Construction Loans

Construction Loans are generally short term loans used to build a home. The Construction Loan is usually structured to come due when the home is complete. A conventional mortgage usually replaces the construction loan. There are many variables, and this website will serve as a guide to Construction Loans.

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Construction Loans - Overview
Construction Loans are a welcome boon for funding your dream home. If you are in the process of building your home, you may at some point of time need financial help for a significant part of the building process. Your construction loan is an ideal source of financing to fund the building of your home so that the construction work goes on smoothly.

Construction Loans may or may not comprise the cost of the land used to build your home on. These loans are such that they set up a line of credit which will help pay the suppliers and subcontractors throughout the building process. This is beneficial for construction workers and laborers who do not have to wait until the building is completed to be compensated for their services.

Put yourself in this position. Your construction work is going fine at a normal pace when all of a sudden you are faced with depleting financial resources. As a result there is a curtailment of the construction activity. Since there is a disruption in the building process, the cost of construction increases. In such a situation, you have got to get hold of a financial source which helps the momentum going. Arranging for finance at such a short notice can be tough, unless you take the help of a construction loan which steps in to aid your building process.


Differences from a Mortgage
Construction Loans are a short-term loan unlike home loans and mortgages that have long-drawn-out repayment duration. Unlike a regular mortgage, which usually has a term of 15, 30 or even 40 years, a construction loan is short-term in nature. Generally, the loan duration ranges from six months to a year, and the money is utilized to finance the building of the home. The loan provider offers the loans and waits till the borrower recovers the occupancy right to the home. Once the borrower has the construction work completed and has the building up and ready to take ownership, the loan is due for repayment.

Unlike mortgages, where the guidelines are based on the rules governed by the Financial Standards Association (FSA), there are no standardized guidelines to state the terms of construction loans. As per the case by case specification and the degree of consideration a borrower enjoys from the lender, the former can get Construction Loans at different terms. The rate of interest is dependent on the level at which the construction process is in and also in accordance with all parties like the lender, the borrower and the contractor (if any), agreeing to the contract. It goes without saying that since a construction loan is a short-term loan, the borrower should be ready to shell out a higher rate of interest compared to a home loan or a mortgage. The rate of interest is charged on an adjustable or flexible basis.

Another interesting aspect to know about the construction loan is that it is usually repayable through small interest-only payments. This is quite easy for borrowers since the repayable installment money becomes relatively less. In case of most mortgages, you pay off a part of the loan amount in the form of monthly payments. With construction loans, however, the entire balance or the principal money is typically due at the end of the loan term once the house is built. This may be tough however on people who may find it hard to arrange for the entire amount to be paid immediately after the construction of the home.

Conversion of a Construction Loan to a Mortgage
Home Construction Loans have the option to convert into permanent financing program or a take-out loan where your loan is converted into a mortgage once you get the certificate of occupancy for your home. The benefit is that you do not have two loans to concentrate on; there is only one application with one closing.

Converting a construction loan to a mortgage has its share of drawbacks. Firstly the borrower is locked in the loan agreement and is at the mercy of lenders. Secondly, he has limited options. He has to either abide by the terms of the lender or make an instant repayment. Most of the borrowers accept the terms of the lender and abide by the deal offered by the loan provider.

It does not mean that it is a trapping situation for the borrower who goes for a take-out loan. He can choose the “rate lock” which is an important method by which borrowers can avoid being cornered by a high interest rate. The rate lock method prevents the rate of interest from rising beyond a certain stage. In fact, the number of days the borrowers wants the rate lock to be in effect will be a deciding factor for its price. Rate locks are normally for a period ranging from 30 to 60 days.

Consideration of the Lender
Before offering the home construction loan, the lender has every right to know the “story” behind the construction of the loan. In other word, the lenders have to be briefed about the exact reasons why the construction work was stopped and why there is a need for funds.

By the very nature of the home construction loan, the lender requires interest-only payments from the borrower during the construction. The borrower is expected to pay the principal payment only after the building process is complete and the borrower receives the certificate of occupancy. The lender has to involve the borrower and the contractor to establish a rate of interest which is variable in nature and based on the level of the construction of the home.

The other point of consideration which the lender makes known to the borrower is how much part of the project, he is willing to fund. The lender can consider the land that you possess for construction of home as an equity or collateral. The borrower should make it a point to compare the rates of different lenders offering the construction loan. Though a lower rate of interest is a tempting factor, it is important to go through the fine print of the documentation and know exactly what the offer entails.

Types of Construction Loans
There are different kinds of home Construction Loans an individual can choose from. If you opt for the “owner builder loan” it means that you are a general contractor, solely liable to see that the construction of the home is completed within a stipulated time and within the budget. The custom contractor loan is another kind of loan which hires a professional contractor to make sure that the construction work gets done within the required time and budget.

You can also avail of a remodel (also known as addition loan) if you want more space in addition to your present home. The loan takes into consideration the net worth of your home after the addition of space or remodeling of your home. There is also another kind of construction loan called the tract or subdivision loan which is the kind of loan you may require if you want to build your home taking into account the builder’s standard plans for your home and adding upgrades from your side.

