||Ask Dr. Don
Financing construction of
a new home
Dear Dr. Don,
My wife and I recently bought a lot to build a
home on about a mile from where we live now. We do not owe anything
on the home we live in presently and are debt free from vehicles to
credit cards. Our home we live in now is worth about $210,000 and
the home we want to build should come in at about that amount also
since the lot is paid for already.
We do not have the money to build the new home without either selling
our present home first or borrowing the approximately $200,000 for
the new home. If we wanted to live in the home we own presently
while we are building our new home, what would be the best route
to go as far as financing the new home? A home equity type loan
against our present home or a separate first mortgage / construction
type loan on the new home?
Are construction loans at a higher interest rate than
regular mortgages and what are the advantages and disadvantages
to construction loans? Are there any other options or considerations
you can think of? The lot we bought is valued at between $40,000
and $50,000. If we borrowed $200,000 will we be liable for PMI or
will the value of the lot the house is being built on allow us to
avoid paying PMI. Thank you,
A construction loan will be an interest-only loan that comes due
once you've received the certificate of occupancy on your new home.
Construction-to-permanent financing allows you to secure both loans
with only one set of closing costs but you give up some negotiating
leverage when it comes time to price the interest rate on your new
If you decide on construction to permanent financing, the lender
should offer you the ability to buy a rate lock to lock in an interest
rate through the expected completion date. The lock should be effective
through the worst case scenario for delivery since an expired rate
lock won't be of any use at closing.
If your current home is worth $210,000 you may have
some difficulty convincing the lender to loan you $200,000 in a
home equity line. High loan-to-value (LTV) home equity loans also
carry a higher interest rate. Bankrate defines high LTV lines of
credit as those that result in an LTV of 90.01 percent or more.
Private mortgage insurance (PMI) is also based on loan to value
calculations. An appraisal of your completed new home will determine
whether you will need PMI. The value of the land will be included
in the appraised value of the home but may not be dollar for dollar
what you paid for the lot.
If you think interest rates are headed higher then you're better
off with a construction to permanent financing package combined
with a rate lock then financing construction with a HELOC and hoping
for the best when it comes to financing your new home.
Read Bankrate's Mortgage
Rate Trend Index each week to take the pulse of the mortgage
market and see what the experts are recommending concerning rate
-- Posted: March 15, 2004