A construction worker wearing a yellow hardhat drills into the wall of a new construction home.

Is a Construction Loan Right for You?

03/16/2021

Can a first-time homebuyer get a construction loan? Here's what to know about new home loans when building.

The housing market is having a moment: Home construction started the year at a blistering pace, with new home permits up 22.5% from January 2020, according to the U.S. Census Bureau. And the New Home Pending Sales Index from Zonda Economics reports that closed sales are up 28.1% year-over-year in January.

An Increased Demand for New Home Construction

The reason? New habits and routines arising from the effects of COVID-19 are leading consumers to rethink their housing needs and seek corresponding lifestyle modifications, says Jim Owen, vice president and National Builder Executive for ‎Fifth Third Bank. "People are understanding that the value of their homes is not just monetary. It’s about the benefits it brings to their life, and many are looking to get more use out of their home’s footprint, inside and out."

A survey from the National Association of Realtors® confirms this trend, with 35% of its members reporting that their buyers’ needs have changed due to the pandemic, citing new priorities that include dedicated home office space, ample yards and a less-dense environment.

Those preferences, coupled with a historic inventory shortage for existing homes, is prompting many would-be home buyers to turn to new construction.

And as they contemplate paying for this purchase that often includes not just the building materials but the land itself, a smart strategy is to consider a construction loan. They are affordable, as the buyer is usually making an interest-only payment on the outstanding balance until they are ready to move in and a certificate of occupancy is issued.

What Happens to the Construction Loan When the Home Is Complete?

Once the home is ready to be occupied, the construction loan converts to a conventional mortgage. "This opportunity to have a one-time close is what makes a construction loan such an appealing product," says Owen. "Once the borrower is initially approved and has closed on the financing, the loan is solid. They don’t have to requalify, and the rate is locked in for permanent financing."

That alleviates borrowers of the worry that rates might increase during the building stage or that something else in their finances might make their eventual mortgage unattainable.

When to Look for a Construction Loan

With a housing market as active as today’s, it’s key for buyers to do the due diligence to confirm how much they will qualify for so they can lock in their financing, says Owen. "Our clients want to ensure they have satisfied all the requirements they need to move forward with the construction. When making a purchase of a lifetime, a homebuyer doesn’t want to experience the heartbreak of getting partway through and realizing there’s an insurmountable obstacle that can dash their dream.

Having a loan in place ensures that building can start as soon as all the pieces fall into place. "Given how busy builders are, it’s prudent to start the process and lock in a rate now, as it could be some time before construction begins," Owen notes. These challenges mean that buyers are wise to have their finances in shape so they can be ready to pounce, should the right lot become available.

How to Qualify for a Construction Loan

A construction loan generally entails a down payment of 10% of the project total, as determined by the cost of the land and the plans the buyer and builder draw up. Before seeking financing, clients will meet with their builder to create a budget, based on size, quality of materials, time frame and more. "We encourage real estate agents to guide their clients through this process since they are the market experts that will have a good handle on typical costs," Owen says.

The down payment is larger than some other mortgages require because a construction loan can be a little riskier than a regular mortgage, as there is not yet a structure to use as collateral. If the borrower owns the land already, that equity can be used as part of the down payment, but if they are purchasing the land as well, it can be rolled into the loan.

And then there’s a lot of flexibility as the loan moves from construction to permanent. Borrowers can use a majority of Fifth Third’s loan offerings, choosing a 15 or 30-year term and then a fixed rate or adjustable-rate (ARM) option.

The process of building a house comes with countless decisions and tradeoffs (and even some headaches), which is why financing shouldn’t be one of them. By locking in a low rate and committing to just one close, a construction loan gives a custom home buyer one less thing to put on their “punch list.”

Find out more about Fifth Third’s construction loans here.

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