Maybe you have a clear vision of your dream home: the very latest in energy efficiency! Shiny new granite countertops in just the right color! You’ve gone to all the open houses, you’ve combed the real estate listings, and you just haven’t been able to find anything in your local area that comes close to the home you envision.
Or maybe you live someplace where the existing housing stock just isn’t sufficient to meet the demands of your rapidly growing community. In plenty of places in the country, buying a newly constructed home is more feasible and less expensive than waiting around for the right currently occupied home to go on the market.
There are plenty of reasons people choose to buy newly constructed homes. If you’re thinking about purchasing a new home, there are a few additional considerations you’ll want to keep in mind when it comes to your mortgage.
New Construction Mortgages and Construction Loans Are Not the Same Things
If you’re dreaming about buying an empty lot and hiring an architect and a contractor, we’re happy to report that it is definitely possible to get lender financing to construct a new home from the ground up. But! A loan to construct a home and a mortgage for a newly built home are two very different things.
For one thing, getting approval for a construction loan is tougher than being approved for your everyday, run-of-the-mill mortgage.
With a regular mortgage, your home is collateral on the loan. If your relationship with your lender goes south and you can’t pay your mortgage, your lender at least has a home they could sell to recoup some or all of their losses. For a construction loan, a home doesn’t yet exist, so lenders are more cautious about lending money to build homes than they are about lending mortgages to buy them.
Getting a Construction Loan
If you do decide to go for a construction loan, you’ll need excellent credit and a sizable downpayment—think something in the 20% to 30% range. You can also expect a thorough review of your finances, and your construction plan, along with multiple check-ins and appraisals from your lender as construction proceeds (hopefully on schedule).
Not every mortgage lender offers construction loans, so you’ll need to shop around. Construction loans usually have relatively short terms—a year or so is pretty standard. At the end of the term, the full construction loan will need to be repaid to the lender. Construction loans also generally have higher interest rates than mortgages: again, they’re a higher risk for lenders.
Most folks who get a loan to construct a home convert that loan into a mortgage once the home has been built.
There are lenders who offer combined construction and mortgage loans, but use caution and crunch the numbers before signing on: locking in your mortgage with the first company that agrees to lend you money for construction could have you end up paying a higher interest rate than you might have if you’d shopped for your mortgage.
What’s Different About Mortgages for New Construction
For now, we’ll assume you’ve either got a construction loan that you’re looking to convert to a regular mortgage, or that the builder or developer for your new housing community has taken on financing the building project, and that you’re simply looking for a mortgage to buy that newly constructed, nearly complete home.
With any mortgage, your lender is going to want a professional to appraise the home being purchased. An appraiser will also make sure that the home with worth at least as much as the homebuyer is borrowing to pay for it.
When a homebuyer is applying for a mortgage to buy an existing home, the appraisal process is pretty straightforward. After the homebuyer has been pre-approved for her mortgage and the seller has accepted the homebuyer’s offer, the lender or broker will arrange for an appraiser to check out the soon-to-be-purchased home. The appraiser will do a quick check of the home for serious condition issue that could affect the value of the home. Then, the appraiser will look at the selling prices for other comparable homes in the neighborhood to come up with a value for the home being purchased.
With a newly-constructed home, the appraisal process gets a little bit tricky. Most appraisers for newly-constructed homes will calculate the value of the home based on the cost of the actual land, labor, and material going into the home’s construction. Your lender will probably want copies of the builder’s plans, blueprints, building specs, and itemized cost breakdowns. Inspectors or appraisers may need access to the home a few times during the construction process. And of course, the lender won’t agree to finalize the mortgage until the home is finished and a final inspection and appraisal have been completed.
Anyone who has built anything knows that sometimes, construction projects fall behind schedule. Days turn into a few weeks: a few weeks becomes a few months. When you apply for a mortgage, a lender will offer you a set interest rate that’s good for a limited period of time. Which means if you’re purchasing a home that’s not quite complete, you’ll want to pay extra attention to the length of time you’ve got for your rate lock. If the final construction takes longer than you anticipated, you may need to negotiate an extension or be ready for an interest rate that’s different than your initial offer. (Not to toot our own horns, but getting some help navigating these sorts of issues is a good reason to work with Morty.)
… And What’s Not Different
Aside from questions related to timing and appraisals, getting a mortgage for new construction isn’t much different from getting any mortgage.
You’ll want to make sure your credit is in tip-top shape before you begin the process. And you’ll also want to be doubly sure not to make any major financial changes that could impact your credit score or debt-to-income calculations in the weeks and months between your initial mortgage application and closing time. Accidentally forgetting to pay a credit card bill, changing jobs, or making a major purchase could jeopardize your mortgage: and for newly constructed homes, where the process can take a few months, it’s easy to make a mistake if you aren’t careful.
Whether you’re interested in purchasing a brand new home, or decide to go with a currently existing home, getting pre-approved for a mortgage first can help you know with confidence exactly how much home you can afford. If you’re ready to start your home buying journey, we’re ready to help.