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Mortgage Basics for Building a Home

Finding the money to build a new home differs from taking out a conventional mortgage on an existing home, because to build a home, you essentially need three loans: one for the land, one for the construction phase, and one for the permanent financing of the home after it is built.

But the process is not nearly as difficult to navigate as it may seem, as many lenders combine these three loans into two or even one loan. Here is some basic information about the process to get you started:

Buying land: Most lenders are cautious about lending money on raw land because it can often be difficult to resell in case of default. Those that will lend may want a large down payment — 20 percent or more — with a high interest rate. It might be best to pay cash, if you can.

Building the home: In order to build, you'll need a construction loan, which isn't available through all lenders. Those that do will require blueprints and specifications, appropriate permits, and a licensed bonded contractor before they will consider lending for construction. This type of loan allows the contractor to make draws on the total amount of money as each phase of construction is completed. The lender may want to inspect the property to insure that the work has been done.

Permanent financing: Once the home is completed, construction financing ends — which means that loan must be paid off. Usually, this happens with a permanent loan, the same way any real property is refinanced.

When each of these three loans is accomplished separately, there are three closings and all of the attendant closing costs, legal fees, and taxes. Combination financing, which ties together all or at least two of the loans, minimizes these costs and paperwork.

One unique approach is a rollover loan, which allows money for the purchase of land, construction of the home, and permanent financing, all in one package. You need to qualify only once and pay only one set of closing costs. Or you may be able to tie only the construction and permanent loans together, if you've already purchased the land or intend to pay cash for it. In some cases, you may be able to use the equity in the land as a down payment for a construction-to-permanent loan.

Every lender is different in their approach to construction-to-permanent loans. To get the best rates and the most appropriate lending plan, shop around and compare. The Web is a good place to start investigating some of the various options and get an idea of what kind of terms you can expect.

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