If you plan to transition from renting to owning soon, you are faced with many big decisions. With limited supplies, rising interest rates, and bidding wars, owning your home may seem more complicated than ever. On top of that, you may wonder whether you should buy a new home or build your own custom home. Should you do a fixer-upper project instead? All of these options have their pros and cons, but you might not know which one is right for you.
In this article, we will discuss the pros and cons of each to help you decide. We will also cover the different mortgage and loan options you will need for buying, building, and fixing up.
When Should I Build My House?
Building your own home will be your best option if you want to call your shots and ensure your home is precisely what you want.
Remember that when you build your home, you don’t need to worry about current market conditions or styles of homes. Usually, home exterior and interior design styles come and go, but when you build your own home, you can make your own style and ensure that it’s the house you dream of.
However, building a home from the ground up is very time-consuming. Not only do you need to find a piece of land first, but you also have to go through the process of drawing, filing permits, getting approved, looking for the right type of builder, and so on. If you need a place right away or don’t have time for new construction, you may want to think twice before getting started.
Financing a New Construction
If you are building a house from the ground up, you should know all the costs before buying. Make sure you are working with certified contractors, zoning officials, and city developers, so you know the full estimates of your home before you begin to build. When you apply for a new construction loan, your lender will likely ask for a breakdown of features and estimated costs. Therefore, you should know the total costs of everything and the project scope before you start.
Construction loans are different from a mortgage. A construction loan is usually a short-term loan that covers the construction cost. A mortgage will be required for the prospective homeowner to take full ownership of the property. There are several types of construction loans available, as listed below.
A construction-only loan, usually with a term of 12 months, covers only the actual construction costs rather than renovations or something else you might add on later. It also may not cover the soft costs associated with the construction, such as architectural fees, filing fees, MEP engineering, structural engineering, etc.
Since most lenders consider this type of loan high-risk, construction-only loans are often harder to qualify for and might have very high interest rates. They are considered higher-risk loans because of uncertainties involved in construction, including getting approvals from local authorities, the cooperation from the builder and their team, and potential supply chain disruptions.
This is a good loan choice for prospective homeowners. With a construction-to-permanent loan, the lender will fund the construction and then convert the loan into a permanent mortgage once the construction is completed.
A construction-to-permanent loan usually comes with one year of interest-only construction period. You will only pay only interest on the funds you have drawn during the 12 months. Once the construction is done, the loan will then be converted into a permanent mortgage.
While construction-to-permanent loans may seem convenient, it’s important to note that these loans can be much more expensive than traditional mortgages. Make sure to shop around and compare rates before you decide who you want to bank with.
> Learn more: How Much Does It Cost to Build a Home?
Buying a Home
Whether you are working with a real estate agent or just found a home you love all by yourself, you might be ready to buy a home as-is. Some homes you look at might need repairs, while others might be good just the way they are.
Buying is the most common form of acquiring a home. There are, therefore, many different mortgage loans for buying an existing home or a newly constructed property. Keep in mind, however, that even with a new home, you won’t be able to customize it as much. Additionally, depending on the zoning codes and your homeowner’s association, you might not be able to do renovations or additions to the home afterward.
You can buy a home with most loan products available now. Below are four types of loans you will likely come across.
A conventional loan, or conventional mortgage, is the most common home loan. They can be used for primary homes, vacation homes, and investment properties. These loans aren’t part of any government program and aren’t insured by government entities. They can be lower in cost than FHA loans but more challenging to qualify for. Borrowers are usually required to put down a 20% down payment and have a FICO score of at least 620. Additionally, if you don’t put at least 20% down, you’ll have to pay private mortgage insurance (PMI) every month.
FHA loans are insured by the Federal Housing Administration (FHA) and must be used for purchasing a primary residence. The FHA loan program was created to encourage homeownership. They are the optimal home loan option for first-time homebuyers with little savings or having lower credit scores.
USDA loans are offered through the United States Department of Agriculture (USDA). These loans are zero down mortgage mortgages for low-income people in rural areas. However, USDA loans are often stricter to qualify for, and not every home is eligible.
To apply for a USDA loan, you must be without safe, sanitary housing. You also need to provide that you cannot secure home loans from traditional sources. In terms of income requirements, you need to be below the income threshold for your area.
VA loans are mortgages issued by a traditional lender (such as a bank, credit union, or mortgage company) and backed by the U.S. Department of Veterans Affairs (VA). These loans are for people in the military or their family members. They don’t require a down payment or mortgage insurance. Funding fees are capped and need to be paid by the seller. Usually, a funding fee is charged on VA loans. This is a good option if you’re a veteran, active service member, spouse, or surviving spouse.
Fixing Up a Home
If you are always looking for a project to work on, this is perhaps your best option. Fixing up a home can be time-consuming, but it’s really rewarding. Usually, you’d be able to acquire the property at a lower price given its condition. You will then start the renovation after closing. Depending on how much fixing up the home needs, you might be unable to live in it while completing the project. This means that if you are going with a fixer-upper, you may need to have another place to stay while you work on the renovation.
FHA 203(k) Loan
An FHA 203(k) loan, also known as a Rehab Loan or FHA Construction Loan, covers the property’s cost and any improvements needed to make it livable. It’s not uncommon for people to hire your friends or do the renovation themselves. But note that FHA 203(k) requires that you hire a certified and insured contractor for the renovation work. Additionally, the program will not finance your project if it’s going to take longer than six months to complete.
Fannie Mae HomeStyle Renovation Loan
The Fannie Mae HomeStyle Renovation Mortgage is a type of renovation loan. This program allows you to borrow up to 97% of the total renovation cost. The max amount you can borrow is calculated based on the after-renovation value of the home or the total cost of the renovation, whichever is lower. You must put down at least 5% on a HomeStyle loan. However, there’s an exception if you qualify for the HomeReady program, which has a down payment requirement of just 3%.
In terms of the types of renovations the loan covers, the Fannie Mae HomeStyle Renovation Mortgage doesn’t have a lot of restrictions, as long as the work done is permanent and increases the property value.
Freddie Mac CHOICERenovation Loan
The CHOICERenovation Mortgage from Freddie Mac allows the borrower to buy and renovate a fixer-upper, all with one loan. The down payment amount could be as low as 3%. The CHOICERenovation Mortgage is just like the Fannie Mae HomeStyle program. Your total loan amount is determined by the after-renovation value of the property or the total renovation cost, whichever is lower. The CHOICERenovation loan is perfect for first-time homebuyers looking for affordable housing options.
Whether you’re more attracted to a customized home or the convenience of ready-to-move-in homes, the most important thing to consider when choosing to build, buy, or fix up is your financial stability and the amount of time you have on hand.
While building your dream home may sound appealing, this approach comes with strenuous challenges. The extended timeframe with the urgency of getting approvals from the municipality may be more stressful than you think. Meanwhile, as the housing supply hits all-time lows and more homebuyers encounter bidding wars, buying a home may seem more unattainable than ever. If you have the capacity for a renovation project and have found a fixer-upper, that may be the solution that will bring you one step closer to owning your dream home.
No matter what you choose, review all loans available, compare the rates and terms, and carefully estimate your cost before proceeding with a lender.