Notes: Home Construction Financing

• What is a home construction loan:
  
  You will need to qualify for a construction loan before meeting with a builder. The construction loan will have a set limit that you can borrow (based on your qualifying ratios: see Step 5), which will determine the expense of your construction project in addition to the up front money that you will invest in the construction.
  
  There are basically two types of loans involved when constructing your home:

1. Construction Line of Credit:
   
   This is a credit line that the lender setups on your behalf for the payment of contractors and supplies during the construction phase of your home.
   
   Cash disbursements may vary by lender. Typically, the first disbursement buys the land and then successive disbursements will be made when certain phases in the construction project have been completed.
   
   Most lines have a term of about 12-18 months, depending on the size of construction and area. Some lenders will offer an extension if needed, but often with up front penalties.
   
   You will pay interest on the amount that you borrow from the line during the construction phrase. The interest rate on construction lines are slightly higher than residential mortgage rates.
   
   
2. Permanent Construction Loan (residential mortgage):
   
   At the end of the construction phrase, the line closes and the amount borrowed is paid off with a mortgage loan of your choice.
   
   Many lenders offer the combined construction line and permanent loan as a bundled product. There are advantages and disadvantages. See our discussion on construction/permanent loans.
   
   If you are unable to obtain the combined construction/perm loan with the same lender, you will need to:
   
   
   1. first qualify for long-term financing (i.e., mortgage loan) with one lender and then,
      
      
   2. meet with a second lender for the construction line of credit — these lenders will typically extend credit once you have the permanent loan arranged.
      
      

• Up front Payment:
  

Mortgage lenders expect owners to use a portion of their own money to finance their home construction. The standard percentage varies, but averages range from 5-10% or more of the home's future value (as determined by the lot, construction plans, and independent appraisal).

Some lenders now allow for lesser percentages — as little as 3-5%, provided that you have good outstanding credit.

Existing homeowners often use the equity value of their existing home as required up front money for construction loans. They may take out a home equity line of credit to pay the up front money or a percentage of the estimated construction cost.

For more information about home equity lines: see our affiliated site at YourEquity.Com


Note: IRS rules allow for an one-time distribution from qualified IRA accounts without the 10% penalty for acquisition of a home for first-time home buyers.

See IRS publication 590 for information:
http://www.irs.gov/formspubs/...

We quote from the IRS web site:

401(K) Plans

Question:
Can I withdraw funds penalty free from my 401(k) plan to purchase my first home?

Answer:
If you are less than 59 1/2 years of age, you cannot withdraw funds from your 401(k) plan to purchase your first home without being subject to a 10 percent additional tax on early distributions from qualified retirement plans.

However, depending on the rules for your 401(k), you may be able to borrow money from your 401(k) to purchase your first home. Your plan administrator should have written information about your particular plan that explains when you can borrow funds from your 401(k) as well as other plan rules.

References:
Topic 424, 401(k) plans



IRAs

Question:
If I can't withdraw funds penalty free from my 401(k) plan to purchase my first home, can I roll it over into an IRA and then withdraw that money to use as my down payment?

Answer:
Yes, if you are receiving a distribution from a 401(k) that is eligible to roll over into a IRA and you meet all of the qualifications for an IRA distribution for a first-time home buyer. Your plan administrator is required to notify you before making a distribution from your 401(k) plan whether that distribution is eligible to be rolled over into an IRA.

To see if you qualify for a distribution to be used as a first-time home buyer, refer to Publication 590, Individual Retirement Arrangements (IRAs) (Including Roth IRAs and Education IRAs).



• Discount Points:
  

Discount points are up front fees that lenders charge in order to offer you a lower interest rate on your permanent construction mortgage.

A point equals 1 percent of the mortgage loan amount. For example, if the lender charges 2 points on an agreed loan amount of $100,000, your point fees will be $2,000.

Many lenders offer mortgage loans with zero points. These products generally carry a higher interest rate.

Typically, each point that you pay on a 30-year loan lowers your interest rate by 0.125 of a percentage point. This reduction may vary by lender.

Compare rates vs. points calculation - from Dinkytown.net:
http://www.dinkytown.net/



• Closing costs:
  

  Closing costs are incurred costs associated with the closing your home construction loan. There could be closing costs for the construction line and additional costs for the permanent loan, especially if you use different lenders for each product.

  These costs include lender fees, prepaid fees, title search, recording fees, surveyor's fees, attorney fees, and other closing-related fees.

  Closing costs can average about 3-5% of the total construction cost, including points.
  
  

• Cash Reserve Account:
  

  It is highly advisable that you set aside a cash reserve account before starting your construction project.
  
  You may need this "extra" money for building deposits, cost overruns, construction changes and requested upgrades.

  There are too many "horror" stories of construction projects coming to a stop because of the lack of funds. Review Step 8: Managing Construction Costs.
  
  Many homeowners will use the equity value in their existing home to open a home equity line of credit as their cash reserve account. In the event of extra cash needed, they will draw upon their equity line account for cost changes.
  
  Caution: your existing home equity value may be needed to close on your residential mortgage. Make sure you run the numbers to determine how much equity can be set aside for your cash reserve account.

  
  

• Add it up to estimate your up front payment and safety net in the event your construction costs exceed plan*: