Are you deciding between buying a new home or building the home of your dreams? If so, you may be wondering; what’s the difference between a conventional mortgage and a construction loan?
What Is a Conventional Mortgage?
Traditional mortgages, also known as conventional mortgages, allow a buyer to borrow the funds they need to purchase a new home.
What Is a Construction Loan?
Construction loans provide borrowers with access to funds as needed during the process of building a home.
How long does each loan last?
Conventional mortgages are long-term loans that borrowers pay back for years after the starting date of the loan. A typical mortgage has a 30-year term, during which the borrower must repay the principal loan amount as well as the interest charges.
On the flip side, construction loans have a draw period of 6,9 or 12 months during the construction phase. After that, the loan converts to permanent financing for the life of the loan which can be up to 30 years.
Do conventional mortgages and construction loans have similar interest rates?
Interest rates on conventional mortgages and construction loans fluctuate along with the Prime Rate. However, in general, interest rates on construction loans tend to be higher than interest rates on mortgages. These higher interest rates on construction loans are due to the larger risk associated with a construction loan versus a conventional mortgage.
What is the approval process like for each type of loan?
To get approved for a conventional mortgage, you’ll need a decent credit score with credit history, proof of income and a down payment that is equal to at least 5% (3% for first-time-homebuyers) of the total loan amount. Most lenders can get borrowers pre-approved for a mortgage in just a few days, but the average approval process for a mortgage is 30-50 days.
Conversely, approval for a construction loan can be quicker, but more comprehensive. Lenders will usually ask to see details about the planned construction project, such as a signed construction or purchase contract with your builder or developer that outlines the total contract amount (cost of construction and land) as well as the construction start and completion dates.
In many ways, though, approval for a construction loan is just like approval for a traditional mortgage. You’ll need to have a decent credit score and proof of income. You’ll also need a down payment that is equal to at least 20% of the total loan amount.
How are the funds paid out in each type of loan?
One of the key differences between a construction loan and a conventional mortgage is the way the funds are distributed. In a mortgage, the entire loan amount is paid out in one lump sum as the borrower takes out the loan. This enables the borrower to purchase their new home immediately upon approval.
A construction loan works differently. Instead of the loan being paid in one lump sum at the onset, funds are paid out in “draws,” or phases, as the construction project progresses. For example, funds may be paid out when each of these stages in the project is reached:
- Delivering the final plans for the home
- Obtaining permits
- Completing the foundation
- Framing out the home
- Installing all drywall, siding, windows and doors
- Installing HVAC systems, electricity and plumbing
- Installing interior trims, cabinets, countertops and flooring
- Substantial completion of the home
- Final completion of the home
No matter which direction you decide to go, Northern Credit Union is here to help you get into the home of your dreams! Get started from the comfort of your home by applying through Online & Mobile Banking, on our website or connect with us through Video Banking, by calling or texting 315.782.0155 or stop into any of our relationship centers!