If you’re thinking of buying a brand-new home, you might be wondering if securing a mortgage will differ from one for a previously owned property.
While much of the financing works the same for homes both new and old, there are a few subtle differences when you purchase new construction. Specifically, there are a few extra steps required to lock down a loan for a new-construction home, making it important for homebuyers to understand what is expected of them—and when.
Here’s what you need to know about getting a loan for a new-construction home—as well as what questions to ask—to keep you on the right path all the way to closing.
Types of mortgages for new-construction homes
First off, one thing to be aware of is that a “construction loan” and a “loan for a new-construction home” might seem the same, but they’re not.
A construction loan is a short-term loan that’s used to finance all of the costs that go into building a property from the ground up, including the land, raw building materials, and hiring an architect and construction crew. This would be the type of loan you’d need if you’re building a custom home yourself.
If, however, you’re buying a new-construction home from a builder, the builder is the one who’s taken out the construction loan—that isn’t your responsibility.
As for which type of loan you should get, many of the most common types of loans are available for newly built homes, including conventional, FHA, VA, USDA, and others at both fixed and adjustable interest rates.
A lender can help you figure out which type of mortgage is best, based on your income, the home you hope to buy, and other factors. Make sure to weigh all of your options, including which lender you use.
How to choose a lender for a new-construction home
When you’re shopping for a loan for a new-construction home, one key difference from buying a pre-existing property is that the builder might have its own lending company or work with a preferred lender.
Odds are, the builder will encourage you to go with its lender since there are benefits for the builder—and for you. For example, builders might throw in builder incentives if you use their preferred lender, like offering lower interest rates or helping with closing costs.
However, going with the builder’s lender is not a requirement; it is your choice. The alternative is to use an outside lender, which might be better if the type of loan you’re seeking is outside of what the builder’s lender may offer, like a specialized VA or state loan.
Basically, the only way to learn about the pros and cons of your options is to speak to more than one lender. However, always make sure the lender has previously dealt with new construction.
“It’s important that a buyer work with a lender who has experience with the nuances of mortgage lending for new construction,” says Kelly Zuccarelli, national builder and condominium program manager for Wells Fargo Home Loans.
Sometimes there can be delays with new construction, and you’ll need a lender who knows how to account for those types of setbacks.
What is a builder’s deposit, and how much is it?
One fee you’ll have to pay at the outset of a new-construction purchase is a builder’s deposit. This is the same idea as an earnest money deposit on a resale home, but a builder’s deposit is usually higher. Because the builders are assuming some risk by financing and building the house for you, they want some protection on their investment upfront.
“The builder’s deposit is usually around 5% and depends on the total price of the home, market conditions, the buyer’s financial profile, and local regulations,” says Jill Gonzalez, an analyst for WalletHub. “If the future homeowners also want to customize or upgrade certain features of the house before it’s finished, the builder might increase the value of the deposit to cover the costs or potential damages.”
This sum also acts as insurance for the builder, reducing the risk of buyers backing out on the deal. If you do back out, you will lose that deposit. The good news, however, is that the builder’s deposit can generally be credited toward your mortgage down payment at the time of closing.
How to qualify for a mortgage on a new-construction home
When applying for a mortgage on a new-construction home, the qualifications you must meet will seem very similar to what you’d need for a pre-existing house. Lenders will look at your credit score and history, your income and employment, your debt-to-income ratio, and your ability to make a down payment to determine if you qualify and for how much.
Lenders will also need to determine how much the home is worth. If a new build is basically complete, it will be easier to estimate a property’s value right away. But if it’s very early on in its construction, this can be tougher to determine.
“Some people apply for a mortgage even before their future home has a foundation,” says Gonzalez. “But this is a pretty risky practice.”
According to Mark Worthington, an Oregon-based branch manager for Churchill Mortgage, typically what happens is the builder will set an initial price on a home. But once you apply for a mortgage, the lender will get its own estimate from a licensed real estate appraiser, who comes up with a number based on the property’s location, condition, comparable home prices in the area (or comps), and other factors.
Odds are, the estimates from the appraiser and the builder will be close. And if your build is still in the works, that appraised price could change by the time the house is complete.
If, in the end, the property’s value comes back lower than the original estimate, this simply means you will borrow less money than you’d anticipated. But if the final valuation is higher than the original estimate, this might mean you’ll have to borrow more. In this case, some lenders might be willing to adjust their offer so you can receive a higher loan amount to cover the difference.
“The lender might also try to make up for it with a lower interest rate or reduced mortgage insurance requirements,” says Gonzalez. “Lenders might even offer more flexibility in terms of down payment, either giving you more time for it or reducing the amount altogether.”
Given these unknowns, homebuyers will want to ask what their options are in various scenarios to make sure they are prepared for whatever happens.
What is a Certificate of Occupancy?
Before you can close on a loan for a new-construction home loan, there’s an extra step where the house must be inspected and deemed safe and habitable. That’s where the Certificate of Occupancy, or CO, comes in.
“The CO is given by an inspector after it’s determined that your future home is in accordance with all the relevant building and safety codes,” says Gonzalez. “Only then can the lender proceed with the mortgage, even if you get pre-approved a few months early.”
While an existing-home closing usually takes around 30 days, a new-construction home takes anywhere from 45 to 60 days, or longer, to close because of the extra signoffs needed for additional inspections and the final independent property value appraisal.
What if interest rates rise by the time the house is built?
If interest rates change by the time your home is complete, this will affect your mortgage payments. But one way to ward off this scenario is to ask your lender for an extended rate lock, which “locks in” the current interest rate as the one you’ll pay when you close on the house.
“There are locks that can go as long as 270 days—or even longer in some cases,” says Worthington. “This is generally up to the lender, so asking these questions upfront is key.”
Another thing to inquire about is if there are any “float down” options.
Zuccarelli explains that some lenders such as Wells Fargo will offer a free float down, which insulates borrowers from any increase in rates but allows them to benefit if rates go down prior to closing.
By Kimberly Dawn Neumann, Realtor.com September 19th, 2023