Construction Loans: What Are They & How Do They Work?
If you are planning to build a new home or structure, you will likely need to obtain a construction loan. A construction loan is a type of short-term loan that is used to finance the cost of building a new home or structure.
Construction loans are typically paid out in installments, or draws, as the building progresses. Once the construction is complete, the loan is typically converted into a permanent mortgage.
If you are approved for a loan, you will work with your loan officer and the builder to set a timetable for the home’s construction.
The lender will give the builder several distributions, or money payments, to use to pay for milestones during the construction phase. This number will depend on your lender’s terms, such as the time limit on how long construction can take.
This post will provide you with a brief overview of construction loans so that you can make an informed decision about whether this type of loan is right for you.
The benefits of construction loans.
Construction loans can be a great way to finance a new building project. As stated above, these are unlike traditional loans, as construction loans are typically paid out in installments, with each installment being used to finance a specific stage of the project. This is what makes construction loans a more flexible and affordable option for borrowers.
There are several other benefits of construction loans. For example, construction loans can be used to finance both the purchase of the land and the construction of the building, which can reduce the overall cost of the project. Additionally, construction loans can be used to finance energy-efficient building materials and appliances, which can save money over the long term.
The risks of construction loans.
Like anything else in life there are pros and cons, and construction loans are no different. They come with a few risks that borrowers should be aware of before taking out a loan.
First, construction loans are typically higher risk than other types of loans because they are based on the value of an unfinished property. This means that if the construction project is not completed or the finished property is not worth as much as the borrower expected, the borrower could end up owing more money than the loan is worth.
Next, construction loans also typically have higher interest rates than other types of loans, and they often have shorter repayment terms. This means that borrowers will need to be able to make larger monthly payments to repay the loan within the required time frame.
Borrowers should carefully consider these risks before taking out a construction loan. Go over every detail and try to anticipate potential added costs ahead of time with your real estate agent and/or loan officer before signing on the dotted line.
Here are the most common construction loans.
There are many different types of loans you can use to finance your home construction project. Some loans are designed for people who have good credit and can afford to pay them back quickly. Other loans are available to people who may not have good credit, but who can make larger payments over time.
Some home construction loans can help you pay for the construction of your home, from the purchase of the land to the actual construction work. These loans usually last for a short period of time, usually between six and 24 months. Let’s look at a few options:
- Construction-to-permanent loan
With a loan like this, you borrow money to build the home. Once construction is done, the loan turns into a traditional mortgage. This means you only pay closing costs once and you may be able to get a good mortgage rate during construction, depending on the lender.
- Construction-only loan
With a construction-only loan, you borrow money to build the home and any associated closing costs and fees. After the home is built, you may need to reapply for a new loan to pay off the construction loan. This process may involve a second closing process and likely more fees.
- Other construction loan alternatives
You may even be able to borrow money to do home renovations on a house that’s already yours, or you can get a loan to use against the value of your home after the renovations. A home equity line of credit (HELOC) is another option, and you can also refinance your home to get more money to use.
Owner-build construction is a type of loan that means you would have to build the home yourself as part of qualifying for this home construction loan. For more ideas, ask your lender about the current commerical and government programs available.
How to get a construction loan.
To get a home construction loan, you need to have good credit. It’s also a good idea to have a large down payment, typically at least 20%. This will help you get better terms from the lender.
Lenders look for good credit and a manageable debt-to-income ratio, which is the total of your monthly debt payments divided by your monthly income.
On top of that, the general requirements are typically strict because the underlying asset is not yet realized – meaning the finished home.
The best construction loan lenders offer low rates and loans that you can use for a variety of purposes. They also have low down payment and credit requirements, which makes it easier for you to qualify. Some top lenders offer construction loans in many different areas across the country. And, depending on your situation, they may also offer loans for different types of construction projects.
Why Embrace Home Loans is a smart choice for your new construction loan.
As a direct lender for Fannie Mae, Freddie Mac, and an approved issuer for Ginnie Mae, at Embrace Home Loans® we underwrite our loans. And that’s a real game-changer. We are not a broker, or a lead reseller and we never take your call and then pass your application off to someone else.
Your Embrace Home Loans Mortgage Specialist works directly with you through the entire loan process — from beginning to end. This kind of personalized service means we can truly get to know you and provide impeccable service that perfectly fits your needs.
It also means we can offer better interest rates and terms — all while keeping you completely informed with real-time, up-to-the-minute information regarding your loan. There’s simply no better way to go through the mortgage process.