We Made This Major Borrowing Mistake When Building Our Home

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If you're building a home, you might make this misstep, too.

When we built our home over a decade ago, we had to borrow to afford to pay for its construction (as most people do). Since this was our first time building, we applied for a construction loan to cover the costs.

When we did this, though, we didn't realize there are different kinds of mortgage loans that fund a new home build. And the loan we chose ended up causing us a lot of unnecessary stress and extra costs. Here's why.

This was our mistake when we got our loan

The big oversight we made when borrowing to buy our home was getting a construction loan that wasn't a construction-to-permanent loan.

See, when you build a home, you get a mortgage that's set up especially to pay the builder during the process. This is true regardless of whether you get a standalone construction loan or a construction-to-permanent loan. Typically, the mortgage lender pays out borrowed money to the builder directly in a series of draws, and money is released as the builder meets construction milestones. As a borrower, your monthly payments cover interest on the loan only, not principal (the original amount you borrowed), so the balance is never paid down. And interest is charged only on the money that's already been released to the builder.

What we didn't realize when we took out this type of loan was, at the end of the construction process, we would need to get a standard mortgage to pay off the construction loan. This was necessary because we didn't get a construction-to-permanent loan, which would have made it easier to convert our construction loan to a regular mortgage that we'd pay off over time.

Even worse, our lender didn't even offer standard mortgages. It only provided construction loans. That meant that as the date drew near for our house to be completed, we had to scramble to find a new lender, apply for a new mortgage loan, and pay closing costs a second time.

Now, there are times when it might make sense to get just a construction loan and then apply for a permanent loan later. You may want to do this if you get a good rate on a construction loan from a lender that doesn't offer conversion to a permanent mortgage, for example. But we hadn't made a carefully thought out decision to do that. And we weren't prepared for the fact we had to go through a separate mortgage application process and pay several thousand dollars more for closing costs right when we were moving into our home.

The process taught me the importance of making sure you understand every detail when you're borrowing for a home. While it ultimately worked out for us and we were able to get a mortgage from a different lender to pay off our construction loan, we would have avoided a lot of unnecessary stress if we knew ahead of time that was expected of us. And had we understood the difference between construction loans and construction-to-permanent loans, we could have made a more informed choice about which one was the better option.

Soon, we'll be building another home. With a decade of experience under my belt, I better understand the options available to borrow for it. And chances are good, we'll be opting for a construction-to-permanent loan this time around to make life simpler.

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