How to pay for your dream house

By Liz Pulliam Weston

If you want to buy a home that somebody else built, you'll have no trouble finding reams of information -- and lenders -- willing to help you.

If you want to build your dream home, however, the road gets rockier. Construction loans aren't as easy to find, or understand, as a traditional 30-year mortgage. Not all lenders offer construction loans, and those that do vary widely in the kinds of terms, rates and fees they offer.

Few would-be homebuilders can do without a construction loan, however. Only about one in five people who build a new house pays cash, according to Census Bureau housing statistics.

So if your heart is set on creating a home from scratch, here's what you need to know about borrowing the money to start turning your dreams into reality.

Two types of construction loans

First, the basics. Construction loans are short-term, interest-only loans that are typically designed to be replaced by a regular mortgage once the home is built. These loans are offered by regional banks, mortgage companies and some national lenders, including Bank of America and Wells Fargo.

Construction loans come in two basic flavors:

• The all-in-one loan (also called the rollover or the construction-to-permanent loan), which automatically reverts to a standard mortgage after construction is completed, and

• The construction-only loan , which comes due at the end of construction and must be paid off or replaced by a conventional mortgage.

Both approaches have their fans. All-in-one loans have one set of fees and one closing, reducing the hassles for buyers, said mortgage broker Allen Bond of Palos Verdes Funding in California. Although many all-in-one programs convert the construction loan to an adjustable-rate mortgage, some plans offer 15- or 30-year fixed-rate mortgages.

But shopping separately gives consumers more choice, because they can select from the thousands of conventional mortgage loans available rather than being restricted to the mortgages offered by construction lenders.

This approach "lets the consumer wind up with the kind of loan they really want for the long term," said Ginny Ferguson, vice president of the National Association of Mortgage Brokers.

What you'll pay in rates and fees

In either case, the interest rate you'll pay on the construction loan is typically fixed for the life of the loan -- usually 12 months or less, although some stretch for 18 months. The rate for people with good credit is usually the prime rate plus zero, one or two percentage points. At the current prime rate, that means a rate of 6% to 8%. You'll typically pay 1% or 1.5% of the total loan amount in origination fees, plus several thousand dollars in other fees to cover costs such as inspections (so the lender can make sure the project is proceeding according to schedule) and title insurance, which tends to be trickier with new construction.

"They take a big chunk" in fees, says Warren Christensen, a Los Angeles homeowner who recently paid $17,000 in fees to get an all-in-one construction loan that replaced his mortgage and provided him $135,000 for a major remodel and addition. "The beauty of (the all-in-one loan) is that you're not paying fees again when you roll over, but it's still a lot of money."

The higher cost reflects the risk of lending on an asset that hasn't been built yet. There are also fewer construction lenders than there are mortgage lenders, so the market lacks the kind of cutthroat competition that has helped drive down costs for regular home loans.

Christensen, a publisher who with his architect wife has built or remodeled several homes in Los Angeles, recommends shopping around to get the best deal. "Go to a bank that does construction loans and to a mortgage company," Christensen said. "Go to three or four different places, because rates can vary greatly."

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