The two primary types of loans used to build a new home in Texas are:
1) Construction-only loan, sometimes referred to simply as a “construction loan” or “standard construction loan”, which is (usually) an interest-only loan with a period of (usually) up to 12 months, after which you will need to apply for an actual mortgage (aka a “permanent” loan) on the finished house.
2) Construction-to-permanent loan, which combines a Construction loan with a Permanent loan so you only apply one time for one loan package, at the beginning of the building process.
By far the most attractive of the two, for most people, is the Construction-to-permanent loan for a variety of reasons.
First, with a Construction-to-permanent loan you only have one closing so you only pay closing costs one time. With a Construction-only loan you pay closing costs on the construction loan, but you will have to apply for a permanent mortgage when construction is complete, so you pay closing costs again.
Second, with a Construction-to-permanent loan you are usually getting a locked-in interest rate for the final, permanent loan (verify this with your lender). When you use a Construction-only loan, you are hoping that interest rates do not rise during the 4 to 6 or even 12 months it takes to complete construction, when you will then have to apply for a permanent mortgage. This is called interest rate risk.
Third, you are eliminating the credit risk you have with a Construction-only loan, which is that something will negatively affect your credit score during the many months it will take to complete construction of your home and then apply for the permanent loan. With a Construction-only loan, you must not purchase anything on credit that would lower your score, and you must hope that something unexpected does not happen that would cause damage to your credit while your home is being built (such as the death of a partner leading to loss of income or default on credit cards, an illness requiring you to use up your credit, etc.). This is called credit risk.
Fourth, you only have to apply for one loan, not two. The loan application process is tedious and painful and requires a lot of time and paperwork, so if you can avoid doing it twice you should.
Fifth, depending on your lender, you can usually roll the cost of the land you are building on into the loan.
Sixth, your home’s appraisal is done up-front, eliminating the risk that an appraisal done later for a permanent mortgage will be too low.
Since the Construction-to-permanent loan is our preference, let’s look at what the bank will require in the way of documentation and assets (note: this is a general outline, and you may be required to produce more based on your credit or the lender’s guidelines).
General requirements for home loan applications:
- 2-6 months of pay stubs
- 2 years of W-2 forms
- 2 years of tax returns
- 2-6 months of bank statements
- Employer information and verification
- Driver license information
- Social Security information
- Detail of all debts
- Down payment
- Cash reserves equal to 6 months of mortgage payments
- Proof of any extra income (such as royalties, rents, alimony, disability, etc.)
- Contract with a qualified builder or contractor
- Plans and specs of house
- Draw schedule from your builder
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