There are many variables in construction loans for a new home. In general there are two loans involved the actual construction loan, and the mortgage loan. These two loans are much more sensible and economical when they are combined into one loan package by the bank. Combining you loan means one closing and one set of closing costs. This means saving several thousand dollars. Another benefit of combining the loans is the opportunity to lock in your interest rate. The interest rate is unprecedentedly low at the moment. It could eventually go up, so it is a good idea to lock in a low rate while rates are low.
Even when the loan is combined into one closing, it is important to remember that there are actually two loans. The construction loan will be active only during the construction process. Once construction is complete, the mortgage loan will pay off the construction loan and you will have to pay mortgage payments.
During the construction process, you will only owe interest on money that has been used for construction. For example if your loan starts in March, and your home builder takes out no money for materials in March or April, then you owe no interest for March and April. If you have borrowed $200,000 and only $70,000 has been withdrawn by July, then you only owe interest on $70,000 for your July payment. Some home building loans expect you to make these monthly interest payments while others add it to the mortgage loan. Which method is chosen depends on your situation, as well as the lending institution’s policy.
A mortgage loan is an amortization loan. Amortization utilizes a complex mathematical computation to equalize payments so that the borrowed amount and interest are divided into a certain number of equal payments. When considering a mortgage loan, you have to consider the actual cost of your home, and that includes interest paid, not just the cost of construction. Many people fail to see this and end up paying too much.
• The longer the term of the loan, the more interest you pay.
• The lower your interest rate, the less the house actually costs.
• The more money you borrow, the more interest you will pay.
• Early monthly payments pay more interest and less principle than later payments.
• Extra payments go entirely to the principle, so that making an extra payment can take several months off the term of your loan.
These three variables determine the actual cost of your home, as much or more than cost of construction. Over the course of a 30-year loan, you will pay at least double the amount of the loan in most cases, even at today’s low interest rates.
If you can possibly afford it, choosing a 15-year loan can usually save you over $100K. Yet, for the last several decades 30-year loans have been the industry standard? Why? Because people wanted the biggest nicest house they could possibly afford. People could pre-qualify for a larger loan amount, by getting a 30-year loan.
The lessons of the last decade have been tough ones. We have learned that perhaps borrowing as much money as possible is not the answer. We have also learned, or rather re-learned that our situation can change rapidly. It is a good idea to plan for an affordable home loan. The question is not always how much can you pre-qualify for? Instead ask yourself:
• How much can you afford no matter what, even if you or your spouse were unemployed?
• How much house do you really need?
• Can you live comfortably on the money left after you make this house payment?
The mortgage loan company will allow you to make payments of up to 35 percent of your current income. If you have no more outstanding debts, your house payment can be over one-third of your current income. In practice paying one-third of your income can be difficult. If possible, build a smaller home, save where you can, and go with a 15 year loan for one fourth of your income. This is a much more affordable standard, which most people find easier to handle. A smaller, more energy efficient home will save on utilities, and make your mortgage payment easier to make.
The construction loan will allow you to borrow up to 85 percent of the lot and construction costs, or 80 percent of the appraised value of the home, whichever is less. This calculation will determine your minimum down payment. The exact percentages though, depend on the lending institution, and your credit rating. Unless you qualify for an FHA or VA loan, you could easily have to make a 15 – 30 percent down payment.
It is easy to get caught up in the excitement of building a grand custom house. However, it is vital to think about how you plan to pay the mortgage. There are sacrifices to be made, and it is a good idea to consider your current budget, and where your income normally goes. Try making practice payments into a savings account in order to make a down payment. How much are you able to contribute to this fund now? It pays to be frugal and realistic when choosing construction loans for a new home.