single point of contact that you can call on from the beginning of the construction project can help relieve stress and increase the chances of meeting the building completion deadline.

I recommend working with a bank who offers a construction loan from start to finish. This ensures that you are working with a dedicated person who understands your construction plans instead of having to deal with multiple lenders or people at different points of the building process. It is hard enough to keep track of the multiple tasks when building a house let alone the different lenders or financing company.

Embarking on a house construction project is a truly exciting endeavor. From budgeting, planning, construction, loan processing and closing to permanent loan financing, download our comprehensive guide on the steps you should take when constructing your home.

Jason Naber

About Jason Naber

With more than 20 years of banking experience, Jason Naber is well versed in FHA/VA, conventional and first-time homebuyer loans, with a specialty in construction lending. He has worked with various types of borrowers, helping them build or remodel from northern Minnesota through the Twin Cities and into western Wisconsin. As a Minnesota Housing (MHFA) and Dakota County certified loan officer, Jason has the experience necessary to assist First-time Homebuyers regardless of where you are looking. 2009-2021 Bremer Mortgage Platinum Club 2013-2020 Minnesota Housing Platinum Level Top Producer 2019 & 2020 Dakota County CDA Star of the Year )

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