Construction loans for new homes are simple balloon loans that expire once the house is built, leaving the entire cost of construction due at the completion of the house. In order to finance the cost of the home, home owners will need a mortgage loan. For this reason most lending institutions offer home buyers the opportunity to combine these two loans and get them both at the same time. The process of getting these two loans can be a bit confusing if you do not understand the purpose of each type of loan.
When money is borrowed for a construction loan, the money is placed in an escrow account accessible only by the home builder. Home owners owe no interest until money is drawn from the account. For example if the home builder withdraws $10,000 the first month and another $20,000 in the second month, then the home owners owe interest on $10,000 for the first month, and $30,000 for the second month. As more money is withdrawn from the escrow account each month, the interest is owed only on money borrowed so far.
In some construction loans for new homes the interest owed is paid monthly by the homeowners, but in other construction loans the interest is subtracted from the escrow account, and added to the money owed at the end of the construction loan. Which type you choose depends on the home owner’s circumstances, and which policy the lending institution prefers.
When construction is complete, any unused funds are returned to the bank, and home owners only owe the money actually used for construction of your home. The construction loan expires at the completion of the home, or after one year, whichever comes first. At that time the construction loan is due to be paid in full.
Home construction loans are designed only to provide funds for the construction of the home. They contain no plan of repaying the principle. Home construction loans for new homes are designed to pay out money, not to collect repayment. For this reason home owners will need a mortgage loan.
Mortgage loans are amortization loans. This means that the amount of the loan, called the principle, and interest are divided into payments of an equal amount. Even though each monthly payment from the first to the last will be the same amount, there is a certain inequality between the first and last payment.
In the beginning of an amortization loan, early payments go almost entirely to interest, while only a small amount of the payment goes towards repayment of the principle. In other words if you owe $200,000 then the interest on this amount is more than near the end of the loan when you may only owe $10,000, yet since the payments have to be equal, your early payments go mostly towards interest and your later payments go mostly towards the principle.
Many people choose to make extra payments at the beginning of an amortization loan, because every penny of an extra payment goes toward the principle. An extra payment early in the loan, can take months off the term of your loan. Another way to save on a mortgage loan is to take a shorter term loan. A 15-year loan can save home owners over $100,000 in interest compared to a 30-year loan.
While home owners can still obtain these loans separately, it is much more advantageous in most cases to close both loans at once. It reduces the cost of closing and other bank fees, and when interest rates are low, it locks in the interest rate at the current, very low rates. Plus, it’s always nice to have the issue settled, since at the end of the loan the home owner will owe the full amount of the loan. It’s nice to know that the mortgage loan is already in place, and just waiting for the day your home will be completed. You will not owe mortgage payments until your home is complete, either way.
Construction loans and mortgage loans are not complicated once you learn what they are for. Amortization loan payments are hard to calculate without a specialized calculator, but thankfully there are many mortgage calculators available online. These calculators will help you understand how much you can afford based on the amount of monthly mortgage payments. You will be able to determine how much to spend on your house based on your income and other expenses. While banks allow payments of up to one third of your income, it is not necessary to borrow that much if you do not need to. Understanding construction loans for new homes makes it much easier to plan financing for your home.