Bad construction credit home loan

You may get construction loan to build dream home

Some people spend years searching for the "perfect home." Others simply have it built. The simple truth is that if you can afford to buy that "perfect home," you might be able to afford to build it-- and make it even "more perfect" in the process. So, would you rather keep looking, or start building?

If building is an option, check out a construction loan. Stuart Tyrie, vice president of Wells Fargo Mortgages National Builder Division, in Columbia, Maryland, said the requirements for getting a construction loan--in terms of income, debt load, loan-to-value and credit worthiness--are the same as for a conventional mortgage, as are the interest rates.

The process, however, is a bit more complicated. The three things you will need are land on which to build the house, a contractor, and building plans.

Most contractors have a wide assortment of building plans from which to choose, and of course you can change them to suit your needs. The contractor and the plans have little to do with the mortgage, but the land does.

Some people buy land years before they are ready to build. Others inherit it. Tyrie said that if you do not already own the land, or own it but are still making payments on it, "You can roll the cost of the land into the overall mortgage."

Once you have the contractor, plans, land and loan, the building starts. This is where a construction loan differs most from a conventional mortgage loan.

With a conventional loan, the day you sign the paper is the day you owe the full amount. Your first monthly payment will be due about a month after closing.

When you get a construction loan you are getting access to a loan for the full amount, but you aren't using all of it right away.

"You draw the money out in stages to pay the contractor as each phase of the project is completed. Then at the end, the loan is modified into a normal mortgage. ... The construction loan is an interest-only loan during the construction process," Tyrie said.

"If, for example, you have a rent payment and can't carry both rent and interest, at Wells Fargo we will allow the consumer to write the closing costs and the interest payments into the loan."

He gave an example of how construction loan financing works based on a $150,000 loan for a home that takes six months to build. By the way, Tyrie said his company automatically adds extra time into the equation because there are almost always delays ranging from problems getting permits or parts to bad weather or strikes.

Additional interest accrues only if that extra time is needed. "When the contractor says it will be built in six months, the loan is made for nine months," he added. Further extensions are possible, depending upon circumstances.

"Let's say you and your cousin build identical houses on identical properties for the same price and at the same 5 percent interest rate, but you pay the interest as you go and your cousin has it added to the final loan. At the end of six months you would have a 30-year mortgage for $150,000, but your cousin would have a 30-year mortgage for $151,500, which would be the $150,000 plus whatever interest he owed." In this example, it would be $1,500.

If it turns out that the home was finished earlier than expected, any overpayment you might have made will be deducted from the loan amount.

One of the realities of building that "perfect home" is the fact that your idea of "perfection" changes as the house is being built.

"It is one constant of construction loans," Tyrie said, adding that this is why they usually add 10 percent to the loan limit. During the course of construction the owners may decide that they really do want a fireplace in the master bedroom, or a skylight in the kitchen, maybe even an apartment or office over the garage. After all, it is the "perfect" house.

"We can usually build in a contingency fund so that the homeowner can add another 10 percent to the cost of the house. If he/she doesn't use it, it just goes away. Ten percent normally covers it. Few people add more than that. If you don't have that provision, it has to come out of your own pocket during the construction."

Whether or not you use that 10 percent, you will still have your "perfect home"--whatever that is. Everybody's idea of the "perfect home" is different. The question is: do you want to look for yours, or have it built?

Bill Steele is financial editor of Interest.com, a national publisher of mortgage rates and information.