How do you get financing for a home that is yet to exist? Some assume that you buy your land first and then acquire some sort of bridge loan or improvement financing. While this is an approach you could take, you will find that there are very big consequences to selecting the wrong type of construction financing. At a minimum, the wrong financing package can cost you several thousand dollars in extra closing costs, and closing costs have to be paid in cash. We have prepared the following information to help you sort through the quagmire of construction financing.

Since the objective is to have a permanent loan on your completed home, regardless of the type of financing, lenders will insist that you must first be able to qualify for the permanent loan. Provided that there are no issues on that point, lenders may offer construction-only financing, "permanent" (regular first mortgage) financing, or various combinations of both. Your Emerge Homes representative will generally recommend a “construction-to-permanent” financing package. This approach features only one settlement, one set of closing costs. The transition is painless. The only noteworthy drawback is that, while “construction-to-permanent” loans are rapidly catching on among mortgage lenders, there are fewer lenders competing for your loan.

Short-term construction-only loans are not generally your best option. They're fine for builders who will be selling the house after it's constructed, but they're a bit risky for you because you will then have to seek your permanent mortgage elsewhere.

Construction-only loans are also more expensive in the long run because you will have to pay extra closing costs. These loans must be paid off in full when construction is complete, and usually within 12 months or so even if construction is not complete.

If you're building a home which you intend to occupy, most lenders will offer you combination "construction permanent" financing. Customs vary from place to place, but there are two basic versions:

The first is a short-term construction-only loan which automatically "rolls" into the permanent mortgage when construction is complete. It's important that these two separate loans be treated as a package. If not, you will have to pay additional closing costs, and possibly, re-qualify for the permanent loan.

The second type is a single long-term permanent mortgage in which the money is paid out as the construction proceeds. Single loan financing is generally the lowest cost, most desirable financing, but you may or may not be able to arrange it. Policies vary, so check additional lenders if the first one doesn't offer this type of financing.

Construction loans, whether construction-only or part of a construction- permanent package, are usually interest-only. That is, you make no payments to principal until construction is complete. The interest rate is typically about 1% to 3% above the lender's Prime Rate at the time the loan is made. Keep in mind, though, that the higher rates will not apply to the permanent portion of the package.

Special Risks In Construction Financing
Your financing 'package' will most likely be comprised of separate construction and permanent loans. This type of financing poses several risks, primarily due to events which can occur during the period between the time you are initially qualified for financing, and when you must be re-qualified before the permanent loan can be closed.

Anything which affects your ability to re-qualify could result in losing your new home, and most or all of your down payment or the money you've invested in a lot.

If construction costs are higher than expected, you may have to come up with extra cash to keep the Loan-To-Value (or the Loan-to-Cost) ratio to the allowable maximum. Be sure you ask about the lender's policy in this event -- just when you will have to come up with the money, for example.

With Emerge Homes you will generally be able to avoid this type of problem because we generally provide you a fixed-price contract. Also, you may be able to realize a lower overall cost with a cost-plus contract if no unforeseen problems arise, so consider your risks carefully.

It may seem obvious, but don't ever make changes or add any 'extras' without prior written cost estimates. Be sure you understand your lender's policy regarding changes. Prior approval is almost always mandatory, so be sure to notify your lender before you authorize even small changes -- and be sure the approval is in writing.

One the greatest risks you can face is that of rising interest rates. The interest rate on your permanent loan will be set at, or shortly before, closing. If rates have risen during the 6 months or so during construction, you may no longer be able qualify at the higher rate. About the only thing you can do in this situation is come up with enough extra cash to bring the loan amount down low enough for you to be able to meet the all-important qualification requirements, which we discuss shortly.

Talk to the lenders that you're considering. Try to determine how each would react if a problem arises. It's unlikely that you'll get any definitive answers -- lenders generally prefer a case-by-case approach -- but you may be able to get an indication of how much latitude you may receive. A lender might be willing, for example, to extend the construction loan for an extra month or two to allow time for you to raise the extra money.

Finally, if at all possible -- even if you have to cut back on your plans a bit -- maintain an extra "cushion" of about 5% - 10% of the total amount you expect to spend. The best way to do this is to postpone something, perhaps a garage, fancy flooring, or other part of your project that can be easily added later - it's just good insurance.

When Construction Begins
After the loan closing, the builder can begin construction. This is typically done in various stages which follow a logical progression: the land is cleared, the foundation is excavated and poured, the framework is built, etc. In many cases, the builder does not do the work himself; rather, he employs numerous independent businesses as "subcontractors" for jobs like plumbing, masonry, wiring, framing, etc. The builder's job, in this case, is rather like the conductor of a symphony: he coordinates the many separate parts to create a finished whole.

It's also the builder's responsibility to supply the materials; the lender will reimburse him at several prearranged stages of the construction. These "disbursements" -- which, in fact, will be released to your attorney as the trustee -- will not be granted, however, until the lender performs inspections on the completed work and is satisfied as to its completion. Here's a typical advance schedule. You'll see that, even though there are only a few advances, there are well over a dozen phases to the construction itself.

A good lender is a protection to you. They don’t pay us until a phase of work is complete. You and the lender will approve a draw schedule with a series (usually 4 or 5) of progression payments,
usually based on percentages of the full loan amount. Here is a common draw formula:

First Advance (Generally 15% of Construction Costs)
Second Advance (Generally 40% of Construction Costs)
Third Advance (Generally 20% of Construction Costs)
Final advance (Generally 25% of Construction Costs)

There are many choices for your construction financing needs.