We have already discussed about the all in one loan or the take-out loan where the existing construction loan can be automatically changed to a mortgage once the completion of home is done. The other type is the “construction only” which is the simplest form of home construction loans. The loan amount is due when the building is done and the loan has to be either paid off or is reinstated by a mortgage.

One should also know about the stated income construction loan. It is a loan which does not need proof of your income. An individual who is self-employed or a freelancer is an example of a person who can opt for stated income construction loans. The benefit of stated income loans is that the approval time is faster in this case compared to other construction loans. The flip side is that the down-payment and the interest rates for the stated income construction loan are always on the higher side as against other types of construction loans. You can apply for the stated income construction loan online or through the lending organization you aspire to obtain the loan from.

Things to Do Before Applying for a Construction Loan
Before you think about building a home, you have to find out as to how much it can cost you. Please take into account the cost of the area where you are going to build your home. You must make sure that the cost of the building site includes both the asking price of the site and the costs involved to expand it. There will be costs associated with working on your home design and construction costs. The construction cost includes the quotes by the subcontractors who will be working on your home. Examples of subcontractors are people who are involved in masonry, fitting of electrical wires and cables, plumbers etc. You should also take into account the cost of financing like a construction loan to ensure that the building process goes smoothly. All these considerations come into play when you assess the total cost of building your dream home.

When you apply for a construction loan, it is a good idea to get pre-qualified for the loan. That way, you are given prior preference to secure the loan. The procedure to pre-qualify takes into account your credit history, the down-payment you can make towards the loan amount, the type of loan you seek and the current market value of homes in that area. If you pre-qualify, you will quite frankly be able to know the exact amount of money required to finance your home.

You can apply for Construction Loans from national lenders or they can be procured through regional banks or mortgage companies.

Commercial Construction Loan for New Business Ventures
For a business, construction work usually involves mammoth capital investment. An entrepreneur may face the problems of paucity of funds when he wants to expands his business premises or undergo renovation works for his office. The problems of scarcity of funds for business ventures can be solved by a commercial construction loan.

Commercial construction loan are either secured (where you have to submit a collateral value as security) or unsecured. Secured commercial Construction Loans are also known as commercial mortgage. The borrower can expect to get a better deal in the loan and a lower rate of interest with easy repayment schedules compared to the unsecured construction loan.

The rate of interest for a commercial construction loan is either variable or fixed. Choosing a fixed rate of interest is good if you are interested in paying a flat rate of amount as repayment every month. With a variable rate of interest, the borrower may have to pay varying amount per month according to the vagaries of the market.

Apart from the value of your collateral and your credit score, the lender considers a host of factors like investments, reasons for taking the loan, the employee or the partner strength of the business, the duration of ownership of the company before approving the loan application. The loan provider also requires a loan application which states the amount of the loan applied for, the reason for taking the loan and the amount of working capital with the business etc. Other documents may also be required which your loan providing company will be able to inform you about. In case the entrepreneur is thinking of starting up a new business venture, he should present a business plan or profile to the lending company, which contains details of the estimated cash flow for the first 24 months.

Maximizing your Savings with a Combination Loan
It is recommended to maximize your savings on your construction loans by shopping for a lender that can provide you with a combination loan. The combination loan begins as a construction loan. During this time, your lender pays your builders and subcontractors for successful completion of each building phase. Once your home is good to be completed, your lender set in motion the traditional mortgage.

The new mortgage loan pays off your construction amount and carries the balance into the assessed value of the new property. The combination loan can save you money because it eliminates a second set of closing costs. Most banks let the commercial side of their business deal with construction loans while the consumer division handles the mortgage aspect of the business. So, the best place to go for the best deal for a combination loan is meeting up with the branch manager of the bank which has offices in your area. The mortgage aspect of the combination loan requires major amount of local overseeing and just being in touch with the Internet or over the phone is not enough. The commercial banks which handle your construction loan will be too happy to expand their business and offer you a reasonable quote for your mortgage which is a high probability. The combination loan deal can suit the lender as well as the borrower just fine because it saves time and money for both parties.

The Construction Loans lender charges a higher administration fee to pay for the step by step supervision and management of your building process. This is okay because it may take a lot of your time if you had to meet your builders and subcontractors individually and pay them up. As an incentive to keep all your business under one roof, many banks will actually refund or discount most of your commercial loan’s administration fee when the time comes to roll it over into the mortgage. You may receive rebate points to be applied to the principal amount or you may even receive a personal mortgage with no points at all.

Making a Smart Choice while Going for a Construction Loan
Most people get carried away experimenting with every option while building their home and find themselves going broke somewhere in the middle of the building process. You should try to keep the cost down and consider what you can add later after the construction of the building is over. For instance, if you are thinking about wall coverings, you can paint them and plan to add them later. This will keep the costs of building low and you stand a better choice for getting the construction loan approved.

You should assess your budget well over and stay away from buying and installing things which are not necessary during the building phase. Also note that the wider your home, the higher it can cost. If you build your home vertically, you stand to save more money. A second storey atop your house can cost less than enlarging the space of your first storey. The reason is that you do not need to spend money on the foundation or the base. The first storey becomes the base of the second storey. You also utilize a smaller amount of land in the process, saving further costs.

Construction Loans are normally for a period of six months to one year. Apart from the lock rate of interest and variable rate of interest, there are loans like bridge loans which use the equity from your current home until your new home is finished.

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