Financing Construction of a Dream Home

Construction loans differ from mortgages. If you're building a home, the USAA Educational Foundation, a nonprofit organization providing consumer information to the military and general public, suggests the following:

Choose the right loan. Construction-only loans provide funds for building your house, and sometimes lot purchase. When construction is complete, you apply for a mortgage, meaning additional closing costs and fees, but you'll have a range of lenders and programs to choose from. Construction-to-Permanent (CTP) Loans are convenient and potentially cost saving. There's one application, one approval process, one-time closing costs and rates for your permanent mortgage are locked in. Rates, however, may be higher, though some CTP lenders are competitive. Look for programs that let you negotiate lower rates just before the loan rolls to permanent. When comparing to construction-only loans, factor in additional closing costs and fees, not just rates.

Choose a length of loan that makes sense. Construction loans typically run six to 12 or even 18 months. Consider how large or complex your home is and whether the site is challenging or remote. Consider the possibilities; if you finish early or not on time, what are the costs of pre-payment penalties or of extending the loan?

Understand the draw schedule and requirements. Construction loans are paid out in draws as building proceeds (you pay interest only on funds you've received). Make sure your builder knows the schedule; if he expects seven draws and the lender allows only five, problems can arise. Your paperwork should state exactly how and when funds will be dispersed and in what time frame. The more flexible the draw schedule, the easier; online access is a plus, too.

Don't underestimate the importance of service. Rates and numbers aren't everything. Good customer service is critical; construction loans require a close working relationship between lender and homeowner. Ask friends, contractors and your local Better Business Bureau which lenders have a track record of providing excellent service. As Jim Fraser, president of IndyMac Bank Home Construction Lending points out, "The quality of loan administration services directly contributes to the success of each project." If your lender doesn't feel that way, find another.

- Christine Loomis