How To Finance Your New Build
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Between picking out floor plans and custom finishes comes a crucial part of the home-buying process for new build families: securing financing.
Homeownership is the single largest purchase you’ll make in your lifetime. Whether you’re buying a new construction or moving into an existing home, the majority of homebuyers don’t have enough money tucked away to pay construction costs.
If you’re buying a new home that’s part of a new housing development led by a professional home builder, the process of securing a mortgage is similar to purchasing a resale home. Homebuyers need to save up for a down payment, get their credit score in prime shape, and shop around for the best rates and terms.
But getting a loan for a newly built home comes with some key differences in financing options and homebuyers need to be aware of them – from new construction loans to builder-arranged loans and bridge financing.
If you’re curious about the loan process and what financing packages may be available for your new build, we have prepared all you need to know in our step-by-step guide.
Determining a Home’s Affordability
Before you start shopping for a new home, it’s best to know just how much mortgage you can afford each month – and how much lenders are willing to commit to. With that figure in hand, you’ll know which houses are in the right price range and which are out of bounds.
As a rule, lenders typically suggest that prospective homebuyers finance a loan that’s about 2 to 2.5 times their gross income. If you’re a couple earning a combined income of $200,000, that means you can afford a $400,000 mortgage, for example. But this doesn’t take into consideration other factors, like your individual financial and personal circumstances.
Start your own calculation process so you can decide how much mortgage you can comfortably afford. Add up your monthly income and tally up your debt repayments, such as credit cards, student loans and lines of credit. Calculate your non-housing monthly expenses: car payments, childcare and other fixed costs.
When you subtract your debts from your income, what’s leftover? This is the amount that can go towards your mortgage payments and other homeownership expenses.
The Homes.com mortgage calculator can help you do the number-crunching, too. This is a great springboard for you to gain an understanding of what’s factored into home affordability equations.
Save for your Down Payment
Once you decided the time was right to buy a new home, you likely carved out a budget and began a savings plan to put together cash for a down payment.
Your down payment is the lump sum payment you make when you purchase your home. Most lenders require that homebuyers put down 20 percent of their home’s purchase price to qualify for a conventional loan. If you know how much your new home will cost, you can aim to save up for one-fifth of it.
If you’re on a tight budget and you still can’t commit to that amount, there are loan options that accommodate smaller down payments. You can also apply for private mortgage insurance, or PMI, for any loans without paying the full 20 percent down.
A hefty down payment will help you secure a loan. The bigger the down payment and the smaller the loan, the less risk your lender needs to take.
Get your Credit Score in Prime Shape
Before exploring loan options, you need to get your financial house in order because your lender will run a background check on your creditworthiness. This make-or-break step will determine whether you secure a loan or not, and what the interest rate will be.
Your lender will consider your gross income, your Social Security benefits, and your credit score. Your credit history is incredibly important here. Have you defaulted on loans before or are you punctual?
Before applying for a loan, pull your credit reports from Equifax, TransUnion and Experian to make sure there aren’t any surprises and you can address any issues. Pay down your outstanding debts as much as you can – this will lower your debt-to-income ratio as you ask for more financing.
Explore Financing Options
Your loan options are plentiful, depending on what suits your needs and what programs you may be able to qualify for. Here’s a list of financing options for a new build home:
Government Loan Programs
If you qualify, it’s worth considering government-backed loans, which provide home buyers major benefits with home financing. They include:
Federal Housing Administration loans are government-backed mortgages designed to help low-and moderate-income homebuyers. As of 2020, loans provided by FHA-approved lenders, require only 3.5 percent down payment. These are easier to qualify for if you don’t have a perfect credit history. You’ll need a credit score of at least 580 to qualify – if it is between 500 and 579, you can still secure an FHA loan with a 10 percent down payment. With conventional loans, you’ll need a credit score of about 620.
Each state has different FHA requirements, so do your research on your jurisdiction. If you have filed for bankruptcy, you must wait two years after declaring to apply. And if you have lost your previous home to foreclosure, you must wait three years and have a clean credit history during this timeframe.
Offered to veterans and military homebuyers, VA home loans are one of the most unique loan programs in the country; the incentives are substantial, including no down payment, no private mortgage insurance, better terms, and lower interest rates.
