Construction Loans and the VA Mortgage Program

Soldiers help build a house
U.S. Army photo by Sgt. Nicholas Olson

If you’re eligible for a VA home loan and you’ve doing a bit of home shopping recently and haven’t really visited any houses that you’re not exactly thrilled about at some stage you might begin thinking of building your own home with the features, rooms and amenities that you desire. If you’ve got a preapproval letter in your hand issued by an approved VA mortgage company it’s to buy and finance an existing home such as a single family residence or in a VA approved condominium project.

But while the VA loan can be used to finance the construction of a brand new home, you’ll be hard pressed to find a lender that will issue one. But that doesn’t leave the VA mortgage program out of the process of building your very own home. Let’s look and see how the VA loan can be used when building new instead of buying an existing property.

Construction Basics

When you decide to build, you’ll need a construction loan. And unlike a traditional VA mortgage, the entire loan amount isn’t disbursed all at once but in stages. As the home is completed, the lender wants the construction loan paid off and this is done with your VA home loan.

You’ll work with your architect to design your home and provide you with your blueprints. Take some time with this and don’t be afraid to change things as you go along. In fact, most blueprints aren’t the same from start to finish as clients change some things around or add amenities as the project progresses. Once the prints have been completed, it’s time to show them to your General Contractor.

Your contractor will then review the plans and prepare a quote based upon the plans and specifications laid out by your architect. The contractor will provide an extensive list of materials needed and other hard costs such as labor, for example. There are other fees that need to be addressed as well referred to as soft costs which are fees needed to pay for permits and zoning compliance.

But just like you searched for the right lender who issued your initial preapproval for a mortgage, you should also get bids from more than just one general contractor. Three should be sufficient. You want to perform your fair share of due diligence here to make sure the contractor is experienced, there are no legal issues or claims against the contractor and especially important is to get referrals from previous clients. You also want a contractor that has built homes similar to the one you’re going to build.

While they’re preparing an estimate for you, you should also contact your selected construction lender to make sure the builder is on the lender’s approved contractor list. If the contractor is not on the list, there is a process to get the contractor approved. However, experienced contractors in your area are more than likely on that lender’s approved list but you need to know this information in advance as it can affect which contractor you choose. Once you select your contractor and you have your estimate, it’s time for a personal visit to your construction lender.

Lender Basics

The lender will then review your plans and specifications. The next step is to order an appraisal on the project. The appraisal will appraise the property as if the home has already been completed, referred to as “As Completed” value. Construction loans like to see some equity in the property and a common amount of equity is 20 percent of the appraised value. If the appraised value comes in at $350,000 for example, the lender would issue a construction loan at 80 percent of that amount, or $280,000. In this amount is an allotment for “change orders.”

It is then your responsibility to take care of the $70,000 equity requirement. However, most often this 20 percent equity requirement comes in the form of the land you already own. If you’re going to get a loan to finance the construction as well as buy the lot, the $70,000 is then in the form of a down payment from you.

The contractor will provide a report that identifies different stages of construction in the form of a Construction Schedule. Broken down into different stages, the lender and the contractor agree to a draw schedule as well as when each stage is expected to be completed as well as when the home will be ready for occupancy. Remember, the construction lender isn’t going receive the entire $280,000 but paid out as instructed in the draw schedule.

For example, an initial draw might be for permits, stakeouts and lot prep. Once the lot has been cleared and ready for foundation work, another draw is issued and the contractor continues. As each agreed upon stage is completed, a new draw is issued. At each issuance, the construction lender sends out an inspector to make sure the work the contractor has claimed has been completed actually is until finally the home is complete and ready for move-in.

Your construction lender now wants its money back. You can do this with your VA home loan benefit.

Permanent Financing

The construction loan was temporary and needs to be permanently replaced. During construction interest on the amounts drawn accrues. This interest is typically paid each month during construction while other construction loans allow interest to accrue and be included in the permanent mortgage.

Your lender who issued your initial preapproval needs to begin updating your mortgage loan application as the documents you originally provided are several months out of date. Loan documents, credit, income and employment will all need to be recertified and you should begin this process at least 30 days out from the expected completion date of your home.

Once the builder issues the certificate of completion you will schedule your final closing. Your lender will order loan payoff amounts from the original construction lender. The settlement agent will prepare a final settlement statement that will show the loan amount, closing costs and down payment (if needed). At the closing, the settlement agent sends your signed VA home loan documents back to the lender who will review and release funds for your VA home loan.

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VA Loan Home Ownership