Understanding Home Construction Loans and Story Loans

Friday, February 5th, 2010

If you plan to build a home in one of our master planned communities, and if you plan on financing the construction of a home on the land, you will need to shop around for a home construction loan. Home construction loans are typically referred to as "story loans" because the lender will want to know the tale behind the loan. They need to know your motivation (you meaning the borrower), and the plan behind the construction of the home. That plays a big role in the interest rate and the options for repaying the loan.

Home construction loans are less "cut and dry" than a traditional 30-year fixed rate mortgage. In fact, home construction loans will depend on the actual type of financing you want and the type of home you're building. In other words, the lender wants to know the "story" behind your loan.

How Story Loans Work
Generally speaking, home construction loans are short term, variable rate loans. They will be priced at a short-term interest rate, and that rate will depend on what's called the "draw schedule". The lender, the home builder/contractor, and the borrower will agree on a schedule for the construction. Traditionally, there are five to ten different stages of construction. The lender will charge interest based on the amount of money that has been "used" or "drawn" to date. In many cases, you, as the borrower, will have an option to take out a construction loan that will then "automatically convert" to a permanent mortgage when you move into the home--or you can structure it so that there are two separate loans. Some home construction or "story loans" can be written so that they include the cost of purchasing the land as well as building the home.

Different Types of Home Construction Loans
There are generally two different types of home construction loans, and each of them have their benefits. As a borrower, you should understand the different options that you have when it comes to financing your new home. The names of the loans do a good job of saying what they do and how they work, but let's review them in more detail.

One-Time Closing Loans
The One-Time Closing Loan is also called a "All-in-one loan" or called a rollover or construction-to-permanent loan. The premise behind this type is loan is that it automatically converts to a standard mortgage after all of the home construction is completed. This usually is when you get the "certificate of occupancy" for the home. There are several costs involved in obtaining a one-time closing loan. The benefit is that you will ultimately reduce your closing costs by combining the land (the lot), the construction, and the permanent loan all into one closing. You'll also reduce the cost of additional fees for confirming your credit, performing a title search, and recording the mortgage. The drawback of a one-time closing loan is that you don't get to shop around for different mortgage rates when the home construction is complete and you're ready to move in.

Construction-Only Loans
Construction-Only loans are just like they sound: they're loans that are just for the construction of the home. In a construction-only loan, you, as the borrower, will apply for this short term loan. It usually ranges from six to 12 months in length and then you will pay the closing costs based on that term. There usually is an upfront fee required, oftentimes the rate is 1 to 3 percent above the current prime rate. You only pay the interest during the home construction, and the entire principal is due at the end of the term of the loan. Once you're ready to move into the home and get your certificate of occupancy, you'll have to apply for a mortgage loan. You'll have the opportunity to apply for the loan usually through the same lender or a different one. As a borrower, you may choose this option because you'll have the opportunity to shop around for the best mortgage rate when the home is complete.

Whether you choose a construction-only loan or a one-time closing loan really depends on your personal preference and your particular situation. If you're looking for the security and piece of mind of a loan that will ultimately convert into a permanent loan, then you may want to choose a one-time closing loan. However, if you can afford the upfront fees and cost of a construction-only loan, then you'll have additional time in order to "shop around" to find a mortgage when you're ready to move into your dream home.

Posted in: Building a Custom Home
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