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How to finance your dream home
A home construction project can be the beginning of a new chapter in your family's life. While it comes with the excitement of a fresh start, it can also come with the added stress of tightening your budget and wondering how your new home will impact your savings and financial goals for the future.
On your new construction journey, understanding your options is the first step to making a well-informed decision for your wallet. If you’re ready to explore the ins and outs of new construction financing, read on for the most important factors to consider before getting started.
Financing options for new construction homes
You've researched new construction and have a vision of your dream home. Now, it’s time to make it reality. While we’d all love to pay for our homes with cash, it’s not always feasible, and that’s where the right financing option comes into play.
The financing option that you choose will have a considerable impact on your family's financial health, so it's important to explore each possibility in detail before making a final call. The most common options available for financing a new construction project include:
| Type of financing: | How it works: | Pros: | Cons: | Other considerations: |
|---|---|---|---|---|
| Construction loans are designed to provide short-term funding for the construction of a new home. There are two main types: Construction-only loans strictly cover that stage and must be repaid upon completion of the build. Construction-to-permanent loans cover that phase and then can be converted to a traditional mortgage (with a fixed interest rate.) | In terms of disbursement, construction loans typically involve a "drawdown" process that provides funds at specific stages in the building process. Typically, interest-only payments are required during the construction phase. If you have cash, from the sale of your previous home for example, you might be able to pay off a loan balance in a lump sum. Otherwise, you’ll pay off the loan monthly. Once your home is complete, a construction-to-permanent loan will convert to a traditional mortgage. | This type of loan can help you cover a variety of costs associated with building a home, including materials, labor, inspections, and land. | Interest rates are typically higher than those associated with a mortgage used to purchase a home. You may need to pay two sets of closing costs if you opt for a construction-only loan, as you’ll pay for closing when you secure a traditional mortgage (unless you’re able to pay off the loan with cash). | Make sure you understand when you’ll need to begin making payments. Sometimes repayment begins after six months. As with all loans, your credit score and financial stability will be requirements for qualifying. A down payment of 20-25% of the project is typically required to secure the loan. |
| Government-backed loans are available in specific cases through various federal departments. | Veterans may be eligible for new construction loans through the Veterans Administration. Borrowers meeting specific criteria, such as first-time homebuyers, may be eligible for new construction loans offered through the Federal Housing Administration (FHA). Rural residents may be eligible for new construction loans offered by the U.S. Department of Agriculture (USDA). | These loan programs come with terms that are friendly to borrowers. For example, low or no down payment, low interest rates, and more flexibility around qualifying requirements. The exact details vary by program. | These loans are designed to increase access to housing for people who might be facing barriers for various reasons. You won't be eligible for these loans unless you meet specific parameters. | The VA’s home loans program helps veterans, service members, and surviving spouses. The FHA’s loan programs include those targeting first-time home buyers and others. The USDA’s home loan program helps rural residents with low to moderate incomes. |
Keep in mind the information here is a high-level introduction to help you plan your project. It’s important to consult your local financial advisor or lender for full details and eligibility. Andersen is not a financial expert.
Credit score requirements for new construction
Construction plan requirements
In order to secure a new construction loan, you'll be required to present documentation detailing the project. Required documents are likely to include a project timeline, budget, materials lists, floor plans, and more. Typically, a builder will help create the construction plan that your lender requires.
This step is required because construction loans are considered riskier for lenders. These loans don't have collateral associated with them, like a mortgage or home equity loan does. In addition to the construction plan, you'll also have to provide documentation proving you're working with a qualified builder who has a track record of built homes.
How to compare financing options
If you’re exploring loans from several different banks, credit unions, or other lenders, it will be important to do your homework by comparing interest rates, fees, and closing costs. Sometimes, there’s an opportunity to use “points” (or “discount points” as they’re also called) to pay down costs associated with a loan. A crucial term to understand when comparison shopping is APR.
What is APR?
APR stands for annual percentage rate. It tells you the total cost of a loan each year. A loan is more than just the principal (the amount you borrow) plus interest (the fee you pay the lender to borrow money). There are other fees, like closing fees and broker fees, for example. An APR will factor in all of these fees along with the benefits that points might provide. For example, sometimes points can be paid up front to secure a better interest rate. Looking at the APR will show you what you’ll actually be paying each year. This is why it’s such a useful tool when comparing options offered by various lenders.
There are many great resources available to help homeowners increase their financial savvy when shopping for a mortgage or home loan. We recommend starting with the Consumer Financial Protection Bureau for the basics on how loans work and how to be a smart shopper.
Why are windows and doors such a significant part of a new construction budget?
No other component in the home is required to meet the same standards for performance, functionality, and aesthetics that windows and doors must, both from an exterior and interior perspective. They must protect a home from the elements, keep conditioned air from escaping, open and close on demand, and add beauty. No other component has to achieve this much. Quality windows and doors can do all of this, but the caliber of the materials, design, and manufacturing are paramount. So, while it's true that windows and doors carry a higher percentage of your budget, if you think about the job they’re tasked with, you'll realize this isn’t a place where you want to cut corners.
How much of a construction budget should be allocated to windows and doors?
We asked builders from different parts of the country what percent of the total construction budget their clients spend on windows and doors on average. We heard answers ranging from 5-15%, depending on the home’s design, but the builders we talked to agreed that reserving 10% of your budget for windows and doors is realistic.
Of course, the actual amount spent on windows and doors will depend on a variety of factors, including the size of your home, the window products you select, your priorities in terms of design and functionality, and your geographic location, as code may require windows to include certain features. All these variables mean the cost of this line item can vary greatly from one home to the next.
Return on investment (ROI) for new windows and doors
If you do decide to invest a larger portion of your construction budget in high-quality windows and doors, rest assured that you’re making a wise investment in the future of your home. Here’s why:
Secure building envelope
Windows and doors, like your roof and walls, help make up your home’s building envelope — the components that protect your home from the elements.
Greater energy efficiency
High-quality windows and doors curb energy loss so you’re more comfortable in all seasons, keeping your utility bills in check while also keeping air temperature at the right level.
Improved curb appeal
Windows and doors add beauty inside and out by bringing in natural light, framing views, and supporting your home’s architectural style.
Seamless indoor/outdoor living
When your indoor and outdoor space are well integrated, you get to enjoy every last bit of your property.
Improved quality of life
Windows and doors affect the way you feel. Natural light has been shown to improve sleep, increase productivity, and boost mood.
In a nutshell, investing now in the right windows will protect the investment in your home and improve your quality of life, too . You might go back and upgrade your countertops later, but going back and adding another window, while possible, is a much larger home improvement project. All the more reason to allocate the budget to do windows and doors right, right from the start.
Financing a new construction project can come with more than a handful of daunting decisions, but it‘s also an exciting time to plan for the future and create a space that's all your own. By understanding the available financing options, assessing your personal financial health, and considering the potential benefits of your investments, you can make a well-informed decision and achieve the home of your dreams.
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