VA home loan programs are offered by the U.S. Department of Veterans Affairs to help veterans buy, build, or improve a home or refinance current home loans. There are four VA-backed loan types but for new homebuyers, purchase loans are the most relevant.
Essentially, VA loans are backed by the government, acting as a guarantor on your mortgage. This means there’s a decreased risk for the lender, so they will be more likely to approve loans with better terms. Nearly 90 percent of all VA-backed home loans are granted without a down payment. You’ll still need to shop around for a VA-approved lender to execute your government-backed loan.
Builder and Developer Sponsored Financing
These days, buying a new home can be a seamless process, with builders offering a hand with the entire process, from sales, design and customizations, to financing and closing.
Prominent builders and developers are usually affiliated with or have wholly-owned mortgage subsidiaries. They are in the same category as banks and mortgage companies and can provide financing to homebuyers. Because builders have become a one-stop shop for some of their clients, they are often also affiliated with title insurance and settlement services.
It’s always a good idea to discuss financing, title insurance and settlement service options with your builder. If you opt to work with them on financing, they’ll often provide great perks, including price breaks on your home, free upgrades, or paying closing costs. Some even offer a cash incentive or pay your home insurance policy for the first year. If you’re in the early stages of your home’s construction, they may even offer to guarantee or lock in your mortgage rate.
In some cases, the builder’s financing may be easier to secure because they’re familiar with the construction and all of the details are under one roof. They may be more inclined to offer you discounts or approve your loan application because you are purchasing one of their homes.
Still, do your homework; compare interest rates and fees to verify theirs are competitive.
Conventional Home Loans
A conventional home loan is a mortgage offered through private lenders, namely banks, mortgage companies and credit unions. If you have accumulated a down payment of about 10 to 20 percent but you aren’t eligible for government loan programs, then conventional mortgages are your best bet.
To qualify, you’ll need to meet common requirements: a solid credit history, stable income, low debt-to-income ratio, and finally, have saved a 20 percent down payment – or will purchase private mortgage insurance to secure your loan.
Bridge Financing Loans
Occasionally, tricky situations arise when homeowner’s haven’t sold their current home; this is when a bridge loan is a useful tool. Bridge financing provides a short-term loan – of about six to nine months – to get you the funds you need in the interim.
Your lender will use the equity tied up on your current home as collateral and advance you the cash for your down payment on the home under construction. Once your former home sells, you can pay off the bridge loan.
These loans are only a temporary solution to this specific situation. They usually have a higher interest rate – perhaps two to three percent higher – than regular mortgages. The demand is high, making them a common product provided by most major banks.
New Home Construction Loans
These are options for homebuyers who are building a custom home, with the help of a contractor or builder instead of going the new construction route that’s part of a builder’s new development. In this instance, traditional mortgages aren’t feasible.
Construction loans are typically higher-interest, shorter-term loans that help homebuyers pay for the various stages of the building process. They include construction-to-permanent loans, which fund the construction of your property and convert to your subsequent long-term mortgage to pay for the home, while construction-only loans pay building costs.
You can discuss costs and timelines with your builder to gain clarity on your financial needs. With custom homes, homebuyers will also need to factor in the price of a lot or land.
These loans aren’t as prevalent as the other options mentioned, so take your time finding a lender who is familiar with the entire construction lending process. Ask about their construction loan programs, rates, terms and requirements.
Progress Draw Mortgages
These provide staggered funding to homebuyers; lenders release loan installments as construction reaches various checkpoints. There are traditionally four phases with phase 1 covering the costs for the plot and laying the foundation, to phase 4 – which is the final payment.
The middle two phases mark when your property is 30 to 50 percent complete, and then 50 to 70 percent complete.
To make sure the construction of your home is progressing smoothly and on time, your lender will send a home inspector to the property before issuing the next installment. If the inspector is unhappy with the workmanship or progress, your loan could be rescinded.
Choose your Lender and your Terms
With many financing options on the table, your job is to choose the one that best suits your needs and your financial situation.
With particular loans, such as VA and FHA, you’ll need to meet certain eligibility criteria, along with finding a government-approved lender. These requirements narrow the scope of who has access to these loans and which lenders can provide them.
In other cases, such as with bridge financing and conventional loans, homebuyers have a handful of lenders to choose from. And remember to do your homework and compare interest rates.
You’ll also have to take stock of your own financial plans, such as your ideal amortization period and how much of a down payment you can afford.