How Does Custom Home Financing Work?

How does custom home financing work

When it comes to custom homes, the building process isn’t the only thing that’s different from buying a home. Lending elements are different as well. (A lot different, actually.) Financing for custom homes can be complicated, but the good news is that the best custom home builders will be knowledgeable about the process and help you every step of the way.

In the meantime, if you’re interested in learning how custom home financing works, here’s a basic overview.

Construction Loans vs. Mortgage Loans

For starters, the loan you get for a custom home is different from a traditional mortgage loan. The biggest reason why? You’re getting a loan for a building that doesn’t exist yet. Lenders typically don’t like to hand out mortgage loans for construction projects that have lots of variables and perceived risk involved with them. 

Instead, you’ll need to pursue a construction loan. These loans often have variable rates, which you’ll have to endure until the construction phase is complete. There’s also lots of paperwork involved related to budgets, timetables and other details. Once the house is finished, you can refinance into a traditional mortgage loan if you prefer.

Down Payments and Interest Rates

With traditional mortgage loans, there are a variety of down payment options. Some lenders or mortgage plans let you pay as little as three percent, or even nothing down. With the construction loan you’ll need for a custom home, prepare to put down 20-25 percent of the loan. 

Custom homes are viewed as “higher risk” by lenders than traditional mortgage loans—as such, they usually require higher down payments and interest rates can fluctuate. It should be noted, however, that there are conversion loans available that have a higher interest rate for the building phase of the custom home, then a lower rate once they convert into a long-term loan.

Bridge Financing and Builder Financing

What happens if you’re interested in a custom home, but haven’t sold your existing home yet? Or what if you don’t have all the cash needed for a down payment? A bridge loan might be necessary to get the timing and financing right. Bridge loans often have higher rates than traditional loans, but they can make the finances work. They’re only ideal for the short term, however (six to nine months).

Your custom home builder may also have a financial option that works for you. Custom builders often have their own mortgage subsidiaries or work with mortgage companies as affiliates, meaning they can offer special financing packages and incentives. 
Talking with a custom builder about your financing questions is the best way to go if you want to see which custom home financing option is best for you. If you have any questions about custom home financing, contact us today.