All home buyers looking to build should know certain things when it comes to financing options. Designing and constructing a home exclusive to your needs is far more preferable for many people compared to buying an existing home. Instead of visiting different areas and visiting open houses on the weekends or comparing different floor plans you can instead include the amenities that you want and exclude the ones you don’t. Here is how construction loans work as they relate to jumbo financing.
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You’ll first need to obtain construction financing. But before you get in front of a lender there’s some homework you need to do in advance. You’ll typically need to own the land you’re going to build on or otherwise be prepared to come to the construction loan settlement with additional cash to acquire the lot on which you intend to build. The land you own will be a part of your equity when the construction loan is being processed. Construction loans will generally require a minimum of 10 percent down payment in most cases, please note this.
*NOTE: The 10% down payment requirement does not apply to new homes that are initially being constructed and financed entirely by the new home builder. An example would be a new community spec home that the buyer is purchasing directly from the builder. In cases like this, the builder already owns the land and has either built or will be building a home for you. Lenders view transactions like this the same as any other mortgage for an existing home and not “construction to perm” financing. Qualified buyers in these cases have Jumbo financing options available up to 95% financing for loan amounts up to $2,000,000. Read more about the Jumbo purchase requirements here.
Design
You probably already have a good idea of what you’re looking for. You know how many bedrooms you want. Everything you want is possible but you need to determine what you truly want. Don’t be surprised when you make additions you hadn’t even thought of as you self-design your luxury home. And even when you think you’re done more ideas will pop up sometimes. Changes in construction plans are common.
It’s now time for a visit with your architect. At this stage, you can only go so far until a professional is brought in to make sure what you want to be built can actually be built but also to properly design your home the way you want with a nod toward building codes and structural issues. The architect will then draw up your plans. And it’s now time to talk further with your general contractor who will oversee the project from start to finish.
Your contractor will also provide you with a total cost for your new home to be built, both hard and soft costs. Hard costs are for physical items such as wood, hammer and nails as well as for the labor needed. Soft costs are those reserved for permits, fees and taxes. At the same time, the builder will tell you how long it will take. There will also be an additional amount added for what banks call “change orders.” A change order is something that occurs that varies from the initial plans. A typical amount for change orders is 10 percent of the total cost.
The Construction Process
Once you have your plans and specifications in hand along with the amount of funds needed to complete the project it’s time to talk to a lender. The mortgage company will review your request and approve the construction loan request and assign someone to monitor the progress of construction as well as handle the payments to the builder. Your general contractor will also need to be approved by the lender through a process that must be completed before building starts. Many borrowers select from a list of approved contractors the bank has worked with in the past.
A construction lender won’t give the builder the entire amount at once but instead, issue the funds as progress is made. For example, the builder will clear and prepare the lot and then inform the bank that portion has been completed. The bank sends out an inspector to make sure the work has been done and then the bank issues the funds dedicated for lot preparation.
There are variances regarding how banks issue funds and the process from one construction lender to the next can be slightly different. For instance, a bank might issue an initial draw before any work has begun and issue the next round of funds prior to each phase.
Next, plumbing lines are installed and the foundation is poured. The bank confirms the progress and releases additional funds. As each phase of construction is completed the funds released at each phase. Lenders refer to this as “fund control.” As the home progresses, the borrowers should also arrange for their permanent financing if they haven’t already.
A construction loan is only for the time it takes to complete the construction and once the home is 100 percent completed and received the final certificate of completion, the entire construction loan becomes due. Each month as the home is being built you will be making payments to the construction lender.
Some construction loans allow interest payments to the lender to accrue each month and no monthly payment is required yet instead the accrued interest is added to the construction loan balance. Many construction loans allow for this option but that will add to the loan balance and could possibly affect the final equity in the property if the balance rises above the lender/banks minimum down payment or equity requirement.
Finally, the lender will want to ensure you’ve been preapproved for a permanent mortgage.
The Permanent Jumbo Loan
While the home is being built the jumbo loan should already have been applied for and a preapproval received. Once you submit your initial loan application and provide your supporting documents your permanent jumbo loan will essentially sit idle during construction. As your home gets closer to completion it’s time to update your loan file.
When you first submitted your loan application you provided things such as pay check stubs, W2 forms, tax returns and bank statements in addition to other items needed. Supporting documentation needs to be less than 30 days old and what you originally submitted has expired.
We will also order a new appraisal at this stage. The initial appraisal was performed on a “to be built” perspective by making an appraised value based upon the plans and specifications originally provided. This valuation is a bit different compared to an appraisal for an existing home.
The value is arrived at using the “cost approach.” While all residential appraisals include a cost approach, property appraisals for existing homes compares recent sales of homes in the area and pays less attention to the cost approach calculation. Cost approach adds up the hard and soft costs plus the land upon which the property sits.
The process to obtain a permanent jumbo loan to replace a construction loan is very much like getting an approval for an existing home. You’ll document the file like you would if buying an existing luxury home. When the home has been finished a payoff amount will be requested to pay off the initial construction loan with the funds from the permanent mortgage.
Construction Loan Limits & Down Payment
Primary Owner Occupied Homes:
- Financing to $750,000: 10% down payment (90% loan to value)
- Financing to $1,500,000: 20% down payment (80% loan to value)
- Financing to $2,000,000: 25% down payment (75% loan to value)
- Financing to $3,000,000: 30% down payment (70% loan to value)
Please also note:
- Vacation homes are also eligible with a 20% minimum down payment. Investment purchases are not eligible
- 720+ FICO credit scores required for financing over 80% loan to value
Buyers can read more about regular Jumbo loans with 5% down here. Please contact us with questions by submitting the Quick Contact form on this page.
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