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Construction loan: Revealing your private financial details to a complete stranger

To build a custom home, you start with a construction loan. First you need to pick a bank that has experience in construction loans. You may have a favorite bank, but if they don't have a lot of experience with construction loans, we highly recommend finding one that does. It's not as straightforward as a conventional mortgage loan, and you want someone who knows the ins and outs.

The person you'll talk to at the bank for a construction loan is called a loan officer. That's banker speak for loan salesperson. Yep, on the surface it's all unicorns and rainbows. The salesperson is probably going to tell you "everything looks good" before the bank has had time to really look into your situation, so be aware of that up front.

Here's how the basic process works.

Paperwork

Any loan means lots of paperwork. You'll gather up your bank statements, W-2s, tax returns, and other documents and take them to the banker. He will forward them to the underwriter—that mythical creature who has the magical powers to discern whether you are a good credit risk.

More paperwork

In any construction loan process, the bank is probably going to call you back three or four times to ask for more documents or more explanation of the documents you already submitted. Why? Usually because the underwriter told him to.

Loan approval with conditions

When your loan gets approved, it'll probably be subject to some conditions. Some common conditions include requiring that the cost to build the house doesn't exceed some specified amount, that the appraised value of the house equals or exceeds some specified amount, and that your income doesn't change and you don't change jobs during the building process. There will probably be some other little details included that the bank thinks are important.

Next steps

Now you know how much you can borrow, and it's up to you to decide whether or not you can afford that amount. Just because the bank will loan you the money doesn't mean it's a good idea.

The process of getting a construction loan will test your patience. If the banker was recommended by your builder, you'll wonder if your builder intended for you to endure such treatment. It really isn't the banker trying to be difficult, it's just a difficult process.

Banking is heavily, heavily regulated. There are more rules to follow than any one person can keep track of, and the penalties for violating those rules can be steep. So, the bank will do everything they can to ensure they meet all of the requirements while making the process as smooth as possible for you.

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