What is a construction loan?
Construction loans fund residential buildings (also known as stick build houses) from the purchase of land to the completed structure. Once the building stage is complete, there are several types of construction loans, including options to convert it into a permanent mortgage, and other options that only cover the construction stage.
What costs are covered by construction loans?
You can use a construction loan to cover costs such as:
-
Land/Lot
- Contractor’s Work
- Building materials
- permission
However, construction loans do not include design costs. If you want to hire a professional architect or interior designer, you will need to pay it individually.
How do construction loans work?
The initial semester of a construction loan generally lasts within a year, during which the project must be completed. You or your general contractor should provide the lender with a construction timeline, detailed plans and realistic budget. Based on that, lenders will usually release funds directly to the contractor once the large milestone is completed.
Construction loan vs. traditional home loan
Beyond the length of the term, there are several main differences between construction and mortgages.
- Drawing and inspection: Unlike mortgages and residential equity loans, when funding is provided with lump sum payments, lenders will call the funds known as “drawings” as the project progresses and undergoes inspections. Expect 4-6 inspections during the project.
- repayment: When you use a mortgage, you will immediately start paying off your principal and profits. With construction loans, lenders typically require only payment of interest on funds previously withdrawn during the construction phase.
- Requirements: Like mortgage borrowers, construction loan borrowers must be financially stable and able to pay down payments. However, because there is no property to evaluate, lenders want to see a detailed overview of the construction plan and the project when deciding how much to lend.
Construction loan fees
Unlike traditional mortgage rates, which are often fixed, construction loans usually have variable interest rates that fluctuate along with the prime rate. This means that monthly payments can increase or decrease based on the broader market.
Construction loan rates are typically about percentage points higher than traditional mortgage rates. That’s because they are not supported by assets. With a traditional mortgage, your home serves as collateral and if payments are the default, the lender can grab your home. With home construction loans, lenders tend to view these loans as greater risk, as they have no option.
Construction loan requirements
Companies that provide construction loans typically require borrowers to:
- Be financially stable. To obtain a construction loan, you typically need a credit score of at least 680, a low debt-to-revenue ratio, and proof of income sufficient to pay off the loan.
- a down payment. While it may be possible to cut just 3% to a traditional traditional mortgage, construction loan lenders can be close to 20%. The exact amount will vary depending on the lender and the amount of the loan.
- There is a construction plan. Lenders want detailed plans and schedules from reputable construction companies.
- Get it Home rating. Even if you are getting a construction-only loan or a permanent loan from construction, your lender will want to be sure your home is worth the money you are lending. The appraiser will assess the blueprint, the value of the lot, and other details to reach the exact number. For inter-construction loans, once construction is complete, the home will act as collateral for the mortgage.
Types of construction loans
Different types of construction loans are designed to suit different borrowers.
Inter-construction loan
Inter-construction loans will transform into traditional mortgages once the home is complete. At that point you will make an interest and payment covering the principal, as you will be mortgaged. Typically you can choose between fixed or adjustable rates and a period of 15-30 years.
Many construction loans are traditional loans that are completely privately funded, but there is also a government version. Your options include permanent loans from the construction of the FHA. It has strict approval standards that are particularly useful for some borrowers.
Whatever type, the big advantage of a permanent approach from construction is that you only pay a set of closing costs, reducing the overall cost.
Note that using some lenders will allow you to transfer your construction loan to a permanent mortgage (also known as an end loan).
Construction-only loan
A construction-only loan will provide the necessary funds to build a home and repay it in full at the end of the semester. You can settle your debts with cash or mortgage.
You may get better terms with a new mortgage, but you may be able to pay more overall as you complete two separate transactions and pay two sets of closing costs. And of course, you need to invest time and energy shopping for a mortgage.
Another consideration: If your financial situation deteriorates during your building, you may not be eligible for a mortgage later and may not be able to move to a new home.
Renovation loan
If you want to upgrade your existing home rather than building it, you can compare home renovation loan options.
“If a homeowner is considering paying less than $20,000, they can consider getting a personal loan or using a credit card to fund renovations,” says Steve Kaminski, US Housing Lending Manager at TD Bank. “For renovations of around $25,000, if the homeowner builds stock in their home, a home equity loan or a credit line might be appropriate.”
In low rate environments, you can also consider refinancing your cash out. In this situation, you will be taking out a new mortgage with more money than your current loan and receiving an additional lump sum payment. However, if the rate of new loans is higher than the original loan, cash-out refi is less appealing.
At Refis or Home Equity Loans, lenders generally do not monitor how homeowners use their funds. Manage budgets, plans, and renovation projects payments. With some renovation loans, lenders will evaluate the builder, review the budget, and oversee the draw schedule.
Owner Construction Loan
The owner’s builder loan is a one-person loan or construction-only loan from construction, and the borrower also acts at the home builder’s capabilities. Lenders generally only allow this option if the borrower is a trade-specific license builder.
Pros and cons of construction loans
How to get a construction loan
In some ways, getting construction loan approval is similar to getting a traditional mortgage. You must meet your financial requirements and pay a down payment. However, there are some major differences as well. Generally, follow these steps:
- Find a license builder: The lender will want to know that the builder of your choice has the expertise to complete the home. To find a contractor in your area, seek recommendations or search the NAHB directory of the local home builders association. Just like comparing multiple existing homes before purchasing, it’s wise to compare different builders to find the right combination of price and expertise.
- Find a construction loan lender: Investigate specific programs of several experienced construction loan lenders, including small regional banks and credit unions. Compare construction loan fees, terms and down payment requirements to make sure you get the best deal possible.
- To summarize the document: Lenders may seek contracts with the builder, including detailed pricing and project planning. Includes builder references and credential proofs. This is added to the same financial documents required for traditional mortgages such as pay stubs and tax statements, as well as proof of assets and employment.
- Get PREAPPROVED: Once approved in advance for a construction loan, you will be able to understand how much you can borrow. This will help you settle your budget in the builder.
- Please take out homeowner insurance: Even though you don’t live in the house yet, your lender will likely need prepaid homeowner insurance, including builder risk coverage. In this way, if something happens during the construction process – if the half-baked property sets on fire or someone destroys it, you are protected.
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Additional Reports by Ashlee Tilford
