New Home Financing: The Basics
When you’re working with clients looking at new and existing homes, part of your role as a real estate agent is to educate your buyers about the differences between those types of purchases.
While your buyers should always consult with a lender to dig into the details of their financing options, the more you understand about what it takes to acquire a new home, the more value you can offer them.
Buyers can finance a new home with the same loan products available on existing homes, including conventional, VA and FHA loans and even USDA Rural Development loans, depending on the home’s location, says Ron Sozio, vice president and divisional builder manager for Wells Fargo Home Loans in Somerville, N.J.
Financing Production, Move-in Ready and Custom Homes
It’s important to distinguish between a to-be-built production home and a newly built home that’s finished or nearly complete, says Nick Peacock, vice president of lender choices for Beazer Homes in Tampa, Fla. The process from contract-to-closing is pretty similar for a move-in ready new home and an existing home, he says.
The biggest challenge for financing a new home that will take four to eight months or longer to complete is figuring out how to manage the timeline, says Timothy McLaughlin, senior vice president for Weichert Financial Services in Morris Plain, N.J. “Everything else about financing a production home is the same as financing an existing home,” says McLaughlin. “Sometimes the mortgage process for a new construction home can be easier because the buyers aren’t as rushed as when they’re trying to guarantee a quick closing on an existing home.”
If you’re working with custom homebuyers, the financing can be a bit more complicated depending on the builder.
“Some builders require a custom home purchaser to buy the lot and take out a construction loan, while others will finance a custom home just like a production home,” says Sozio. “A construction loan usually requires a down payment of at least 20 percent or more and excellent credit. The process is a little different, too, because the lenders will need to disperse funds to the builder at various stages of construction and then sometimes require a second appraisal and closing when the home is complete.”
In this article, we’re discussing financing to-be-built production homes.
In-House vs. Outside Mortgage Lenders
Some larger builders have an affiliated mortgage business, while others have one or more preferred lenders to recommend to customers. Consumers are always free to finance their home purchase with any lender they choose regardless of the builder’s relationship with a mortgage company. However, many builders offer specific incentives limited to buyers who use their preferred lender and title company, such as paid closing costs or free options.
“Buyers should always compare all their options for financing,” says Peacock. “The benefit of using a preferred lender or an in-house lender is that they’re familiar with the process of building a new home and are likely to know about things specific to the development, such as whether a condominium has received FHA financing approval. A lender who understands the appraisal process for a new home and can coordinate everything easily through regular contact with the builder can be helpful.”
Beazer offers customers a list of three to five local lenders in each of their communities so buyers can choose among several competing lenders. “It’s extremely important for buyers to select a lender with new construction experience, particularly because a settlement date isn’t set in stone,” says Sozio. “The reason builders have an in-house lender or a preferred lender program is that they want a predictable, positive process and to make sure that everything goes through when the buyers are ready to close.”
Start with a Preapproval
Before buyers look at either new or existing homes, you should make sure they consult a lender to get a preapproval for a mortgage, so they understand their budget and know they can qualify for a loan when they’re ready to buy.
“The typical process is for buyers to get preapproved and then sign a purchase agreement for a home,” says Sozio. “The lender will do a credit approval and make a commitment for a mortgage based on the timeframe, then finalize the mortgage based on the final price and appraisal once the settlement is scheduled.”
When to Lock-in a Mortgage Rate
Mortgage rates fluctuate daily and they could change significantly between the time buyers sign a purchase agreement and the completion of the home.
“A lot of lenders offer an affordable long-term rate lock option, but unfortunately not everyone takes advantage of this,” says Peacock. “Higher mortgage rates could raise the payment by $100 or more a month and can even mean the buyers are no longer able to qualify for a loan.”
McLaughlin says that while some buyers opt to watch the market and lock in their mortgage rate if rates start to rise, borrowers can either pay one point (equal to 1 percent of the loan amount) as a deposit or pay a slightly higher interest rate on a six, nine or even 12-month lock.
Some lenders offer a “float-down” option that allows buyers to take advantage of lower mortgage rates if interest rates have dropped since the lock-in. Sozio says an experienced new home lender can coach buyers to help them determine when to lock their rate and for how long.
To qualify for a loan for a new construction home, borrowers must meet the same credit standards and guidelines as if they were applying for any other mortgage. Most lenders require a credit score of 620 or 640 or higher for an FHA-insured loan, while a credit score of 720 or 740 and above is necessary to get the lowest rates on conventional loans.
Borrowers should have a maximum debt-to-income ratio of 41 to 43 percent for most loan programs and will need to provide extensive proof of their income, assets and employment history, including tax returns.
“It’s important for new home buyers to work through the selection process with their budget in mind,” says Sozio. “They need to qualify for a loan based on the total price.”
Lenders typically require one point from the buyers as a deposit that will later go toward points or closing costs at settlement, says McLaughlin. Otherwise, he says, the cash requirements are similar for both existing and new home purchases in terms of the down payment, closing costs and any required cash reserves, which all depend on the loan product.
“Many builders offer incentives for buyers, including offering to pay closing costs, so the out-of-pocket costs of buying new are often lower than buying an existing home,” says Peacock.
Keeping Your Client’s Credit Profile Intact
Peacock says that since so much time passes between an initial loan approval and settlement, Realtors and lenders need to nurture their clients to make sure they still qualify for the loan when the home is complete.
“Tell buyers not to buy a car, take on new debt or change jobs if they can help it while they wait for their home to be built,” says Peacock.
Buyers can use the months during construction to improve their credit if it needs a boost, which occasionally could result in a lower mortgage rate when the loan is finalized.
“The best thing a Realtor who wants to sell new homes can do is to form relationships with builders and with lenders who are experienced with financing new construction homes,” says McLaughlin. “Realtors, builders and customers need to know they’re working with a lender who will communicate with them and be there at the end of the day when it’s time to close.”
Michele Lerner is an award-winning freelance writer, editor and author who has been writing about real estate, personal finance and business topics for more than two decades.