A First-Time Buyer’s Guide to Getting a Building Construction Loan
Published June 19, 2022
If you're willing to invest the time, energy, and funds into the project, building your own house can be an excellent way to secure your dream home. When you purchase the lot and build the property from the ground up, you and your builders have complete control over the result. Additionally, existing homes have been in short supply in the last couple years. You might find building to be a preferable option.
That said, the process of building your home is far different from the process of purchasing an existing home. Instead of applying for a traditional mortgage, you'll need to apply for a construction loan. Fortunately, there are some great options for first-time homebuyer building loans that allow you to access the funds you need to purchase a lot and build a home. Here is everything you need to know as a first-time homebuyer building a house.
How construction loans differ from mortgages
A first-time homebuyer building loan is structured differently from a traditional mortgage. Some lenders offer both building loans and conventional home loans. Some only offer one or the other. To apply for either option, you'll need to provide proof of income, assets, and debts, and you'll need to undergo a credit check. However, the application for a first-time homebuyer building loan may have stricter qualifications and require additional documents.
You can use a building or construction loan to purchase a plot of land and build your home. If you already own the lot you plan to build on, you can use the loan just for the construction project. The key difference between a first-time homebuyer building loan and a first-time homebuyer mortgage is that the building loan is very short-term. Construction loans generally last for only one year. At that point, you'll have to convert the loan into a traditional mortgage.
Construction loans are also usually paid out in phases instead of in a lump sum. Because building a home is a lengthy process, your lender will pay the builder piece by piece as they need more funds.
Construction only loans
Construction-only loans are one of the most common financing options that first-time homebuyers building a house will use. Construction-only loans are short-term loans that provide funds while the home is being built. In most cases, the loan has a lifespan of just one year.
Then, when the loan is about to expire, you can apply for a traditional mortgage and transfer the balance of the construction loan to the new home loan. This means that you'll go through two loan applications and two closing meetings. Sometimes, homeowners work with just one lender to acquire their construction loan and their permanent mortgage. Other times, they transition to a new lender.
Construction to permanent loans
An alternative to a construction-only loan is a construction-to-permanent loan, which consolidates the debt into one account. The account begins as a construction loan and then converts into a traditional mortgage once the house is complete. Borrowers typically only pay interest on the loan while the house is under construction.
Construction-to-permanent loans have a number of benefits for a first-time homebuyer building a house. You only have to submit one application and close on one account, so the process is far more streamlined than the construction-only loan process. Once you've been approved for the initial loan, you don't have to go through the stress of submitting another application.
The biggest downside to a construction-to-permanent loan is that this option tends to be more expensive. Interest rates and fees can be much higher than the costs for a construction-only loan or for a conventional mortgage. However, first-time homebuyers may have an even better option with the FHA One-time Close Loan.
FHA one-time close loan
The FHA One-time Close program offers first-time homebuyer building loans to qualifying borrowers. Just like traditional mortgages with the FHA, building loans with the FHA are generally more accessible to first-time homeowners because they have lower credit and down payment requirements.
The FHA requires a 3.5% down payment for a first-time homebuyer building loan, which is far less than you'd need to pay for most other types of construction loans. If you already own the land you hope to build on, you might be able to use your land equity as the down payment.
You may also qualify for down payment assistance through a federal, state, or local program. Some down payment assistance programs partially or fully fund down payments for low-income individuals, and others provide funds for people who work in a specific line of work or who live in a disadvantaged area. Combining a down payment grant with an FHA first-time homebuyer building loan is a great way to minimize your expenses as you prepare for construction.
Qualifying for a first-time homebuyer building loan
The qualifications for your first-time homebuyer building loan may vary depending on your lender and the type of loan you apply for. A typical construction loan may require a down payment of 10% to 20% of the project total because construction loans are riskier than traditional mortgages. However, the FHA One-time Close Loan for first-time buyers only requires 3.5% down.
Credit requirements may be stricter for a construction loan, too. In most cases, lenders want to see a credit score of at least 620, but a higher score will help you get a better interest rate. Although the FHA allows lower credit scores for traditional mortgages, you need a score of 620 or more to be approved for the One-time Close Loan.
As a first-time homeowner, building your house is a big endeavor. Still, seeing your vision for your dream home come to life is worth the effort. If you meet the credit and down payment requirements, you can secure a construction loan through the FHA or through a traditional lender. Each option has its benefits and drawbacks, but you can consult with a mortgage specialist to determine which form of financing is best for you