“Dream home” loans require special attention to financing

Especially for people who have a particular vision for their home, creating a house from the ground up has a lot of appeal. It also comes inherent with its own set of challenges, not least of which is how the buyer and the lending institution will come to an agreement regarding how it should be financed. 

With a traditional mortgage, the house itself is capable of serving as collateral in the event of nonpayment and foreclosure. With so-called "dream homes," however, there is no such guarantee. One option that banks have been using to navigate this tricky grey area is issuing "construction-to-permanent loans."

These are most viable when potential homeowners hire builders who don't have the means to provide their own financing. In this case, the lending institution can release the money piecemeal, often directly to the construction company itself. During the period the house is being built, the borrower pays interest only on this smaller amount, rather than the entire mortgage, a cost-effective option for a cash-strapped person. 

The Wall Street Journal discussed another financial benefit to the buyer:

"The advantage of construction-to-permanent loans is that borrowers often face only one set of closing costs, rather than paying such costs for both a construction loan and a subsequent mortgage. Closing costs can equal about 2% of the loan amount, says Keith Gumbinger, vice president at mortgage-information website HSH.com, so borrowers can save thousands of dollars," explains the source.

Construction-to-permanent loans are short-term solutions while building is underway, and generally only last in this form for one or two years. As such, they create unique challenges for the lenders tasked with keeping track of all of the details, increasing the need for personal loan software.