Residential Construction Loans Explained

Residential construction loans are mortgages designed for building homes. Steven wrote me asking about building a house.

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During construction, incremental funds are issued to the contractor in draws to pay for labor and materials as needed. After construction is complete, the homeowner will need long-term financing also.

There are two ways to handle these loans designed for building a house.

1 -- Temporary Residential Construction Loans

Residential construction loans can be temporary. These short term loans are followed by a mortgage refinance after construction is complete. Sometimes a builder applies for this temporary financing, other times the homeowner.

Either way, it is up to the homeowner to provide long-term financing after the short-term construction loan has run its course.

2 -- Permanent Residential Construction Loans

Another form of residential construction loans are called Construction To Perm or All In One. As described,the financing has two parts but is one loan. Beginning with a short-term construction loan, it converts to a permanent long term home mortgage upon completion of the dwelling.

The advantage to these types of residential construction loans is that the homeowner only incurs one set of charges and can lock in their interest rate sooner.

The disadvantage to permanent construction loans is a long-term interest rate that is higher as opposed to a rate for buying houses already built.

Questions About Building A House

Steven wrote Ask Kate™ about building a house in addition to keeping his current home that has no mortgage. You can read Steven's letter here.

Q: Will I have to use my current property to obtain a residential construction loan without putting up any money out of pocket?

A: Down payments for residential construction loans can come from a cash out mortgage refinance of another home with existing equity. Since Steven's current house is owned free and clear without a mortgage, this is a strong possibility. It does mean the current house will acquire a lien.

Q: If so will I be able to separate the two properties at the mortgage closing?

A: Since Steven's current home is worth $60,000, he could refinance it to borrow the down payment needed for building a house. The remainder of the funds to build the new house would come from either a temporary construction loan that will need to be refinanced or a long-term All In One. (see above for more explanation)

Q: How can I build a new home but keep my current place separate for security reasons?

A: Actually, in this example, each home has its own mortgage. Although both have a lien, they are separate from each other.

Unique Home Buying Information

Here is your next stop in my home buying series -- When private mortgage financing originates between family members, property tax and mortgage interest deductions frequently come into question.

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