If you are about to seek a loan to buy a new house, you may be wondering, “How do home building loans work?” It can be confusing unless you understand one simple fact which clears up most questions. A home building loan is a different loan than a home mortgage loan, and you will likely need both. A home building loan is used to gradually spend the money on the home. The mortgage loan is a plan to repay the money borrowed during the home building loan.
How Do Home Building Loans Work: Two Loans, One Closing
Many lenders offer loans which combine the closing for both the home building loan and the mortgage loan. In this way, you can lock in a really low interest rate for your mortgage, and save on closing costs. It is also nice to know, since you will owe the full amount of the loan at the time your home is completed, that you have a home mortgage loan waiting in the wings to pay that off.
When the home is complete the entire amount of your home building loan is due, like a balloon note. The home building loan is not a mortgage loan and therefore has no reasonable plan by which you can pay it off. Therefore the mortgage loan pays off the home loan, and now you have a mortgage loan. You also now have regular monthly mortgage payments!
Money in a home loan escrow account can only be withdrawn by the general contractor. Unless you are acting as the general contractor you will not have access to this money. Your building contractor will. Any unused money will be returned to the bank with no interest owed, once construction is complete. If you plan to have a contractor build a shell only and you plan to complete the interior later, it is important to make that clear to the lender, so that arrangements can be made for a change in the authorization of payments. It can be done, but it is important to tell them in advance.
The term of a home building loan is for one year, or until construction is completed. During that time you will only be required to pay the interest on the principle used. If by July for example your building contractor has withdrawn a total of $80,000 from escrow account which holds your home building money, you will owe the interest on $80,000 not interest on the entire amount. If by September he has used $150,000 then you owe only the interest on that amount. In the first month, before any money was withdrawn you owed no interest. Some lenders expect this interest to be paid monthly, but other home building loans just add the interest to the total cost of the home. It is usually an option decided at the beginning of the loan.
The mortgage loan is best thought of as completely different money than the money from the home building loan. The money from the home building loan is gone. You have spent it building the home, so you must borrow money to pay off that loan, since that loan has no plan of repayment. Your mortgage loan is also borrowed from the lending institution, and it pays off the home building loan so that it no longer exists. It’s gone, paid off and no longer effective. Your mortgage will be only for the amount of money you actually spent on the home. A mortgage loan’s payments will eventually pay off the cost of home and the interest, in equal monthly payments over either 15 or 30 years. In the beginning most of your payment goes to interest, but if you make extra payments, the additional money goes to pay off the principle. In this way, you can take months or even years off the total number of payments, when you make extra payments. So, how do home building loans work? First you spend the home loan money gradually on building the home, but after the house is built you repay it with the mortgage loan.
I hope you found this article on “How do home building loans work?” useful.