Construction loans are typically subject to higher interest rates than longer-term home loans. The money from a construction loan is usually paid in a series of advances as construction progresses. Sometimes Construction loan payments begin 6-24 months after the loan is made. You can pay the balance in a lump sum, or you could convert the loan to a conventional home loan, although if your construction loan does not automatically convert, you may have to reapply for a new loan. Your options will depend on the lender and your credit history at the time of loan application, so don’t forget to compare multiple loans, their terms, and their features.
A construction loan is a short-term interim loan to pay for the construction of a house. As the work progresses, the lender pays the money in stages. The rates for this type of loan are higher than for permanent home loans. To get approved, the lender will need to see a construction schedule, detailed plans, and a realistic budget sometimes called the “story” behind the loan.
How do construction loans work?
Construction loans often have higher interest rates than traditional mortgages. With traditional mortgages, your home acts as collateral, and the lender can seize your home if you do not meet your payment. With home construction loans, lenders don’t have that option, so they tend to see these loans as a higher risk.
Construction loans are very short schedules and depend on the completion of the project, so you need to provide the lender with a construction schedule, detailed planning, and a realistic budget.
Once approved, the borrower will be placed in a draft or pull schedule following the construction phase of the project and is usually expected to pay interest-only during the construction phase. Unlike personal loans, which make balloon payments, lenders pay in stages as the work of the new home progresses. Borrowers usually only have to repay interest on previously withdrawn funds until they are fully constructed. While the house is being built, the lender has an appraiser or inspector review the house at various stages of construction. If approved by the appraiser, the lender will make an additional payment to the contractor known as the draft.
Depending on the type of mortgage, the borrower may need to convert the mortgage into a traditional mortgage once the home is built or obtain another mortgage designed to repay the mortgage.
There Are Two Main Types Of Home Construction Loans.
1. Construction on Permanent Loan.
Under construction to permanent loan, you borrow money to pay for the construction costs of your home. Once the home is complete and you move in, the loan becomes a permanent mortgage.
Because this format is a two-in-one loan, you only have to pay one set of closing costs, reducing the number of fees you owe.
During the construction of your home, you pay interest only on the outstanding balance; you don’t have to worry about paying the principal yet. Typically, you will have a variable interest rate during the construction phase, so the rate and your payment can fluctuate.
2. Construction Loan Only
With the construction-only loan approach, you get two separate loans. One is solely for the construction of the house, which generally lasts for a year or less. Then when you move out, you take out a home loan to pay for construction.
With an exclusive construction loan, you don’t need such a large down payment. This can be a smart choice for homeowners who are building their next home. You may have limited cash now, but once your current home is sold, you will have more money to pay off the mortgage on the completed home.
However, construction-only loans can cost you. Because you have to complete two separate transactions, you will pay two sets of fees. And, if your financial situation worsens – for example if you lose your job – you may not be able to qualify for a mortgage to move into your home.
A construction loan is used to cover labor and material costs for newly built homes. Some of the items you can finance with a Construction loan include permits, contractor labor, roof and many of the other expenses involved in building a home.