Soft Costs? What does that mean? Terms You Need to Know & Understand.

The more you know the better prepared you will be to discuss construction financing. There are many terms that might be new to you, and helpful as you research your options.

1. Soft Costs - These are permit, architectural, engineering, survey, school taxes, utility connection fees and any other fees incurred before your actual construction begins. Funds from your construction loan become available at the beginning of actual construction. These soft costs frequently occur before construction begins. Based on your choice and your lender's options, you may choose to be "paid back" for these costs when your funds are available at the beginning of construction.

2. Hard Costs - These are the actual costs for all materials and labor associated with the actual building of your home.

3. Closing Costs - These are the costs associated with closing your construction loan such as title cost, loan fees, discount fees, insurance, and appraisals.

4. Interest Reserve - This reserve account is established to pay the estimated interest on the loan during the construction process. This way, you do not have to make any payments during the construction of your home. In the rare occurrence that this reserve is depleted due to lengthy construction times, then you will begin to make interest only payments on your loan.

5. Contingency reserve - This reserve is created to cover unforeseen cost overruns in the construction of your home. It is usually equal to 5 percent of the hard cost of your construction.

6. Lot Value - The value of your lot will be determined by one of two methods. If the property was purchased in the last 12 months, the purchase price is used to determine the value of the site. If the property has been owned for more than 12 months, an appraiser's estimate of the site value will be used.

7. Inspection fees - Some lenders require that inspectors determine of the progress of your construction project. If these are needed, there may be a fee charged for each inspection.

8. Loan to Cost Ratio (LTC) - This ratio compares the project cost of your home to the total loan amount. As an example, if the project costs for your home are $350,000 and your loan is $325,000, your LTC ratio is 93 percent. Maximum LTC ratios vary from lender to lender, and may be a factor you want to take into account when selecting a lender.

9. Draws - Money drawn during construction to pay for materials and/or suppliers. While there are a few more elements to construction financing than with your traditional mortgage, you are now better equipped to talk with lenders to determine how they can help you build your dream home.