New construction loans are a special category of loans.
Not all new construction requires a new construction loan.
And not all lenders offer them.
Whether or not you need a new construction loan is dictated primarily by two things:
- The type of house and location
- The builder
The type of house and location:
If you’re building in a large subdivision controlled by one builder and the lot is included in your build cost, your builder will likely not require a new construction loan. This is referred to as a tract home builder. They accept traditional financing, and a lot of them even offer financing.
Refer to the New Construction Series, Part 1, for more details on this type of build.
If you are building in a neighborhood that is not controlled by a builder or own land off a gravel road somewhere, you are more likely to need a new construction loan. At that point, it’s more dependent upon the builder.
The builder:
Not all builders require a new construction loan. Make this one of the first questions you ask when interviewing potential builders.
Without a new construction loan, the builder owns the home throughout the building process, with an agreement to purchase the home once completed. Once the building phase is complete, the purchasers take a loan on the finished home and ownership is transferred.
With a new construction loan, the purchasers assume financial liability upon closing the new construction loan, before construction has even started with the builder. I’ll go into more detail below about what the closing and building phase of a new construction loan looks like in New Construction Series, Parts 5.2 and 5.3.
BONUS: USING THE LOAN TO BUY THE LOT
New construction loans can be used to buy the lot. You can also buy the lot/land without financing and apply for the new construction loan once you have plans and a builder.
We did the latter: bought the lot, took our time developing the plans and interviewing builders, and then applied for the new construction loan.
The pro: you’re not on a timeline to finalize your plans and you can take your time selecting a builder.
The con: you may buy a lot and then later find out that you can’t afford to build the house you want or within the covenants of the neighborhood. Other life factors may change your financial situation and result in you not being able to get preapproved for the loan or for the amount you need to build the house you designed.
For example: we waited about a year and a half before applying for the new construction loan. In that time period, mortgage rates doubled and building costs changed (some decreased while most increased). Our neighborhood also has a minimum requirement for square footage, brick/stone, garage spaces, and driveway material. If including all of these items resulted in all builder quotes above what we could afford, then we would have been stuck with a lot that we couldn’t build on.
Disclosures:
*This information is specific to our experience. Every lender, county, and/or builder may be a little different.
*I am not a loan officer or associated with any lending institution.
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