USDA loans offer 100% financing for homebuyers. What you might not know is that you can use the program to buy new construction. However, just like buying an existing home, there are many restrictions. Understanding how the process works and what you can and cannot buy will ensure your success.
A Modest Home
Just like with an existing home, the home you build must be moderate. This goes for the land and the house itself. Moderate means it must be a moderate size for the area. It must also be modest in design. The USDA program is for low to moderate-income families that could not secure financing from any other program. Building an extravagant house is not part of the program. Instead, it should be a home of adequate size for your family without going overboard.
What the Loan Covers
A new construction loan covers more than the purchase of a home. You must pay for materials, labor, architectural fees, as well as any administrative costs. Talking to a builder will let you know what costs you can expect. Again, for the USDA loan, the costs must be average for the area. This may require a little shopping around to find a builder that fits your budget and the USDA requirements.
Choosing the Right Builder
Choosing the right builder means more than finding someone that will build the house you want. The USDA has requirements regarding the contractors as well. Because there is more risk in a new construction loan than an existing loan, the USDA gets more involved.
Start by looking at builders that have at least 2 years’ of experience building new homes. Without the proper experience, the USDA will not approve the loan. The USDA wants a builder with adequate experience handling the issues that can occur with building a new home. Builders need more than experience building a home. They need to be able to handle the finances that go along with it, including preparing for the unexpected.
In addition, lenders need to show proof of adequate licensing and insurance for the industry and area they work. They must also prove they don’t have a criminal past or any pending lawsuits against them. The USDA will approve the builder you choose. It’s always best to secure quotes from a few builders in order to ensure the USDA/lender approves at least one of them.
Releasing the Funds
A new construction loan works differently from a standard mortgage. First, you need funds to build the home. The builder must be paid, but no lender is going to pay them outright. They pay them in predetermined increments based on the contract signed. The builder and lender will need to come to an agreement on this timeframe.
This financing for the building portion of the home is temporary. You only pay interest on the part of the loan that was disbursed each month. Generally, lenders disburse 50% off the funds upfront and the remaining funds as the builder completes the work. Generally, a representative for the lender/USDA must approve the completion of the work before any funds get released.
Your mortgage does not turn into a permanent loan until the home is complete and livable. At this point, the permanent mortgage funds pay off the temporary loan. You then begin paying principal and interest payments as you would on a standard USDA loan.
If there are any extra funds left after your home is built, the lender will apply it to your principal. This can knock down the amount you owe right off the bat. The lender cannot give you the funds as cash in hand. The only exception to the rule is if you paid for anything out of pocket and can provide proper receipts for reimbursement.
Qualifying for the USDA Loan
Qualifying for a USDA loan whether for new construction or an existing home is the same. The USDA has flexible guidelines with low credit score requirements of 620. The largest hurdle oftentimes is your household income. It may not exceed 115% of the median income for your area. This includes all money made by anyone in your household.
You should also have a debt ratio that does not exceed 29% on the front end and 41% on the back end. Your front-end ratio is your principal, interest, taxes, insurance, and annual mortgage insurance fee. Your back-end ratio is the front-end ratio plus any other monthly liabilities you have.
The USDA loan does not require a down payment and is the most flexible new construction loan available today. If you have moderate income and plan to buy a home in a rural area, it could be the answer to your funding needs.