How to Finance Your New Home Construction

Building your dream home from the ground up is exciting – but figuring out how to finance it? That’s where things can get tricky. If you’re planning on financing new home construction in Memphis, it’s important to understand your options, from construction loans to working with local lenders. 

Fortunately, with the right plan, financing doesn’t have to be a headache. This guide will walk you through the process step by step, helping you make informed choices that fit your budget and bring your dream home to life.

Understanding Home Construction Loans

Financing a new home construction project is different from buying a pre-existing home. One of the main differences is the type of loan you’ll need. Most people opt for home construction loans to fund the building process. This type of loan is specifically designed for home construction and is different from traditional home mortgages.

There are two main types of home construction loans:

• Construction-to-Permanent Loans: This type of loan combines the financing for building the home and the permanent mortgage. Once construction is completed, the loan converts to a standard mortgage. The advantage of this loan is that you only have to close once, which saves you time and money. However, one thing to keep in mind is that you will need a clear and accurate budget. If there are any unexpected costs, you’ll need to cover them out of pocket unless your lender allows adjustments during the building process.
• Standalone Construction Loans: With this loan, you get financing only for the construction phase. After the home is built, you’ll need to secure a separate mortgage. This can be a good option if you want flexibility in choosing a lender for your permanent mortgage, but it does mean going through two separate closings. This might result in additional fees and paperwork, so it’s important to calculate whether the potential savings from shopping for a separate mortgage outweigh these added costs.

Choosing the right loan type depends on your specific situation and preferences. If you prefer simplicity and want to avoid multiple closings, a construction-to-permanent loan might be the best choice. 

On the other hand, if you’re confident you can secure a better mortgage deal separately, a standalone construction loan may work in your favor. Consulting a financial advisor or a loan officer can help you understand which loan type aligns best with your goals.

How Construction Loans Differ from Traditional Mortgages

Construction loans are different from traditional home mortgages in several ways. The biggest difference is how lenders distribute the money.

With a standard mortgage, the lender gives you the full loan amount upfront to buy the home. With construction loans, the lender pays out money in stages, or ‘draws,’ as you complete different parts of the home. For example, the lender releases money after you pour the foundation, then after the walls go up, and so on. You and your contractor agree on these stages in advance with the lender.

Another major difference is the type of payments. With a construction loan, you usually make interest-only payments during the construction phase. This means you only pay for the interest on the money that’s been disbursed so far, not the principal loan amount. This approach helps keep your monthly payments lower while you build the home. Once you finish construction, you either pay off the loan or convert it into a regular mortgage, depending on the loan type.

In addition to the payment schedule, down payments for construction loans tend to be larger than for traditional mortgages. Most lenders require at least 20% down, but some might ask for even more depending on the complexity of the project or the perceived risk. This helps protect the lender because home construction is riskier than buying an existing home. For example, there could be delays due to weather, material shortages, or other unforeseen circumstances that could increase the cost of the project.

Steps to Secure Financing for New Home Construction

Now that you understand how construction loans work, let’s look at the steps you’ll need to follow to secure financing for your new home construction in the greater Memphis area.

• Step 1: Pre-Qualification Before you can apply for a construction loan, it’s a good idea to get pre-qualified. This involves providing a lender with your financial information, like your income, debts, and assets. The lender will then give you an estimate of how much you can borrow. Pre-qualification can give you a clearer idea of what’s financially possible for your new build. Pre-qualifying also helps you narrow down your design options because the process provides a budget range for your project.
• Step 2: Create a Construction Budget A detailed construction budget is critical when applying for a loan. This budget will include the cost of land (if you haven’t purchased it already), the cost of building materials, labor, permits, and more. It’s important to work closely with your builder and general contractor to create a realistic budget. This budget should also include contingency funds for unexpected expenses, such as increases in material costs or design changes. Planning for these contingencies can help avoid delays and keep the project on track.
• Step 3: Work with a Lender Next, you’ll need to find a lender that offers home construction loans. Not all lenders provide this type of financing, so it’s important to do your research. Look for lenders with experience in construction financing and those that can offer competitive interest rates. Local banks in Memphis and national lenders are good places to start your search. You may also want to consider working with a mortgage broker who specializes in construction loans. A broker can compare rates and terms from multiple lenders to help you find the best option.

