OnPath Credit Union

What Is Covered in a New Construction Loan?

A new construction loan is different from your typical home mortgage. It's a short-term, interim loan for financing the cost of construction. It operates on an interest-only basis during the building phase, meaning you'll only be paying off the interest on the money drawn out while your home is being built.

In a traditional mortgage, a lump sum is paid to the home seller. In the context of new home construction, there is no seller – just a home builder. Giving a builder a lump sum up front is problematic for a couple reasons, which is why lenders instead disburse the funds in stages (referred to as “draws”).

Why Don’t Lenders Just Give Builders the Lump Sum?

Risk Management

There are a lot of trusted home builders in the New Orleans area, but that doesn’t mean lenders want to roll the dice every time someone wants to have a home built. Plus, as the homebuyer, it’s your credit that’s on the line, not the builder’s credit. Disbursing the funds in stages as the build progresses helps manage the risk. It also lessens their potential liability if the borrower defaults on the loan since the lender won’t have paid out the full available sum in advance.

Cost Control

The lender and borrower can ensure the construction loan funds are being spent in line with budget expectations and the timeline outlined at the start of the project by adhering to a draw schedule, especially if it’s tied to specific progress benchmarks. After each phase, an inspection may be performed to ensure the work is properly completed before the next draw is released to the builder.

Shielding You, the Borrower

A dishonest builder can’t take all the money upfront without completing the work when the draw system is followed. It also lets the borrower pay less interest during the build process since you’ll only be paying interest on the amount that has been drawn up to that point rather than the full approved loan amount.

Cash Flow Management

Managing cash flow on large build projects like home construction is often vital to hold all parties accountable to the agreed upon terms. Disbursing the entire amount up front could result in problems down the line if cash isn’t managed properly during the build and funds run out.

What Costs Are Covered by a New Build Loan?

A new construction loan can cover a wide range of expenses. These include everything from the purchase of the land, if you haven't done so already, to labor and materials, permits, architect fees and even contingency reserves for any unexpected construction costs that pop up.

Once the construction of your home is complete, the team of mortgage professionals at OnPath Federal Credit Union will help you transition the new construction loan into a traditional mortgage. This is often referred to as a construction-to-permanent loan. The advantage here is that you only have to apply for one loan and pay one set of closing costs, saving you both time and money.

Remember, while construction loans offer flexibility and can ultimately help make your dream home a reality, they do come with a certain level of risk given the nature of constructing a new home.

Costs can overrun, construction can be delayed and market conditions can change (i.e., lumbar costs can increase dramatically in a short time period). This risk is also shared by the lender, which is why these loans may require larger down payments and may have less advantageous terms or rates compared to the permanent loan you receive at the end of the process.

Should You Consider a New Construction Loan in New Orleans?

There are compelling reasons to consider building a new home instead of purchasing an existing home (although the process is not for everyone). Building something new provides an opportunity to customize the home to your specific needs, tastes and lifestyle. Depending on the builder’s floorplans or customization options, you may be able to decide the layout, room sizes, design elements and finishes, creating a space that's truly personal and functional for you.

New construction homes usually have fewer maintenance and repair needs, and things like HVAC systems or roofs should be expected to last for a decade or two before needing replacement.

New homes are also far more energy efficient than older homes and are constructed using higher-quality, longer-lasting materials, which means you may end up saving you money on heating and cooling costs (not to mention better overall comfort control).

If you think building a new home is right for you and your family, the mortgage team at OnPath Federal Credit Union can help. Call us at 504.648.2064 to learn more about your loan options.