Building your first custom home is an exciting, unforgettable experience. Of course, for many customers, it can also be a huge learning opportunity, because purchasing a custom home is so much different from buying a traditional, prebuilt one. It’s no wonder we encounter a lot of people who have questions about the financing process, which is unfamiliar territory for most first-time custom homebuyers.
Although securing financing for a custom home requires a few more steps than a traditional home purchase, it’s a very well-established process that is not difficult. And you may be surprised to discover that the unique nature of custom home financing gives you a lot more flexibility than you would get with a traditional home loan.
Types of Loans
One of the key differentiators of custom home loans versus traditional home loans is that there are actually multiple types of loans involved in the former. Financing a custom home typically includes two loans:
- A standard construction loan. This loan finances the construction process and includes the cost of your land if you don’t already own the property.
- A regular mortgage. After construction is complete, you refinance the construction loan into a regular mortgage that covers the price of the home itself.
Obtaining Your Construction Loan
For some customers, it can be challenging to find a lender that offers construction loans for custom homes. Why? Many lenders require buyers to have higher-than-average credit and to provide a down payment of at least 20 percent for a construction loan. This has become increasingly common since the recession, as lenders have become wary of customers who, in their eyes, may not have enough capital on hand to account for any problems or delays in the construction process.
However, select lenders set themselves apart with construction loans at competitive interest rates and with little or no money down. These lenders often specialize in providing financing for custom homes and are very familiar with the construction process and the needs of the custom homebuyer.
For example, Alliance Financial Services, which serves the Pacific Northwest, provides construction loans without requiring 20 percent or more down. Instead, the company allows its customers to create “move-in equity” by handling certain site-development tasks themselves.
So instead of handing over tens of thousands of dollars to secure a construction loan, you can opt to DIY certain aspects of the site-development process, such as graveling a temporary driveway, painting the home’s exterior, or providing a portable toilet. All the while, you’ll be chipping away at the overall site-development costs, which helps you build instant equity.
As anyone who has bought a prebuilt home can attest, this is one perk of custom homebuilding that is simply not possible with a traditional home.
Securing Permanent Financing
Once construction is complete, it’s time to refinance your construction loan and roll it into a mortgage. This part of the process works a lot more like financing for a prebuilt home. Working with your lender, you can choose the best mortgage for you and your family, such as a conventional, FHA, VA, or USDA loan. Depending on your budget, your income, and the amount of your construction loan, you can choose from a 15-year or 30-year mortgage with fixed or variable interest rates. You can also select an interest-only or a debt consolidation loan.
Once you have closed on your mortgage, the financing process is complete. Now it’s just like any other loan: You make your monthly payments and, in the meantime, enjoy living in the custom home of your dreams.
Ready to learn more about how the custom homebuilding process works? Download our Path to Home Ownership guide to get started.