Common Requirements for Construction Loans

When applying for new home construction loans, lenders will require certain qualifications and documentation. These typically include:

• Credit score: Most lenders will require a good to excellent credit score, usually above 680. A higher credit score will help you qualify for lower interest rates, which can save you thousands of dollars over the life of the loan.
• Down payment: As mentioned earlier, expect to put down at least 20%. Some lenders might require more depending on the project’s complexity and your financial history. If you have strong financials and a higher down payment, you may qualify for better loan terms.
• Construction plan: Lenders will want a detailed construction plan, including architectural drawings, a breakdown of materials, and an estimated timeline. This helps the lender ensure that you can complete the project and use the loan wisely. The plan should also include a clear timeline and milestones for the project to keep the lender updated on the progress.
• Licensed general contractor: Most lenders will require you to work with a licensed and experienced general contractor. This helps reduce the lender’s risk, as a qualified contractor is more likely to complete the project on time and within budget. Working with a licensed contractor also gives you peace of mind, knowing that your project is being handled by a professional with a proven track record.

For more tips on finding a reliable contractor, check out our blog on Hiring a Commercial Contractor in Tennessee.

Local Financing Options in Memphis/Arlington

If you’re building a home in the Memphis/Arlington area, you’ll have access to several local lenders that specialize in home construction loans. Local credit unions and community banks can be great options, as they may offer more flexible terms and a more personalized experience compared to larger national banks. Many local lenders also understand the regional market and may offer loans tailored specifically for the area’s housing market.

It’s important to remember that the mortgage isn’t the only thing to consider when building a new home – you’ll also want to take taxes, cost of ownership, speed of transaction, and available amenities into account. Often, you’ll find that new construction can be as cost-effective to buy as an existing home. As always, it depends on your specific needs and what’s available in your market.

Some local banks may also have programs specifically for financing new home construction in Memphis, including special rates or incentives for first-time homebuilders. It’s worth checking out local options in addition to national lenders to find the best terms for your loan. You can also ask about any community programs that might offer down payment assistance or other benefits for local homebuilders.

Other Financing Methods for Home Construction

In addition to traditional construction loans, there are other ways to finance your new home construction. These include:

• Personal savings or home equity: If you have significant savings or equity in another property, you might be able to fund your home construction project without taking out a loan. This can save you money on interest and other loan-related fees. Using personal savings can also speed up the process, as you won’t have to wait for loan approvals or disbursements.
• Builder financing: Some builders offer their own financing options, which can simplify the process. However, it’s important to carefully review the terms and compare them with other loan options to make sure you’re getting the best deal. Builder financing may also come with incentives like discounted rates or upgraded features, which can add value to your project.
• Government-backed loans: If you qualify, government loan programs like FHA construction loans can provide more affordable financing options. These loans are designed to help low-to-moderate-income individuals finance home construction projects. FHA loans often have lower down payment requirements and more flexible credit criteria, making them an attractive option for first-time homebuilders.

Working with a General Contractor to Stay on Budget

One of the best ways to avoid financial surprises during the construction process is to work with a skilled and trustworthy general contractor. A general contractor can help manage every aspect of the construction process, from ordering materials to coordinating with subcontractors, and keeping the project on schedule. They work closely with your lender to request construction draws at the right time and provide all necessary documentation.

A good general contractor will also help you stay on budget by anticipating potential cost overruns and making adjustments when necessary. For example, if the price of a certain material suddenly increases, your contractor can help you find an alternative that fits your budget without compromising the quality of the project. 

For more on how a general contractor can help you, take a look at our blog on The Role of a General Contractor in Commercial Contracting.

Tips for Managing Construction Costs

Building a home can be expensive, and unexpected costs can quickly add up. Here are some tips to help you stay on budget:

• Plan for the unexpected: Set aside 10-15% of your total budget for unexpected expenses. This helps ensure you’re financially prepared if the project takes longer or costs more than expected. It’s also a good idea to discuss potential risks with your contractor upfront so that you can plan accordingly.
• Choose materials wisely: The cost of building materials can vary significantly. Work with your contractor to choose materials that fit your budget without sacrificing quality. For example, you may be able to save money by choosing mid-range finishes for areas like flooring or countertops while splurging on key areas like the kitchen or bathrooms.
• Stick to the plan: Once construction begins, avoid making changes to the original plan unless absolutely necessary. Changes can lead to delays and additional costs. It’s important to finalize your design decisions before construction starts to avoid costly revisions later on.

For more information on how to plan for costs, check out our blog on Tips for Budgeting Your Commercial Construction Project. 

Next Steps

By understanding your options, working with experienced professionals, and managing your budget carefully, you can make your dream home a reality. Whether you choose a construction-to-permanent loan, standalone loan, or another financing method, the key is to be prepared and informed.

Contact InterVision today for expert guidance and support on building your new home. We’re here to help you through every step of the process and ensure your construction project is completed efficiently and within budget!